Oil and Gas Lawyer Blog
Last July the Fort Worth Court of Appeals decided City of Crowley v. TotalEnergies E&P USA, Inc. Last week the Texas Supreme Court denied the City’s petition for review. Another case in which Heritage v. NationsBank has raised its ugly head.
The City’s lease had the following provisions related to how its royalty should be calculated:
• The Lessee is to pay the Lessor “the Royalty Fraction of the market value at the point of sale, use, or other disposition” (the
“Valuation Provision”);
• “The market value of gas will be determined at the specified location” and “will never be less than the total proceeds received
by lessee in connection with the sale, use, or other disposition of the oil or gas produced or sold” (the “Total Proceeds Provision”);
• “[I]f Lessee realizes proceeds of production after deduction for any expense of production, gathering, dehydration, separation,
compression, transportation, treatment, processing, storage, or marketing, then the reimbursement or the deductions will be
added to the total proceeds received by Lessee” (the “Add-to Provision”); and
• “Lessor’s royalty will never bear, either directly or indirectly, any part of the costs or expenses of production, separation,
gathering, dehydration, compression, transportation, trucking, processing, treatment, storage, or marketing of the oil or gas
produced from the Land . . . .” (the “Post-production Provision”).
Total sells its gas to Total Gas & Power North America, Inc. (TGPNA), its affiliate, at the wellhead. TGPNA pays Total for the gas based on a weighted average sales price received for sales by TGPNA at points of sale downstream from the wellhead, less TGPNA’s gathering and transportation costs. Crowley argued that, under the Add-to Provision of its lease, those gathering and transportation costs had to be added back to the price for purposes of calculating Crowley’s royalty. The Court of Appeals disagreed.
The Court of Appeals held that the precedent set in the Supreme Court’s opinion in Heritage v. NationsBank controls. The point of sale is at the wellhead, and the royalty is based on market value at the point of sale, so the Add-to Provision of the lease is “surplusage” under Heritage.
In its petition for review Crowley argued that Heritage is distinguishable and that Devon v. Sheppard should control. The Crowley lease provides that the royalty shall never be less than the “total proceeds received by Lessee”, and if those proceeds are paid after deduction of post-production costs, those costs should be added back:
Because TOTAL sells the gas to its affiliate, TGPNA, at the wellhead, no post-production costs are incurred before the valuation point at the wellhead. (see also Heritage, 939 S.W.2d at 130 (holding no post-production costs are incurred before the wellhead). And there is no dispute that TOTAL pays Crowley’s royalties based on the total proceeds it receives at the wellhead. These facts are in line with the facts in Sheppard, where Crowley receives its royalty based on total proceeds at the point of sale unburdened by pre-sale, post-production costs and where the lessors in Sheppard received their royalties based on gross proceeds at the point of sale unburdened by pre-sale, post-production costs. Total proceeds at the well are no different than gross proceeds in this context—both are already free of post-production costs up to the valuation point.
The flawed reasoning of Heritage continues to haunt royalty owners.
A solution to this problem is to provide in the lease that, if the lessee sells to an affiliate, the royalty will be paid on the gross price received by the affiliate, with no post-production costs deducted.