Post-Production Deduction Cases in Texas · to be free of all post‐production costs? YES – “Generally speaking, overriding royalty on oil and gas production is free of production

Money Talks: Post‐Production Deduction Cases

in TexasThis webcast will begin promptly at 12:00 PM Eastern

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Today’s Presenters

Andrew S. GrahamMorgantown, WV304‐598‐8161

andrew.graham@steptoe‐johnson.com

Kacie M. BeversThe Woodlands, TX

281‐203‐5770kacie.bevers@steptoe‐johnson.com

Today’s Menu

• What are post‐production costs in Texas?• What effect does a “Anti‐Heritage Clause” have on a lease?

• Can post‐production costs be deducted from an overriding royalty?

• How does Texas treat post‐production costs differently from other states?

A Guiding Principle?

• No matter what they’re talking about, they’re talking about money– Todd’s Second Political Principle

Defining Costs

• Most courts distinguish between:– Costs of production– Costs subsequent to production

• Royalty interests (whether lessor’s royalty, ORRI, or NPRI) are free of the costs of “production”

• But, where does “production” phase stop and when does “post‐production” phase begin?

“At the Wellhead”

Two Approaches

• Capture‐and‐hold– Costs of transporting, compressing, and processing or cleaning are charged proportionately against royalty interest where gas is sold “downstream” from the lease

• Marketable product– Lessee has implied duty to lessor to make production marketable and “production” does not end until the product is marketable

Heritage Resources v. NationsBankSupreme Court of Texas (1996)

• Issue: Can the Lessee (Heritage) deduct transportation costs from the value of Lessor’s (NationsBank’s) royalty?


• Royalty Provision

“the market value at the well of 1/5 the gas so sold or used . . . 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.”


• Facts– Lessee sold gas off the leased premises– Lessee deducted the cost to transport the gas from the wellhead to the point of sale as a post‐production cost from the sales price before calculating royalties


• Prior History– Trial Court: Awarded Lessor the transportation costs Lessee deducted

– Court of Appeals: Affirmed Trial Court• The royalty clauses showed the parties’ intent not to deduct the post‐production transportation costs when determining market value at the well


• Majority Opinion– Can the Lessee (Heritage) deduct transportation costs from the value of Lessor’s (NationsBank’s) royalty? YES

– Lessee properly deducted costs of transporting gas to point of sale, despite clauses in the leases limiting deduction from royalty for postproduction costs


• Dissenting Opinion– “What could be more clear? This provision expresses the parties’ intent in plain English, and I am puzzled by the Court’s decision to ignore the unequivocal intent of sophisticated parties who negotiated contractual terms at arm’s length.”


MAJORITY CONCURRING DISSENTING

Heritage Resources v. NationsBankMotion for Rehearing ‐ Supreme Court of Texas (1997)

MAJORITY CONCURRING DISSENTING

[RECUSED]

Chesapeake v. HyderSupreme Court of Texas (2015)

• Issue: Is an overriding royalty clause that is “cost‐free” to be free of all post‐production costs?

• Facts:• Leased 948 mineral acres in Barnett Shale• No oil, 29 producing gas wells• Three royalty provisions, only the third was in question


• Royalty Provision

“a perpetual, cost‐free (except only its portion of production taxes) overriding royalty of five percent

(5.0%) of gross production obtained.”


• Anti‐Heritage Clause

"Lessors and Lessee agree that the holding in the case of Heritage

Resources, Inc. v. NationsBank, shall have no application to the terms and

provisions of this Lease."


• Prior History– Trial Court: Lessors awarded $575,359.90 in post‐production costs Lessee wrongfully deducted

– Court of Appeals: Affirmed Trial Court decision


• Majority Opinion– Is an overriding royalty clause that is “cost‐free” to be free of all post‐production costs? YES

– “Generally speaking, overriding royalty on oil and gas production is free of production costs but must bear its share of postproduction costs unless the parties agree otherwise.”

– Court held that lease expresses a different agreement.


• Majority Opinion– “Heritage Resources does not suggest, much less hold, that a

royalty cannot be made free of post‐production costs. Heritage Resources holds only that the effect of a lease is governed by a fair reading of its text. A disclaimer of that holding, like the one in this case, cannot free a royalty of post‐production costs when the text of the lease itself does not do so.”

– “Here, the lease text clearly frees the gas royalty of post‐production costs, and reasonably interpreted, we conclude, does the same for the overriding royalty. The disclaimer of Heritage Resources’ holding does not influence our conclusion.”


• Dissenting Opinion– “Parties are free to allocate post‐production costs as they wish, and our task is to determine how those costs were allocated under this particular lease.”

– Read the overriding‐royalty clause as granting the Hyders a percentage of production before post‐production value is added and without allocating their share of post‐production costs to Chesapeake

– “I would thus hold Chesapeake properly deducted post‐production costs to arrive at the royalty’s value.”


• Dissenting Opinion– Anti‐Heritage clause:

• “I agree a disclaimer of that precedent cannot itself free a royalty of post‐production costs. But the ‘free and clear’ language here is similar in specificity to the language held ineffective in Heritage.”

• “The disclaimer could be interpreted as a belt‐and‐suspenders attempt to ensure the ‘free and clear’ language is given effect despite its conflict with the oil royalty’s market‐value‐at‐the‐well definition.”

Chesapeake v. HyderMotion for Rehearing – Supreme Court of Texas (2016)

• Court alignment remained the same in denying motion for rehearing (5‐4)

• Decision now final

Burlington Resources v. Texas Crude EnergyCourt of Appeals – Corpus Christi (2017)

• Issue: Can post‐production expenses be deducted from overriding royalty payments?


• Royalty Provision– If owner of ORRI chooses to receive production in‐kind, share must be delivered “into the pipeline, tank or other receptacle to which any well or wells on such lands may be connected, free and clear of all royalties and other burdens and all costs and expenses except the taxes thereon or attributed thereto.”


• Royalty Provision– If owner of ORRI chooses not to receive production in‐kind but rather as cash payment, the amount of the payment must be based on the “amount realized” from the sale of the minerals if sold in an “arm’s length sale,” or based on the “market value at the wells” if not sold in an “arm’s length sale.”


• Facts– ORRI owner elected to receive all royalties in cash

– ORRI payments “clearly identified post‐production deductions that were being taken within the royalty calculation, such as transportation and processing, both on a gross basis for 100% of the production and for” the ORRI percentages


• Prior History– Trial Court: Assignments did not allow for the deduction of post‐production expenses

– Court of Appeals: Affirmed


• Court of Appeals– “[T]he plain language of the assignments unambiguously provides that, when the royalty is taken in cash and the minerals are sold at an arm's‐length sale, as here, the royalty is based on the ‘amount realized’ by Burlington from the sale, and is therefore free of post‐production costs.”


• Appeal to Supreme Court of Texas– Petition for Review– Respondent’s Response to Petition for Review


Supreme Court of Texas?

Burlington Resources v. Texas Crude Energy

MAJORITY DISSENTING

Chesapeake v. Hyder (2015)

Burlington Resources v. Texas Crude Energy

Supreme Court of Texas (2018)

Texas vs. Other States• West Virginia

– Leggett v. EQT Prod. Co., 800 S.E.2d 850 (W. Va. 2017)• Ohio

– Lutz v. Chesapeake Appalachia, L.L.C., 71 N.E.3d 1010 (Ohio 2016)• Colorado

– Lindauer v. Williams Production RMT Co., 381 P.3d 378 (Colo. App. 2016)• Pennsylvania

– Kilmer v. Elexco Land Servs., Inc., 990 A.2d 1147 (Pa. 2010)• North Dakota

– Bice v. Petro‐Hunt, L.L.C., 768 N.W.2d 496 (N.D. 2009)• New Mexico

– Creson v. Amoco Prod. Co., 10 P.3d 853 (N.M. App. 2000)• Oklahoma

– Mittlestadt v. Santa Fe Minerals, Inc., 954 P.2d 1203 (Okla. 1998)• Kansas

– Sternberger v. Marathon Oil Co., 894 P.2d 788 (Kan. 1995)

Questions?

Mark Your Calendar for Next Month’s Webcast

February 28, 2018 At Noon Eastern

“Colorado, North Dakota, and Wyoming Oil and Gas Update”

Presenters: David Little and Deva Solomon

Be on the lookout for your invitation soon!

Thank You

Andrew S. GrahamMorgantown, WV304‐598‐8161

andrew.graham@steptoe‐johnson.com

Kacie M. BeversThe Woodlands, TX

281‐203‐5770kacie.bevers@steptoe‐johnson.com

These materials are public information and have been prepared solely for educational purposes. These materials reflect only the personal views of the authors and are not individualized legal advice. It is understood that each case is fact‐specific, and that the appropriate solution in any case will vary. Therefore, these materials may or may not be relevant to any particular situation. Thus, the authors and Steptoe & Johnson PLLC cannot be bound either philosophically or as representatives of their various present and future clients to the comments expressed in these materials. The presentation of these materials does not establish any form of attorney‐client relationship with the authors or Steptoe & Johnson PLLC. While every attempt was made to ensure that these materials are accurate, errors or omissions may be contained therein, for which any liability is disclaimed.

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Post-Production Deduction Cases in Texas · to be free of all post‐production costs? YES – “Generally speaking, overriding royalty on oil and gas production is free of production