BlueStone Nat. Res. II, LLC v. Nettye Engler Energy, LP is another Texas case deciding whether language creating a nonparticipating royalty interest prohibited deduction of post-production costs. (Spoiler alert: it didn't. Read on to learn why.)
By a 1986 Deed Engler's predecessors conveyed land to BlueStone's predecessor. Grantor reserved an undivided 1/8th NPRI in the minerals and was entitled to 1/8th of gross production, " ... to be delivered to Grantor's credit, free of cost in the pipe line, if any, otherwise free of cost at the mouth of the well or mine ... ." (emphasis ours).
Bluestone as operator interpreted the NPRI to be subject to post-production costs and calculated Engler's royalties on the value of gas produced at the point the gas entered the pipeline rather than at the point of sale, so it deducted post-production costs.
Trial court and the appeal
In dueling motions for summary judgment BlueStone argued that under the 1986 Deed Engler's royalty was subject to post-production costs. Engler argued the opposite. Engler jumped out to an early lead. The trial court found that BlueStone improperly deducted gathering and compression costs.
In analyzing the 1986 Deed the court of appeal relied on Burlington Resources Oil and Gas v. Texas Crude Energy. Where valuation of a lease royalty is measured determines whether the royalty is burdened with post-production costs. Burlington concluded that "in the pipe line" was equivalent to creation of a valuation point "at the wellhead or nearby", which meant that the royalty was burdened with post-production costs. Engler's royalty bore post-production costs.
Engler distinguished Burlington by arguing that "pipe line" referred to one of two specific "major" pipelines that are far from the wellhead, and that "pipe line" could not mean the gathering system at or near the wellheads. The court disagreed. The Supreme Court of Texas' has held that a gathering line is a pipeline.
Engler then argued that "free of cost at the mouth of the well" sets the valuation point for oil and "free of cost in the pipe line" sets the valuation point for gas. The two distinct valuation points indicated that "in the pipe line" meant somewhere other than at the wellhead. Again, the court disagreed, construing the operative language to mean that if there is a pipeline, then the valuation is made "in the pipe line," and if there is not a pipeline, then the valuation is "at the mouth of the well or mine." Effectively, the valuation point was at the wellhead.
Finding as much success as if he were convincing President Trump that the votes have been counted, Engler argued that Chesapeake Exploration v. Hyder (caveat - the ruling was 5-4) controlled the 1986 Deed. In Hyder, the grantor held "a perpetual, cost-free (except only its portion of production taxes) overriding royalty of [5%] of gross production ... ." That provision created an interest free of post-production costs; however, unlike in Hyder, the 1986 Deed did not specifically except any post-production costs.
Engler further argued under Hyder that "free" 1/8th of gross production rendered the reserved royalty free of post-production costs. No go. The court cited the cases holding that "cost-free overriding royalty" is often a synonym for a royalty burdened with post-production costs, and "free royalty" generally creates a royalty free of production costs but burdened with post-production costs. "Free" as used in the 1986 Deed was a reference to the free-from-production-cost nature of a standard royalty.
In a hail-mary, Engler pointed out that the grantors would have had no motivation to burden their reserved royalty with post-production costs. The court agreed, but a reviewing court cannot look to the drafters' subjective intent.
The NPRI created by the 1986 Deed was burdened by post-production costs.
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