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The Texas Supreme Court recently considered oil and gas leases that involved the interaction of the “free use of gas” clause and the royalty due on gas used off the leased premises.

In Carl v. Hilcorp Energy Co., ___ S.W.3d ___, 2024 WL ___ (Tex. May 17, 2024), individuals brought a class action against Hilcorp, claiming Hilcorp owed royalties on gas used off-lease for post-production activities. According to the leases, royalties were paid based on the value of gas at the well, and this language allows deduction of post-production expenses. The leases stated that Hilcorp must pay as royalties “on gas . . . produced from said land and sold or used off the premises . . . the market value at the well of one-eighth of the gas so sold or used.” The leases also provided that Hilcorp “shall have free use of . . . gas . . . for all operations hereunder.”

The Court was answering two certified questions from the Fifth Circuit. In answering those questions, the Court held that a market-value-at-the well lease containing an off-lease-use-of-gas clause and free-on-lease-use clause can be interpreted to allow for the deduction of gas used off lease in the post-production process. The Court also discussed that the deduction could use either the value per unit of gas, or the units of gas, to determine the gas upon which royalties must be paid, since either calculation yielded approximately the same results.

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The Texas Supreme Court is going to hear a case in which the issue is whether the interest to be paid on past due royalties is simple or compound interest.

In the case of Samson Exploration, LLC v. Bordages, 662 S.W.3d 501 (Tex. Civ. App.—Beaumont 2022, pet. granted September 1, 2023), the lessors executed a number of oil and gas leases with Samson. The leases provide for an 18% late-charge penalty on past-due royalties to be calculated each month but do not expressly state whether the interest should be compound or simple.

The specific language in the lease is:

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The El Paso Court of Appeals, in the recent case of Cactus Water Services LLC v. COG Operating LLCwas faced with the issue of who owns the water produced by a hydraulic fracturing operation: the oil and gas company operating the well or the surface owner and the company the surface owner leased its water rights to?

The operator, COG, was the lessee of several mineral leases in Reeves County on which it was drilling and completing horizontal wells, which require fracing. As most of you know, the fracing process involves large amounts of water. In addition, in most shale plays, the amount of produced water is also huge. As the Court notes, the median water used per well in the Permian Basin is 42,500 cubic meters of water. That water, plus water produced along with oil and gas once a well is online, is generally considered to be “produced water”.

Produced water has historically been treated as a waste product and its disposal has been highly regulated in Texas, at great cost to operators. However, new technologies are beginning to be implemented in the oil patch that allow wastewater to be treated to make it usable and sold back to operators. Suddenly, what was a waste product is becoming a valuable commodity, especially in water starved Texas.

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In Hogg v. Blackbeard Operating, 656 S.W.3d 671, 673 (Tex. App.—El Paso 2022, no pet.), the El Paso Court of Appeals evaluated an assignment of leases in Winkler County, Texas.

The owner of the minerals in question executed two leases for their interests, one in 1994 and one in 1998. In 2005, their lessee executed an assignment of leases to Standolind Oil and Gas.  The exhibit to the assignment listed the 1994 lease but not the 1998 lease.

The Court noted that the language of the assignment was broad. It assigned “all of the assignor’s interest in “the land conveyed by the Leases” and lands pooled therewith. The Court held that since 1998 lease covered must of the same land as the 1994 lease, and given the broad language of the assignment, the 1998 lease was covered by the assignment, even though it was not listed in the exhibit describing the property being assigned.

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The El Paso Court of Appeals recently interpreted two deeds with conflicting fractions that each exhibited the estate misconception theory. In Davis v. COG Operating, LLC, 658 S.W.3d 784 (Tex.Civ.App.—El Paso 2022, no pet.) the original mineral owners executed two deeds to two different grantees. In the first deed to W. H. Haun, the interest conveyed is described as a “1/32 interest in and to all of the oil, gas, and other minerals.” Another clause described the interest as including “1/4 of all of the oil royalty and gas rentals, or royalty” under an existing lease. Another clause indicated that the deed included “1/4 of the money rentals” to extend the existing lease. Yet another clause stated that, once the lease terminated, the grantee would own a “1/4 interest in all oil, gas and other minerals.” A final clause indicated that a prior version of the deed mistakenly described the interest as “1/8 of said oil, gas and royalty,” but was being corrected to convey “1/4.”

In a second deed to Roberts, it was stated that “1/32 of the oil, gas and other minerals has heretofore been conveyed to W. H. Haun, and this conveyance does not include such mineral interests so conveyed”. This second deed also contained a reservation of “one-fourth (1/4) of the 1/8 royalty usually reserved by…oil and gas leases, so 1/4 of the 1/8 royalty [is] to be paid to us, our heirs or assigns… [and] in the case of production, we are to receive 1/4 of the 1/8 royalty and this conveyance is executed subject to the mineral interest theretofore conveyed to W. H. Haun, and also to the 1/4 royalty interest reserved by us as hereinbefore stated.

The “estate misconception theory” is a theory that reflects the mistaken belief in older deeds that, in entering into an oil-and-gas lease, a lessor retained a 1/8 interest in the minerals, rather than a 1/8 royalty. Thus, in the first deed, the grantor thought they were conveying 1/4 of their 1/8 mineral interest, or 1/32.

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The Texas Supreme Court recently decided a case in which an oil company’s withholding of production payments was contested. In Freeport-McMoRan Oil & Gas LLC v. 1776 Energy Partners, LLC, ___ S.W.3d ___, 2023, WL ___ (Tex. May 19, 2023), two oil companies, Ovintiv and 1776 Energy, entered into an agreement to jointly develop and produce minerals from certain leases they owned in Karnes County. Ovintiv  was in charge of distributing production payments.

A third oil company sued 1776 to require it to transfer leases to the third company, and obtained a constructive trust on production payments until the transfer was completed. Because the trust clouded title to the production payments, Ovintiv suspended payments to 1776. 1776 eventually got paid but wanted interest on those payments from Ovintiv.

The Supreme Court held the suspension was authorized by the Texas Natural Resources Code. That Code provides that withholding payments without interest was allowed when a title dispute “would affect distribution of payments.” The Code also states that allows a payor can withhold payments without interest when the payor has reasonable doubt that the payee has clear title to the proceeds. Thus, the Court held 1776 was not entitled to interest.

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In Bridges v. Uhl, No. 08-21-00130-CV,  (Tex. App.—El Paso 2022, no pet. h.) the El Paso Court of Appeals added it’s decision to the already substantial volume of court decisions grappling with the question of whether the royalty language in a deed was a fixed or a floating royalty.

The distinction has substantial economic consequences. As the Court describes it: “(A royalty) interest may be conveyed or reserved in one of two ways: ‘as a fixed fraction of total production’ (fractional royalty interest) or ‘as a fraction of the total royalty interest’ (fraction of royalty interest) … A fractional royalty interest is referred to as a fixed royalty because it ‘remains constant’ and is untethered to the royalty amount in a particular oil and gas lease. A fraction of royalty interest is referred to as a floating royalty because it varies depending on the royalty in the oil and gas lease in effect at the time, such that it is calculated by multiplying the fraction in the royalty reservation by the royalty in the (current) lease. Based on interpretation principles, the language used in the conveying or reserving instrument determines whether an interest is fixed or floating.”

In this case, the Court was asked to interpret a 1940 royalty deed that reserved a non-participating royalty interest with this language:

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I recently had occasion to reread an article from 2021 by Jude Clemente, a contributor to Forbes and the Principal at JTC Energy Research Associates, LLC. The article contains an excellent analysis of the benefits of fracking and the problems with the arguments against it. The article is entitled “Why Do ‘Fracking’ Opponents Ignore Its Moral Benefits” and you can read it here. The article is well researched, and I recommend it to any of you interested in the pros and cons of fracking, regardless of your personal view.

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The Texas Supreme Court has just issued an opinion in Point Energy Partners Permian LLC v. MRC Permian Co., ___ S.W.3d ___, 2023 WL ___, (Tex. Apr. 21, 2023) that involves the application of the force majeure language in an oil and gas lease.

Force majeure is a legal doctrine that excuses performance under a lease for certain unforeseen circumstances or “Acts of God”. In this case, the oil and gas lease required the oil company to commence drilling a new well by a certain date in order to prevent the lease from terminating at the end of the primary term. The oil company scheduled the drilling of a well, but for a date three weeks after the primary term of the lease had expired. (Presumably the lease was not being held by production).

The lease had a force majeure clause that said “[w]hen Lessee’s operations are delayed by an event of force majeure,” the lease shall remain in force during the delay with ninety days to resume operations. The oil company sent the lessor a letter invoking the force majeure clause in the lease, stating that they had to use their drilling rig to remedy wellbore instability on another (and unrelated) lease and that this prevented them from drilling the new well before the primary term expired. The problem was that a new oil company executed a new lease with the lessor after the primary term on the original lease expired.

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The Texas Supreme Court recently issued an opinion in a case in which royalties were calculated on more than gross proceeds. Specifically, the Court approved royalty language that calculated royalty on the total of gross proceeds (which by definition does not include expenses) and post-sale expenses.

In Devon Energy Prod. Co. v. Sheppard, ___ S.W.3d ___, 2023 WL ___ (Tex. Mar. 2023) [20- 0904], the leases being considered provided for royalty payments based on gross sales proceeds. However, in what is frankly unusual language for leases, the leases stated that if “any reduction or charge for [postproduction] expenses or costs” has been “include[d]” in “any disposition, contract or sale” of production, those amounts “shall be added to the . . . gross proceeds.” (Emphasis added.) In other words, the leases actually required Devon Energy to add postproduction costs incurred by third-party purchasers to the gross proceeds from sale before calculating Sheppard’s royalty.

Devon disagreed that any amount should be added to the gross proceeds. The Court noted that the contracts that were used to determine gross sales proceeds used publish index prices at market centers downstream from the point of sale.