The Texas Supreme Court recently issued an opinion in a case in which royalties were calculated to be greater than gross proceeds.
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 royalty. 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.
The Supreme Court held that the unusual language in the leases unambiguously requires that downstream costs identified in the oil and gas operator’s downstream sales contracts must be added to the royalties, even though the royalties would then exceed actual gross proceeds.
No doubt mineral owners will attempt to add language like the language in these leases to their oil and gas leases. However, expect major pushback from the oil companies.