Twenty years ago I wrote an article, “Issues Concerning Royalty Valuations and Deductions,” published in the Petroleum Accounting and Financial Management Journal. One of those issues I discussed was the recurring problem of post-production cost deductions. In the article I contrasted the approaches to lease construction illustrated by two cases: Heritage Resources v. NationsBank, 939 S.W.2d 118 (Tex. 1996), and Rogers v. Westerman Farm Co., 29 P.3d 887 (Colo. 2001). A recent decision from the Colorado Supreme Court, Board of County Commissioners of Boulder County, Colorado v. Crestone Peak Resources Operating, LLC, 2023 WL 8010221 (Nov. 20, 2023), further illustrates the contrasting approaches taken by Texas and Colorado courts in construing oil and gas leases.
First, Heritage v. NationsBank and Rogers v. Westerman. Both decided whether post-production costs could be charged to the royalty owner in two oil and gas leases. The NationsBank lease provided 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.” But because the lease provided for gas royalties based on “market value at the well,” the Texas Supreme Court held that transportation costs were deductible from NationsBank’s royalty. The Westerman lease provided that the royalty would be “one-eighth of the gross proceeds received from the sale of such produced substances where same is sold at the mouth of the well, or … if not sold at the mouth of the well, … one-eighth of the market value thereof at the mouth of the well, but in no event more than one-eighth of the actual amount received by the lessee for the sale thereof.” The Colorado Supreme Court held that the lessee must bear all post-production costs necessary to get the gas into “marketable condition.”
The Heritage court hung its opinion on the term “at the mouth of the well.” Since royalty is to be based on the market value at the well, there can be no deductions from that value, so the no-deductions clause was “surplusage.” The Westerman court instead said the term “at the mouth of the well … says nothing about the parties’ intent with respect to allocation of costs,” and concluded that the lease is “silent with respect to allocation of costs.”