As readers of this blog know, we have been following the case of Marcia Fuller French, et al. v. Occidental Permian Ltd., which is an important Texas case involving gas royalties. You can read our previous blog post here. The case was heard by the Supreme Court of Texas on February 5, 2014 and the The Texas Supreme Court has issued its decision.
As you may recall, Martha Fuller French and the other Plaintiffs were royalty owners and lessors on two oil and gas leases in Scurry County and Kent County, Texas. One lease is referred to in the decision as the “Fuller Lease”, which was executed in 1948, and the other lease is referred to as the “Cogdell Lease”, which was leased 1949.
In 2001, Occidental Permian began injecting wells on these leases with carbon dioxide to boost oil production. As a result, the natural gas produced from these leases contained about 85% carbon dioxide. Occidental then treated the gas to remove the carbon dioxide and sold the remaining gas, sending the carbon dioxide back to be reused at the well. Occidental paid Ms. French and the others royalties on the gas after it was treated and then deducted treatment costs from the royalties.
In Texas, the general rule, which can be modified by the language in a lease, is that royalties are not subjected to the costs of production, but are usually subjected to post-production costs, including taxes, treatment costs to render the hydrocarbons marketable, and transportation costs. Ms. French and the other Plaintiffs claimed that they should have received royalties on all gas produced, that Occidental should not have deducted post production costs, and since these costs were deducted from their royalties, they were underpaid by Occidental. The trial court agreed with them and awarded them $10.5 million in compensation. The case then went to the Texas Court of Appeals in Eastland, Texas, which overturned the judgment of the trial court and vacated the $10.5 million award.
In the Texas Supreme Court, the principal issues were: 1) whether the gas should be valued in its original state, before extraction from the well, or at the wellhead where it is commingled with carbon dioxide; 2) whether removing, compressing, and transporting carbon dioxide should be classified as a production operation; and 3) whether carbon dioxide removal off site for reuse is a production operation.
In a decision written by Chief Justice Nathan Hecht, the Texas Supreme Court affirmed the decision of the Court of Appeals. The decision held that carbon dioxide removal is a post-production expense that royalty owners share with the field operator. In the leases in this case, the Plaintiffs gave Occidental the right and discretion to decide whether to reinject or process the casinghead gas (which is gas produced with oil in oil wells, which is different from gas produced in a gas well) and since the Plaintiff royalty owners benefited from that decision, the royalty owners must share the cost of carbon-dioxide removal. The Court pointed out that the Fuller Lease specifies that the cost must be considered when determining the market value of the gas, and it is this figure that the royalty is based on. The Cogdell Lease provided that the cost of off-site manufacturing of the natural gas liquids and residue gas is deducted from royalties.
This decision contains two important lessons. First, an oil and gas lease may last for decades. Secondly, whether or not costs are deducted from your royalties can make a substantial difference in the amount of your royalty check. This case illustrates once again how critical it is to have an experienced oil and gas attorney review the fine print before you sign an oil and gas lease.
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