The practice of deducting post-production costs from landowner royalties continues to be controversial and contentious issue here in Pennsylvania. Many landowners sought to insulate their royalties from such deductions by negotiating royalty clauses which require the royalty to be calculated “free of cost forever”. The intent of such language appeared obvious: No costs of any kind would ever be deducted from or against the landowner’s royalty. Unfortunately, many of these clauses neglected to define or designate exactly what “costs” were subject to the prohibition. Did the prohibition apply to both “production” costs as well as “post-production” costs? Drillers seized on this manufactured ambiguity and often argued that the “free of cost” language, without more, was not enough to insulate the landowner royalty from post-production costs. As I have written before, this argument was soundly and correctly rejected by the Texas Fourth Court of Appeals (San Antonio) back in 2024. See, Texas Appellate Court Rules that ‘Free of Cost’ Clause in 1960 Deed Prohibits the Deduction of Post-Production Costs. (December 2024). However, the Texas Supreme Court recently agreed to reexamine the substance of this opinion and granted the driller’s petition for review. See, Fasken Oil and Ranch Ltd. v. Puig (No. 24-1073, January 16, 2026). The Texas Supreme Court will now hear argument on whether the Fourth Court of Appeal’s decision should be reversed. As detailed below, this is potentially troubling news for landowners.
Before we address the underlying opinion in Fasken Oil, a brief review of the distinction between production costs and post-production costs is warranted. It is well-settled that the driller generally bears all costs associated with the planning, construction and completion of an oil and gas well. These costs are not limited to the mere drilling of the well. There are significant expenses and costs that must be spent before the drill bit ever touches the ground. See, Types of Costs: Production Costs vs. Post-Production Costs (April 2024). For example, the driller will often incur costs related to the investigation and status of the chain of title of each drill site tract. Seismic testing and other geologic studies must also be performed and evaluated. And preliminary engineering work must be performed regarding the well pad design, the placement of pipelines and the location of access roads. Additionally, there are costs associated with the preparation and submission of various environmental and municipal permits. All of these costs are known as “production” costs and are the responsibility of the driller. See, Heritage Resources, Inc. v. Nations Bank, 939 S.W.2d 118 (Tex. 1996)(“. . . royalties are not subject to the costs of the production. . .”); Bluestone Natural Resources v. Randle, 620 S.W. 3d 381 (Tex. 2021) (“[G]as royalties are generally free from the expenses incurred to extract raw gas from the land. . .”); Devon Energy Production Co. v. Sheppard, 668 S.W.3d 332 (Tex. 2023)(“[U]sually, the landowner’s royalty is free of the expenses incurred to bring minerals to the surface. . .”). In sum, the general rule is that driller is solely responsible for all of the costs of getting the gas out of the ground. See, Kilmer v. Elexco Land Services, 990 A.2d 1147 (Pa. 2010)(“. . . the expenses of production relate to the costs of the drilling the well and getting the product to the surface. . .”).
Post-production costs, on the other hand, are those costs incurred between the wellhead and the downstream point of sale. These expenses typically include the cost to dehydrate, separate, compress and transport the raw gas. For many years, these costs were not incurred by gas drillers, as they typically sold their gas to pipeline companies at the wellhead. The pipeline companies then processed and transported the gas as per federal regulations. Since the point of sale was essentially at the wellhead, calculating the value of the royalty was relatively straightforward and without controversy. This all changed in 1992. On April 8, 1992, the Federal Energy Regulation Commission issued Order No. 636, which directed the pipeline companies to “unbundle” transportation services from their own gas sales operations and, in effect, “provide common-carriage services” to gas drillers. As a result of this deregulation, gas drillers, not the pipeline companies, now performed the processing, dehydrating and compression services. As I have written before, this had a profound effect on the manner in which production royalties were calculated. See, Ohio Court of Appeals Addresses Whether Gathering and Transportation Are Separate and Distinct Post-Production Activities, (December 2024); Federal District Court Injects Confusion into Definition of Gross Proceeds Royalty Under Pennsylvania Law (June 2021); Texas Supreme Court Rules That Gross Royalty Clause Prohibits Driller From Deducting Post-Production Costs (March 2021). In sum, production costs are generally never deducted from the royalty calculation. On the other hand, post-production costs can be deducted depending on the precise language in the underlying oil and gas lease.
At issue Fasken Oil was a deed executed in 1960 concerning 11,973 acres in Webb County, Texas (the “1960 Deed”). The 1960 Deed reserved, on behalf of the seller, a non-participating royalty of one-sixteenth (1/16) in and to:
“all the oil, gas and other minerals, except coal, in 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. . . “
The dispute arose when Fasken Oil and Ranch Ltd. (“Fasken”) began to deduct post-production costs from Puig’s royalty payments. The Puig heirs objected to the deductions and filed suit in 2021 alleging a breach of the 1960 Deed.
In their suit, the Puig family essentially argued that the scope and effect of the “free of cost” language in the 1960 Deed was controlled by the Texas Supreme Court’s landmark opinion in Chesapeake Exploration LLC v. Hyder, 483 S.W. 3d 870 (Texas 2016). In Hyder, the Texas Supreme Court opined that a royalty clause which provided for a “perpetual cost-free” royalty was sufficient to exempt the royalties from all post-production costs.See, Hyder, 483 S.W. 3d at 874 (“[T]he general term cost-free does not distinguish between production and post-production costs and thus literally refers to all costs”). The Puig family contended that the “free of cost forever” language in the 1960 Deed should be construed in the same manner (i.e. no deductions).
Conversely, Fasken argued that Hyder compelled the exact opposite result given a subtle distinction between the language in the Hyder royalty clause and the 1960 Deed. Fasken further argued that the “free of cost” language only applied to production costs and had no bearing on the deduction of post-production costs. Finally, Fasken argued that the 1960 Deed required the royalty to valued “at the well-head” and, therefore, under Texas law, the net-back method authorized the deduction of costs incurred between the well-head and the downstream point-of-sale. Fasken’s argument was peculiar as the 1960 Deed did not expressly identify or designate any valuation point. In short, Fasken suggested that the “free of cost” language meant nothing and did not prohibit the deduction of post-production costs.
The trial court rejected Fasken’s strained interpretation of the “free of cost” clause and entered judgment in favor of the Puig family. The trial court observed that the “[P]uig royalties are free of post-production costs, with the exception of their pro-rata share of severance taxes.” Fasken promptly appealed to the Fourth Circuit of Appeals in San Antonio.
On appeal, Fasken reiterated its primary theory that the “free of cost” language referred only to production costs and did not exempt the royalty from post-production costs. Fasken argued that, under Hyder and its progeny, a royalty “is free from production costs but must bear its share of post-production costs unless the parties agree otherwise”. Hyder, 483 S.W.3d at 871. Fasken contended that the “free of cost” language in the 1960 Deed was insufficient to rebut this default rule. In other words, because the 1960 Deed did not clearly and unequivocally articulate an express prohibition on the deduction of post-production costs, Fasken argued that the “free of cost” language, standing alone, was not enough to overcome the default rule under the Texas law. As such, Fasken suggested that the “free of cost” language was superfluous and merely repeated the general prohibition on the deduction of production costs.
In addition, Fasken argued that the deductions were nonetheless authorized because the 1960 Deed implicitly valued the royalty at the wellhead. Again, as noted above, this argument was curious as the 1960 Deed did not expressly reference or designate any royalty valuation point. As I have written before, when the royalty valuation point is designated “at the wellhead”, drillers can utilize the “net-back” method to deduct the costs incurred between the wellhead and the downstream point-of-sale to arrive at a wellhead value. See, Pennsylvania Superior Court Rules that Royalty Clause Referencing Both ‘Gross Process’ and “At the Well’ Was Ambiguous (May 2022). See also, Heritage Resources, Inc., 939 S.W. 2d at 130 (“. . . the value of the minerals ‘at the well’ is determined by subtracting reasonable post-production costs from the value of the minerals at the point-of-sale”). Fasken suggested that the use of the word “produced” in the 1960 Deed reflected an intent to value the royalty at the wellhead. As support for this novel interpretation, Fasken noted that the term production typically refers to where “actual physical extraction from the land” occurs (i.e. the wellhead). Since the 1960 Deed stated that the royalty was based on “all the oil and gas and other minerals produced from the above-described land. . .” this implicitly created a valuation point at the wellhead, thereby inviting application of the “net-back” method. Fasken’s argument was, and is, troubling.
The Court of Appeals rejected both arguments. First, the Court of Appeals concluded that the “free of cost forever” language was functionally no different from the “perpetual cost free” royalty in Hyder:
“[W]e likewise do not see a significant distinction between the language used in Hyder and the language in this case. Thus, just as in Hyder, the ‘free of cost forever’ language in the [1960] Deed here does not distinguish between production and post-production costs and thus literally refers to all costs”
Fasken, p.8. Since Fasken had failed to adduce evidence demonstrating that the parties specifically intended to limit the clause to only production costs, the Court of Appeals was compelled to apply the clause as drafted and exempt all costs.
The Court of Appeals was also unpersuaded by Fasken’s convoluted valuation point argument. The Court of Appeals observed that the term “produced” would likely have been used in the 1960 Deed regardless of whether the valuation point was expressly referenced as being at the wellhead or at the point-of-sale. The panel opined that “. . . regardless of the location of the valuation point, the minerals would still have to be produced at some point in time.” The court characterized Fasken’s theory as “a strained extension of current law” as the gas must actually be produced for any royalty to be generated and payable. As such, Fasken’s construction of the term “produced” was unreasonable: the mere use of the term “produced” did not magically create a valuation point at the wellhead. Accordingly, the Court of Appeals affirmed the trial court’s order granting summary judgment in the favor of the Puig family.
Like Pennsylvania, an appeal to the Texas Supreme Court is discretionary and requires the petitioner (in this case Fasken) to make a persuasive showing that the underlying appeal presents a significant and compelling legal issue. On January 15, 2025, Fasken filed a “Petition for Review” with the Texas Supreme Court and framed the “compelling” legal issue as follow:
“The general rule in Texas in that “royalty on oil and gas production is free of production costs but must bear its share of postproduction costs unless the parties agree otherwise.” Chesapeake Exp., L.L.C. v Hyder, 483 S.W.3d 870, 871 (Tex. 2016) (emphasis added). Did the court of appeals err in holding, as a matter of law, that the phrase “free of cost forever,” without more, constitutes the parties’ agreement that the royalty is free from postproduction costs?
Fasken further argued that the Fourth Court of Appeal’s decision was in “direct conflict” with the Second Court of Appeal’s decision in Bluestone Natural Resources II, LLC v. Nettye Engler Energy, 640 S.W. 3d 237 (Tex. App – Fort Worth 2020). Given this purported conflict on how to interpret and apply “cost free” royalty language, Fasken urged the Texas Supreme Court to grant the petition and clarify Texas law. The author submits that there was/is no “conflict” as suggested by Fasken as the Bluestone Natural Resources royalty clause was critically different than the language in the 1960 Deed. See, Texas Supreme Court Issues Troubling Decision in Royalty Dispute (March 2022). Nonetheless, the Texas Supreme Court granted Fasken’s Petition on January 16, 2026 and oral argument will now be heard on March 3, 2026 in Austin. While any ruling of the Texas Supreme Court will not be binding on Pennsylvania courts, a reversal of the Fourth Court of Appeal’s decision could be problematic for landowners in general and will provide ammunition to drillers here in Pennsylvania.
