In resolving a dispute over deductions for post-production costs from oil and gas royalties (PPC), the tribunal de Shirlaine West Properties Ltd et al against Jamestown Resources, LLC and Total E&P USA, Inc. considered that the case “… is yet another episode in the endless struggle in the oil and gas context between lessors and tenants in the allocation of [PPC’s] in the calculation of royalty payments.
To take with
Was the lessor’s gas royalty encumbered by the PPCs? Yes. The market value royalty clause unambiguously set the wellhead as the valuation point for calculating the royalty.
The royalty clause
The lessor has done its best to be PPC free:
- The gas royalty was 25% of “… market value at point of sale, use or any other disposition …
- … To be determined “… at the location specified and by reference to the gross calorific value…”.
- “The market value used in the calculation… must never be less than the total proceeds received by the tenant in connection with a sale, use or other disposition…”.
- The royalty “… will be free and free from all costs and expenses whatsoever, with the exception of ad valorem and production taxes”.
- … [N]notwithstanding any provision to the contrary herein, all oil, gas or other products accruing to the Lessor … will be without deduction for [PPC’s] … And the costs resulting from the improvement in value could be deducted “… but in no case would the Lessor receive a price lower or higher than the price received by the Tenant. “
- If the tenant has realized a product after deduction of PPC “… the proportional part of these deductions must be added to the total product received by the tenant…. “.
- Heritage Resources v. NationsBank would have no application.
The tenants have entered into a complex marketing regime involving a series of transactions with related and unrelated entities and a weighted average selling price. There was no PPC activity at the wellhead and the gas did not require any special handling to be sold and transported out of the lease.
The court referred the reader to Bluestone Resources v. Randle for the basic structure of royalty terminology and for the historical legal background to the treatment of royalty clauses in oil and gas leases.
The court cited two examples of contracting parties so that the royalties of a lessor are exempt from PPC: “product” leases (Hyder vs. Chesapeake) and “amount realized” of the leases (Bowden v. Phillips Petroleum). These cases were of no help to donors.
The court reviewed the Supreme Court’s decision in Burlington Resources that he had never interpreted a contractual valuation method based on the amount realized to override a contractual valuation point at the well, thus neutralizing the effect of the language on which the lessor relied to avoid PPCs.
Considering all of the writing in an effort to harmonize and implement all its provisions so that none lose their meaning, the court concluded that the first two sentences of the royalty clause set the market value as a measure of value and fixed the location of value at the point of sale. It was not disputed that the point of sale for the gas in question was at the wellhead. Potential sales at other points might rightly fall within the Heritage resources considering that the provisions aimed at deducting or exempting PPC from the lessor’s royalty are considered to be excess. But the court was not informed of these facts and refused to make a prognosis about them. Patrimony was not applicable.
The lessor’s dependence on Hyder was misplaced: exemptions are generally subject to PPCs. The court’s justification for the detention Hyder was never clearly explained. In any case, Hyder did not assess the waiver on the market value of the well and therefore did not exercise control.
Your musical interlude.