that excludes postproduction costs, holds greater value for the royalty holder but is more costly for the producer. This is because the landowner will benefit from the increased value of production without having to bear the expenses incurred in getting the product to market. Consequently, disputes over the terms of mineral leases and the distribution of postproduction costs are quite common. However, the specific application of the royalty clause in this lease are unique and, according to the Texas Supreme Court, “unprecedented.” Analysis So why is the Texas Supreme Court who is historically “pro-industry” ruling against an oil and gas company? In my opinion, the Texas Supreme Court has gone to such extremes to rule in favor of oil and gas companies that it is to the point of bordering on the ridiculous. Take the 1995 Texas Supreme Court case quoted in the lease provision, Heritage v. Nations Bank . In that case, the royalty clause had typical market value language but also included this language: …provided, however, that there shall be no deductions from the value of the Lessor’s royalty by reason of any required processing, cost of dehydration, compression, transportation or other matter to market such gas. That’s pretty unambiguous language in my opinion. Yet in Heritage, the court ruled that this language was “surplusage” and that the lease language really meant that oil and gas royalty were to be paid on net proceeds and deductions were allowed. One could argue that if one part of the royalty clause called for a market valuation and another part said “no deductions,” this creates an ambiguity. Under contract law, an ambiguity in a lease is construed against the lessee. Despite this, the court ruled in the oil and gas company’s favor. This paved the way for a skilled attorney and mineral owner to skillfully construct language designed to counter the ruling in the Heritage case, ultimately leading to the present outcome. I would
contend that the financial burden on the oil and gas company is significantly higher when they are obliged to pay post-deduction costs to a third-party affiliate, as opposed to if the court had permitted post-production deductions prior to sale. Typical post-production cost deductions range from a few cents (19 - 21 cents per barrel), rather than nearly $20 per barrel as in this example. Nevertheless, this is the current situation we find ourselves in. Impact on Land Professionals This affects all land professionals. For the landman, be aware of this provision and its impact on your company’s bottom line when negotiating a new lease. For lease analysts, make sure you note these provisions well when analyzing the oil and gas lease. For division order analysts, this may require manual handling of checks for lessors with this lease language. Typically, when the revenue accountant gets a posted index price, that price is applied to all the owners in a deck. That won’t work for lessors with this language creating a whole new administrative burden (not to mention financial) to the oil and gas company. Conclusion In conclusion, the recent Texas Supreme Court ruling restricting post-production cost deductions in new royalty clauses has sent shockwaves through the oil and gas industry. With landowners now armed with a powerful legal precedent, oil and gas companies will need to carefully review their lease agreements and navigate the complexities of calculating royalties. This landmark ruling serves as a reminder that the balance between landowners and producers is constantly evolving, and the interpretation of lease provisions can have significant financial implications. It remains to be seen how this ruling will shape future lease agreements and the relationship between landowners and oil and gas companies. This is why it is crucial for all stakeholders to stay informed and seek expert guidance to ensure fair and equitable agreements moving forward .
Alyce B. Hoge Land Training ahoge@landtraining.net
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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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