[co-author: Madison Schrutka]
I. Introduction
The dispute over a lessee’s obligation to pay royalty amounts for gas used off-premises continues as the Fifth Circuit certified two questions to the Texas Supreme Court last month. At issue, is whether Hilcorp Energy (as lessee) has to pay royalties on the gas used in post-production that occurred off the leased premises.
II. Parties and Lease Agreement
Plaintiffs, Anne Carl and Anderson White, as trustees of the plaintiff Carl/White Trust, and Hilcorp are successors in interest to a mineral lease governing at least two wells in Brazoria County, Texas. The Trust filed a class action complaint of behalf of several royalty owners with similar leases with Hilcorp alleging Hilcorp failed to make proper royalty payments on gas used for dehydration and compression based on the following lease provisions:
[Gas Royalty Clause] The royalties to be paid by Lessee are: . . . (b) on gas, including casinghead gas or other gaseous substance, produced from said land and sold or used off the premises or in the manufacture of gasoline or other product therefrom, the market value at the well of one-eighth of the gas so sold or used…
[Free Use Clause] Lessee shall have free use of oil, gas, coal, wood and water from said land, except water from Lessors’ wells, for all operations hereunder, and the royalty on oil, gas and coal shall be computed after deducting any so used.
III. Plaintiffs Argument
According to Plaintiffs, the lease’s market value at the well provision does not limit or otherwise affect the off-lease and free-use clauses, which entitle Plaintiffs to royalties on gas used off-lease. Central to the Plaintiffs’ argument is the recent opinion rendered by the Texas Supreme Court in BlueStone Nat. Res. II, LLC v. Randle, 620 S.W.3d 380, 387 (Tex. 2021). Plaintiffs assert Randle applies in this matter and that the clauses stating “sold or used off the premises” and “free use” require Hilcorp to pay the entire royalty for gas used off the premises, regardless of whether the lease agreement includes a “market value at the well” clause.
IV. Hilcorp’s Argument
For its part, Hilcorp argues that Randle is inapplicable to the present case, as the Randle case addressed a gross-value-received lease, and therefore, did not interpret a lease subject to the market value at the well royalty calculation. Thus, Plaintiffs’ reliance on Randle is misplaced and does not apply to the facts in this case.
V. District Court and Fifth Circuit Opinions
Judge Keith Ellison from the Southern District of Texas, Houston Division, agreed with Hilcorp about the (in)applicability of Randle, as it pertained to a gross-value-received lease, and not a value at the well lease. On appeal, however, the Fifth Circuit issued a per curiam opinion that although Randle involves a distinct lease type, the portion of the Texas Supreme Court’s opinion discussing the free-use clause could be interpreted to apply to free-use clauses in a broader sense. As such, it begs the question of whether the free-use clause in this case, when read in conjunction with the rest of the lease, permits deduction of gas used off lease for post-production purposes. The Fifth Circuit noted: (1) the parties’ cited cases pre-date the Randle decision; (2) and as of now, the Texas Courts have yet to have the opportunity to determine whether its analysis of free-use is applicable to value-at-the-well leases; and (3) while the federal cases are meticulous, they offer little more than “Erie guesses about what the Supreme Court of Texas would do.”
VI. Certified Questions
Because of the ambiguity surrounding Randle’s impact, the Fifth Circuit ultimately certified the following questions to the Texas Supreme Court:
- After Randle, can a market-value-at-the well lease containing an off-lease-use-of-gas clause and free-on-lease-use clause be interpreted to allow for the deduction of gas used off lease in the post-production process?
- If such gas can be deducted, does the deduction influence the value per unit of gas, the units of gas on which royalties must be paid, or both?
On January 19, 2024, the Texas Supreme Court accepted the certified questions. Oral arguments are set for March 19, 2024, at 9:00 a.m. CST. We will continue to follow this case and provide any updates.
