Opinion
111,571.
06-12-2015
In the Matter of the Protest and Equalization Appeals of RAINS & WILLIAMSON OIL COMPANY, INC., for the Years 2011 and 2012 in Sheridan County, Kansas.
Jarrod C. Kieffer, of Stinson Leonard Street LLP, of Wichita, for appellant. Bradley A. Stout, of Adams Jones Law Firm, P.A., of Wichita, for appellee.
Jarrod C. Kieffer, of Stinson Leonard Street LLP, of Wichita, for appellant.
Bradley A. Stout, of Adams Jones Law Firm, P.A., of Wichita, for appellee.
Before MALONE, C.J., PIERRON and ATCHESON, JJ.
MEMORANDUM OPINION
PER CURIAM.
Sheridan County (County) appeals the 2011 and 2012 property tax valuation of an oil lease (Fore lease) owned by Rains & Williamson Oil Company, Inc. (Rains). The County argues the Kansas Board of Tax Appeals (BOTA), known as Court of Tax Appeals at the time, improperly deviated from the Kansas Department of Revenue, Division of Property Evaluation 2011 Oil & Gas Appraisal Guide (Guide) in determining the amount of annual production and the rate of production decline on the Fore lease. The County also argues BOTA erred in admitting undisclosed expert testimony concerning wells drilled into a different reservoir on the leased property and that deviation from the Guide was never raised as an issue by Rains in the prehearing order.
The Fore lease covers approximately 240 acres in Sheridan County and began production in 1987 with one well (Fore No. 1) in the southwest portion of the lease. Fore No. 1 remained the only well on the Fore lease for over 20 years. By 2009, Fore No. 1 was only producing approximately 3 barrels of oil per day, i.e., 90 barrels a month.
Additional wells were drilled on the Fore lease over the next several years. In September 2009, Rains drilled Fore No. 2 in response to, and as an offset to, a well drilled on an adjoining lease. Fore No. 2 is in the northwest portion of the Fore lease. After drilling Fore No. 2, production on the Fore lease dramatically increased from approximately 90 barrels a month to nearly 4,000 barrels a month. In April 2010, Fore No. 3 also began production in the northwest portion of the lease. It enjoyed the same production characteristics as Fore No. 2. Production on the Fore lease again dramatically increased from 4,903 barrels a month in March 2010 to 9,120 barrels in May 2010 after Fore No. 3 began production. Fore No. 4 was drilled east of Fore Nos. 2 and 3, but it was a dry hole. In January 2011, Fore No. 5 also began production in the northwest portion of the lease. In the first quarter of 2011, Rains performed a work-over on Fore No. 2. Fore No. 6 was drilled south from Fore Nos. 2, 3, and 5 and north of Fore No. 1. However, Fore No. 6 was determined to be a dry hole.
Following is a chart illustrating the monthly production of the Fore lease and the addition of the new wells:
| Year | Barrels | |
|---|---|---|
| 2009 | ||
| Jan | 74 | |
| Feb | 73 | |
| Mar | 76 | |
| Apr | 75 | |
| May | 84 | |
| June | 100 | |
| July | 82 | |
| Aug | 92 | |
| Sept | 3689 | Fore No. 2 Added |
| Oct | 4458 | |
| Nov | 4591 | |
| Dec | 4500 | |
| 17894 | Actual Production Total | |
| 2010 | ||
| Jan | 4739 | |
| Feb | 4180 | |
| Mar | 4903 | |
| Apr | 7928 | Fore No. 3 Added |
| May | 9120 | |
| June | 8447 | |
| July | 8457 | |
| Aug | 7743 | |
| Sept | 7098 | |
| Oct | 5772 | |
| Nov | 4118 | |
| Dec | 3267 | |
| 75772 | Actual Production Total | |
| 2011 | ||
| Jan | 4149 | Fore No. 5 added |
| Feb | 5835 | |
| Mar | 6716 | Fore No. 2 workover |
| Apr | 9341 | |
| May | 7126 | |
| June | 6391 | |
| July | 5755 | |
| Aug | 5470 | |
| Sept | 4821 | |
| Oct | 4590 | |
| Nov | 4352 | |
| Dec | 3794 | |
| 68340 | Actual Production Total | |
| 2012 | ||
| Jan | 3643 | |
| Feb | 3415 | |
| Mar | 3349 |
Rains challenged the County's valuation of the Fore lease for the tax years of 2011 (2010 Production Year) and 2012 (2011 Production Year). The County's valuation for 2011 was $20,127,398 and for 2012 was $15,224,856. Rains disagreed and argued flush production must be removed for purposes of determining annual production and that the maximum 50% decline rate should be used for both tax years. Based on these two factors, Rains argued the Fore lease should be valued at $3,338,523 for tax year 2011 and $3,151,881 for tax year 2012.
Both parties presented evidence before BOTA. Kenton Hupp, a licensed petroleum engineer with a bachelors of science in petroleum engineering, testified on behalf of Rains. Hupp testified Fore Nos. 2, 3, and 5 were drilled into a different reservoir. Hupp also testified the annual production should be reduced to eliminate flush production and the lease exhibited an annual decline rate in production of 50%. David Stithem, the Sheridan County Appraiser, testified on behalf of the County. Stithem testified the valuation of a lease like the Fore lease is contemplated by the Guide for determining production on an existing lease after addition of new wells. Stithem also testified the historical decline figure of 13% is the best information for determining the annual decline rate for 2011 tax year, but he used a 15% decline rate for 2012.
BOTA found this case presented a unique set of facts because the Fore lease was not a new lease, but an existing lease with the addition of multiple new wells—Fore Nos. 2, 3 and 5—into a different reservoir than the original well—Fore No. 1. BOTA found that use of the historical decline rate was not as compelling for the Fore lease because the new wells were not in the same reservoir and the production data from the new wells provided a constant rate of decline after the flush production. BOTA found there was sufficient evidence to support a decline rate of 50% for both tax years and after reduction for flush production, the gross reserved value of the Fore lease for tax year 2011 was $4,115,784 and for 2012 it was $4,423,258.
The County filed a motion for reconsideration raising the same issues now argued on appeal. BOTA denied the motion and found the County had not raised any new arguments that changed its previous order. The County appeals.
Standard of Review
Judicial review of orders of BOTA is governed by K.S.A.2014 Supp. 77–621. For purposes of this appeal, application of this statute requires the appellate court to grant relief if (i) the agency has erroneously interpreted or applied the law; (ii) the agency failed to follow prescribed procedure; (iii) the agency's determination of fact is not supported by substantial evidence; or (iv) the agency's action is arbitrary, capricious, or unreasonable. See K.S.A.2014 Supp. 77–621(c)(4), (5), (7), (8). The County challenges the finding of an independent reservoir; but for the most part, it is challenging BOTA's application of legal principles—appraisal principles—to the facts of this case.
BOTA's findings of an independent reservoir and also certain months of flush production are critical facts in this case. We must grant relief if BOTA's action is based on a determination of fact, made or implied by the agency, that is not supported to the appropriate standard of proof by evidence that is substantial when viewed in light of the record as a whole. K.S.A.2014 Supp. 77–621(c)(7). The burden of proving the invalidity of BOTA's action is on the County. K.S.A.2014 Supp. 77–621(a)(1). In reviewing the evidence in light of the record as a whole, the appellate court shall not reweigh the evidence or engage in de novo review. K.S.A.2014 Supp. 77–621(d). Under K.S.A.2014 Supp. 77–621(d), an appellate court's analysis of the case in light of the record as a whole requires it to review the evidence both supporting and contradicting BOTA's findings, examine the presiding officer's credibility determinations, if any, and review the agency's explanation as to why the evidence supports its findings. Redd v. Kansas Truck Center, 291 Kan. 176, 182, 239 P.3d 66 (2010). To uphold a decision, the evidence in support of it must be substantial, meaning that a reasonable person could accept it as being sufficient to support the conclusion reached. In re Protests of Oakhill Land Co., 46 Kan.App.2d 1105, 1114, 269 P.3d 876 (2012). Additionally, to find a lack of substantial evidence, this court has said the decision must be “so wide of the mark as to be outside the realm of fair debate.” In re Equalization Appeal of Prieb Properties, 47 Kan.App.2d 122, 137, 275 P.3d 56 (2012).
Oil and Gas Leasehold Valuation
The court in Helmerich & Payne, Inc. v. Board of Seward County Comm'rs, 34 Kan.App.2d 53, 55–56, 115 P.3d 149, rev. denied, 280 Kan. 982 (2005), discussed the statutory guidelines and theory of oil and gas leasehold valuation for ad valorem taxation in Kansas:
“For purposes of valuation and taxation in Kansas, all oil and gas leases and wells are considered personal property. K.S.A. 79–329. Persons who own such personal property are required to file a statement of assessment on standard rendition forms on or before April 1 of each tax year. K.S.A. 79–332a. In practice, the county appraiser then reviews the taxpayer's rendition and determines whether changes to the valuation are required and thereafter notifies the taxpayer of the appraised value. See K.S.A.2004 Supp. 79–1460. The county appraiser is obligated to follow the Oil and Gas Appraisal Guide (Guide) prescribed by the Director of Property Valuation but may deviate from the Guide on an individual piece of property ‘for just cause shown and in a manner consistent with achieving fair market value.’ K.S.A. 79–1456. In determining the value of such property, the appraiser must also consider statutory factors of value.
“ ‘Except as otherwise provided in subsection (b) of this section, in determining the value of oil and gas leases or properties the appraiser shall take into consideration the age of the wells, the quality of oil or gas being produced therefrom, the nearness of the wells to market, the cost of operation, the character, extent and permanency of the market, the probable life of the wells, the quantity of oil or gas produced from the lease or property, the number of wells being operated, and such other facts as may be known by the appraiser to affect the value of the lease or property.’ K.S.A.2004 Supp. 79–331(a)'
“Consideration of these statutory factors is mandatory; failure to take into consideration any of these statutory factors will invalidate the assessment. See Garvey Grain, Inc. v. MacDonald, 203 Kan. 1, 14–15, 453 P.2d 59 (1969). In the context of oil and gas valuation, failure to give consideration to known production decline in making an assessment may be considered inadequate consideration of the ‘probable life of the wells,’ thus rendering the assessment arbitrary, capricious, and void as a matter of law. Angle v. Board of County Commissioners, 214 Kan. 708, 713, 522 P.2d 347 (1974).”
The County argues BOTA erred in failing to value the Fore lease in accordance with the Guide. The County argues BOTA erroneously relied on vague speculation and conclusory allegations made by Hupp that should not be taken as legal conclusions under K.S.A. 60–456(b). See Kuxhausen v. Tillman Partners, 40 Kan.App.2d 930, 944, 197 P.3d 859 (2008) (“ ‘[E]xpert testimony must be based on reasonably accurate data and not simply based on unsupported assumption, theoretical speculation, or conclusory allegations.’ “ quoting Olathe Mfg., Inc. v. Browning Mfg., 259 Kan. 735, 767, 915 P.2d 86 91996) ] ), aff'd 291 Kan. 314, 241 P.3d 75 (2012).
K.S.A. 79–1456 provides:
“The county appraiser shall follow the policies, procedures and guidelines of the director of property valuation in the performance of the duties of the office of county appraiser.
“The county appraiser in establishing values for various types of personal property, shall conform to the values for such property as shown in the personal property appraisal guides prescribed or furnished by the director of property valuation. The county appraiser may deviate from the values shown in such guides on an individual piece of property for just cause shown and in a manner consistent with achieving fair market value.”
The County argues BOTA's valuation methodology does not comply with Kansas law and does not accurately reflect the expected production trends for the Fore lease. The County insists the Guide provided a methodology that produced a fair market value of the lease and no basis existed for BOTA to deviate from the Guide. The essential mathematical formula to achieve the goal of fair market value is annual production rate times net price on valuation date equals estimated gross income times present worth factor associated with decline rate equals estimated gross reserve value. The decline rate is “the most critical factor in establishing its valuation.” Board of Ness County Comm'rs v. Bankoff Oil Co., 265 Kan. 525, 529–30, 960 P.2d 1279 (1998).
Total Oil Production x Net Price = Estimated Gross Income x Present Worth Factor (PWF) = Estimated Gross Reserve Lease Value
Rains responds that the purpose of the Guide is to corral the 105 county appraisers, not to limit BOTA, and the County has not provided any authority concerning any limitation on BOTA's deviation from the Guide. Instead, BOTA is charged with the duty to assess uniform and equal taxation based on fair market value. Rains argues BOTA did not deviate from the Guide, but it rather used the valuation formula stated above. Rains argues BOTA's decision, after due consideration, to reject the historical decline rate and adopt a decline rate based on actual production is entirely consistent with the goal of determining actual market value. Rains states the Guide specifically says that the County appraiser should only “consider” using the historical decline rate, not that it is “mandated.” Last, Rains argues the example relied on by the County showing new wells drilled on an existing lease only teaches how production from less than a full year is annualized and does not demonstrate how to deal with flush production for the new well.
We are not persuaded by the County's argument that BOTA deviated from the Guide as contemplated in K.S.A. 79–1456. First, the fact that BOTA removed flush production from the determination of annual production was not a deviation from the Guide, but instead it was in accordance with the provisions of the Guide to remove production characterized as “Gusher” or flush production followed by a rapid decline to a stabilized level. See Guide § I. f-Adjustment for Flush Production, p. 6. Second, BOTA did not deviate from the Guide by deciding the historical decline rate was not the best rate when the Guide specifically instructs that “[i]f the property shows a constant rate of decline after the ‘flush’ production, the appropriate present worth factor for that rate should be used with production annualized for the period reflecting the stabilized production period.” Guide § II. 1a-Abnormal Decline for New and Existing Leasing, p. 10. BOTA applied the Guide. It did not deviate from it.
Did BOTA Determine the Proper Amount of Annual Production for the 2011 and 2012 Tax Years?
The overriding issue in this case is whether it was proper for BOTA to exclude the flush production from its annualized production figures and also in establishing the decline rate where the Fore lease was an existing lease, not a new lease. Factoring out the influence of flush production in the annual production rate is established in the Guide and also caselaw. See Guide § I. f, p. 6 (annual production should not include gusher data or flush production); In re Tax Appeal of EOG Resources, Inc., 46 Kan.App.2d 821, Syl. ¶ 7, 265 P.3d 1207 (2011) (“Where the only available production data as of appraisal date for a new oil or gas well is clearly distorted by flush production, but all such data indicates that the production rate from which a stable decline will commence has not yet been achieved, fair market value is not achieved by application to inflated production rates of a 30% assumed decline rate.”), rev. denied 296 Kan. 1130 (2013); Helmerich, 34 Kan.App.2d at 61 (“We hold that, whether or not argued at BOTA, flush production is so common and so prominently addressed in the Guide and our case law that it cannot be ignored.”).
As noted by our Supreme Court in State ex rel. Stephan v. Martin, 230 Kan. 747, 749, 641 P.2d 1011 (1982) :
“It has long been recognized that when a new well is completed it will ordinarily produce at a far greater rate than will be customary for that particular well after only a few weeks or months have elapsed. This initial excessive production is referred to as ‘flush production’ and, if used as one of the factors for determining value, is misleading and often results in excessive valuation and assessment for the initial year of taxation. Prior to the [1979] amendments [to K.S.A. 79–331,] local assessors often failed or refused to take into consideration the ‘flush production’ feature of new wells and for wells completed late in the year would merely annualize the initial ‘flush production’ and arrive at a greatly inflated production factor resulting in excessive valuation and assessment along with other consequences detrimental not only to the oil and gas producers and royalty owners but to the public at large.”
Annual Production–2011 Tax Year
In determining the annual production for the 2011 tax year, BOTA annualized the production pursuant to Hupp's appraisal after accounting for flush production:
“Accordingly, this same production from August to December 2010 should be annualized for purposes of determining annual production. See Helmerich, 34 Kan.App.2d at 62–63. Annualization of August to December 2010 production results in annual production of 66,793 bbls (27,998 bbls 153 days of production x 365 days in a year). We recognize that the County followed an example in the Guide to annualize the production for tax year 2011, but the example is just that: an example. In our opinion, the example does not mirror the facts exactly as presented in this case because it does not include and does not address flush production from the added new well. Based on the findings above, we conclude that the estimated gross reserve value of the subject lease for tax year 2011 is $4,115,784.”
The Guide provides the following example for calculating production on new wells drilled on existing leases:
EXAMPLE
| Month | Number of Wells | Production (Bbls) | Bbls/Well |
|---|---|---|---|
| January | 3 | 750 | 250 |
| February | 3 | 720 | 240 |
| March | 3 | 699 | 233 |
| April | 4 | 900 | 225 |
| May | 4 | 860 | 215 |
| June | 4 | 840 | 210 |
| July | 4 | 868 | 217 |
| August | 4 | 800 | 200 |
| September | 5 | 1050 | 210 |
| October | 6 | 1200 | 200 |
| November | 6 | 1145 | 190 |
| December | 6 | 1122 | 187 |
“In this example, the older wells were making about 240 Bbl/well/month and the total lease for the last quarter shows about 190 Bbl/well/month. Use 6 wells and the last quarter annualized.” Guide § I. 4a-Change in Production Wells–New wells drilled on existing leases, p. 8.
The County argues Stithem correctly followed the Guide in determining the annual production for the 2011 tax year. The County contends the Guide provides the above-cited example showing the proper annualization of production of a similar scenario where production is annualized beginning with the first full month after the addition of a new well. For the 2011 tax year, the County annualized production in accordance with the Guide example at 80,482 barrels. To arrive at this number of barrels, Stithem annualized production from May through December 2010. Stithem selected May as the beginning point for his calculations because that was the first full month for which he had production data after the addition of Fore No. 3 in April 2010.
The County argues the Guide's examples are simply not examples but more akin to instructions for certain situations under the Guide. The County points out that flush production is mentioned in other places in the Guide but is specifically not mentioned in the above-cited example of new wells on existing leases. The County also argues Stithem's use of the Guide “predicted future production and long-term decline for the Subject Lease with stunning accuracy.” Comparatively, the County states BOTA's valuation substantially underestimated actual production and overestimated stabilized decline for the Fore Lease “resulting in the ludicrous result that the Court's value for the total lease was less than one year's gross income for the lease.”
Rains argues BOTA correctly adopted Hupp's production amounts taking into consideration flush production. Hupp annualized the 2010 fourth quarter (October 2010 through December 2010) production resulting in an annualized “annual production” of 52,199 bbls (13,157 bbls ÷ 92 days production x 365 days in a year). Hupp found the decline stabilized during the fourth quarter of 2010. Rains cites Helmerich and the court's statement that the failure to account for flush production results in an inaccurate valuation and assessment. 34 Kan.App.2d 53, Syl. ¶ 5. However, Helmerich only involved production from a new oil lease. Rains argues BOTA's decision regarding the appropriate annualized production for tax years 2011 and 2012 is supported by substantial competent evidence.
BOTA essentially applied the new lease provisions of the Guide to the existing Fore lease based on the fact that Fore Nos. 2, 3, and 5 were drilled into a new reservoir: “The subject lease is technically not a new lease. It is an existing lease with the addition of new wells in a different reservoir (neighborhood) than the original well.” (Emphasis added) BOTA found the rationale for excluding flush production “applies equally to flush production from a new well on an existing lease or a new well on a new lease.” We agree.
We will not adopt the County's limitation of when flush production is recognized. BOTA's reliance on Hupp's testimony regarding the new reservoir is supported by the evidence. First, Fore Nos. 2, 3, and 5 were specifically drilled in response to, and as an offset to, a well drilled on an adjoining lease. Second, the new wells (northwest) and the original well (southwest) are on geographically different parts of the leased property. Third, the production for Fore No. 2 was exponentially greater than the modest production from Fore No. 1. Fourth, Fore No. 6 was drilled between the two areas of production and was determined to be a dry hole.
We find BOTA correctly accounted for flush production despite the fact that Fore lease was not a new lease. The Guide generally advises that the “prior year production may not represent the production capability of the lease for several reasons,” including when “[l]ease production began during the year with ‘gusher’ characteristics (flush production) followed by rapid decline to a stabilized level.” Guide § I. f, p. 6. The Guide specifically instructs county appraisers to account for flush production. The County argues the Guide example it relied upon did not address flush production for an existing lease and consequently it should not be used for new wells on existing leases. However, the Guide does not limit its express flush exception to any particular situation, nor do we. Bankoff teaches that flush production is the reason for the discount provided in K.S.A. 79–331(b) and that this subsection “compels appraisers to anticipate a decline in production, even though no decline is apparent from a lease's prior production history.” 265 Kan. at 540. Bankoff recognized that the failure to account for flush production would “result in an inaccurate valuation and assessment.” 265 Kan. at 541 ; see Martin, 230 Kan. at 755–57.
For all of these reasons, BOTA correctly accounted for flush production apparent in the months of May, June, and July 2010 for the Fore lease. The production in these months is clearly the typical gusher characteristic recognized in flush production. Flush production “can and should be identified exclusively from an analysis of raw production data.” Helmerich, 34 Kan.App.2d at 62. Here, the production from May, June, and July 2010 (9120, 8447, and 8457 bbls) exceeded any prior monthly production in January, February, and March 2010 (4739, 4180, and 4903 bbls) sometimes by more than 50%. Production data from these months was clearly flush production and should not be considered for purposes of determining annual production as factors to be employed in the formula to calculate gross reserve value for the subject lease.
2012 Tax Year
There was apparently no dispute between the parties as to the production for the 2011 calendar year. Both the County and Rains had agreed in their assessment rendition that actual production for 2011 was 68,340 bbls. Stithem testified that the County used the actual 2011 production of the Fore lease (68,340 bbls) although a new well was added in January 2011 and Fore No. 2 was worked-over in March 2011. Stithem stated the 2011 production could have been annualized for 11 months of the year, but since Fore No. 5 was added on January 19, 2011, the data was close enough to a full year to use the actual production—which actually benefitted Rains.
It appears BOTA sua sponte decided not to use actual production because January through April 2011 was flush production based on drilling of Fore No. 5 and the work over of Fore No. 2. Consequently, after annualizing production from May through December 2011, the resulting annual production used by BOTA was 63,017 bbls (42,229 bbls ÷ 245 days of production x 365 days in a year). BOTA determined the estimated gross reserve value of the Fore lease for tax year 2012 was $4,423,258.
On appeal, the County states the annualization of the 2011 production was not an issue in the prehearing order or at the hearing. The County argues BOTA erred in valuing the Fore lease for 2012 tax year using an annual production value that was even less than requested by Rains. Rains contends BOTA applied the same flush production analysis it used for the 2011 tax year by disregarding the January through April 2011 production and annualizing the production for May through December 2011. Rains states BOTA's decision to disregard flush production or the accelerating production from the addition of Fore No. 5 and the work-over of Fore No. 2 is consistent with Hupp's testimony.
There is substantial evidence in Hupp's testimony to support the values used by BOTA in determining the 2012 tax year production. Hupp testified at the hearing that the amount of production in the 2012 Oil Assessment Rendition did not remove the flush production. And, Hupp testified the peak of 9,000 barrels in April 2011 was flush production and that if he annualized the production based on a fourth quarter of 2011 annualization and that figure (50,529 bbls) was incorporated in the formula with the 50% decline rate, the fair market value for tax year 2012 would be $2,224.71. Hupp clearly testified as to the amount of production alleged to be flush production in 2012. BOTA followed Hupp's opinion in reducing all of the flush production for the 2012 tax year.
Did BOTA Determine the Proper Decline Rate for Both the 2011 and 2012 Tax Years?
In Angle, 214 Kan. 708, the court was faced with a situation where the trial court found that certain oil and gas leases were appraised for taxation without certain relevant factors of K.S.A. 79–331 (Weeks 1969) being taken into account. The lease in Angle produced from the Lansing oil reservoir and production from that formation in that locality had a notoriously short life. This is very similar to Hupp's rationale of why the wells in the current case declined so rapidly as well. The assessor in Angle failed to take into account such rapid decline thereby ignoring the statutory factor of “the probable life of the wells.” K.S.A. 78–331 (Weeks 1969) The Angle court affirmed the trial court's decision that such intentional refusal by the taxing officials to take into consideration relevant factors set forth in the statute was arbitrary and rendered the assessments void. See 214 Kan. at 710–14. Conclusions of the trial court, which were affirmed on appeal, included:
“ '11. Since the assessor admitted he had not given effect to the anticipated rapid decline in production on these leases, and the uncontradicted evidence showed that his valuations were predicated on constant, nondeclining production, contrary to the known and undisputed facts, the assessments in question must be held invalid. In those few instances where the assessor considered some decline in production he ignored the actual rate of decline in production so as to arrive at a higher valuation. Such assessments must also be held arbitrary and invalid because they failed to give effect to the actual facts then known. A method of valuation based solely on barrels of oil produced during part of a preceding year, without reference to other pertinent facts affecting market value, is “unquestionably void.” Richardson v. State, 53 S.W.2d 508, at 510 (Tex.[Civ.App.1932] ).' “ Angle, 214 Kan. at 712–13.
The court in Bankoff stated that a reading of Angle would appear to uphold the usage of all available valuation information. 265 Kan. at 541. Bankoff also explained:
“Ad valorem taxation of oil and gas leases differs from that of most other personal property in that the assessment is based on the present worth of the lease's future production. The determination of the fair market value of a lease necessarily requires consideration of the expected future income potential of a lease, including the age and probable life of producing wells thereon....
“The appraisal difficulties created by the flush production of a new lease are similar to the difficulties encountered when a lease begins a production decline late in the year preceding appraisal. The Guide developed by the Division of Property Valuation treats both incidents similarly, as the failure to properly calculate and confirm the decline rate of a lease would inaccurately reflect its future production and result in an inaccurate valuation and assessment just as the failure to account for flush production in a new well would. ” (Emphasis added.) 265 Kan. at 541–42.
2011 Tax Year
BOTA found that as of January 1, 2011, three wells were producing on the Fore lease (Fore Nos. 1, 2, and 3). BOTA stated that if the new wells, Fore Nos. 2, 3, and 5, were in the same reservoir as the original well, Fore No. 1, then use of the historic decline rate would be appropriate and the Guide would be sufficient to address the situation. Hupp essentially testified the Fore Nos. 2, 3, and 5 wells were not 3–barrel–a–day wells. BOTA again stated that the concept of accounting for flush production “applies equally to flush production from a new well on an existing lease or a new well on a new lease.”
BOTA found production following the addition of Fore No. 2 in September 2009 increased dramatically and remained stable through March 2010. In establishing a decline rate of 50% for tax year 2011, BOTA held:
“In April 2010, Fore No. 3 was added and production again increases dramatically. According to the uncontroverted testimony of Mr. Hupp, the May, June and July 2010 production was flush production. As such, the flush production should be disregarded. Production from August to December 2010 with three wells continues to decrease. The production plot and decline curves show that the decline was in excess of 50% during these five months, and Mr. Hupp believed the decline to be stable during this time. Since another well was added in January 2011 increasing production in January, February and March 2011 and not confirming a pre-valuation trend, this first quarter production has little to no weight for tax year 2011. See Bankoff. The County's methodology uses the significantly increased production for purposes of the annual production, but fails to consider the production data for purposes of the decline rate. This failure ignores relevant data pertaining to the lease's future productivity and income. Based on the weight of the evidence, we find there is sufficient evidence to support a decline rate of 50% (0.79 PWF) for tax year 2011.”
Again, the County argues the Guide clearly addresses the very situation presented in this case. The County argues the historic decline of 13% for the tax year 2011 specifically applies to existing leases with new wells exhibiting unstable production and abnormal decline. The County argues the only way Hupp and BOTA could justify a 50% decline rate was to cherry-pick data points from only the short-term steep decline periods, while ignoring the short-term increases and long-term trend of relatively low decline. The County argues that for BOTA to base its decline and production off of a short-term sharp decline without recognizing corresponding increases in production due to prudent management results in a gross undervaluing of the Fore Lease. The County suggests BOTA failed to apply a prudent management standard, yet that issue was never raised below. See K.S.A.2014 Supp. 77–617 ; Kingsley v. Kansas Dept. of Revenue, 288 Kan. 390, 411, 204 P.3d 562 (2009) (In an appeal from a decision by an administrative agency, a party is limited to the issues raised at the administrative hearing.).
The 2011 Guide contemplates the decline of production because “producing a finite reserve results in a depleting asset.” Guide § II.1a, p. 10, provides:
“la) Abnormal Decline for New and Existing Leases
“Abnormal sharp decline is usually found with initial production from newly completed wells on new leases, added wells on existing leases, and re-completion or work-over on existine leases. The appraiser should consider application of historic decline when actual declines are uncertain or are obscured from lease development or work-over. A lease with initial ‘flush’ production will show an abnormal sharp decline followed by change in the decline rate to normal rate of decline. If the property shows a constant rate of decline after the ‘flush’ production, the appropriate present worth factor for that rate should be used with production annualized for the period reflecting the stabilized production period.
“A decline curve, with downtime noted, should be submitted with the filing when an adjustment for abnormal decline is requested. No production period less than four to six months should be used to establish an abnormal decline. In addition to decline curves, water cut, and/or gas oil ratio curves may be filed with the filing to document changes in reservoir behavior.”
The County states Stithem found that historic decline is the only Guide-approved method for calculating the decline rate for the Fore lease. The County states the historic decline rate of 13% for 2011 should be used because the Fore lease has not shown a constant rate of decline over a stabilized production period. For the 2012 tax year, the County calculated both the historic decline (13%) and the actual year-to-year decline (15%) and selected the higher of the two (15%) to the benefit of Rains.
The County argues BOTA's finding of stable production decline in the 2011 tax year is not supported by the record. The County argues Hupp's testimony of May, June, and July as flush production is vague, conclusory, and not uncontroverted. However, Stithem, the County's expert, testified that May, June, and July 2010 “very well could be flush production.” The County relies on Hupp's testimony that he expected a new well on an existing lease would lead to a jump in production followed by a steep decline and that Hupp also testified there was “unstable production during that time [2011 and 2012 tax years].” The County also states that Hupp testified the last two quarters in 2012 had a 17% decline rate and that Hupp expected the rate to flatten out in 2013. The County argues BOTA erroneously rejected data from the first quarter of 2011. The County contends this data confirms a prevaluation trend that additional oil wells would generate additional production from oil already in the ground on the Fore lease, i.e., that the steep decline in the second half of 2010 was not a permanent feature of the lease.
The County insists BOTA cannot deviate from the Guide or refuse to apply its policies, procedures, or guidelines. The court in In re Tax Appeal City of Wichita, 277 Kan. 487, 495, 86 P.3d 513 (2004), stated:
“Administrative regulations have the force and effect of law. They are presumed to be valid, and one who attacks them has the burden of showing their invalidity. To be valid, rules or regulations of an administrative agency must be within the statutory authority conferred upon the agency and must be appropriate, reasonable, and not inconsistent with the law. Those rules or regulations that go beyond the statutory authorization violate the statute, or are inconsistent with the statutory powers of the agency have been found void.”
The County maintains Stithem and his appraisal followed the Guide in its valuation of the Fore lease and BOTA's decision, relying on Hupp, substituted its judgment for that of the legislature by disregarding the Guide's plain language. See K.S.A. 79–1456 (“The county appraiser shall follow the policies, procedures and guidelines of the director of property valuation in the performance of the duties of the office of the county appraiser.) The County argues BOTA did not establish just cause to deviate from the Guide and should have followed the historical decline for new wells on existing leases. The County argues Hupp's opinion that Fore Nos. 2, 3, and 5 were drilled into a different reservoir was flimsy, unsupported, and nonsensical. The County also argues it is too coincidental that there were two oil reservoirs located within 240 acres on the same lease, drilled at the same depth, that were not connected.
BOTA's decline rate for tax year 2011 is supported by the Guide and also the evidence in the case. BOTA's decision to consider, but not adopt, a historical decline rate is also supported by the evidence. Hupp, and ultimately BOTA, relied on a decline rate demonstrated by actual production and based on production from a different reservoir on the lease. Once flush production was removed, the production for the remainder of 2010 reflected a stable production decline from August to December in 2010. Rains points out that even the County's expert Stithem testified that May, June, and July 2010 “very well could be flush production.” BOTA's decline curve analysis is in fact consistent with the language in the Guide specifically dealing with existing leases—“If the property shows a constant rate of decline after the ‘flush’ production, the appropriate present worth factor for that rate should be used with production annualized for the period reflecting the stabilized production period.” Guide § II. la, p. 10. Production from the addition of Fore No. 2 until March 2010 showed little or no decline. Production started to decrease in August 2010 (7743) and continued to decrease through December 2010 (3267). As found by BOTA, “the production plot and decline curves show that the decline was in excess of 50% during these five months, and Mr. Hupp believed the decline to be stable during this time.” BOTA's decision is supported by substantial competent evidence.
2012 Tax Year
For the 2012 tax year, the principle issue was the decline rate. BOTA again established the maximum decline rate of 50% for the 2012 tax year:
“For tax year 2012, the production data through March 2012 is relevant to the lease's future productivity and earning potential. See Bankoff, 265 Kan. at 542 ; Helmerich, 34 Kan.App.2d at 61–62 ; EOG Resources, 46 Kan.App.2d at 830. As of the valuation date of January 1, 2012, four wells were producing and one of the wells was worked-over in March 2011. As a result of the addition of Fore No. 5 in January 2011 and the March 2011 work-over of Fore No. 2, production increased dramatically in January 2011 through April 2011. Taxpayer's production plot, decline curve and back-to-back quarter analysis support the application of the 50% decline rate (0.79 PWF) for the tax year 2012. Mr. Hupp believed the decline to be stable during this time. Further, the County's comparison of 2010 annualized production to the 2011 actual production fails to properly consider the addition of new wells and work-over. See Guide, p. 10 (“When using prior years' production to estimate the current year decline, the appraiser must be sure that the production figures are for a full year and represent a typical operation with no significant work-over periods, lease shutdowns, or other non-producing periods affecting the lease production capability.”). Based on the weight of the evidence, there is sufficient production history from May 2011 through March 2012, with four wells, to support a decline rate of 50% as of January 1, 2012.
“With respect to annual production, the flush production in January through April 2011 should be disregarded. Annualization of production from May through December 2011 results in annual production of 63,107 bbls (42,229 bbls ÷ 245 days of production x 365 days in a year). Based on the findings above, we conclude that the estimated gross reserve value of the subject lease for tax year 2012 is $4,423,258.”
BOTA's decline rate for 2012 is supported by substantial competent evidence as well. Production in April 2011 was flush production, and the production for the remainder of May through December 2011 was relevant and demonstrated a stable decline rate. Hupp testified as to the actual decline rates for the second quarter of 2011 through the first quarter of 2012. These rates established an average stable decline of .229 which equated to over a 50% decline rate pursuant to the Guide. BOTA developed a decline rate that removed the impact of flush production and is supported by the evidence.
The County argues BOTA's valuation of the Fore Lease is not consistent with fair market value. See K.S.A.2014 Supp. 79–503a (“Fair market value” means the amount in terms of money that a well informed buyer is justified in paying and a well informed seller is justified in accepting for property in an open and competitive market, assuming that the parties are acting without undue compulsion.”). The County states the gross revenue of the Fore Lease in 2010 was approximately $5.9 million (75,772 bbls x $78/bbl) and in 2011 was approximately $6.1 million (68,340 bbl x $88.85/bbl). Yet, the County is adamant that it strains credulity that BOTA has ordered a valuation of approximately $2.7 million in 2011 and $2.8 million in 2012. The County also argues BOTA's valuation also fails to accurately predict future production—BOTA predicted 33,000 for 2011, yet actual production was 68,340 barrels. Whereas, the Guide method predicted 70,000 barrels for 2011, which was nearly the same as actual production of 68,340 bbl. We disagree with the County's argument on fair market value. The contrary is actually true. If flush production is not removed in this case from the amount of annual production or in establishing the decline rate, the resulting valuation figures are “clearly distorted,” misleading, and often “result in an inaccurate [excessive] valuation and assessment.” See In re Tax appeal of EOG Resources, Inc., 46 Kan.App.2d 821, 831, 265 P.3d 1207 (2011), rev. denied 296 Kan. 1130 (2013); Helmerich & Payne, Inc. v. Board of Seward County Comm'rs, 34 Kan.App.2d 53, 61–62, 15 P.3d 149, rev. denied 28 Kan. 982 (2005).
Did BOTA Err in Admitting Expert Testimony Concerning Wells Drilled into a Different Reservoir on the Lease Property?
Next, the County argues BOTA erred in admitting undisclosed expert testimony concerning wells drilled into a different reservoir on the lease property. The County claims BOTA's decision was an erroneous interpretation and application of the law, BOTA engaged in unlawful procedure, and it acted unreasonably, arbitrarily, and capriciously in violation of the Kansas Judicial Review Act. See K.S .A.2014 Supp. 77–621(c)(4), (5), (8).
The admission of expert testimony lies within the sound discretion of the trial court. Its decision will not be overturned absent an abuse of such discretion. See Irvin v. Smith, 272 Kan. 112, 125, 31 P.3d 934 (2001). Judicial discretion is abused only when no reasonable person would take the view adopted by the trial court. City of Wichita v. Eisenring, 269 Kan. 767, 776, 7 P.3d 1248 (2000).
At the BOTA hearing, Hupp testified that Fore No. 2 was drilled into a different reservoir. The County objected that Hupp had not been disclosed as an expert on reservoir analysis. Rains stated that Hupp was their valuation witness and “the reservoir, the fact that it's a different reservoir does impact the decline rate and what one would expect to see in a decline rate. Our disclosures were to his—his analysis of this lease and that's part of it.” BOTA overruled the objection.
In discussing this issue in its journal entry, BOTA explained: “Although not expressly identified in the prehearing order, ... identification of the expert, and exhibits exchanged in advance of [the] hearing identifying production and decline rate[s] as issues proved sufficient notice of a possible different reservoir contention.” BOTA ultimately held that the location of the new wells, their production characteristics compared to the original well, and Hupp's testimony persuaded BOTA that the new wells were located in a different reservoir.
The County argues administrative proceedings specifically adopt the Kansas Code of Civil Procedure to govern discovery matters. See K.A.R. 94–5–16(a)(2014 Supp.) (“All discovery matters, including disputes and requests for sanctions, shall be governed by the Kansas administrative procedure act and the Kansas code of civil procedure.”). K.S.A.2014 Supp. 60–226(b)(6) requires the disclosure of an expert witness' identity as well as the substance of his or her anticipated testimony. In Rain's expert witness disclosure, Hupp was projected to testify that “the relevant production data demonstrates a decline rate of 50% ... that the facts and circumstances of the production for the Subject Property does not support use of a default rate of 30% or any rate less than 50%.” The County maintains there was no expert disclosure that Hupp would testify on the subject of reservoir differentiation and this evidence should have been excluded from the hearing by BOTA.
Rains argues its disclosure of Hupp as an expert witness was sufficient disclosure under K.S.A.2014 Supp. 60–226(b)(6). Rains maintains disclosure of an expert's testimony does not require disclosure of every fact the expert relies on in rendering his or her opinion. Rains suggests Hupp's inference of a new reservoir was not an element of the computation in determining value, but it was a reason he chose to use the production data he had disclosed instead of using the County's production data and decline rate from Fore No. 1 to predict the production from the other wells. Rains argues Hupp fully disclosed his production data, decline rate, and how that information established the fair market value of the lease. Rains contends the County's complaint would create an oppressive and ridiculous requirement for expert testimony and the scope of an expert's disclosure should be measured by the facts and opinions the experts will testify to, not by trying to discern what the opposing party is likely to argue the expert should have done differently. Rains argues if it should have disclosed Hupp's opinion of a new reservoir, any err was harmless because the disclosure of data and decline rates provided the County with all the information it needed to depose Hupp and explore his opinion.
We agree with BOTA that the prehearing order, identification of Hupp as an expert, and the exhibits created by Hupp explaining the relevant production—and use of a decline rate substantially different than the historical declining rate—all provided sufficient notice of a possible new reservoir. The County knew about Hupp's valuation and the exponential burst in production and corresponding rapid decline following the addition of the new wells. It is undisputed that Fore No. 6 was a dry hole situated between the three new wells (Fore Nos. 2, 3, and 5) in the northwest portion of the least and the original well (Fore No. 1) in the southwest comer of the lease. Based on these facts, there was no unfair surprise to the County or any reason the County could not have deposed Hupp due to the inconsistencies in the valuations. See K.S.A.2014 Supp. 60–226(b)(5)(A) (A party may depose any person who has been identified as an expert whose opinions may be presented at trial.); Honeywell International v. RTF International, No. 98,933, 2009 WL 1858232, at *6–7 (Kan.App.2009) (unpublished opinion) (appellants were not unduly prejudiced by purportedly untimely disclosure of expert witness partly because appellants could have requested a continuance to enable them to obtain their own expert or depose the appellee's expert); Mai v. High Plains Comprehensive Com. Mental Health Ctr., No. 91,481, 2005 WL 1089037, at *4–5 (Kan.App.2005) (unpublished opinion) (trial court did not abuse discretion in permitting substitution of defendant's expert witness after previously designated witness had unexpectedly died; plaintiff “had a number of opportunities to depose” the substituted expert witness).
In light of the facts presented in the case and the discretion afforded to BOTA in discovery and admission of evidence, it cannot be said that no reasonable person would have agreed with BOTA's denial of the County's objection to the new reservoir evidence. See Walder v. Board of Jackson County Comm'rs, 44 Kan.App.2d 284, 286, 236 P.3d 525 (2010), rev. denied 292 Kan. 969 (2011).
Affirmed.
ATCHESON, J., concurring:
I concur in the result.