Is “Into the Pipeline” the equivalent of a wellhead appraisal? Not So Fast, Says Texas Supreme Court | Alston and bird
Our oil and gas team analyzes a Texas decision that reminds courts to look at the entire contract, not just a favorite word or phrase.
- The parties disagreed on where the pipeline royalty assessment should take place
- The Texas Supreme Court rejected an absolute rule to define “in the pipeline”
- Ultimately, it is up to the parties to decide where the royalty assessment will take place, which may include specifying a particular pipeline or location along the pipeline.
Last week, the Texas Supreme Court provided key guidance on lease royalty provisions that require an assessment of pipeline royalties. In Nettye Engler Energy LP v BlueStone Natural Resources II LLC, No. 20-0639, the court carefully reviewed the wording of the lease to conclude that oil and gas operator BlueStone had correctly deducted post-production costs incurred downstream of a gas gathering system at a site in well. Significantly, the court rejected the appellate court’s rigid application of its Burlington Resources holding, explaining that courts must consider and harmonize all of the writing, rather than relying on one key word or phrase. In short, valuation at the “pipeline” does not necessarily mean “at the well”.
The non-participating royalty interest clause at issue stated that the licensor should receive its fractional royalty “without charge in the pipeline, if any, otherwise without charge at the mouth of the shaft or mine”. The parties agreed that the royalty should be calculated at a pipeline, but disagreed on which pipeline should establish the assessment. BlueStone assessed the gas royalty at the mouth of the wellsite gathering system, while the licensor requested an assessment at the transmission pipeline level or further downstream, as a “gathering system” differed from an “oil pipeline”. The licensor also argued that a pipeline assessment implies that the royalty must be calculated when the gas is transferred to a third party. The Fort Worth Court of Appeals rejected the licensor’s arguments and ruled in favor of BlueStone. The Court of Appeal relied heavily on the Supreme Court’s decision in Burlington Resources Oil & Gas Co. v. Texas Crude Energy LLC., in which the court interpreted an “in the pipeline” provision to be functionally equivalent to a wellhead assessment.
While the Supreme Court upheld the appeals court’s decision, it denied the lower court’s request for Burlington Resources[…]this case, she explained, did not establish a “fixed construct” for interpreting pipeline royalty provisions. The language of pipeline-based royalties is therefore not always the equivalent of a wellhead assessment. Instead, courts must review and harmonize the entire scripture according to its ordinary meaning.
The court reviewed the lease, common industry usage, regulations, statutes and case law to conclude that a collection system could serve as an assessment pipeline. Because the Nettye lease did not specify “any particular pipeline or any type of pipeline, as it could have” and that a gathering system is a species of pipeline, the assessment at the level of the well site gathering system was appropriate. Parties can, of course, agree to assess royalties on certain pipelines or types of pipelines by saying so.
Although both Burlington Resources and Nettye interpreted the “in preparation” assessment as the practical equivalent of wellhead assessments, neither of these decisions creates an absolute rule. Rather, all parties should analyze their particular lease provisions to ensure that royalties are calculated correctly. The parties must also ensure that the provisions drafted reflect the true intention of the parties.
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