Co-author Brittany Blakey

The question is presented again but in a different format: In Texas is a lessee allowed to deduct post-production costs (PPC’s) from the lessor’s gas royalty? In Carl v. Hilcorp, the answer was “yes” based on the language in the oil and gas lease at issue. The question was for gas used by the lessee off the lease premises.

The lease provisions

Gas royalty owners brought a class action in the U. S. District Court for the Southern District of Texas alleging underpaid royalties on two wells. Paragraph 3 of the lease addresses gas royalty and free use of gas:

  • The royalties to be paid by Lessee are: … on gas, … produced from said land and sold or used off the premises or in the manufacture of gasoline or other product therefrom, the market value at the well of one-eighth of the gas so sold or used …
  • Lessee shall have free use of oil, gas, … from said land, …, for all operations hereunder, and the royalty on oil, gas and coal shall be computed after deducting any so used.

Hilcorp did not pay royalty on gas used off the lease premises. Plaintiffs alleged that the royalty clause requires royalty to be paid on any gas used off the premises and that, even absent the royalty provision, the free use clause independently and expressly allows gas to be used only on the lease premises, so royalty must be paid for gas used off the premises.

Hilcorp responded that the market-value-at-the-well valuation means that royalties need not be paid on gas used off the premises that increases the value of the raw gas in preparation for downstream sale. The “off-lease use” and “free use” provisions do not change this structure.

A refresher on “market value at the well”

The court reviewed the seminal Texas cases: BlueStone v. Randle, Heritage, Burlington Resources, French, and from Mississippi, Piney Woods. When the location for measuring market value is “at the well,” market value may be estimated by subtracting from proceeds of a downstream sale PPC’s incurred between the well and the point of sale. Because these costs add value to the gas, backing out the necessary and reasonable costs between the sales point and the wellhead is an adequate approximation of market value at the well. Therefore, for gas that is subsequently treated, processed and transported for sale at a remote location, necessary and reasonable value-enhancing PPC’s are properly deducted from the royalty calculation.

Gas royalty

Applying that methodology, the court found that reasonable and necessary PPC’s may be deducted from the royalty calculation. As the Texas Supreme Court explained in Burlington Resources, the term post-production costs generally applies to processing, compression, transportation, and other costs expended to prepare raw oil or gas for sale at a downstream location. The lease in this case did not define “post-production expenses” in any unique way. The Complaint as much as acknowledged the standard arrangement. The Court concluded that these “off-lease” uses are PPC’s that are properly excluded from the royalty calculation.

Free use

The Court agreed with Hilcorp that despite that free-use was only for on-lease operations, Hilcorp was not precluded from deducting gas used as fuel or in-kind payment for post-production services in this market-value-at-the-well lease. The Court determined that under Texas case law, the market-value-at-the-well provision is the critical clause. The court interpreted Paragraph 3 as a matter of law and determined that Hilcorp was entitled to deduct reasonable and necessary value-enhancing PPC’s.

A musical interlude for your grandfathers, uncles, aunts, fathers, mothers, brothers, sisters, husbands, wifes, sons, and daughters who have served in the military.

Co-author Jamie Mills*

Is it worth spending extra dollars, days, and windshield time to discover what mischief your oil and gas operator might be making on your property? The landowner-plaintiffs in Mustafa v. Americo Energy would certainly say so.

The “discovery rule” offered them no help in their suit against their lessee for negligence when visible soil contamination occurred over two years before suit and was filed and the landowners had not visited the property in over six years. The two-year statute of limitations barred the landowners’ claim. Continue Reading Landowners Vanquished by the Discovery Rule

Co-author Carolina Cuppetilli*

Today we will skip our usual routine of explaining how court rulings on the question of the day might affect your interests. Instead we will discuss the fallout from abysmal document drafting. In Rosetta Resources Operating v. Martin, the Supreme Court of Texas cautioned that an express covenant to protect against drainage suffered from both lack of clarity and lack of accuracy. Although the Court attempted to harmonize the conflicting provisions in an effort to give effect to the intent of the parties as expressed in the contract, “Addendum 18” was so riddled with grammatical and typographical errors that its interpretation should not be relied upon as a useful guide for determining how covenants to protect against drainage typically function. (We’ve discussed Addendum 18 before.)

The clause

Addendum 18 of a mineral lease between the Martins as lessor and Rosetta Resources as lessee was an express covenant to protect the premises from drainage:

… [It] is further agreed that [(1)(a)] in the event a well is drilled on or in a unit containing part of this acreage or is drilled on acreage adjoining this Lease, [(b)] the Lessor [read “Lessee”], or its agent(s) shall protect the Lessee’s [read “Lessor’s”] undrilled acreage from drainage and [(2)] in the opinions of reasonable and prudent operations [read “operators”2], [(a)] drainage is occurring on the un-drilled acreage, even though the draining well is located over three hundred-thirty (330) feet from the un-drilled acreage, [(b)] the Lessee shall spud an offset well on said un-drilled acreage or on a unit containing said acreage within twelve (12) months from the date the drainage began or release the acreage which is un-drilled or is not a part of a unit which is held by production.

(Emphasis added by the Court to aid its analysis)

The facts

Rosetta, Newfield and others created the Martin Unit, pooling portions of the Martin Lease. Rosetta assigned an ORRI in the Martin pooled acreage to Newfield. Newfield drilled the Martin well on the Martin pooled acreage and then created the Simmons Unit that is not adjacent to the Martin Lease, and drilled the Simmons well.

The Martins sued Rosetta and Newfield for breach of Addendum 18, alleging an obligation to protect the undrilled Martin lease acreage from drainage caused by the Simmons well. Lessees countered that their obligation to protect had not been triggered because the Simmons well was not drilled on land adjacent to the Martin Lease.

The trial court granted summary judgment for Rosetta. The court of appeals reversed and remanded, instructing the trial court to grant partial summary judgment for the Martins. At the Supreme Court the parties argued over whether Addendum 18 allowed for separate triggering and draining wells.

The Court’s analysis

Could Addendum 18 be reasonably read to stand for the proposition that drainage that part (1)(b) obligates Rosetta to protect against is limited to drainage from a well listed in part (1)(a)? There were two reasonable interpretations regarding this question. If the meaning of the lease is uncertain and doubtful, or it is reasonably susceptible to more than one interpretation, then a fact issue arises regarding the parties’ intent.

Because both interpretations were reasonable there was an issue of material fact, rendering summary judgment improper. The Court punted the case back to the trial court for further consideration (likely a trial on the merits where a jury will sort it out).

Your musical interlude. 

* Carolina has recently survived her second year at SMU Law School and is a Gray Reed summer associate.

Co-author David Leonard

If perpetuation of a mineral lease beyond the primary term is contingent upon continuous operations, do traditional notions of “production in paying quantities” always matter? Spoiler: No.

In Thistle Creek Ranch, LLC v. Ironroc Energy Partners, LLC, an appellate court affirmed partial summary judgment in favor of lessee Ironroc Energy Partners under these odd clauses in the Kettler lease.

The habendum clause:

Unless sooner terminated …  this lease shall remain in force for a term of three (3) years from the date hereof, hereinafter called “primary term,” and as long thereafter as operations, hereinafter defined, are conducted upon said land with no cessation for more than ninety (90) consecutive days.

The lease defined “operations” as:

“ … any of the following: drilling, testing, completing, reworking, recompleting, deepening, plugging back or repairing of a well in search for or in any endeavor to obtain production of oil [or] gas, …  production of oil [or] gas, … whether or not in paying quantities.

The oddity, of course, is that the lease could be perpetuated by operations, whether or not there was production in paying quantities. Continue Reading Lease Perpetuated Beyond Primary Term Without Production in Paying Quantities

Co-author Brittany Blakey

The question in litigation is usually “WHAT”: what happened, what contract was breached, what did someone do or fail to do, and so on. In Hughes v. CJM Resources, LP, the question was, “WHO” had the right to file the suit in the first place? The Eastland Court of Appeals affirmed the trial court’s holding that the plaintiff no longer owned the causes of action he pursued after he conveyed his mineral and royalty interests to a third party.

The timeline and the suit

  • September 2017: Hughes, as lessor, enters into a paid-up oil and gas lease with CJM.
  • February 2018: Hughes assigns the minerals to Decatur Mineral Partners conveying all “claims and interests in and to the [“… well(s), land(s) and/or unit(s)”].
  • November 2018: Decatur executes a Mineral Deed to Universal Royalty & Mineral Fund purporting to convey all of Decatur’s interest that it received from Hughes.
  • September 2018: Hughes sues CJM; dismissed for lack of standing.
  • 2019 but effective 1/1/2018: Decatur reconveys the claims to Hughes (without success, it turns out).
  • August 2019: Hughes again sues CJM alleging false representations, fraud and negligent misrepresentation in the lease negotiations.

CJM responded with a plea to the jurisdiction asserting that Hughes did not have standing, specifically that he conveyed any causes of actions he had under the lease when he assigned the minerals to Decatur. Hughes countered by contending Decatur’s deed to Universal excepted (or reserved) the causes of action that Hughes now asserts.

The trial court granted CJM’s plea to the jurisdiction, concluding that Decatur’s Mineral Deed to Universal conveyed everything that Decatur received from Hughes in the original conveyance, including any causes of action.

On appeal, the court analyzed the Mineral Deed from Decatur to Universal to determine if Decatur retained the causes of action after the conveyance—because Decatur purportedly conveyed the claims back to Hughes after the conveyance to Universal.

The greatest estate doctrine

In Texas, deeds are generally construed to confer upon the grantee the greatest estate that the terms of the instrument will allow. In other words, a deed will pass whatever interest the grantor has in the land, unless it contains language showing a clear intention to grant a lesser estate.

Decatur’s deed to Universal stated that Decatur “does hereby grant, bargain, … to [Universal] all of [Decatur’s] interest in [the subject lands]… [.]” The conveyance also identified the interest Decatur conveyed to Universal as the interest Decatur received from Hughes. Therefore, the court concluded that the parties’ objective intent in the Decatur-to-Universal conveyance was for Decatur to convey all interests it obtained from Hughes. These interests included the causes of action that Hughes conveyed to Decatur.

The “subject to” clause

The Decatur-to-Universal deed was was “subject to” rights in valid oil and gas leases, and purported to grant to Universal “… benefits which may accrue after the date of this Mineral Deed”. The court construed that clause as purporting to except property from the conveyance, but the clause did not identify the causes of action with sufficient specificity and therefore did not except the causes of action from the deed.

Lessons learned?

Make your exceptions and reservations specific, especially if you know exactly what you are trying to carve out. Otherwise you might have regrets, like Lake Street Dive, or only left with Darius Rucker to console you.

Co-author Julia Edwards

This “most-favored-nations” clause in three oil and gas leases on land in LaSalle County, Texas, was at issue in EP Energy E&P Co., L.P. v. Storey Minerals, Ltd.:

If … the lessee … acquires an Oil and Gas Lease [on certain lands] on such terms that the … bonus … [is] greater than th[at] provided to be paid to lessor hereunder, lessee  …  agrees that it will execute an amendment to this lease, effective as of the date of the third party lease on the leased premises, to provide that the lessor hereunder shall receive thereafter the same percentage (per net mineral acre) … bonus … as any subsequent lessor of the leased premises to the extent that such … bonus … [is] greater than those provided to be paid herein. … “

In the end, as a result of lessee EP’s subsequent leases lessors (MSP) were entitled to increased bonuses on leases from the time prior to execution of the triggering lease. Once again, a court applied the plain, ordinary, and generally accepted meaning of the contract. Continue Reading Most-Favored-Nations Clause Costs Lessee

Co-author Justin Cowan

Does a former working-interest owner of a well bear continuing responsibility for a defective gas line despite having conveyed its ownership interest? The line was constructed by the former owner as operator of record, and it received a fee as operator. (One could assume there was a RRC Form P-4 on file and a Model Form JOA, but the court doesn’t say.)This was the question before the Texas Supreme Court in In re Eagleridge Operating, LLC.

 Facts

Aruba Petroleum owned a minority working interest in the Donnell 2-H well and was operator of record, for which it received a fee with the consent of the majority working-interest owner, USG Properties Barnett II.  As operator Aruba was responsible for drilling, operating, and servicing the well and securing proper equipment.  In 2013, while Aruba was a working interest owner and operator, a gas line was installed on the property. Aruba and USG paid their proportionate share of the construction expenses.

Four years later Aruba conveyed its working interest to USG and ceased serving as operator. Eagleridge subsequently entered into a written contract with USG to serve as operator and assumed control of the well in 2017. A few months later the gas line ruptured and injured Lovern, the plaintiff in the underlying negligence suit.

The suit

Eagleridge sought to designate Aruba as a responsible third party, asserting that Aruba, as a prior owner-operator, caused or contributed to Lovern’s injuries because Aruba was responsible for installing the gas line, selecting the materials, and determining its placement on the property.

Lovern moved to strike Arbua’s designation and sought a partial summary judgment. He argued that, under the Supreme Court’s opinion in Occidental Chemical Corp. v. Jenkins, a former premises owner owes no duty (and has no responsibility) related to the condition of the premises after conveying its ownership. Occidental  involved a sole owner-operator’s improvements.  On the other hand, Aruba was not just a property owner—it also received a fee as operator and made improvements in that capacity.  Accordingly, said Eagleridge, Aruba had a duty as an independent contractor, and that duty did not terminate when its control over the property ceased.

The trial court granted both of Lovern’s motions and the court of appeals denied Eagleridge’s request for mandamus relief. The Supreme Court’s review was confined to whether Occidental precluded Aruba’s responsibility for defects in the pipeline and whether the trial court erroneously struck Aruba’s designation as a responsible third party.

The result

The Supreme Court agreed with the lower courts and denied mandamus relief, reaffirming its position that Occidental precludes the “dual-role” analysis Eagleridge proposed.  A property owner, when making improvements on its own property, acts solely in its capacity as an owner and not as an independent contractor.  That analysis is not altered by the fact that USG paid Aruba to operate the well.  The core holding in Occidental is based on ownership, and the Court held that Aruba was a property owner exercising its possessory right to develop its property when it installed the gas line.

Aruba’s responsibility for premises defects did not survive conveyance of its ownership interest to USG.  Aruba and USG were tenants-in-common, and each could construct improvements on the property without the other’s consent.  Aruba’s right to construct the pipeline was independent of, did not arise from, and was not extinguished by its agreement to serve as operator of record.  Aruba’s receipt of compensation as operator neither transformed it from an owner into an independent contractor nor materially distinguished the case from Occidental.

Your musical interlude.

Co-author Max Brown

Commonwealth of Pennsylvania v. International Development Corporation resolved the question, In a 100 year old Pennsylvania deed is a “subject to” provision an exception to a grant or a warranty disclaimer?

The transactions:

  • 1894: 2,094 acres are sold by deed from Proctor and Hill to Union Trading Company; Proctor and Hill reserve all minerals.  This reservation is not reported to the taxing authority, and the property is assessed and taxed as a whole following the sale.
  • 1903: Union deeds the surface to CPLC.
  • 1908: Property is sold in a tax sale to McCauley. This effectively “washes” the title and reunifies the two estates; McCauley owns the surface and the minerals.
  • 1910: McCauley conveys the property back to CPLC.
  • 1920: CPLC sells the property and other land to the Commonwealth of Pennsylvania. The deed had two key clauses.

The clauses

The “First Clause”: The conveyance was “subject to” the mineral interests “as fully as said minerals and mineral rights were excepted and reserved in [the 1894 deed].”

The “Second Clause”: The conveyance was “also subject to all the reservations, exceptions, covenants, and stipulations contained in [the 1894 deed] … and in the [1903 deed].”

More transactions

CPLC quitclaims the mineral rights, the minerals were resold multiple times, in 2000 International Development Corporation (IDC) purchases the property.

Who owns the mineral rights, IDC or Commonwealth? Continue Reading The Meaning of “Subject To” in a Deed

Co-author Darien Harris

The Texas Civil Practices and Remedies Code, Chapter 95, limits a property owner’s liability when an independent contractor hired to construct, repair, renovate or modify an improvement to the owner’s property brings a negligence claim that arises “from the condition or use of the improvement.” The Texas Supreme Court has ruled that the property owner is free from liability when negligence elsewhere contributes to the plaintiff’s injuries. But the contributing negligence must involve the condition or use of the improvement on which the plaintiff was working.

If you’ve stayed with us this far you must be a lawyer.

The facts

In Energen Res. Corp. v. Wallace, Energen hired Nabors and New Prospect to drill an oil well in Pecos County. Energen contracted Dubose Drilling to complete a water well that would assist the oil well drilling operation.  Dubose subcontracted with Elite Drillers to complete the water well.  Elite’s president, Wallace, supervised the water well project. Because the wells were only 500 feet from each other, Energen and Elite more or less worked side-by-side. Continue Reading Operator Escapes Liability For a Gas Kick and Resulting Fire

Co-author Brittany Blakey

Zehentbauer Family Land, LP v. TotalEnergies E&P USA, Inc. is a story we’ve heard before: Royalty owners contend they are not getting a big enough slice of the hydrocarbon pie, which presents a question courts must answer: Where is the valuation point for royalty calculation?

Under the oil and gas leases at issue, royalties are to be paid:

“based upon the gross proceeds paid to Lessee for the gas marketed and used off the leased premises, including casinghead gas or other gaseous substance… computed at the wellhead from the sale of such gas substances so sold by Lessee.”

The midstream arrangements and the “netback method”

Chesapeake and Total sell their production at the wellhead to their respective midstream affiliates, CEMLLC and TGPNA, each of which sells the transported product to unaffiliated downstream companies. The affiliates account for the gas using the “netback” method, which “takes a weighted average of prices at which the midstream affiliates sell the oil and gas at various downstream locations and adjusts for the midstream company’s [various costs (including transportation)] to move the raw oil and gas from the wellhead to downstream resale locations.” The netback method accounts for these midstream (post-production) costs. The midstream affiliates pay this reduced amount to the producers, who use this netback price as the base for calculating the plaintiffs’ royalty payments. Continue Reading Ohio Royalty Owners Burdened with Post-Production Costs