Texas Court Discusses Allocation of Post-Production Costs in Recent Oil and Gas Royalty Dispute

Austin, TX (Law Firm Newswire) July 7, 2021 – The state’s high court recently issued a written opinion that provides some clarity in an often murky area of the state’s oil and gas jurisprudence. The case involved a dispute over the costs that a lessee of a mineral lease is entitled to deduct when calculating royalty payments owed to a lessee.

It is common for the landowner to provide the right to extract petroleum to a specialized oil and gas company. In turn, the company will provide the landowner with royalty payments. This transaction is usually referred to as an oil and gas lease. The specific obligations of each party are typically laid out in the lease.

The operator is usually responsible for all preproduction costs, such as surveying the land and drilling the oil well. In most cases, these expenses do not get subtracted from the royalty payments owed to the landowner. However, the costs associated with bringing the oil from the well to market, known as post-production costs, may be subtracted from the royalty payments, depending on the contract’s language.

Royalty amounts are often determined in one of two ways. “At the well” valuation looks to the value of the oil once it is extracted. Because oil “at the well” needs to be transported before it can be sold, the gas company will often subtract these post-production costs from the royalty amount.

 The other alternative is an “at the market” valuation. “At the market” valuation looks to the value of the oil once it arrives at the market and is ready to be sold. In an “at the market” lease, the oil and gas company cannot generally charge post-production costs.

The difference between these two valuation methods can be significant because the value of oil or gas increases substantially as it is processed, transported, and eventually arrives at the market.

The dispute, in this case, arose when Bluestone, an oil and gas company, began to subtract post-production costs from the royalties paid to the landowner. The lease provided a royalty amount of the “market value at the well of one-eighth of the gas so sold or used.” However, an addendum to the lease stated that the royalty amount was calculated based on the “gross value received.”

Thus, according to the landowner, the original lease provided for an “at the well” valuation and the addendum provided for an “at the market valuation.” And because the addendum was created after the lease, the landowner claimed that Bluestone could not subtract post-production costs. Given the alleged conflict between the lease and the subsequently signed addendum, the court was tasked with determining whether Bluestone could subtract post-production costs from the royalties payable to the landowner.

Ultimately, the court agreed with the landowner, finding that the “gross value received” language in the addendum created a conflict between the lease and the addendum. The court explained that the language in the lease implied a royalty based on “net” proceeds, whereas the language in the addendum required the royalty payments to be based on “gross” proceeds. The court noted that “gross” and “net” are inherently conflicting terms and that the “at the well” lease clause did not trump the “at the market” clause in the addendum. Thus, the court held that Bluestone could not subtract post-production costs from the royalties owed to the landowner.

Austin oil and gas lawyer, Gregory D. Jordan, explains the importance of the court’s recent opinion, “While there are certain commonly accepted customs in the oil and gas industry, it is imperative for parties to put their agreements in writing to avoid potential conflicts down the road. In Bluestone, the lease did not distinguish between the valuation method and the valuation point, which lead to confusion. To the extent that a form contract is used with an addendum to flesh out the details, it is crucial that the two documents be read together.”

At the Law Offices of Gregory D. Jordan, Attorney Jordan represents individuals and businesses in all types of Texas oil and gas cases and contractual disputes. Attorney Jordan has over 30 years of relevant experience helping clients confront the complex legal issues they face throughout Texas. Contact the Law Offices of Gregory D. Jordan at http://www.theaustintriallawyer.com/.

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