LESSEE AGREES THAT all royalties accruing under this Lease (including those paid in kind) shall be without deduction, directly or indirectly, [of post-production costs]. Lessee agrees to compute and pay royalties on the gross value received […].
The lease also provided that “Exhibit ‘A’ supersedes any provision to the contrary in the printed lease hereof[.]” The Texas Supreme Court neatly explained several terms at issue in this case and the interplay/conflict between them. It first noted that “‘[m]arket value’ means ‘the price a willing buyer under no compulsion to buy will pay to a willing seller under no compulsion to sell.’ While agreeing that the “preferred method of determining market value is by using actual sales that are comparable in time, quality, quantity, and availability of marketing outlets[,]” the Court acknowledged that this information may not be available. The Court correctly identified an alternative method for determining market value in these cases – “the ‘net-back’ or ‘workback’ method.” So, when a lease requires measurement of market value “at the well”, “the workback method permits an estimation of wellhead market value by using the proceeds of a downstream sale and subtracting postproduction costs incurred between the well and the point of sale.” The Court, citing to a previous opinion, went on to provide that “‘[p]roceeds’ 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,” […] and “may be either the gross amount received or the net amount remaining after deductions[,]” depending on the contract language. As an example, the Court stated that “an ‘amount realized’ clause, standing alone, creates a royalty interest that is free of postproduction costs.” However, if this clause is modified by “net” language (e.g. “at the well” or “into the pipelines, tanks or other receptacles with which the wells may be connected”), post-production costs may be deducted. “When proceeds are valued in ‘gross,’ however, the valuation point is necessarily the point of sale because that is where the gross is realized or received.” BlueStone argued that the “‘gross value received’ term [could] be melded with an ‘at the well’ valuation point to produce a net-proceeds calculation.” But the Court did not “agree because ‘gross’ and ‘net’ terms do not peaceably coexist.” In announcing this, the Court dispelled the contention that “‘at the well’ language [is] a ‘trump’ card that supersedes ‘amount realized’ language without regard to other lease terms requiring royalty calculation on the ‘gross’ and without regard to the parties’ own agreement about what language controls in the event of a conflict.” The Court ultimately found that, in this case, “the parties expressly agreed to resolve the conflict in favor of a royalty free of postproduction costs, and courts must enforce unambiguous contracts as written. […] We accordingly hold that BlueStone wrongfully deducted postproduction costs in satisfying its royalty obligations to the Lessors.” Going forward, we have been shown a clearer path to understanding the interplay between these terms and when they conflict. Moreover, any misconception regarding the superior treatment of the phrase “at the well” has been alleviated. And once again, the Court insists that must apply “the unremarkable principle that contracts must be construed according to their terms.”