BlueStone Natural Resources II, LLC v. Walker Murray Randle Stetson Massey, Jr. Jo Ann Randle Massey Sundance Minerals, LP Deborah Lou Marshall Scherer Marshall Scherer Ranch, LP Sherry E. Marshall Pomykal Marshall Pomykal Ranch, LP Ardis Elaine Marshall Nancy Putteet Fish Gary M. Putteet James Calhoun Langdon, Jr. Sandra Wilson Langdon Joseph Steadman Langdon And Karen Rae Langdon

In the
Court of Appeals
Second Appellate District of Texas
at Fort Worth
___________________________
No. 02-18-00271-CV
___________________________
BLUESTONE NATURAL RESOURCES II, LLC, Appellant
V.
WALKER MURRAY RANDLE; STETSON MASSEY, JR.; JO ANN RANDLE
MASSEY; SUNDANCE MINERALS, LP; DEBORAH LOU MARSHALL
SCHERER; MARSHALL SCHERER RANCH, LP; SHERRY E. MARSHALL
POMYKAL; MARSHALL POMYKAL RANCH, LP; ARDIS ELAINE MARSHALL;
NANCY PUTTEET FISH; GARY M. PUTTEET; JAMES CALHOUN LANGDON,
JR.; SANDRA WILSON LANGDON; JOSEPH STEADMAN LANGDON; AND
KAREN RAE LANGDON, Appellees
On Appeal from the 355th District Court
Hood County, Texas
Trial Court No. C2016258
Before Gabriel, Pittman, and Bassel, JJ.
Memorandum Opinion by Justice Bassel
MEMORANDUM OPINION
I. Introduction
In this appeal’s primary issue, we deal with a perennial struggle in Texas oil and
gas law: Does the lessor or the lessee pay post-production costs (the processing and
marketing costs of gas produced from a lease after the gas’s extraction from the
ground)? Appellant/Lessee characterizes the lease we interpret as “Frankenstein’s
Monster” with its parts cobbled together from the parts bin of oil and gas lease
provisions. For this reason and others, Appellant urges that we must harmonize the
terms of this unique creation to avoid having a perhaps inadvertently-included
provision govern. Appellees’/Lessors’ theme is that no matter its conception, we are
bound by the language of the lease; that its terms dictate how to resolve conflicts in its
language; and that any desire for a harmonious interpretation must give way to an
obvious conflict between two of the lease’s terms.
Our specific task of interpretation begins with a royalty provision contained in
a printed form lease that placed the burden on Appellees to pay post-production
costs. The complication is that the parties appended additional terms to the printed
form, and Appellees argue that one of the terms in the addendum created a royalty
measure that shifted the burden of post-production costs onto Appellant. We
conclude that the printed and appended terms are contrary to each other and that the
controlling provision is in the appended terms. This resolution places the burden of
paying post-production costs on Appellant. Accordingly, we affirm.
2
II. Procedural Background
The underlying litigation was originally brought in separate suits by various
Appellees/Lessors. In the separate suits, Appellant and Appellees filed cross-motions
for partial summary judgment that hinged on whether the provisions of the oil and
gas leases at issue permitted Appellant to deduct post-production costs from royalty
payments owed to Appellees. The parties entered into various stipulations regarding
damages, depending on the trial court’s summary-judgment ruling.
The trial court signed orders granting Appellees’ motions for summary
judgment, which decreed that the leases did not permit the deduction of post-
production costs and that the deduction of these costs breached the leases. The trial
court then signed interlocutory judgments that again concluded that the leases did not
permit the deduction of post-production costs and that the deduction of these costs
breached the leases at issue. The trial court found that two additional breaches had
occurred from Appellant’s failure to pay royalties on what the parties stipulated to be
Plant Fuel and Compressor Fuel. The interlocutory judgments awarded damages in
accord with the parties’ stipulations. Finally, the interlocutory judgments awarded
attorneys’ fees through trial but reserved the issue of appellate attorney fees for
determination in a separate judgment.
The parties next filed various agreed motions to consolidate, which the trial
court granted. The trial court incorporated the interlocutory judgments into a
3
“Consolidated Final Judgment.” The Consolidated Final Judgment also awarded
appellate attorneys’ fees. This appeal followed.
III. Lease Terms
Because the primary question before us is how to interpret two terms of an oil
and gas lease, we set forth the key terms. This appeal involves twelve leases, but the
parties agree that the terms at issue are virtually identical among those various leases.
Each lease has two components. The first component is a set of printed terms
covering two pages. The second component is labeled “Exhibit ‘A’” and also
contains printed terms, which cover three pages. For ease of reference and for
consistency with how the documents refer to themselves internally, we will refer to
the two components as the Printed Lease and as Exhibit “A.”1
One of the two terms at issue is in Paragraph 3 of the Printed Lease. That
paragraph provides a royalty for gas produced from the leased properties in the
following fashion:
(b) on gas, including casinghead gas, or other gaseous substance
produced from said land and sold or used off the premises or for the
extraction of gasoline or other product therefrom, the market value at
the well of one-eighth of the gas so sold or used, provided that on gas
sold by Lessee the market value shall not exceed the amount received by
Lessee for such gas computed at the mouth of the well, and on gas sold
at the well the royalty shall be one-eighth of the amount realized by
Lessee from such sale . . . .
1
We refer to all of these as Exhibit “A” despite the fact that some of the
addenda are technically labeled “Exhibit B” because those are preceded by an exhibit
containing a legal description of the leased premises.
4
One of the twelve leases has a slightly different form but still states a royalty valuation
for gas sold by Appellant/Lessee as “the amount realized by [L]essee, computed at
the mouth of the well.”
The introductory paragraph in Exhibit “A” states, “It is understood and agreed
by all the parties that the language on this Exhibit ‘A’ supersedes any provisions to the
contrary in the printed lease hereof[.]” The other provision in controversy is
Paragraph 26 of Exhibit “A.” That provision states in whole as follows:
LESSEE AGREES THAT all royalties accruing under this Lease
(including those paid in kind) shall be without deduction, directly or
indirectly, for the cost of producing, gathering, storing, separating,
treating, dehydrating, compressing, processing, transporting, and
otherwise making the oil, gas[,] and other products hereunder ready for
sale or use. Lessee agrees to compute and pay royalties on the gross
value received, including any reimbursements for severance taxes and
production related costs.
IV. Summary-Judgment Standard of Review
We apply a de novo standard of review to summary judgments. Travelers Ins.
Co. v. Joachim, 315 S.W.3d 860, 862 (Tex. 2010). “When competing summary-
judgment motions are filed, ‘each party bears the burden of establishing that it is
entitled to judgment as a matter of law.’” Tarr v. Timberwood Park Owners Ass’n, Inc.,
556 S.W.3d 274, 278 (Tex. 2018) (quoting City of Garland v. Dallas Morning News, 22
S.W.3d 351, 356 (Tex. 2000)). “[I]f ‘the trial court grants one motion and denies the
other, the reviewing court should determine all questions presented’ and ‘render the
judgment that the trial court should have rendered.’” Id.
5
V. Guiding Rules of Construction for Oil and Gas Leases
“An oil and gas lease is a contract, and its terms are interpreted as such.”
Tittizer v. Union Gas Corp., 171 S.W.3d 857, 860 (Tex. 2005). “In construing an
unambiguous oil and gas lease, . . . we seek to enforce the intention of the parties as it
is expressed in the lease.” Id. “We give terms their plain, ordinary, and generally
accepted meaning[s] unless the instrument shows that the parties used them in a
technical or different sense.” Heritage Res., Inc. v. NationsBank, 939 S.W.2d 118, 121
(Tex. 1996).
“We examine the entire lease and attempt to harmonize all its parts, even if
different parts appear contradictory or inconsistent.” Anadarko Petroleum Corp. v.
Thompson, 94 S.W.3d 550, 554 (Tex. 2002) (citing Luckel v. White, 819 S.W.2d 459, 461
(Tex. 1991)). A court examines all of the lease’s provisions “because we presume that
the parties to a lease intend every clause to have some effect.” Id. (citing Heritage Res.,
939 S.W.2d at 121). Finally, we “cannot change the contract merely because we or
one of the parties comes to dislike its provisions or thinks that something else is
needed in it.” Arlington Surgicare Partners, Ltd. v. CFL Invs., LLC, No. 02-15-00090-CV,
2015 WL 5766928, at *2 (Tex. App.—Fort Worth Oct. 1, 2015, no pet.) (mem. op.)
(quoting Cross Timbers Oil Co. v. Exxon Corp., 22 S.W.3d 24, 26 (Tex. App.—Amarillo
2000, no pet.)). 2
2
Parties may contend, or an appellate court may determine on its own, that a
lease is ambiguous. Coker v. Coker, 650 S.W.2d 391, 393 (Tex. 1983). The parties’
6
VI. Overview of Royalty Provisions and
the Allocation of Post-Production Costs
As noted in the introduction, one frequent source of conflict between lessors
and lessees and the central conflict in this appeal is which party bears the costs of
processing minerals once they are extracted from the ground, i.e., which party will
bear the post-production costs. The unique terminology used to express the
calculation of a royalty, especially a gas royalty, requires a description of the standard
practice in allocating costs, the structure of a royalty clause, and the nuances in arcane
oil and gas terminology that impact the question of the allocation of post-production
costs.
At its most elementary level, a royalty is the landowner’s share of production
from a lease. See U.S. Shale Energy II, LLC v. Laborde Props., L.P., 551 S.W.3d 148, 154
(Tex. 2018). Of course, there are costs both for bringing the minerals, such as oil and
gas, to the surface and for processing those minerals once they are brought out of the
ground. The issue of which party to a lease pays the post-production processing costs
of gas is of greater moment than for the processing of oil:
[U]nlike oil, which is typically sold to a refinery from storage tanks near
the well and trucked to the refinery, the sale of gas involves substantial
costs after the gas is brought to the surface. The gas must be
disagreement about a document’s meaning does not make it ambiguous; ambiguity
arises only if the document is subject to more than one reasonable interpretation.
Endeavor Energy Res., L.P. v. Discovery Operating, Inc., 554 S.W.3d 586, 601 (Tex. 2018).
None of the parties in this appeal contend that the leases are ambiguous, and we do
not conclude that they are.
7
compressed, processed, and transported to a market hub. Those
operations are often expensive[] but usually increase the value of the gas.
Joseph Shade & Ronnie Blackwell, Primer on the Texas Law of Oil & Gas, 59 (5th ed.
2013).
In Texas, a royalty is free of the expenses of production—the expenses of
bringing it to the surface. Chesapeake Expl., L.L.C. v. Hyder, 483 S.W.3d 870, 872 (Tex.
2016) (op. on reh’g) (Hyder II) (citing Heritage Res., 939 S.W.2d at 121–22); Chesapeake
Expl., L.L.C. v. Hyder, 427 S.W.3d 472, 480 (Tex. App.—San Antonio 2014) (Hyder I),
aff’d, 483 S.W.3d 870 (Tex. 2016). The contrary is true of the costs incurred once the
minerals reach the surface, and the “royalty is usually subject to post-production costs,
including taxes, treatment costs to render it marketable, and transportation costs.”
Heritage Res., 939 S.W.2d at 122. As with any contract, the parties may modify the
general rule that the lessor bears the post-production costs. Hyder II, 483 S.W.3d at
872; Heritage Res., 939 S.W.2d at 122.
To try to bring some order to our review of how the leases at issue dealt with
post-production costs, we begin with a brief description of royalty clauses. One
commentator has superimposed a structure on royalty clauses and described the
clauses as commonly having the mechanics of “at least three components: (i) the
royalty fraction—e.g., 1/8th, 25%, 1/5th; (ii) the yardstick—e.g., market value,
proceeds, price; and (iii) the location for measuring the yardstick—e.g., at the well, at
the point of sale.” Byron C. Keeling, In the New Era of Oil & Gas Royalty Accounting:
8
Drafting a Royalty Clause That Actually Says What the Parties Intend It to Mean, 69 Baylor L.
Rev. 516, 520 (2017). This appeal focuses on the second and third components.
The second component—establishing “the yardstick”—may create a payment
measure that looks to an outside source, such as a market value, or may simply reflect
what was received in payment for the minerals, i.e., the proceeds of the sales of the
minerals. Bowden v. Phillips Petroleum Co., 247 S.W.3d 690, 699 (Tex. 2008). The
supreme court has provided a succinct description of the two measures:
“Proceeds” or “amount realized” clauses require measurement of the
royalty based on the amount the lessee in fact receives under its sales
contract for the gas. Union Pac. Res. [Grp.] v. Hankins, 111 S.W.3d 69, 72
(Tex. 2003) (citing Yzaguirre [v. KCS Res., Inc.], 53 S.W.3d [368,] 372
[(Tex. 2001)]). By contrast, a “market value” or “market price” clause
requires payment of royalties based on the prevailing market price for
gas in the vicinity at the time of sale, irrespective of the actual sale price.
Yzaguirre, 53 S.W.3d at 372. The market price may or may not be
reflective of the price the operator actually obtains for the gas. Id. at
372–73.
Bowden, 247 S.W.3d at 699; see Burlington Res. Oil & Gas Co. LP v. Tex. Crude Energy,
LLC, No. 17-0266, 2019 WL 983789, at *4 (Tex. Mar. 1, 2019) (discussing “proceeds”
or “amount realized” yardstick). 3
Because of its complexity, we will look first at the market-value yardstick. One
method of making the market-value determination relies on comparable sales, looking
for sales that are “comparable in time, quality, quantity, and availability of marketing
Burlington Resources was handed down after this case was submitted, but both
3
Appellant and Appellees filed post-submission letter briefs addressing the effect of
this new case on their positions on appeal.
9
outlets.” Heritage Res., 939 S.W.2d at 122. Lessees seldom use the comparable-sales
method because of a lack of data to make the calculation that measure requires.
Keeling, supra, at 531.
Instead, “[m]ost lessees use a different methodology for calculating their royalty
payments—the ‘workback method,’ which permits them to calculate the value of their
production at the wellhead by subtracting post-production costs from the price that
they receive for their production at a downstream sales location.” Id. Or as the
supreme court described the alternate methods of calculation: “Evidence of market
value is often comparable sales, . . . or value can be proven by the so-called net-back
approach, which determines the prevailing market price at a given point and backs out
the necessary, reasonable costs between that point and the wellhead.” Heritage Res.,
939 S.W.2d at 130 (Owen, J., concurring).4
The third component of the royalty mechanism—the location for measuring
the yardstick—is a vital part of the royalty calculation. It establishes the point from
which a lessee works back to determine market value. Keeling, supra, at 530–32. The
third component does this by setting the point along the process from production to
sale where the value determination is made. Id. at 524. Determining this location is
pivotal because of the process of gas becoming more valuable as it moves away from
the point where it was extracted from the ground (the wellhead) to a point
4
Because Justice Owen’s concurring opinion in Heritage Resources became the
plurality opinion of the Texas Supreme Court on rehearing, we will cite her
concurrence as if it were the plurality opinion. See Hyder II, 483 S.W.3d at 875 & n.25.
10
downstream in the refining process and eventually to its sale. Id. at 524–25. To
elaborate on the point we made initially, moving away from the wellhead adds value;
thus, “[o]il and gas production is less valuable at the wellhead because any arm’s
length purchaser will assume that it will have to incur the cost to remove impurities
from the production, to transport it from the wellhead, or otherwise to get it ready for
sale to a downstream market or the general public.” Id.
Tying the allocation of post-production costs to a point set between
production and sale creates the potential for unpleasant surprises for lessors.
Contrary to what a drafter unschooled in the nuances of oil and gas law might think, a
lease usually does not express the allocation by saying that one party or another will or
will not pay the post-production costs. Indeed, as discussed below, a provision
making that simple statement may be interpreted as empty words when inserted in a
royalty clause that expresses the allocation of costs in more traditional oil and gas
jargon.
A traditional expression—that requires the lessor to bear all the post-
production costs—places the third component (that establishes the location for
measuring the yardstick) “at the well.” Id. at 530–32. Thus, if market value is the
yardstick, the point of measuring the yardstick is “market value at the well,” which has
a commonly accepted meaning. Heritage Res., 939 S.W.2d at 122. This measure places
the burden of paying post-production costs on the lessor because gas that has just
emerged from the ground has not yet been “transported, treated, compressed, or
11
otherwise prepared for market,” and the market value at the well does not include the
value added by those yet-to-occur processes. Id. at 130. The lessee recoups its
expenses by working back the value from the amounts received in payment for the
minerals, with the lessor’s royalty payment being the amount that the lessee received
from the sale of the minerals net of all the expenses incurred by the lessee from the
point that the minerals emerged from the ground to the point that they were sold.
Keeling, supra, at 531–32. In other words, the lessor bears the burden of post-
production costs because the lessee deducts those costs from the price it receives and
remits to the lessor the amount received net of the amount of the post-production
costs. Judice v. Mewbourne Oil Co., 939 S.W.2d 133, 135 (Tex. 1996) (“[Market value at
the well] means value at the well, net of any value added by compressing the gas after
it leaves the wellhead.”). 5
The supreme court recently summarized this process of net-back post-
5
production expenses as follows:
The question of how to allocate post-production costs can arise when
the sale used to calculate the royalty payment is downstream from the
point at which the royalty interest is valued. If the royalty is valued at
the well but the sale takes place after the product has been processed
and transported, the product sold is generally of greater value than the
product in which the royalty holder has an interest. In this situation, the
sales price must be adjusted to properly calculate the royalty payment.
Courts have recognized that one way to make this adjustment is to
subtract the costs of bringing the product to the market (the post-
production costs) from the sales price obtained at the market.
Burlington Res., 2019 WL 983789, at *4 (citations omitted).
12
Because of the nuances in expressing the allocation of post-production costs,
there is sometimes a “night-is-day” feeling to the results in interpreting royalty clauses.
We noted above that inserting a statement in a lease to specify who will or will not
bear the post-production costs may have no effect. Blindly inserting a provision that
states no post-production costs shall be deducted from the value of the lessor’s
royalty in juxtaposition to a provision that sets the valuation yardstick “at the well” is
an exercise in futility. As one commentator noted, in leases that provide for the net-
back of post-production expenses, “there are times when the express language of the
lease may contain conflicting or inconsistent signals.” Patrick H. Martin & Bruce M.
Kramer, 6 Williams & Meyers Oil & Gas Law, § 645.2 at 614.8(1) (2018 ed.).
The supreme court explained this interpretive twist in Heritage Resources. 939
S.W.2d at 120. The royalty clause in Heritage Resources set the yardstick at the market
value of the gas produced from the lease and the point where to measure the yardstick
at the well. Id. at 120–21. But the royalty provision also included a statement—often
referred to as a “no-deductions clause”—that on its face appeared to say that the
lessor would not be charged post-production costs: “[T]here shall be no deductions
from the value of lessor’s royalty by reason of any required processing, costs of
dehydration, compression, transportation, or other matter to market such gas.” Id. at
121.
The quoted provision was not enough to put the genie back into the bottle and
save the lessor from the commitment in the first portion of the royalty clause to have
13
the market value of the royalty measured at the well, with its corresponding
commitment to allow the lessee to net-back post-production costs it had incurred
between the well and the point of sale of the gas. Id. at 130–31. The additional
phrase did not conflict with the “at the well” royalty formulation or render the clause
ambiguous; the “no deduction of post-production expenses” clause simply meant
nothing. Id. In the supreme court’s view, the appended phrase was surplusage:
As long as “market value at the well” is the benchmark for valuing the
gas, a phrase prohibiting the deduction of post-production costs from
that value does not change the meaning of the royalty clause. Thus,
even if the Court were to hold that a lessee’s duty to market gas includes
the obligation to absorb all of the marketing costs, the proviso at issue
would add nothing to the royalty clause. All costs would already be
borne by the lessee. It could not be said under that circumstance that
the clause is ambiguous. It could only be said that the proviso is
surplusage.
Id.6
A federal court summarized the Heritage Resources surplusage holding as
6
follows:
The Heritage [Resources] court held that the “no deductions” clauses were
not in conflict with the royalty provisions. The deduction of post-
production costs incurred between the wellhead and a downstream point
at which market value could be ascertained was nothing more than a
method of determining market value at the well in the absence of
comparable sales data at or near the wellhead. The value of the gas, and
therefore the value of the royalty, was not reduced. As the concurring
opinion stated, “[T]he concept of ‘deductions’ of marketing costs from
the value of the gas is meaningless when gas is valued at the well. Value
at the well is already net of reasonable marketing costs.”
Potts v. Chesapeake Expl., L.L.C., 760 F.3d 470, 475 (5th Cir. 2014) (citing Heritage Res.,
939 S.W.2d at 130).
14
Though the no-deductions clause in Heritage Resources meant nothing, that does
not mean that a lessor cannot find language to shift the burden for post-production
costs to the lessee. As noted, the supreme court has acknowledged that the parties
may agree to allocate the post-production costs however they wish. Hyder II, 483
S.W.3d at 872; Heritage Res., 939 S.W.2d at 122. The parties can specify a different
point to measure the yardstick and place the point of valuation further down the path
from production to sale. Heritage Res., 939 S.W.2d at 131 (“If [the parties] had
intended that the royalty owners would receive royalty based on the market value at
the point of delivery or sale, they could have said so.”).
Another method a lessor may use to avoid the burden of post-production
expenses is to specify a different yardstick than market value. When we first
described the second component of the royalty clause, we noted that one of the other
yardsticks that could be used to measure the royalty was proceeds. See Keeling, supra,
at 521–22. By specifying the yardstick of the amount the lessee actually receives, the
royalty provision may also remove the lessee’s ability to net the post-production
expenses out of the payment it makes to the lessor. Hyder II, 483 S.W.3d at 873. To
make our own contribution to the jargon of royalty measures, we will refer to this as a
pure-proceeds measure.
One example using this simplified mechanism/pure-proceeds measure
specifies that the lessee receives a percentage share “of the price actually received” by
the lessor. Id. at 871. The supreme court described the effect that this measure has
15
on the allocation of post-production costs as follows: “Often referred to as a
‘proceeds lease,’ the price-received basis for payment in the lease is sufficient in itself
to excuse the lessors from bearing postproduction costs.” Id. As a federal court
interpreting a royalty clause also noted, one method for a lessee to shift the burden of
paying post-production costs is to say “in the addendum that the lessor was entitled to
22.5% of the actual proceeds of the sale, regardless of the location of the sale.”
Warren v. Chesapeake Expl., L.L.C., 759 F.3d 413, 418 (5th Cir. 2014). The supreme
court recently summarized how a proceeds-based measure may affect the allocation of
post-production costs: “This Court and other courts have recognized that an
agreement to value a royalty interest based on the ‘amount realized,’ or similar
language, can grant the royalty holder the right to a percentage of the sale proceeds
with no adjustment for post-production costs.” Burlington Res., 2019 WL 983789, at
*4. 7
The supreme court in Burlington Resources substantiated the quoted statement by
7
referencing its holding in Hyder II as follows:
The majority opinion in Hyder stated that a royalty provision giving
lessors 25% of “the price actually received by Lessee” disallowed
deduction of postproduction expenses because “it is based on the price
[lessee] actually received for the gas through its affiliate, Marketing, after
postproduction costs have been paid” and because “the price-received basis
for payment in the lease is sufficient in itself to excuse the lessors from bearing
postproduction costs.” 483 S.W.3d at 871, 873.
Burlington Res., 2019 WL 983789, at *4 (emphasis added).
16
But a location for measuring the yardstick can also be superimposed on the
proceeds measure. Specifically, the addition of the words “at the well” to a proceeds
measure reverses course and restores the burden of post-production costs to its
traditional place in the lessor’s column. The supreme court recently (and succinctly)
made the point that it has “never held that an ‘amount realized’ valuation method
frees a royalty holder from its usual obligation to share post-production costs even
when the parties have agreed to value the royalty interest at the well.” Id. at *5. The
“at the well” valuation point controls the allocation of post-production costs,
apparently, no matter the underlying yardstick as noted by the supreme court:
We have never construed a contractual “amount realized” valuation
method to trump a contractual “at the well” valuation point. To the
contrary, prior decisions suggest that when the parties specify an “at the
well” valuation point, the royalty holder must share in post-production
costs regardless of how the royalty is calculated.
Id. (citing Warren, 759 F.3d at 417–18; Judice, 939 S.W.2d at 136; Heritage Res., 939
S.W.2d at 123).8
8
See also L.B. Hailey L.P. v. Encana Oil & Gas (USA) Inc., No. 5:17-cv-00149-
RCL, 2018 WL 3150691, at *5 (W.D. Tex. June 27, 2018) (mem. op.) (holding that
once a royalty clause sets an “at the well” valuation, the lease must have language to
“sufficiently circumvent” that valuation point to alter the allocation of post-
production costs). The court in Encana Oil stated,
As in Hyder [II] and Heritage [Resources], the text of the royalty clause
speaks for itself: the point of valuation is the wellhead, so post-
production costs must be deducted from the royalty to reach the proper
amount from which to calculate the royalty. These positions are
reinforced by identical interpretations of Texas state law by the Fifth
Circuit in Warren and Potts. None of the clauses in 3(d) sufficiently
17
But to take the interpretive process fully down the rabbit hole, there may be
documents that state both a pure-proceeds measure and another value tied to an “at
the well” measure. Then, the measures of royalty contradict one another. See Judice,
939 S.W.2d at 136. The supreme court has highlighted that an instrument using the
term “gross proceeds” is at odds with “at the well” language and with its mechanism
to place the burden of post-production costs on the lessee: “The term ‘gross
proceeds’ means that the royalty is to be based on the gross price received by [Lessee]
Mewbourne. The use of the term ‘at the well’ indicates just the opposite, that the
royalty is to be based on its value ‘at the well.’” Id.; see also Heritage Res., 939 S.W.2d at
130 (stating that court was not presented with a clause similar to the one at issue in
Judice in which “a division order directed royalties to be based on ‘gross proceeds
realized at the well,’” and that there is an “inherent, irreconcilable conflict between
‘gross proceeds’ and ‘at the well’ in arriving at the value of the gas,” which is a
“conflict [that] renders the phrase ambiguous”).
VII. Appellees’/Lessors’ Royalty Is Not Burdened with Post-Production Costs
In its first issue, Appellant argues that the unambiguous leases allow for the
deduction of post-production costs. Thus, our discussion up to this point has not
been purely academic. Instead, it gives context to Appellant’s and Appellees’ themes
circumvent the “at the wellhead” royalty valuation of 3(b)(1)—they are
“simply ineffective.”
See id.
18
in this appeal. To elaborate on the themes described above, Appellant’s theme is one
of harmony, arguing that we must view the various provisions at issue from a starting
point that Paragraph 3 of the Printed Lease creates a market-value-at-the-well measure
for Appellees’ gas royalty—a measure that no one disputes saddles Appellees with the
post-production expenses. With this baseline, and driven by the goal of a harmonious
interpretation, Appellant argues that the terms in Paragraph 26 of Exhibit “A”
attached to the Printed Lease do not alter—but rather are “baked into,” as Appellant
calls it—this yardstick of royalty valuation.
Appellees’ theme is conflict. They argue that the provisions of the Printed
Lease and Exhibit “A” irreconcilably contradict each other because one embodies a
market-value-measured-at-the-well yardstick and the other a pure-proceeds yardstick.
In the event of a conflict between the documents, Exhibit “A” commands that its
terms supersede those of the Printed Lease. In Appellees’ view, Exhibit “A’s” pure-
proceeds measure controls and so burdens Appellant with the post-production
expenses.
With those themes as a backdrop, our analysis will progress as follows:
• The Printed Lease creates an “at the well” royalty yardstick and measure;
• Exhibit “A” attached to the Printed Lease provides that when the terms
of the two documents are contrary to the other, Exhibit “A” supersedes,
and the lack of a specific direction in Paragraph 26 that it controls in the
19
event of a conflict is not necessary to give that paragraph a superseding
effect if it conflicts with the royalty provision of the Printed Lease;
• The test to determine whether the terms of the Printed Lease and
Exhibit “A” are contrary to each asks whether the terms of each are so
inconsistent they cannot subsist together;
• Paragraph 26 as a whole creates a pure-proceeds measure of royalty,
which is contrary to the Printed Lease’s “at the well” measure, and thus
Exhibit “A” supersedes;
• The failure of Paragraph 26 to specifically alter the point of sale does not
prevent it from superseding the different royalty measure in Paragraph 3;
• The El Paso court’s opinion in SandRidge,9 at first blush, may appear to
conflict with our analysis, but it does not address the specific arguments
we resolve; and
• Paragraph 26 cannot be read as a backstop provision to deal with
disparities between the market price of gas and the price for which gas is
sold under long-term contracts.
Comm’r of Gen. Land Office of State v. SandRidge Energy, Inc., 454 S.W.3d 603 (Tex.
9
App.—El Paso 2014, pets. denied).
20
A. We set forth the Lease Provisions and their effect on the royalty
determination.
1. The Printed Lease establishes a market-value-at-the-well royalty
yardstick.
No one disputes that the measure of royalty is created by Paragraph 3 of the
Printed Lease. That paragraph provides in relevant part that the royalty on gas is
“the market value at the well of one-eighth of the gas so sold or used.” Breaking
down the royalty clause into the components described above, (1) the
Appellees’/Lessors’ fractional share of the production is 1/8, (2) the yardstick of the
valuation is market value, and (3) the location for measuring the yardstick is “at the
well.”10 On its own, Paragraph 3 states the classic formulation that permits a lessee to
net-back the post-production expenses it incurs between the well and the point of sale
of the gas. In other words, the Appellees/Lessors bear those expenses under
Paragraph 3.
2. The first sentence of Paragraph 26 of Exhibit “A” in isolation
duplicates the no-deduction clause that the Texas Supreme Court has
held to be surplusage.
The first sentence of Paragraph 26 provides, “LESSEE AGREES THAT all
royalties accruing under this Lease (including those paid in kind) shall be without
deduction, directly or indirectly, for the cost of producing, gathering, storing,
10
The specific Exhibit “As” increase the fractional share by which the royalty is
calculated.
21
separating, treating, dehydrating, compressing, processing, transporting, and otherwise
making the oil, gas[,] and other products hereunder ready for sale or use.”
This sentence, again in isolation, ties itself to the “royalties accruing under this
lease.” At this point in the analysis, the royalty accruing under the lease is the market-
value-at-the-well analysis set out in Paragraph 3 of the Printed Lease. The language
that comes after the phrase “accruing under this lease” is almost a duplicate of the no-
deductions clause—“there shall be no deductions from the value of Lessor’s royalty
by reason of any required processing, costs of dehydration, compression,
transportation, or other matter to market such gas”—that the supreme court in
Heritage Resources held was surplusage. 939 S.W.2d at 130–31. Again, this language is
surplusage because it does not change the meaning of the “at the well” valuation
point. Appellees’ counsel agreed during oral argument that if the terms had ended
with the first sentence of Paragraph 26, the Appellees/Lessors would be subject to a
market-value-at-the-well royalty and thus burdened with the payment of post-
production costs.
3. But we must consider whether the second sentence of Paragraph 26
changes the foregoing conclusions.
This case turns on the impact of the second sentence of Paragraph 26 of
Exhibit “A.” That sentence provides, “Lessee agrees to compute and pay royalties on
the gross value received, including any reimbursements for severance taxes and
production related costs.” Thus, we next focus on this sentence’s place in the mix of
22
terms in the Printed Lease and Exhibit “A” and examine (1) why we construe it to
create a pure-proceeds yardstick for royalty valuation and (2) why it sets the measure
of royalty between the parties.
4. The introductory paragraph of Exhibit “A” establishes that its terms
supersede contrary provisions of the Printed Lease.
The first battle line in the parties’ themes of harmony and conflict involves
Exhibit “A” and how it resolves conflicts between its terms and those of the Printed
Lease. We will examine the terms referenced by the parties and how the arguments
parsing the terms have evolved during the briefing of this appeal. But at the end of
the day, we construe Exhibit “A” to provide that if any of its terms are contrary to
those of the Printed Lease, Exhibit “A” supersedes. With that guidance in mind, we
will then address the question of whether Paragraphs 3 and 26 are contrary to each
other.
The introductory paragraph of Exhibit “A” states that the
Exhibit is attached to and made a part of the Printed Lease. It then states, “It is
understood and agreed by all parties that the language on this Exhibit ‘A’ supersedes
any provisions to the contrary in the printed lease hereof[.]”
Appellees rely on the breadth of this sentence and interpret it as a self-
contained instruction that the language of Exhibit “A” supersedes “any” provisions of
the Printed Lease when provisions in the two documents are contrary to each other.
In Appellees’ view, we need not look at any other provisions of Exhibit “A” for
23
instruction on how to resolve a conflict between that Exhibit and the Printed Lease
because it has already directed that it supersedes in “any” conflict created between the
contrary terms of the documents.11
Appellant counters that Exhibit “A” states additional requirements that must
be met before its terms supersede. Appellant relies on the fact that specific
paragraphs in Exhibit “A” begin with the phrase “ANYTHING HEREIN TO THE
CONTRARY notwithstanding.” In Appellant’s view, these specific paragraphs carry
the consequence that “[w]here the parties to the Leases intended a numbered
paragraph in the addendum to amend and supersede a specific provision in the
preprinted portion, they did so consistently and unambiguously by starting the
paragraph with the phrase ‘ANYTHING HEREIN TO THE CONTRARY
notwithstanding.’”
Appellees’ rejoinder is that the inference Appellant draws from the “Anything
Herein” paragraphs is absurd, and Appellees counter by pointing out that the purpose
of the “Anything Herein” references deals not only with conflicts between the Printed
Lease and Exhibit “A” but also with internal conflicts within Exhibit “A.” Appellees
go further and point to paragraphs in Exhibit “A” that obviously conflict with the
Printed Lease but do not begin with the “Anything Herein” phrase. Their final
11
Appellees argue as follows: “To accept [Appellant’s] argument, the [c]ourt
would have to ignore the word ‘any’ or rewrite the Addendum to limit the unlimited
plain meaning of ‘any’ to [certain paragraphs in Exhibit ‘A’]. [Appellant] violates
fundamental contract construction rules.” See Fischer v. CTMI, L.L.C., 479 S.W.3d
231, 239 (Tex. 2016).
24
rejoinder is that there is even a paragraph in Exhibit “A” that begins with
“[n]otwithstanding any other provisions . . . to the contrary,” but it does not conflict
with any provisions of the Printed Lease.
In its reply brief, Appellant challenges the particular lease form that Appellees
selected to make their points in the prior paragraph because Appellant claims that the
form is not a representative sample of the terms of the various Exhibit “As.” But
after challenging the form of Exhibit “A” that Appellees highlight, Appellant presses
the argument only to the extent of saying that the issue is not dispositive or
particularly significant, and “at the end of the day, the issue is whether the relevant
provisions can be harmonized, and they can.” 12
We conclude that the instruction in the introductory paragraph of
Exhibit “A”—that its language “supersedes any provisions to the contrary in the
printed lease hereof”—is not diminished by the absence of an “Anything Herein”
phrase in its Paragraph 26. The use of the “Anything Herein” phrase is not used with
such consistency that we can be guided by its presence or absence in a paragraph. See
12
We note that there are variations between the Printed Lease and Exhibit “A”
other than those highlighted by Appellees that are contained in paragraphs that do not
begin with the “Anything Herein” phrase. Examples include the following: (1) the
Printed Lease in Paragraph 3 provides for pooled gas units of 640 acres, but
Exhibit “A” in Paragraph 13 provides for pooling units of 160 acres; (2) the time that
continuous operations may hold the lease in Paragraph 5 of the Printed Lease appears
to be changed by Paragraph 13 of Exhibit “A”; (3) the time that Lessee may recover
its property specified in Paragraph 6 of the Printed Lease appears to be modified by
Paragraph 39 of Exhibit “A”; and (4) Paragraph 6 of the Printed Lease requires
pipelines to be buried “below ordinary plow depth,” but Paragraph 32 of Exhibit “A”
requires a depth of thirty inches.
25
Lavaca Bay Autoworld, L.L.C. v. Marshall Pontiac Buick Oldsmobile, 103 S.W.3d 650, 659
(Tex. App.—Corpus Christi–Edinburg 2003, no pet.) (“[W]hen differences exist
between terms in the same instrument, those that contribute most essentially to the
agreement are entitled to greater consideration.”); Caranas v. Morgan Hosts–Harry Hines
Blvd., Inc., 460 S.W.2d 225, 228 (Tex. App.—Dallas 1970, no writ) (same). The
introductory phrase’s plain language requires that we compare the terms in
Paragraph 3 in the Printed Lease with the terms in Paragraph 26 in Exhibit “A,”
determine if they are “contrary” to each other, and implement the instruction to have
the terms in Exhibit “A” supersede if they are contrary. See Heritage Res., 939 S.W.2d
at 121.
5. We adopt Appellant’s test for deciding whether the terms in the
Printed Lease’s Paragraph 3 are contrary to the terms in Exhibit “A’s”
Paragraph 26.
In deciding whether Paragraph 3 of the Printed Lease conflicts with
Paragraph 26 of Exhibit “A,” we rely on the test advocated by Appellant. Again,
Exhibit “A” states that it “supersedes any provisions to the contrary in the printed
lease hereof.” Appellant urges us to focus on the word “contrary” in the provision
and cites cases instructing that a conflict between terms exists “when terms of one
contract are so inconsistent with those of the other that the two cannot subsist
together[, and] there is a presumption that the second [contract] superseded the first.”
See Saturn Capital Corp. v. Dorsey, No. 01-04-00626-CV, 2006 WL 1767602, at *4 (Tex.
App.—Houston [1st Dist.] June 29, 2006, pet. denied) (mem. op.) (quoting IP
26
Petroleum Co. v. Wevanco Energy, L.L.C., 116 S.W.3d 888, 899 (Tex. App.—Houston [1st
Dist.] 2003, pet. denied) (op. on reh’g)); see also Allen Drilling Acquisition Co. v. Crimson
Expl. Inc., 558 S.W.3d 761, 773 (Tex. App.—Waco 2018, pet. filed) (op. on reh’g)
(same).
Appellees urge us to also note the effect a superseding clause may have, such as
when a document states that it supersedes a previously executed document or if it
specifies that one document is given effect in the event of a conflict. See Albert v.
Dunlap Explr., Inc., 457 S.W.3d 554, 563–64 (Tex. App.—Eastland 2015, pet. denied);
Helmerich & Payne Int’l Drilling Co. v. Swift Energy Co., 180 S.W.3d 635, 643 (Tex.
App.—Houston [14th Dist.] 2005, no pet.). But the introductory paragraph of
Exhibit “A” does not give sway to its provisions because they are later in time.
Instead, it gives sway only when its provisions are contrary to those of the Printed
Lease.
Thus, whether we rely on the general principle to determine if provisions
conflict or the standard set by the introduction of Exhibit “A,” our task remains the
same—to determine whether the provisions of Paragraph 3 and Paragraph 26 are “so
inconsistent with those of the other that the two cannot subsist together.”
6. The royalty measure in Exhibit “A’s” Paragraph 26 supersedes the
one found in Printed Lease’s Paragraph 3 because those provisions are
contrary to one another.
The next line of battle between harmony and conflict is the decisive one.
Appellant’s strategy is to analogize Exhibit “A’s” Paragraph 26 to the supreme court’s
27
holding in Heritage Resources and to characterize that paragraph as a no-deductions
clause that simply reiterates the already-stated yardstick measure of an “at the well”
royalty valuation found in the Printed Lease’s Paragraph 3. This, in Appellant’s view,
makes Paragraph 26 surplusage. Reinforcing that theme, Appellant ensured that we
were aware of the supreme court’s recent opinion in Burlington Resources, with emphasis
on that opinion’s holding that the “at the well” valuation point is a “trump” that
creates the traditional allocation of post-production costs even when applied to a
proceeds measure in the absence of a conflict-control provision like the one here. See
Burlington Res., 2019 WL 983789, at *5. Appellees’ counter-strategy focuses on the last
sentence of Paragraph 26 and construes that sentence to create a freestanding pure-
proceeds royalty measure—a measure that, as noted above, is in contradiction to a
market-value-at-the-well yardstick.
Resolving this conflict presents two questions. Does the second sentence of
Paragraph 26 establish a pure-proceeds yardstick for royalty valuation? It does. Is
that measure in Paragraph 26 contrary to the measure in Paragraph 3 of the Printed
Lease such that Paragraph 26 supersedes Paragraph 3? It is.
The second sentence of Paragraph 26 provides that “Lessee agrees to compute
and pay royalties on the gross value received.” Appellees provide the following
construction of these words:
The Gross Value Received Clause in Paragraph 26 of the Addendum
unambiguously requires BlueStone to calculate Lessors’ royalties on the
“gross value received.” . . . “Gross” means “[u]ndiminished by
28
deduction, entire.” Hyder [II], 483 S.W.3d at 873 (quoting Black’s Law
Dictionary 818 (10th ed. 2014)). Under Texas law, “gross value
received” means the value actually received by lessee, including proceeds
at the point of sale—without deductions for post-production costs. See
Heritage [Res.], 939 S.W.2d at 121; Hyder [II], 483 S.W.3d 870; Judice v.
Mewbourne Oil Co., 939 S.W.2d 133, 135 (Tex. 1996).
This construction is a reasonable one and creates a proceeds yardstick for royalty
valuation. Indeed, the supreme court in Judice noted in simple terms that “[t]he term
‘gross proceeds’ means that the royalty is to be based on the gross price received by
[the owner of the working interest].” 939 S.W.2d at 136. And as Appellees noted,
Hyder II also looked to the use of the word “gross” and found that its presence
indicated a measure that did not require deductions. See Hyder II, 483 S.W.3d at 873.13
And Appellant never tells us why the three words—gross value received—
mean something other than what Appellees contend that they mean. Indeed, in one
of its briefs, Appellant states that “[t]he ‘gross value received’ at the point of sale
13
One commentator described Hyder II’s holding as follows:
While admitting that the royalty clause language in this case is not as
clear as in Heritage Resources in that no point of valuation is mentioned at
all in paragraph 10 and there is no express language relating to
deductions, the court focused its attention on two matters—the use of
the term “gross” to modify “production” and the exclusion of
production taxes. As with many overriding royalty interests not only is
there no defined point of valuation, but there is no express language
stating whether the royalty obligation is a delivery or payment obligation.
The court said that the reference to gross production evinced an intent
that there not be deductions in addition to the volumes being measured
at the well.
Martin & Kramer, supra, § 645.2 at 614.13.
29
includes everything [Appellant] received at that point of sale, ‘including any
reimbursements for severance taxes and production related costs.’” Thus, the
interpretive conflict is not on what the words “gross value received” mean in
isolation. Instead, Appellant focuses on how the words (1) should not alter the
royalty measure established by Paragraph 3 of the Printed Lease, (2) have been held to
be surplusage by another court, and (3) are a protective measure that addresses
disparities between the market value of gas and the price for which it is sold under
long-term contracts.
Thus, the Printed Lease contains—as all agree—a market-value-at-the-well
royalty yardstick. Paragraph 26 of Exhibit “A” contains a pure-proceeds royalty
yardstick. These royalty measures are contrary to each other; as stated by the supreme
court, “There is an inherent, irreconcilable conflict between ‘gross proceeds’ and ‘at
the well’ in arriving at the value of the gas.” See Heritage Res., 939 S.W.2d at 130. The
introductory paragraph of Exhibit “A” tells us how to resolve that conflict by
directing that its terms supersede.
B. We reject Appellant’s argument that attempts to avoid the effect of
Paragraph 26’s pure-proceeds measure.
1. No rule of super clarity required the parties to specify a particular
point of sale when they selected a pure-proceeds royalty yardstick.
Appellant argues that once an “at the well” measure is baked into the royalty
provision, it requires super clarity in any provision that attempts to alter its effect. We
construe this argument to mean that once a royalty provides an “at the well” point of
30
valuation, a lease can alter that scheme of valuation only by clearly altering its terms to
provide a different point of valuation, such as by striking the words “at the well”
when they appear in a lease.
Appellant’s argument has crystalized further after the supreme court’s opinion
in Burlington Resources and its description of the “at the well” point of valuation as a
“trump.” Appellant summarizes the issue and its position on how the issue should be
resolved:
Given Burlington Resources’s emphasis on the point of valuation, the
critical question for this [c]ourt in construing the [l]eases is whether
“gross value received” in [P]aragraph 26 of the addendum supersedes
not just the “market value” pricing method in [P]aragraph 3 but also the
“at the well” point of valuation in [P]aragraph 3. Paragraph 26 is silent
as to the point of valuation. It does not say “at the point of sale” or
anything else regarding the point of valuation. This [c]ourt should
construe the Leases to leave [P]aragraph 3’s “at the well” point of
valuation in place and allow for deduction of post-production costs.
The reason that Appellant offers for leaving Paragraphs 3’s point of valuation in place
is that Paragraph 26 does not explicitly state a point of valuation, and this absence
means that Paragraph 3’s point of valuation must remain operative.
This argument has force. Paragraph 26 of Exhibit “A” does not explicitly
delete Paragraph 3’s specific “at the well” point of valuation or explicitly state a new
point of valuation. And we agree that Burlington Resources contains a clear lesson on
the power of an “at the well” valuation point to control the allocation of post-
production costs, no matter whether the yardstick utilized is market value or pure
proceeds. See Burlington Res., 2019 WL 983789, at *5.
31
But Exhibit “A” states that it supersedes when the provisions are contrary to
the Printed Lease. In our view, Paragraph 3 and Paragraph 26 are inherently contrary
to each other: one contains an “at the well” measure, and one does not because it
contains a proceeds measure not tied to a particular point of sale—what we have
termed a pure-proceeds measure.
At its most elementary level, we would not be giving Paragraph 26 superseding
effect if we held that Paragraph 26 meant the same thing as the provision with which
it conflicts, i.e., the “at the well” measure in Paragraph 3. Further, to accomplish what
Appellant wants, we would have to import words from Paragraph 3 into Paragraph 26
because the latter paragraph does not contain an “at the well” valuation measure. In
other words, we do not see how we would be giving Exhibit “A” its controlling role if
we were to cut and paste the words “at the well” from Paragraph 3 of the Printed
Lease into Paragraph 26 of Exhibit “A.” In fact, that approach would seem to take
exactly the opposite approach mandated by the superseding provision in Exhibit “A”;
we would be resolving the conflict by giving superseding effect to the terms of the
Printed Lease. Also, looked at from a different perspective, the power that Appellant
ascribes to the “at the well” measure accentuates the level of conflict between
Paragraph 3 and Paragraph 26, and thus, it pulls the trigger even harder on Exhibit
“A’s” superseding provision.
Further, Judice, Heritage Resources, Hyder II, and Burlington Resources all recognize
that a proceeds measure—not tied to particular point of sale—creates a measure that
32
does not allow the lessor to net-back its post-production costs. 14 And if the rule were
the one Appellant advocates, we could not account for the statements in Judice and
Heritage Resources that in some circumstances, an “at the well” valuation measure and a
proceeds measure may irreconcilably conflict.15 If the “at the well” measure, once it
appeared, were so unalterably “baked into” (to use Appellant’s term) the royalty
formulation, then there would not be a conflict should a pure-proceeds measure also
appear in a lease. There could be no conflict because the “at the well” measure would
vanquish any other measure that conflicts with it.
Nor is there a logical reason to make the “at the well” measure, once stated,
unalterable if it is contrary to other controlling provisions of a lease. Again, we are to
glean the parties’ intent from the terms they use, and the allocation of post-
production costs—though traditionally on the shoulders of the lessor—may be
allocated as the parties agree. See Hyder II, 483 S.W.3d at 872; Heritage Res., 939 S.W.2d
at 122.
In essence, Appellant’s position boils down to the argument that once it
appears, the “at the well” measure is so “baked into” the royalty calculation that it has
See Burlington Res., 2019 WL 983789, at *5; Hyder II, 483 S.W.3d at 873; Judice,
14
939 S.W.2d at 136; Heritage Res., 939 S.W.2d at 130.
15
See Judice, 939 S.W.2d at 136 (“The term ‘gross proceeds’ means that the
royalty is to be based on the gross price received by [Lessee] Mewbourne. The use of
the term ‘at the well’ indicates just the opposite, that the royalty is to be based on its
value ‘at the well.’”); Heritage Res., 939 S.W.2d at 130 (“There is an inherent,
irreconcilable conflict between ‘gross proceeds’ and ‘at the well’ in arriving at the
value of the gas.”).
33
to be physically removed by going to the length of actually striking those words
wherever they appear. Both Appellant’s reply brief and one of its recent briefs
interpreting Burlington Resources cite a treatise that suggests this course. 16 And the
logical implication of Appellant’s argument is that if the “at the well” measure has the
power it is portrayed as having, it would have to be physically removed from the
document to avoid its all-consuming effect.
But Burlington Resources’s holding—that a proceeds measure may still be subject
to an “at the well” point of valuation—does not state such a hard and fast rule. 2019
WL 983789, at *5. The supreme court in Burlington Resources summarized its holding as
follows:
To sum up, the Valuation Clause specifies that the royalty payment shall
be calculated based on the “amount realized” from the sale, but the
agreements also provide that the royalty interest shall be delivered “into
the pipelines, tanks, or other receptacles with which the wells may be
connected.” In the context of these agreements, this latter term fixes the
royalty’s valuation point at the physical spot where the interest must be
delivered—at the wellhead or nearby.
16
Appellant’s reply brief includes the following quote:
If the parties agree that the net[-]back methodology should not be used,
nowhere in the royalty clause provision should there be a reference to
“at the well” or “at the mouth of the well.” Even agreeing on a
downstream point of valuation, such as “point of sale,” will be
ineffective to reach that result where the “point of sale” is the wellhead
even where the wellhead sale is a non-arms’-length transaction. Attaching
addenda to form leases that contain “at the well” language should be discouraged
unless one crosses out such references in the form leases.
Martin & Kramer, supra, § 645.2 at 614.14.
34
Id. at *11. The supreme court in Burlington Resources interpreted the unique language of
the instruments it examined and did not deal with the situation we face—a lease that
contains two contradictory royalty measures and a provision that dictates how to
reconcile that conflict.
Finally, Appellant urges that we look to the Fifth Circuit’s opinion in Warren
because it “is arguably the most significant precedent on the valuation point issue
presented here, because the leases in that case comprised a preprinted form that
provided for royalties based on a value ‘at the well,’ together with a typewritten
addendum that prohibited post-production costs.” Obviously, Warren reached the
conclusion that Appellant wants—the lessor bore the burden of post-production
costs—but Warren, as with Burlington Resources, did not deal with the lease structure at
issue in this appeal. See id.; Warren, 759 F.3d at 415–19.
The printed lease in Warren stated an “at the well” point of valuation, though it
used the term “amount realized” as the yardstick. 17 759 F.3d at 416. The provision in
the addendum at issue in Warren had two sentences. Id. The first sentence was the
Burlington Resources described the basis for Warren’s holding as follows:
17
[In Warren], the agreement provided that the royalty holder would
receive a percentage of the “amount realized” by the lessee. But this
language was modified with language that the amount realized shall be
“computed at the mouth of the well,” leading the court to conclude that
“the royalty is based on net proceeds, and the physical point to be used
as the basis for calculating net proceeds is the mouth of the well.”
2019 WL 983789, at *10 (citing Warren, 759 F.3d at 417).
35
classic no-deductions clause that everyone agrees is surplusage under Heritage Resources.
See id. at 418 (citing Heritage Res., 939 S.W.2d at 130–31). The second sentence states
that the lessor bore “a proportionate part of all those expenses imposed upon Lessee
by its gas sale contract to the extent incurred subsequent to those that are obligations
of Lessee.” Id. The court in Warren construed this sentence to mean that “[t]o the
extent that a gas sale contract requires the lessee to bear the cost of delivering
marketable gas to a sales point other than the mouth of the well, the second sentence
expressly provides that the lessor will bear a proportionate part of all those expenses.”
Id. at 419.
Here, the second sentence of Paragraph 26 has completely different language
than that used in Warren’s addendum. Thus, the distinguishing factor between the
documents we interpret and those in Warren is not the presence of an addendum but
the language used in the addendum.
In our view, the provisions of Paragraph 26 of Exhibit “A” do not approach
the reallocation of post-production costs by altering the point of valuation to
determine the market-value measure and, by this means, impact where along the post-
production path to allocate costs. Instead, an entirely different royalty measure is
created by Paragraph 26—the pure-proceeds measure—and this different measure is
what places the burden of post-production costs on Appellant/Lessee. This measure
is contrary to the “at the well” measure stated in the Printed Lease and thus
supersedes the Printed Lease.
36
2. The El Paso Court of Appeals’s opinion in SandRidge may conflict
with our holding, but nothing in that opinion causes us to question our
analysis.
Appellant relies on the El Paso court’s opinion in SandRidge. 454 S.W.3d at
606. That reliance is understandable because the El Paso court examined a paragraph
almost identical to Paragraph 26 of Exhibit “A” and found that it did not alter an “at
the well” valuation into a proceeds valuation. See id. at 614–15. We are not swayed by
SandRidge to question our analysis because the El Paso court disposed of the meaning
of the provision before it in one sentence without analyzing the arguments that we
face. Further, the interrelation of the paragraphs in the SandRidge lease with its royalty
clause is different than the one we face, and that difference in terms makes the
conflict less stark than the one we resolve.
In SandRidge, the El Paso court engaged in a lengthy analysis and concluded
that a royalty provision in the lease it interpreted provided for a market-value-at-the-
well valuation. Id. at 613–14. The lease in SandRidge contained a paragraph 7 that is
almost identical to Paragraph 26 at issue in this appeal:
7. NO DEDUCTIONS. Lessee agrees that all royalties accruing under
this lease (including those paid in kind) shall be without deduction for
the cost of producing, gathering, storing, separating, treating,
dehydrating, compressing, processing, transporting, and otherwise
making the oil, gas[,] and other products hereunder ready for sale or use.
Lessee agrees to compute and pay royalties on the gross value received,
including any reimbursements for severance taxes and production related
costs.
37
Id. at 609. The court in SandRidge summarily rejected an argument that its paragraph 7
had any effect on the already established “at the well” royalty measure:
Appellants next contend that construing paragraph 4(B) as a market[-]
value[-]at[-]the[-]well clause renders paragraph 7 of State Leases
meaningless. Paragraph 7 is a “no deduct” clause, prohibiting the
deduction of post-production expenses from all royalties accruing under
the State Leases. This is precisely the sort of clause that a market[-]
value[-]at[-]the[-]well provision renders “surplusage as a matter of law.”
Heritage Res[.], 939 S.W.2d at 123.
Id. at 614.
The court in SandRidge did not note, and certainly did not examine, the
difference between its paragraph and the one interpreted in Heritage Resources. That
difference is the last sentence stating that “Lessee agrees to compute and pay royalties
on the gross value received.” Id. at 609. Obviously, that sentence and Exhibit “A’s”
instruction that its terms supersede is the lynchpin of this appeal and our analysis. In
our view, the presence of that sentence in Exhibit “A” in the leases before us takes
Paragraph 26 from the status of surplusage to a provision that is contrary to the “at
the well” valuation point. We do not know if the El Paso court would have changed
its view if presented with the argument we face, but we do conclude that the El Paso
court’s summary characterization gives us no basis to change our analysis.
And there is an interrelation between the royalty provision in SandRidge and its
paragraph 7 that is absent from the lease before us. Because the royalty clause that
the court in SandRidge construed used the term “gross production,” that opinion
concluded that the royalty clause provided for an “at the well” valuation point. Id. at
38
613. Though the royalty provision also used the words “gross price paid,” the court
in SandRidge tied those words back to gross production and concluded that the “gross
price paid” language did not turn the royalty provision into a proceeds provision. Id. 18
The court’s conclusion in SandRidge—that the “gross price paid” language in the
royalty provision did not alter an “at the well” valuation point—adds more force to an
argument that the use of similar words in its paragraph 7 (“gross value received”) was
a reiteration of what the royalty provision already stated and was surplusage because it
consisted of repeated but meaningless words.
3. We cannot harmonize the provisions at issue by holding that
Paragraph 26 functions as a backstop provision.
Appellant argues that the last sentence of Paragraph 26 should be construed to
perform a different purpose than setting the yardstick for the royalty and yardstick
measure and instead should be viewed as a backstop provision. This is another aspect
18
As set forth in SandRidge,
Although paragraph 4(B) provides that market value may be determined
by the gross price paid or offered, the substance to be valued by its gross
price continues to be “gross production.” In other words, this language
refers to the gross price that might be paid or offered to SandRidge by a
buyer for the raw gas—i.e., the price offered or received for gas at the
well without any deduction from the royalty for the costs of production.
This reading comports with the well-understood characteristics of
royalty: “Royalty is commonly defined as the landowner’s share of
production, free of expenses of production.” See Heritage [Res.], 939
S.W.2d at 121–22 (citing Delta Drilling Co. v. Simmons, . . . 338 S.W.2d
143, 147 ([Tex.] 1960)).
454 S.W.3d at 614.
39
of Appellant’s theme of harmony by which it argues that the last sentence of
Paragraph 26 does not clash with the royalty valuation in the Printed Lease and does
not alter that form’s royalty valuation.
Appellant describes a backstop as a provision inserted in mineral leases to
address the disparity that may arise from a difference in the market value of minerals
in comparison to the price received by the lessee under a contract by which the gas is
sold. Understandably, the sales price received from the contract executed some time
ago may not align with the current market price. But we do not interpret the last
sentence of Paragraph 26 to address that potential disparity because it does not
contain language addressing how to resolve a disparity between the price received and
the market price, and for this reason, the last sentence of Paragraph 26 cannot be
interpreted as a backstop provision.
The situation addressed by a backstop exists because minerals may be sold by
the lessor under the terms of gas sale or purchase contracts, and the price in those
contracts may no longer reflect the reality of the current market. Westport Oil & Gas
Co., L.P. v. Mecom, 514 S.W.3d 247, 253–54 (Tex. App.—San Antonio 2016, no pet.)
(discussing cases examining the disparity between the price received under gas
purchase or sale contract and measure set by lease royalty clause). A lessee that does
not protect itself for a decrease in the market price may find that it has to pay the
lessor a royalty based on a higher market price though it is only receiving the lower
contract price because “[w]hen royalty payments are based on market value under an
40
oil and gas lease in Texas, the lessee owes royalties based on the price of gas on the
open market, even though the gas was actually sold for less than this price under a
long-term sales contract.” Yzaguirre, 53 S.W.3d at 369 (citing Tex. Oil & Gas Corp. v.
Vela, 429 S.W.2d 866, 871 (Tex. 1968)).
The disparity may be the reverse and create a situation when the market price is
lower than the price set in the lessee’s long-term sales contract. Id. at 369–70. If the
mineral lease does not address this contingency, the lessor cannot complain that the
lessee is reaping a bounty under the lease. Id. at 373 (stating that when lease entitles
lessor to market-value royalty, lessor is entitled to royalty calculated only on the
market value and not a higher royalty based on the amount realized by lessee under
the sales contract).
Here, Paragraph 3 specifically protects the lessee should it receive a sales-
contract price that is lower than the market price by “provid[ing] that on gas sold by
Lessee[,] the market value shall not exceed the amount received by Lessee for such
gas computed at the mouth of the well.” Appellant argues that the second sentence
of Paragraph 26 is the “counterpart” to the Lessee’s protection in Paragraph 3 and
that “[t]he backstop provision in [P]aragraph 26 of the Leases ensures that the
[L]essor would not receive royalties on a lower current market value if the [L]essee’s
actual proceeds were much higher.”
Appellees counter that turning the last sentence of Paragraph 26 into a
backstop provision requires us to judicially amend the lease and to add words to its
41
provisions. In their view, Paragraph 26 of Exhibit “A” has no language indicating
that its purpose is to reconcile a disparity between a market price and a sales contract
price because it “does not have the conditional ‘provided that’ language appearing in
the backstop provision in [P]aragraph 3, nor does it mention or reference market
value at the well. It plainly states [that] royalties will be computed and paid on the
gross value received—the opposite of market value at the well.”
We agree with Appellees. Paragraph 26’s last sentence provides, “Lessee agrees
to compute and pay royalties on the gross value received . . . .” It does nothing to
reconcile a disparity between the gross value received and the market value. See
Westport Oil & Gas Co., L.P., 514 S.W.3d at 254 (holding that when royalty was stated
as percentage of market value at the well, “[t]he gas purchase agreement minimum
sales price formula [did] not apply to the royalty provision, and the royalty owed [was]
exactly what the lease state[d]”). We would violate our duty to take the words as we
find them if we added the words necessary to turn the provision into a backstop
provision that reconciled the two measures. See Arlington Surgicare Partners, 2015 WL
5766928, at *2 (stating that we “cannot change the contract merely because we or one
of the parties comes to dislike its provisions or thinks that something else is needed in
it”).
Even the case relied on by Appellant/Lessee supports our view. Appellant
cites us again to the El Paso court’s opinion in SandRidge and this time looks to that
opinion’s interpretation of a royalty provision’s use of the term “gross price paid” as a
42
protection of “the lessor in the event a long-term gas purchase agreement between the
lessee and a buyer results in the gas being sold at a premium over a lower, then-
current market value.” 454 S.W.3d at 614. But SandRidge interpreted a provision
stating its royalty calculation as
25% part of the gross production or the market value thereof, at the
option of the owner of the soil or the Commissioner of the General
Land Office, such value to be based on the highest market price paid or
offered for gas of comparable quality in the general area where produced
and when run, or the gross price paid or offered to the producer,
whichever is the greater.
Id. at 608 (emphasis added). This provision—which is not found in Paragraph 26—
directs how to choose between two measures. Unlike the provision in SandRidge,
Paragraph 26 does not reconcile a difference between two measures but merely
instructs the single measure to be used in calculating the royalty.
C. We conclude that Appellees do not bear the burden of post-production
costs.
We have tried to pull the interpretive threads that guide us through the phrases
in Paragraph 3 of the Printed Lease and in Paragraph 26 of Exhibit “A” and to weave
a coherent whole. At the end of that process, we share the frustration recently
expressed by the supreme court when it described the effort that comes with trying to
glean the parties’ intent from the “recondite” terms of royalty clauses that are layered
on top of each other and that clash in the measure they create.19 We glean and
As the supreme court recently stated in Burlington Resources,
19
43
conclude that the trial court properly granted summary judgment that the leases at
issue were breached by Appellant’s deduction of post-production expenses from
Appellees’ royalty payments. We overrule Appellant’s first issue.
VIII. Appellant Owes Royalty on Plant and Compressor Fuel
In its second issue, Appellant challenges whether the leases accord it the right
to use gas produced from Appellees’ property to conduct operations off the leased
premises and not pay a royalty on that gas. To answer this question, we focus on the
leases’ “free use” provision—a provision that allows a lessor to use minerals produced
from a leased premise to conduct operations and, as the name of the provision
suggests, not pay a royalty for those minerals. Here, Appellant used gas produced
from the leases as fuel for operations conducted outside the leased premises. We
interpret the “free use” provision of the leases to avoid the payment of royalty only
for minerals used to conduct operations on the leased premises. Appellant used the
gas to conduct the operations off the leased premises, and thus, the “free use” clause
We conclude that the rules of contract construction favor Burlington’s
interpretation of this recondite clause. But the parties could have saved
considerable time, money, and heartache if their cryptic language had
truly been “delivered . . . into the . . . receptacle[ ].” It could then have
been re-written to say exactly what the parties intend, without resort to
industry jargon, outdated legalese, or tenuous assumptions about how
judges will interpret industry jargon or outdated legalese. If you can’t
understand what your contract means without asking the lawyer who
wrote it, you should not be surprised later if judges—who can’t just take
your lawyer’s word for it—also have trouble understanding what it
means.
2019 WL 983789, at *9 n.10.
44
did not free it from the payment of royalty on the gas used to fuel those operations.
A. The Parties’ Stipulations
Appellant has not paid Appellees a royalty on gas that the parties described as
Plant Fuel and Compressor Fuel. The parties stipulated to the meaning of the terms
and to how the gas used as Plant and Compressor Fuel is segregated from other gas
produced from Appellees’ leases, which we summarize in relevant part below.
Appellant meters gas from each of the wellheads on the leases. The gas
produced from the leases is then “commingled” with gas produced from other leases
in the area held by Appellant. The commingled gas is transported to a processing
plant operated by a third party.
Part of this commingled gas—the part defined as Plant Fuel—is the subject of
a contract between Appellant and the third party that operates the processing plant.
Appellant pays the third party “to gather [Appellees’] Gas and gas from other [of
Appellant’s] wells in the area, process the gas to extract liquids, and redeliver the
processed gas and processed liquids to [Appellant].” A negotiated term of the
contract between Appellant and the third party allows that party to use a portion of
the gas delivered by Appellant as fuel to operate the processing plant. The third party
delivers the processed gas to Appellant, and Appellant then sells the gas to third
parties. Appellant is not paid by the third party for the portion of the gas used to fuel
the processing plant. The portion of the gas used to fuel the plant is consumed and
45
thus is not redelivered to Appellant for downstream sales, and Appellant does not pay
royalty to Appellees for the Plant Fuel.
Appellant also does not pay Appellees for what the parties defined as
Compressor Fuel. The parties’ stipulations describe the use of the Compressor Fuel
as a part of the fuel that the third party delivers to Appellant. The third party
redelivers a portion of the commingled processed gas to [Appellant],
which [Appellant] then transports to various well sites, including well
sites on lands covered by the [leases at issue]. [Appellant] uses some of
this processed gas to power compressors (“Compressor Fuel”). The
compressors are used in [Appellant’s] operations on various well sites,
including on the [leases at issue], to increase production of gas. The
compressors used for [Appellant’s] operations on the [l]eases are located
on the [l]eases.
The parties’ stipulations further note that Appellant “does not pay [Appellees] royalty
on gas used for Compressor Fuel. Gas used for Compressor Fuel is consumed by the
compressors, and it is not redelivered to [Appellant] for downstream sales.”
The trial court concluded that Appellant had breached the leases by not paying
Appellees a royalty on the Plant and Compressor Fuel. The interlocutory judgments
incorporated into the Consolidated Final Judgment awarded damages for the amounts
that the parties stipulated that Appellees should have received if Appellant were
obligated to pay royalty on the Plant and Compressor Fuel.
B. The “free use” provision of the leases governs whether Appellant could use
the Plant and Compressor Fuel without paying royalty on the gas used as fuel.
To resolve the question of whether royalty is owed for Plant and Compressor
Fuel, we must first decide which provision of the leases governs the question of
46
whether Appellant pays royalty on the Plant and Compressor Fuel. The leases contain
a specific “free use” provision, and the parties have given us no reason to look
beyond the provision that specifically deals with the question of the free use of gas.
The “free use” clause of the lease provides that “Lessee shall have free from royalty or
other payment the use of water, other than water from Lessor’s wells or tanks, and of
oil, gas[,] and coal produced from said land in all operations which Lessee may
conduct hereunder, including water injection and secondary recovery operations, and
the royalty . . . shall be computed after any so used.”
Appellees/Lessors also direct us to an aspect of the royalty provisions that deal
with the payment of royalty for gas “used off the premises.” We do not view this
statement as giving direction as to the free use of gas or providing any additional
guidance beyond that provided by the “free use” clause. See Sefzik v. Mady Dev., L.P.,
231 S.W.3d 456, 461 (Tex. App.—Dallas 2007, no pet.) (“When interpreting an
agreement, ‘[s]pecific and exact terms are given greater weight than general language.’”
(quoting Pratt-Shaw v. Pilgrim’s Pride Corp., 122 S.W.3d 825, 829 (Tex. App.—Dallas
2003, no pet.))). Instead, we agree with Appellant that the “free use” provision
provides more specific guidance on the issue. Specifically, we agree with Appellant’s
conclusion that
[t]he only way to give meaning to the [“]free use[”] provision is to
construe it as an exception to the general royalty provision and apply it
to volumes that would otherwise bear royalties. The scope of the
express [“]free use[”] provision controls, and the proper inquiry,
47
therefore, is whether the Plant Fuel and Compressor Fuel volumes are
used in “operations which Lessee may conduct hereunder.”
Focusing on the “free use” clause also avoids the interpretive morass involved in
deciphering the phrase “used off the premises.” See Southland Royalty Co. v. Pan Am.
Petroleum Corp., 378 S.W.2d 50, 52–57 (Tex. 1964) (op. on reh’g) (interpreting effect on
royalty calculation of the phrase “used off the premises”); Hutchings v. Chevron U.S.A.,
Inc., 862 S.W.2d 752, 756–58 (Tex. App.—El Paso 1993, writ denied) (same).
For the same reason, we reject Appellees’ argument that Appellant should pay
royalty because Appellant is receiving a value for the use of the gas and that the
obligation to pay Appellees for the “gross value received” sweeps up the value
received from the Plant and Compressor Fuel. We will address how the use of the
word “value” impacts one of Appellant’s arguments, but we do not view the “gross
value received” clause as having an impact on the question of whether the “free use”
clause permits a royalty-free use of gas outside Appellees’ leased premises. The “free
use” clause provides a specific direction on this issue, and that clause is the best
indication of the parties’ intent on whether royalty is owed for the Plant and
Compressor Fuel.
C. The “free use” provision limits a royalty-free use of minerals to operations
conducted on the leased premises.
Focusing on the “free use” clause, the question turns on the interpretation of
the “free use” clause’s limitation in the scope of the free use by its words “in all
operations which Lessee may conduct hereunder” and specifically whether the use of
48
the word “hereunder” limits the free use of gas to operations conducted on the leased
premises. We conclude that it does, and because Plant and Compressor Fuel is used
off the leased premises, Appellant must pay royalty on it.
We will refer to the Texas cases cited by the parties below, but we begin by
noting that the cited cases provide little guidance in resolving the interpretation
question before us. For that reason, we look to treatise commentaries and to a recent
opinion from a federal circuit court of appeals for guidance.
The treatise commentaries do not provide precise direction but suggest that
“free use” clauses traditionally limit the free use to the leased premises. See 3A
Summers Oil & Gas § 33:16 (3d ed. 2018) (“Where the lease provides for free gas to the
lessor for domestic purposes or provides that the lessee is privileged to use the gas in
operating the lease, it is generally held that the gas used for these purposes should be
excluded in the calculation of the lessor’s royalty.”); Martin & Kramer, supra, § 661.4
at 763 (“Usually it is held that the lessor’s free gas may not be used off the leased
premises, such holding being based on the construction of the [‘]free gas[’] clause as
being applicable to particular dwellings on the premises.”).
More precise direction comes from the Tenth Circuit in Anderson Living Trust v.
Energen Resources Corp., 886 F.3d 826 (10th Cir. 2018). One of the leases that the court
in Anderson examined contained a “free use” clause providing that the lessor “shall
have free use of oil, gas[,] and water from said land . . . for all operations hereunder.”
49
Id. at 848. The court in Anderson defined and integrated the word “hereunder” into
the “free use” provision as follows:
The plain meaning of “hereunder” is “under or in accordance with this
writing or document” or “[a]s provided for under the terms of this
document.” See https://www.merriam-webster.com/dictionary/hereunder;
https://en.oxforddictionaries.com/definition/hereunder; see also Black’s
Law Dictionary (10th ed. 2014) (defining “hereunder” as “[l]ater in this
document” or “[i]n accordance with this document”). The term
“hereunder” qualifies the phrase “all operations.” So, to be free of royalties,
the use of the gas must be for operations “under or in accordance” with the lease or
“as provided for under the terms” of the lease.
Id. (emphasis added).
Here, the leases use the word “hereunder” to qualify a phrase almost identical
to the one used in Anderson. In the leases under review in this appeal, the word
“hereunder” qualifies the phrase “in all operations which Lessee may conduct.” With
such similar language, we interpret the language of the leases that we review to also
require that the use is free of royalty if “the use of the gas [] be for operations ‘under
or in accordance’ with the lease or ‘as provided for under the terms’ of the lease.” See
id.
The court in Anderson determined that the terms of the lease it reviewed leased
the premises to conduct operations “thereon.” Id. at 849. With this term, the
Anderson court concluded that the purpose of the lease was to allow the lessor “to
produce oil and gas from the leased premises and to store oil and build infrastructure
on the leased premises.” Id. This purpose limited the scope of the “free use” clause
to gas used in operations conducted on the leased premises:
50
Thus, the operations called for by the lease are those occurring on the
leased premises. As a result, the plain language of the “free use” clauses
in these leases suggests only gas used on the leased premises is free of
royalty. Fuel gas used off the leased premises is not a free use.
Id.
Though obscured in a fog of verbiage, the leases at issue appear to also have
the purpose of conducting lease operations “thereon” the leased premises:
Lessor . . . hereby grants, leases[,] and lets exclusively to Lessee for the purpose
of investigating, exploring, prospecting, drilling[,] and mining for and
producing oil, gas, sulphur, fissionable materials[,] and all other minerals
(whether or not similar to those mentioned), conducting exploration, geologic
and geophysical tests and surveys, injecting gas, water[,] and other fluids and air
into subsurface strata, laying pipelines, establishing and utilizing facilities for
the disposition of salt water, dredging and maintaining canals, building roads[,]
bridges, tanks, telephone lines, power stations[,] and other structures thereon ,
and on, over[,] and across lands owned or claimed by Lessor adjacent and
contiguous thereto necessary to Lessee in operations to produce, save, take care
of, treat, transport[,] and own said minerals, the following described land in
Hood & Somervell Counties, Texas[.] [Emphasis added.]
Though a minor point, the limited scope of the “free use” clause is also
signaled by the phrase that follows the word “hereunder” in that clause. The specific
language of the clause is “hereunder, including water injection and secondary recovery
operations.” Though it does not say so explicitly, it would be unreasonable to read
these words to authorize a royalty-free use for operations that occur off the leased
premises. This at least hints that that the word “hereunder” speaks to a limit of free
use that occurs on the leased premises.
Thus, we interpret the language of the “free use” clause and the purpose of the
lease to be the same as in Anderson and apply its holding and guidance to our facts.
51
The “free use” clause does not authorize a royalty-free use of gas that occurs off the
leased premises.
As we explained above, we turned to the Tenth Circuit opinion in Anderson
because the Texas cases cited by the parties give little guidance to resolve the question
of whether the “free use” provision freed Appellant from paying a royalty on Plant
and Compressor Fuel. Appellant cites Mitchell Energy Corp. v. Blakley, 560 S.W.2d 740,
744 (Tex. App.—Fort Worth 1977, writ ref’d n.r.e.). But Mitchell held that gas sold to
a third party but used on the leased premises fell within the ambit of a “free use”
clause. Id. at 743–44. Application of Mitchell to our issue begs the question. In
Atlantic Richfield v. Holbein, also cited by Appellant, the Dallas court held that gas used
for compressor operations fell within a “free use” clause. 672 S.W.2d 507, 515–16
(Tex. App.—Dallas 1984, writ ref’d n.r.e.). But the Dallas court supported its holding
primarily by looking to industry custom and usage rather than to the language of the
“free use” clause, and we conclude that it is inapposite to the issue before us. See id.
We will also address two subordinate arguments made by Appellant. First,
Appellant argues that if we accept (as we have) Appellees’ argument that Paragraph 26
creates a pure-proceeds royalty measure, then it should not pay royalty on the Plant
and Compressor Fuel because it receives no proceeds from the sale of that fuel.
Appellees respond that the superseding provision of Paragraph 26 requires Appellant
to calculate royalty not on proceeds but on the broader term of value, and Appellees
note that “‘[v]alue is broader than, and not limited to, proceeds.’ See Value, Merriam-
52
Webster’s Collegiate Dictionary 1382 (11th ed. 2009) (defining value as ‘a fair return or
equivalent in goods, services, or money for something exchanged’).” Indeed, when a
lease defined proceeds—in words similar to the definition of value used by
Appellees—as “the entire economic benefit and all consideration in whatever form
received by or accruing to Producer,” a court agreed that there were “proceeds” from
gas used for fuel and that a royalty was owed. See HighMount Expl. & Prod. LLC v.
Harrison Interests, Ltd., 503 S.W.3d 557, 561–63 (Tex. App.—Houston [14th Dist.]
2016, no pet.).
Appellant also attacks Appellees’ statement that it “receives value from [the
third party’s] use of Plant Fuel in the form of lower processing costs” as being
unsupported by the record. But no matter what the specific nature of the value
received by Appellant, it surely receives something in return for the gas that fuels the
plant. In fact, the parties stipulated as to the “value” of the Plant Fuel “gas
attributable to [Appellees’] interests.”
We reject Appellant’s argument that it received nothing of value from allowing
the third-party free use of the Plant Fuel and that it thus owed nothing as royalty.
Undoubtedly Appellant received some value by allowing free use of the fuel. Not
only is it common sense that Appellant would permit the use of the gas only if it
received some value but also the parties were able to quantify that “value” in their
stipulations.
53
Appellant also argues that Compressor Fuel is used on the leases to benefit
Appellees. As we interpret the argument, Appellant begins with the premise that a
portion of the Compressor Fuel is commingled with gas from other leases as it
emerges from the tailgate of the plant, that it returns to compressors on Appellees’
leased premises, and that the operation of those compressors benefits the operations
of Appellees’ leases. In Appellant’s view, Appellees place the impossible burden on
Appellant to account for which specific molecules of gas go to fuel compressors on
Appellees’ leases and which go to fuel compressors on other leases. Appellant’s
argument continues that all the gas that is produced and sold from Appellees’ leases is
commingled with gas from other leases and then the royalty is calculated based on the
allocation of the volume of gas produced from the respective leases.
Appellant appears to argue (1) that Appellees have never challenged the fact
that gas is commingled from the production coming from various leases or by
objecting to the commingling of gas generally and (2) that having never made that
challenge, Appellees should not be able to challenge in this suit that commingled gas
is used to power compressors on their leases and others and should not be able to
force Appellant to account for which portion of commingled gas goes to which
compressor. In essence, the concept of “all for one and one for all” demonstrates the
benefit that Appellees receive from the commingled gas powering the various
compressors.
54
Appellees respond that by commingling the Compressor Fuel, Appellant also
assumed the duty of accounting for the aliquot share of the gas that returns to fuel the
compressors on Appellees’ leases and cannot simply take what it claims to be
Compressor Fuel and deduct that entire volume from the amounts upon which it pays
royalty. 20 Indeed, Appellant never tells us or points to anything in the record that
explains why it can make the allocation of commingled gas to pay royalty but why it
cannot make a corresponding allocation to establish which portion of the commingled
gas is used to power compressors on Appellees’ leases and on leases owned by other
lessors.21
Appellees cite Humble Oil & Refining Co. v. West, 508 S.W.2d 812 (Tex. 1974).
20
Humble Oil explains the duty to account that results from commingling as follows:
As a general rule, the confusion of goods theory attaches only when the
commingled goods of different parties are so confused that the property
of each cannot be distinguished. Where the mixture is homogeneous,
the goods being similar in nature and value, and if the portion of each
may be properly shown, each party may claim his aliquot share of the
mass. Additionally, the burden is on the one commingling the goods to
properly identify the aliquot share of each owner; thus, if goods are so
confused as to render the mixture incapable of proper division according
to the pre-existing rights of the parties, the loss must fall on the one who
occasioned the mixture. Stated differently, since Humble is responsible
for, and is possessed with peculiar knowledge of the gas injection, it is
under the burden of establishing the aliquot shares with reasonable
certainty.
Id. at 818 (citations omitted).
As we read the parties’ stipulations, Appellant deducts the entire volume of
21
fuel used to power compressors on both Appellees’ leases and leases owned by others
from the volume used to calculate the royalty: “[Appellant] does not pay [Appellees]
55
And we see a false equivalency in the argument that Appellees have allowed
their gas to be commingled with production from other leases and sold. In that
situation, apparently, Appellant has the data to and does perform an allocation
between the gas commingled from various leases. Appellees are not complaining
about the concept of commingling in general but instead argue that they have no
reassurance that production from their leases is being used disproportionately to aid
the production of other leases. Again, Appellant agreed for each Appellee to a
stipulation of the value of the gas used as Compressor Fuel. This indicates that
Appellant can allocate the volumes of Compressor Fuel among the leases it operates.
Further, Appellant cites no specific provisions of the leases that permits it to use
volumes of Plant and Compressor Fuel from Appellees’ leases to benefit other
lessors.
D. Appellant is obligated to pay royalty on Plant and Compressor Fuel
The “free use” clause provides only for the royalty-free use of gas on the
premises of the leases. Because Appellant uses gas outside those confines, it owes
royalty on the Plant and Compressor Fuel. We overrule Appellant’s second issue.
IX. Attorneys’ Fees
In its conditional third issue, Appellant challenges the trial court’s award of
attorneys’ fees if we “reverse[] the summary judgment in whole or in part.” We have
royalty on gas used for Compressor Fuel. Gas used for Compressor Fuel is
consumed by the compressors, and it is not redelivered to [Appellant] for downstream
sales.”
56
overruled Appellant’s dispositive issues attacking the trial court’s summary judgment.
Thus, we have no basis to review the attorneys’ fee award and therefore overrule
Appellant’s third issue as moot.
X. Conclusion
Having overruled Appellant’s first and second issues, which are dispositive of
this appeal, we affirm the trial court’s judgment.
/s/ Dabney Bassel
Dabney Bassel
Justice
Delivered: April 18, 2019
57