Posted on: Jun , 2022

Answer:  No, if the lease is a “market value at the well lease” and the gas is used to power equipment used to make the gas marketable, no royalties are due.

In another victory for oil and gas companies, royalty owners who brought a class action lawsuit in the U.S. District Court for the Southern District of Texas, were denied recovery for underpayment of royalties on gas used off the lease premises.

In the case of Carl v. Hilcorp, Case 4:21-cv-02133, TXSD (November, 2021), plaintiffs allege that based on the lease language, Hilcorp as defendant was required and failed to pay royalty on gas used off of the leased premises (off-lease.) Specifically, the lease stated:

  1. The royalties to be paid by Lessee are:…on gas,… 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…
  2. Lessee shall have free use of oil, gas, … from said land, …, for all operations hereunder, and the royalty on oil, gas and coal shall be computed after deducting any so used.

Hilcorp paid royalties only on gas used on the leased premises, but not for gas used off the lease premises.  Plaintiffs claimed that this violated clause #1 above and referenced clause #2 as reinforcement of their premise that lessee had free use of gas only “from said land,” and not off the lease premises.

PPC’s, as defined by the Texas Supreme Court in Burlington, (Burlington Res. Oil and Gas Co. LP v. Texas Crude Energy, 573 S.W.3d 198, 203 (Tex. 2019), are costs expended to prepare raw oil or gas for sale at a downstream location.  These generally include costs of separating, compressing, dehydration, processing and transportation.   Under Burlington, the court ruled that any costs used to make the gas marketable are deductible as PPC’s in a market-value-at the well lease.

In the case at hand, Hilcorp used the gas off-lease to power the equipment used for separating, compressing, dehydrating, processing and transporting the gas.  Since the lease was a “market value at the well lease,” the court held that Hilcorp could deduct the cost of the fuel without paying royalty for its use.  Thus, Hilcorp had the right to deduct the gas as a reasonable and necessary value-enhancing PPC.

This case emphasizes the proclivity of Texas courts to find in favor of oil and gas companies with respect to the deduction of PPC’s.

Midland College – Module 4 Courses Open for Registration

There is still time to register for our July Module 4 courses for PLM and DO. As always, these courses are in a fully online format to allow working professionals a flexible way to deep dive into key areas of our work as land professionals.

PLM: Oil & Gas Law & Its Impact on Land Practices

Module 4 helps students understand:

  • The Rule of Capture and its impact on Drilling
  • Mineral Owner Rights
  • Surface Owner Rights
  • The Dominant Mineral Estate
  • Implied Covenants in the Oil & Gas Lease
  • Oil & Gas Calculations

DO: Oil & Gas Calculations

Module 4 helps students understand:

  • How to read a title opinion
  • How to set up a well in Excel for a single well, a well in a unit and a well with an overriding royalty interest
  • How to calculate the interests of each of the owners including royalty owners, working interest owners, non-participating owners, etc.