This lease royalty case involved a dispute over whether the lessee was permitted to deduct volumes of gas used off the premises to power post-production activities on other gas produced from the same well. Carl v. Hilcorp Energy Co., 689 S.W.3d 894, 896 (Tex. 2024) on questions certified in Carl as Co-Tr. of Carl/White Tr. v. Hilcorp Energy Co., 91 F.4th 311, 313 (5th Cir. 2024).
The lease provided for a royalty calculated based on the “market value at the well.” The lessor acknowledged that this “at the well” language, if standing alone, would generally entitle the lessee to deduct volumes of gas used in post-production activities. However, the lessor argued that two additional lease provisions modified that result. The Texas Supreme Court disagreed.
The Royalty Clause Argument
First, the lessor relied on a portion of the royalty clause indicating that royalty was due “on gas … produced from said land and sold or used off the premises.” The lessor argued that this meant royalty was due on all volumes produced and used off the premises, which would not allow removal of fuel gas volumes used off premises when calculating royalty. The Court disagreed, reasoning that although the lessee was obligated to pay a royalty on all gas produced, the lessee was entitled to convert its downstream sales price into an at-the-well market value by deducting from its sales price the value of the gas that was used off the premises to prepare other royalty-bearing gas for sale. In the Court’s view, when the value was calculated in this manner, the lessor was still paid on all volumes of gas produced.
The Free-Use Clause Argument
The lessor also relied on a free-use clause, which provided “Lessee shall have free use of oil [and] gas … for all operations hereunder, and the royalty … shall be computed after deducting any so used.” The lessor argued that this meant the lessee was only allowed free use of gas for operations on the leased premises, and was therefore required to pay a royalty for gas used in operations off the leased premises. The Court rejected that argument, reasoning that it was irrelevant whether the lessee was allowed free-use of certain gas, because that would not change the fact the lessor held an at-the-well royalty which meant it must share in post-production costs.
Distinguishing from BlueStone Nat. Res. II, LLC v. Randle
The lessor relied on BlueStone Nat. Res. II, LLC v. Randle, 620 S.W.3d 380, 387 (Tex. 2021), where the Texas Supreme Court held that a free-use clause allowing free use of gas used “in all operations … hereunder,” meant the lessee was entitled to free on-lease use of gas, but did not entitle the lessee to free use of gas off the leased premises. The Court distinguished Randle, reasoning that it involved a “gross proceeds” royalty which generally does not bear post-production costs and “so the question of how to account for post-production costs was not before the Court at all in Randle.” Further, in the Court’s view, nothing in Randle suggests that a free-use clause can change an at-the-well royalty holder’s obligation to bear its share of post-production costs.
