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Another Case on Post-Production Costs

Netty Engler Energy, LP has asked the Texas Supreme Court to review the decision of the Fort Worth Court of Appeals in Netty Engler Energy, LP v. Bluestone Natural Resources II, LLC, 2020 WL 3865269 (July 9, 2020).

Engler owns a royalty interest in a section of land in Tarrant County on which Bluestone owns a lease and operates gas wells. Engler’s Top-Tenroyalty interest originated in a deed in which the grantor reserved a one-eighth non-participating royalty interest. The deed provides that the grantor reserves “a free one-eighth (1/8) of production … to be delivered to Grantor’s credit, free of cost in the pipe line, if any, otherwise free of cost at the mouth of the well or mine.”

Bluestone contracted with Crestwood Equity Partners to gather its gas through a gathering system owned by Crestwood and deliver it to various delivery points into a pipeline owned by Energy Transfer, where the gas is sold. Bluestone deducted the gathering fees charged by Crestwood from Engler’s royalty.

Engler argued that the “pipe line” referred to in the royalty reservation is Energy Transfer’s transmission line, not Crestwood’s gathering lines, and that Crestwood’s fees could not be deducted from its royalty. The trial court agreed, but the Court of Appeals reversed, relying on the Texas Supreme Court’s opinion in Burlington Resources Oil & Gas Co. LP v. Texas Crude Energy, LLC, 573 S.W.3d 198 (Tex. 2019). In Burlington v. Texas Crude, the Court held that the term “into the pipeline” in a grant of overriding royalty was equivalent to “at the well,” and Burlington could deduct post-production costs from Texas Crude’s overriding royalty even though the assignment provided that the royalty would be “free and clear of … all costs and expenses except the taxes thereon.”

At the trial court, Engler introduced the affidavit of an expert in support of its motion for summary judgment. The expert said that “pipeline” as commonly used in the industry means a transmission pipeline like Energy Transfer’s, and not gathering lines like those owned by Crestwood. The Court of Appeals does not mention or address this affidavit in its opinion. But the Court rejected Engler’s argument that Crestwood’s gathering system is not a pipeline as that term is used in the royalty reservation.

Our firm assisted Texas Crude in its appeal to the Texas Supreme Court. One of our arguments was that the term “free of cost into the pipeline” as used in royalty reservations and grants was intended to mean that the royalty owner’s interest should not bear any cost incurred in moving gas to the purchaser pipeline. We cited an article by A.W. Walker, Jr., who was a prominent oil and gas attorney in the early 20th century, a law professor, and the author of seminal articles explaining the basics of Texas oil and gas law. He was a founder of the firm Jackson & Walker, and the University of Texas School of Law has an endowed professorship in his name. Professor Walker wrote more than 50 years ago that the phrase “into the pipeline” in a royalty clause was intended to make the royalty free of any cost incurred to get the production “into the pipeline” – at that time the point of sale:

When the royalty upon oil is payable in kind it is usually stipulated that the royalty oil shall be delivered, free of cost, in the pipe line to which the lessee may connect the wells. The lessor by his division order contract with the pipe line company provides for its receipt at that point and for the time and manner of payment by the purchaser. This clause obviates the necessity of any expenditures by the lessor in connection with the storage, treatment, and transportation of his royalty oil to his purchaser, and requires these expenses, sometimes of considerable proportions, to be borne by the lessee. It is, therefore, a vitally important provision from the standpoint of the lessor.

Although Professor Walker’s comments are with respect to oil production, his logic applies as well to gas production. His remarks are consistent with Engler’s argument that the “pipe line” referred to in the royalty reservation is the point where the production is delivered to Bluestone’s purchaser.

Unfortunately for royalty owners, if the Fort Worth court’s opinion in Engler v. Bluestone stands, future cases will view the words “into the pipeline” in a royalty reservation as equivalent to “at the well” for purposes of allocating post-production costs, and any other language in the royalty reservation will be considered “surplusage” under the holding in Heritage Resources v. NationsBank.

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