Summary
BlueStone Natural Resources II v. Walker Murray Randle arises from a dispute relating to natural gas royalties BlueStone Natural Resources II, LLC (“BlueStone”) paid to various groups of Lessors. The Lessors sued BlueStone, alleging BlueStone improperly used an “at the mouth of the well” computation and wrongfully deducted post-production costs before calculating payments to Lessors. Specifically, Lessors argued a controlling addendum to the lease mandated calculating royalties on “gross value received.” The Lessors also argued that BlueStone impermissibly failed to pay royalties on commingled volumes of gas used by an off-lease third party through misconstruction of a “free use” provision in the lease.
In the trial court, Lessors prevailed on a traditional summary judgment motion as to both claims, and the Fort Worth Court of Appeals affirmed the judgment. The Supreme Court affirmed the lower courts’ calculation of the royalties based upon gross value and their interpretation that the “free use” clause was limited to on-lease operations, but remanded for further findings on the appropriate damages measure.
In reaching its decision, the Court applied general contract-law principles and determined that proper construction of the lease was predicated upon the language in the agreement and the parties’ intentions as expressed in that writing. In doing so, the Court distinguished Burlington Resources Oil & Gas Co. LP v. Texas Crude Energy, LLC, 573 S.W.3d 198 (Tex. 2019), from the language at issue, concluding that the addendum’s superseding language eclipsed the language allowing deduction of post-productions costs at issue in the Burlington case. Similarly, the Court followed the plain language of the lease to determine that the free-use clause was geographically limited to only on-lease operations.
No Post-Production Deductions
The Lessors filed suit against BlueStone after BlueStone acquired the rights to their leases and began to deduct post-production costs from royalty payments using an “at the mouth of the well” computation formula. To make these calculations, Blue Stone relied upon the printed lease, which required payment of gas royalties based on “the market value at the well . . . of the gas so sold or used [off the premises]” (emphasis in opinion). The Lessors, by contrast, looked to the addendum attached to the lease which stated it “supersedes any provisions to the contrary in the printed lease.” The addendum further provided “[l]essee agrees to compute and pay royalties on the gross value received, including any reimbursements for severance taxes and production related costs” (emphasis in opinion). It also included “no deductions” language specifying that “royalties accruing under this lease . . . shall be without deduction for postproduction costs.”
BlueStone argued the net-value “at the mouth of the well” provision was the only language in the lease or addendum providing a valuation point. Accordingly, BlueStone argued there was nothing contradictory between the printed lease and the addendum, and as such, they could be construed in conjunction. The Supreme Court of Texas rejected this argument, ruling in favor Lessors, and stating that “gross” and “net” terms cannot peaceably coexist.
Looking to the parties’ lease agreement as a whole, the Court determined the addendum’s language to be dispositive, holding it expressly superseded the text of the lease and required the royalty to be based upon “gross value received.” In the Court’s words, the decision merely “applied the unremarkable principle that contracts must be construed according to their terms.”
The Limits of a “Free Use” Clause in a Gas Lease
While the litigation was ongoing, Lessors also discovered BlueStone had not been paying royalties on commingled gas used as plant fuel by a third-party processor off the lease premises or on commingled gas the processor returned to BlueStone to fuel compressors both on and off the lease premises. Lessors argued BlueStone owed royalties for this gas. BlueStone contended it was following the lease, which provided:
“Lessee shall have free from royalty or other payment the use of . . . gas . . . produced from said land in all operations which Lessee may conduct hereunder, including water injections and secondary recovery operations, and the royalty on . . . gas . . . shall be computed after deducting any so used” (emphasis in opinion)
BlueStone argued that under this clause, it was entitled to royalty-free use of gas regardless of whether it was consumed on premises so long as the use benefitted or furthered operations.
Having never before construed a “free use” clause, upon examination of the lease and decisions from other courts, the Court ruled largely in favor of Lessors, agreeing with the appellate court’s analysis based upon the lease’s provisions: (1) limiting free use to “operations . . . hereunder,” (2) describing operations under the lease as those “thereon” the leased premises, and (3) giving free-use examples that are limited to on-lease activities. The opposite construction, allowing broad off-premise free use, would “inject uncertainty and lead to a fact-finding mission to determine whether progressively more attenuated uses ‘benefit’ or ‘further’ the lease operations.” While parties are free to tailor contracts to suit their purposes, the Supreme Court of Texas determined that the free use clause here did not allow for off-premises royalty-free use of Lessors’ gas.
With respect to damages, the Court remanded for further fact finding. Specifically, the parties did not provide sufficient evidence delineating the proportion of commingled compressor fuel used off-lease as compared to the amount used on the leased premises for the benefit of lease operations. To the extent the compressor fuel was actually used on the leased premises, it would be subject to the free-use clause and not entitle Lessors to royalties. The district court awarded Lessors damages for a royalty based on the entire amount of compressor fuel, and the Court of Appeals affirmed because BlueStone could not make a “corresponding allocation to establish which portion of the commingled gas is used to power compressors on [Lessors’] leases and on leases owned by other lessors.” The Supreme Court reversed, determining that the lack of evidence regarding an allocation between on-and-off lease consumption presented a fact issue, rendering summary judgment improper. Because stipulated facts indicated at least some of the compressor gas was used on some of the leased premises, more evidence was necessary regarding the correct measure of damages. The Court affirmed with respect to the damages for the off-lease plant fuel, however, because there was no on-lease usage that would have been subject to the free-use clause. Accordingly, the Court remanded for the presentation of more detailed evidence.
Key Takeaways
- Oil and gas leases will be interpreted pursuant to their plain language and, where a conflict is found, a court will rely on the parties’ explicit instruction in the agreement as to how to resolve the conflict.
- It is imperative to carefully and proactively draft oil and gas leases to avoid conflicts related to royalty calculations. The specific language in oil and gas leases will control the interpretation through application of traditional contract law principles.
- A “free use” clause is limited by specific enabling language in the lease provision.
Client Alert 2021-078
