Producers May Subtract Gas Used to Power Post-Production Activities From “At-the-Well” Royalty Payments

June 24, 2024

In Carl v. Hilcorp Energy Co., the Texas Supreme Court—addressing certified questions from the Fifth Circuit—held that producers may subtract the volume of gas powering post-production activities from “at-the-well” royalty calculations as a post-production cost.

Hilcorp, an energy exploration and production company, held leases with the royalty holders, Anne Carl and related parties, that conveyed an “at-the-well” royalty. In other words, Carl’s “royalty interest [was] in the minerals as they come out of the ground, not after processing, transportation, or other ‘post-production’ efforts have increased the mineral’s value.” Hilcorp used some of the gas produced from Carl’s well to power post-production activities “off the premises” for other gas produced from the well. As a result, Hilcorp subtracted the volume of gas used in its post-production efforts from the total volume of gas used to calculate Carl’s royalty.

Hilcorp’s calculations spurred litigation. Carl asserted that Hilcorp could not subtract the volume of gas used in post-production and that she was entitled to a royalty on all gas produced from the well.

First, Carl argued that the lease did not allow Hilcorp to subtract gas used in post-production activities because the lease required royalty payments on “all gas produced from the well.” Hilcorp argued that this provision did not overcome the fact that an “at-the-well” royalty allows for gas used in post-production to be subtracted from Carl’s royalty. The Court sided with Hilcorp, holding that it “was entitled to account for reasonable post-production costs, which include the value of the gas used off the premises to prepare other royalty-bearing gas for sale.” The parties could have contracted differently, but they did not.

Second, Carl argued that the Court’s prior decision in BlueStone Natural Resources II, LLC v. Randle barred Hilcorp from subcontracting post-production costs from the “at-the-well” royalty calculation. She read Randle to mean that “free-use” clauses—such as the one in Carl’s lease—changed her obligation to bear her share of post-production costs. The Court rejected this argument, stating that Randle only “reiterate[d] the longstanding rule that an ‘at-the-well’ royalty ‘bears its usual share of post-production costs.’”

Practical Takeaways

The Texas Supreme Court’s decision in Carl v. Hilcorp provides clarity for producers and royalty holders related to post-production costs. It reaffirms that producers—with an “at-the-well” royalty—may subtract the value of gas used in post-production activities on or off the premises from the royalty calculation, including the value of gas used to power post-production activities. Rather than removing a royalty holder’s obligation to share post-production costs, Randle confirmed that “at-the-well” royalty holders bear its usual share of post-production costs.

However, an “at-the-well” calculation is not without limitations. The Court also noted that, “[i]f some of the gas produced from the well were ‘used off the premises’ for something other than post-production activities on other gas produced from the well, then a royalty would be due on the gas so used.” In the future, there is still room for argument among producers, royalty holders and the courts over where, how and why post-production activities and costs are incurred.

Special thanks to summer associate Michael L. Johnson who contributed to the alert. He is not licensed to practice law.