Texas Supreme Court once again rules against royalty owners in post-production costs case

Today the Texas Supreme Court decided Carl v. Hilcorp Energy Co, No. 24-0036. Its opinion addresses certified questions submitted to it by the US Fifth Circuit Court of Appeals concerning a class action suit pending in that court.

The Carls’ lease provided for payment of gas royalty based on its “market value at the well.” The lease also provided that royalty must be paid on gas “sold or used off the premises.” Hilcorp used some of the gas produced “off the premises” to transport or process the gas produced from the lease. Hilcorp did not pay royalty on the gas used. The Texas Supreme Court agreed with Hilcorp that it owes no royalty on the gas used off the premises.

This is another in a long line of cases in which the Court relies on its flawed reasoning in Heritage Resources v. Nationsbank. The Court’s reasoning: because the measure of gas royalty is “market value at the well,” the lessor must bear its share of post-production costs. Hilcorp’s use of gas for post-production costs must therefore be part of the cost borne by the lessor. One way to do that is to not pay royalty on the gas used. So, even though the lease provides for royalty on gas “used off the premises,” Hilcorp need not pay royalty on such gas as long as it is used to enhance the value of the gas after it leaves the lease. If Hilcorp were to use some of the gas for other purposes, royalty would be due.

In my view, the Court has re-written the clause “sold or used off the premises” so that it can reinforce its holding in Heritage that “market value at the well” requires the lessor to bear all post-production costs regardless of any other lease language to the contrary.