In the recent opinion of Carl v. Hilcorp Energy, the Texas Supreme Court delivered an Order on “Certified Questions from the United States Court of Appeals for the Fifth Circuit,” and held that royalty holders of an “at-the-well” royalty provision are not entitled to royalty on gas “sold or used off the premises” pertaining to gas used to transport or process the gas produced from the lease. The Court determined that because the royalty owed was based on “the market value at the well,” the lessors must bear the cost of a company’s use of gas for post-production costs, reaffirming the law that the “holder of an ‘at-the-well’ royalty must share proportionately in the post-production costs.”
Background
The May 2024 ruling emerged from a dispute on the method used to account for post-production costs. Anne Carl and Anderson White, as Co-Trustees of the Carl/White Trust, acting on behalf of itself and other royalty holders (“Carl”), owned an oil and gas lease that required Hilcorp (the operator) to pay royalty on all gas “sold or used off the premises.”
The leases include royalty clauses stating not only is the payment of royalties based on the “market value at the well,” but that royalty must be paid on gas “sold or used off the premises.” Hilcorp Energy Company (“Hilcorp”) used some of the gas from the lease in post-production efforts off the lease and accounted for this by deducting the value of the gas used in post-production from the total value of the gas on which it owed royalty. Following this, Carl sued Hilcorp for the subtraction of gas used in post-production efforts based on the above-stated provisions requiring royalty on all gas produced from the well. Carl opposed Hilcorp’s calculation claiming that the provisions in the lease override Carl’s obligation to pay their share of post-production costs. Hilcorp argued that it was within its rights to deduct the value of the gas used in post-production efforts before fulfilling its royalty obligations because of the leases’ specification of an “at-the-well” royalty provision. Ultimately, the Texas Supreme Court concluded that the calculation of royalty, based on the “market value at the well,” obligated the royalty holders to shoulder a portion of the post-production expenses, thus siding with Hilcorp’s interpretation.
Texas Supreme Court Review
Upon review of whether royalty calculations must account for post-production costs in this case, the Texas Supreme Court reiterated that royalty holders must share in post-production costs.
In general, most leases give royalty owners interest in minerals “at-the-well” or “at the wellhead,” meaning their ownership extends to minerals as they are extracted, not after undergoing post-production processes. Further, minerals are not frequently sold until after their value has been increased by post-production costs in which the value is more than what the royalty holder had an interest in. However, this leads to a disparity in which the royalty owner receives a higher benefit. To address this imbalance, the Texas Supreme Court held in Heritage v. NationsBank that the holder of an “at-the-well” royalty must share post-production costs expended prior to the sale.
The Court reasoned that because post-production costs increase the value of the minerals, the gas used for this must be accounted for when calculating the royalty interest of “at-the-well” minerals. In BluestoneStone Nat. Res. II, LLC v. Randle, the Texas Supreme Court reiterated its holding from Heritage that because post–production costs are incurred after gas leaves the wellhead and because value is added to the gas, removing post-production costs incurred between the sales point and the well results in an accurate estimation of the market value at the well. The Court further named this method of accounting for post-production costs “the workback method.” Additionally, Carl argued that Hilcorp did not have “free use” of the gas used for post-production efforts, therefore, it must pay the respective royalties instead of removing the cost from the royalty calculations. In response, the Court held that this provision of the lease is irrelevant and reiterated that royalty holders of an “at-the-well” royalty must bear the share of post-production costs as stated in Randle.
The Texas Supreme Court concluded that while the royalty holders are owed royalty which is “the market value at the well” on gas “sold or used off the premises,” they must also bear the share of post-production costs which includes the value of gas produced from the well and used off the lease.
This opinion provides clarity on how post-production costs must be accounted for when calculating “at-the-well” royalty payments in oil and gas leases by requiring royalty holders to bear their share of post-production costs by allowing the operator to subtract the costs from royalty payments. By reaffirming the holdings from Heritage and Randle, the Court has reinforced this precedent and created a consistent legal framework for resolving future disputes. Further, by rectifying the payment disparity to ensure both parties benefit equally, this precedent fosters greater equity in oil and gas lease transactions.
Kuiper Law Firm, PLLC specializes in all aspects of oil and gas operations including oil, gas, & mineral leases. We will continue to monitor any updates on this case law. If you have any questions about the information in this article or how it may affect your operations, please do not hesitate to contact us.