On March 1, 2019, the Texas Supreme Court issued its opinion in Burlington Resources Oil & Gas Company LP v. Texas Crude Energy, LLC. dealing with whether royalties paid under an overriding royalty agreement should bear deductions for post-production expenses. The court’s opinion illustrates that whether royalty interests bear post-production expenses depends entirely upon the language of the contract and whether the royalties are determined “at the well” before post-production or further downstream at the point of sale. In this particular case, the court held that the royalty interest was responsible for its share of post-production expenses.
Texas Crude and Burlington entered into overriding royalty agreements as part of a Prospect Development Agreement. A dispute arose between the parties regarding whether the royalties paid to Texas Crude based upon Burlington’s sale of products from its wells were subject to deductions for post-production expenses. Texas Crude argued that because the royalties were based upon “the amount realized” by Burlington for the arm’s-length sale of products from the wells, then Burlington could not deduct post-production expenses from royalties paid to Texas Crude.
The Texas Supreme Court reversed and held that Texas Crude was responsible for its share of post-production expenses because the royalty agreements provided that the royalty interest shall be delivered “into the pipelines, tanks, or other receptacles
with which the wells may be connected.” The court analogized this provision with “at the well” royalty clauses where the royalty is based upon the price obtainable at the point of production before the oil and gas products are treated, processed, and transported. This would be a price derived by deducting the post-production expenses incurred by Burlington to prepare the products for sale from the amount Burlington realized from the sale. Therefore, the court held that Texas Crude’s royalty was, under the language of this contract, based upon the price received by Burlington minus the post-production expenses.
The issue of whether royalty interests under oil and gas leases or similar agreements should bear post-production expenses has spawned extensive litigation in Texas courts. This opinion may provide additional guidance toward resolving these issues in cases with similar royalty provisions. However, the language used in royalty clauses varies tremendously and each lease or agreement must be individually reviewed to determine the proper allocation of post-production expenses between operators and royalty owners. Even then, ambiguity or lack of clarity may require court determinations for certainty.