City of Crowley v. TotalEnergies E&P USA, is a post-production cost (PPC) case with a predictable result. The Fort Worth Court of Appeals confirmed its reasoning in Shirlaine W. Props. Ltd. v. Jamestown Res., L.L.C from 2021, that under a market-value oil and gas lease, gas sold at the wellhead means that other promises within the lease that royalties will never bear PPCs don’t matter. The lessee will bear its share of costs incurred to make the gas marketable.
Background and legal framework
The lessor’s share of production depends on two factors: the valuation metric (market value, proceeds, or price) and the point of valuation (at the well or other point of the). Together, these factors determine whether the royalty bears PPCs.
Gas sold at the wellhead is valued before PPCs are incurred and the royalty owner typically shares those costs through the workback method (which estimates wellhead value by subtracting PPCs from prices received downstream). In contrast, a gross-proceeds royalty is measured by the lessee’s actual receipts at the point of sale and is free of PPCs when the sales occur downstream.
The lease provisions
The court examined four key provisions of the royalty clause:
- Payment will be the “Royalty Fraction of the market value at the point of sale, use, or other disposition”. The point of sale here was the wellhead;
- The market value “will never be less than the total proceeds received by Lessee in connection with the sale …” .
- “[I]f Lessee realizes proceeds of production after deduction for any expense of [postproduction] . . . then the reimbursement or the deductions will be added to the total proceeds”; and
- “Lessor’s royalty will never bear, either directly or indirectly, . . . any part of [PPCs].”
Shirlaine controls
The court found the lease provisions to be nearly identical to those in Shirlaine. The valuation provision fixed market value at the wellhead – the point of sale. Moreover, adopting the lessor’s reading would improperly rewrite an at-the-well market-value lease into a “total proceeds” lease.
The court’s analysis
The Shirlaine reasoning was logically, legally, and linguistically sound, said the court.
The City’s argument that PPCs constitute “deductions” because gas buyers anticipate incurring them “twists commonsense economics into something it is not.” Treating the gas buyer’s expectation of downstream costs as a “deduction” from the seller’s proceeds conflates price formation with expense recovery. While the commonly-used workback method anticipates PPCs to estimate wellhead market value, this doesn’t mean the seller actually “realizes proceeds . . . after deduction” of those costs. The workback method is merely a proxy for market value.
Market value at the well means the value before gas is prepared for market. There are no marketing costs to deduct from the value. Post-sale expenses are, by definition, post-sale. Therefore, with the wellhead as the valuation point the lessees do not “realize proceeds . . . after deduction for any [postproduction] expenses.”
The add-on and no-PPC clauses did not apply to these facts; perhaps those clauses could apply if the point of sale was a place other than the wellhead.
The court affirmed summary judgment for the lessees. The lessees did not breach the lease by calculating the lessor’s royalty without including PPCs.
Caveat
Don’t read too much into this or any other PPC case. Our Supreme Court reminds us frequently that the effect of any royalty clause depends on the language of the clause itself. Beware of general statements of the law.
Your musical interlude.
Lagniappe
Its bedtime and your stash of melotonin is depleted? We can help! Read these summaries of cases cited in the opinion to learn more about PPCs:
BlueStone Nat. Res. v. Randle
Burlington Res. Oil & Gas Co. v. Tex. Crude Energy
Devon Energy Production Co. v. Sheppard
Shirlaine
[View source.]
