Oil and Gas Lawyer Blog
In Fasken Oil and Ranch, Ltd. v. Puig, No. 04-23-00106-CV, the San Antonio Court of Appeals was asked to construe a royalty reservation in a 1960 deed:
There is saved, excepted and reserved, in favor of the undersigned, B.A. Puig, Jr., out of the above described property, an undivided one-sixteenth (1/16) of all the oil, gas and other minerals, except coal, in, to and under or that may be produced from the above described acreage, to be paid or delivered to Grantor, B.A. Puig, Jr., as his own property free of cost forever. Said interest hereby reserved is Non-Participating Royalty.
Fasken operates wells on the property; the Puig descendants sued Fasken for deducting post-production costs from their royalty. The trial court agreed with Puig, and the court of appeals affirmed, in a well-reasoned opinion relying on the Supreme Court’s opinion in Chesapeake Exploration v. Hyder, 483 S.W.3d 870 (Tex. 2016). “Free and of all cost forever” means what it says and includes both production costs and post-production costs. The court distinguished Heritage Resources v. Nationsbank, 939 S.w.2d 118 (Tex. 1996) because unlike Heritage the royalty clause in this reservation “does not contain a valuation point.” The lease in Heritage provided that royalty was payable on the market value “at the well,” the point at which royalty was valued for purposes of calculating royalty; so even though the lease also provided for no deductions from the lessors’ royalty, the Supreme Court said post-production costs incurred downstream of the well could be deducted.
If the Supreme Court does not reverse Fasken v. Puig, we now know that an oil and gas lease can simply reserve a royalty on all oil and gas, “free of cost,” without providing a valuation point such as “at the well,” and thereby prohibit deduction of post-production costs from the lessor’s royalty. No other language is necessary, at least for post-production costs incurred by the operator before the point of sale. If post-production costs are borne by the purchaser of production and deducted from the sales price, more is needed to prohibit the deduction of such costs. See Devon v. Sheppard. Also, if the operator sells “at the well” to an affiliate of the operator, the royalty clause must address sales to an affiliate to avoid indirect deduction of post-production costs incurred by the purchaser affiliate.
In any event, those of us representing royalty owners now know how to draft a royalty clause that is truly “cost-free.”