Court Addresses State Severance Tax Impact of Crude Oil "Barrel-Back" Transactions and Crude Oil Posted Price Class Action Royalty Settlement
Submitted by Mark D. Christiansen, Crowe & Dunlevy (Oklahoma City)

In Oklahoma Tax Commission v. Sun Company, Inc. (R&M), 2009 OK 11, 2009 WL 349702, the Oklahoma Supreme Court was presented with assertions by the Oklahoma Tax Commission that Sunoco had underpaid gross production taxes on oil that was marketed under "barrel-back" arrangements between the producers and Sunoco. The Oklahoma Tax Commission contended that Sunoco was liable for additional taxes by virtue of both (1) "barrel back" purchases by Sunoco, and (2) the dollar amount that Sunoco paid to settle a class action suit by royalty owners over the payment of royalties based upon posted prices, including "barrel back" transactions, in In re Lease Oil Antitrust Litigation, 186 F.R.D. 403 (S.D. Tex. 1999). The court indicated that, under the "barrel-back" sales arrangements, Sunoco purchased oil at the lease and transported it to a market center, where Sunoco would then sell the oil back to the producer for the price paid by Sunoco plus transportation costs. The producer would then sell the oil to third parties at the price set by the New York Mercantile Exchange. In these transactions, gross production taxes were paid based upon the prices paid by Sunoco to the producer at the lease in accordance with 68 O.S. § 1010(B)(5).

The Tax Commission asserted that "barrel back" arrangements are nothing more than "a scheme for producers to sell oil off the lease at a price higher than the prevailing field price, but with" production taxes and royalties being computed on the lower field price paid by Sunoco.  2009 OK 11, at ¶ 2.  The Commission asserted that oil and gas producers could not carry out the alleged "scheme" without the complicity of transporters such as Sunoco who, the Commission asserted, "ostensibly buy the oil at the lease, but have no intent to sell the oil to any other party than the producer."Id."In substance, the Tax Commission argues that Sunoco has acted as an accomplice to tax evasion not only in the movement of oil off-lease, but also by filing misleading returns." Id. at ¶ 3. The Commission asserted that Sunoco, by virtue of its role in the process, was jointly liable with the producers for the additional taxes alleged to be due based upon the value paid at the market center.

In response, Sunoco maintained that it had done everything the law required of it in connection with its purchase of the oil at the lease.  Sunoco, in substance, urged that the sale of the oil by the producer at the lease concluded the producer's status as a producer for purposes of gross production tax liability. "Thereafter, the producer is just another market buyer when repurchasing the oil at the market center. In turn, when reselling the oil to other market buyers, the producer is acting as any other market seller." Id. at ¶ 4.

The Tax Commission asserted that the oil was not actually sold at the time of production but was instead retained by the producer through the "barrel-back" arrangements. The Commission cited provisions of the applicable severance tax code to the effect that "[i]n the event oil is not sold at the time of production but is retained by the producer, the tax on such oil not sold shall be paid by the producer . . ."  68 O.S. § 1009(D).  So, the court focused on the issue of whether the oil had been "retained" by the producers. With regard to that issue, the Oklahoma Supreme Court held as follows:"

¶10 Under the facts concerning the 'barrel-back' arrangement as assumed true by the trial court, the producers sold the oil to Sunoco and parted with possession of it. Thereafter, the oil was kept by Sunoco in Sunoco's pipeline until it reached the market center. Even under the Tax Commission's version of the facts, the oil was not 'retained' by the producers within the ordinary sense of the word." Id.

With regard to the claim that Sunoco's payment to settle the class action royalty lawsuit represented an admission that additional value was due royalty owners for oil produced in the State of Oklahoma (thereby implicating additional severance taxes on the higher values alleged to be due for the production), Sunoco asserted that the amount paid in the settlement did not represent additional value paid for the oil. Rather, Sunoco asserted that it was simply making the payment in order to buy peace and settle a disputed claim.

The Oklahoma Supreme Court held that the gross production tax law as written by the Legislature did not subject the producers' buy-back of oil and resale at the market center to taxation.  In the absence of tax liability on the part of the oil and gas producer, there could be no tax liability for Sunoco to jointly incur with the producer.  The Court found that this conclusion was dispositive of the Tax Commission's claim for additional taxes both (a) on the direct sales between the producers and Sunoco and (b) on the class action royalty settlement payment made by Sunoco in connection with the nationwide class settlement in In re Lease Oil Antitrust Litigation.

For a more-detailed discussion of certain aspects of the factual background and arguments presented in this appeal, particularly insofar as they concerned the ramifications of the class action royalty settlement, see the earlier decision of the Oklahoma Court of Appeals which was affirmed in the above opinion. State of Oklahoma ex rel. Oklahoma Tax Commission v. Sun Company, Inc. (R&M), 78 O.B.J. 1658 and 2146 (Okla. App. 2007 - #103,776) (Not for Publication).