Pay attention – there are some new royalty clauses in town and the Texas Supreme Court is interpreting them against oil and gas companies who attempt to deduct post-production costs from their lessor’s royalty payment. What’s unique about these provisions is that they prohibit deductions AFTER the point of sale to third-party affiliates. Devon v. Sheppard Lawsuit Landowners and oil and gas companies in Texas are facing a significant legal battle over the interpretation of new royalty clauses. The recent ruling by the Texas Supreme Court has restricted post-production cost deductions, causing turmoil in the industry. This groundbreaking decision has sparked a $100 million lawsuit against Devon Energy and BPX Properties, with landowners alleging underpaid royalties. In this article, we will delve into the details of this case and explore the implications of the court’s ruling on the oil and gas sector. In the case of *Devon et al. v. Sheppard (No. 20- 0904, March, 2023), the Texas Supreme Court affirmed the lower court’s ruling that the clear language of the lease provision unambiguously prevented deductions of post-production costs from a third-party affiliate who deducts costs from published index prices downstream from the point of sale. *Devon Energy Production Co., L.P., f/k/a GeoSouthern DeWitt Properties, LLC; BPX Properties (NA) LP; GeoSouthern Energy Corp.; and BPX Production Co. are all being sued under these leases. The recent test case highlights the impact of this new ruling. Specifically, Devon Energy and BPX are facing lawsuits from numerous landowners in DeWitt County, southeast of San Antonio. These landowners in the Eagle Ford Shale allege that they have been underpaid royalties and interest amounting to $100 million, citing the Texas Supreme Court opinion as supporting evidence. (See Houston Chronicle article by Amanda Drane of July 3, 2023)
So, what are these new provisions? First, it’s important to understand that the plaintiff in the Supreme Court case and the newly filed case is Michael Sheppard, an attorney and mineral owner who created the provisions not only for his lease but for other lessors in the area. Second, the parties all agree that per the “gross proceeds” language of the traditional royalty clause in the lease, no post-production costs are deductible to the point of sale. At issue are these new, bespoke provisions affecting whether oil companies can take the posted price of the product and deduct costs for “gathering and handling, including rail car transportation, of $18” as discussed in the case, from the per barrel posted price and use this figure to calculate royalties.
Here are the two provisions:
3(c) If any disposition, contract or sale of oil or gas shall include any reduction or charge for the expenses or costs of production, treatment, transportation, manufacturing, process[ing] or marketing of the oil or gas, then such deduction, expense or cost shall be added to…gross proceeds so that Lessor’s royalty shall never be chargeable directly or indirectly with any costs or expenses other than its pro rata share of severance or production taxes.
AND
Payments of royalty under the terms of this lease shall never bear or be charged with, either directly or indirectly, any part of the costs or expenses of production, gathering, dehydration, compression, transportation, manufacturing, processing, treating, post-production expenses, marketing or otherwise making the oil or gas ready for sale or use, nor any costs of construction, operation or deprecation of any plant or other facilities for processing or treating said oil or gas. Anything to the contrary herein notwithstanding, it is expressly provided that the terms of this paragraph shall be controlling over the provisions of Paragraph
New Royalty Provisions
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G rowth T hrough E ducat i on - J uly / A ugus t / S ept ember 2023
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