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  • Writer's pictureByron C. Keeling

BlueStone Redux: The Texas Supreme Court Opinion

On March 12, 2021, the Texas Supreme Court issued its opinion in BlueStone Natural

Resources II, LLC v. Randle, No. 19-0459, 2021 WL 936175 (Tex. March 12, 2021). The supreme court ruled that a “gross value received” royalty clause means exactly what it says — that the royalty owners are entitled to receive a fractional share of the gross value that the lessee ultimately receives from the sale of its oil or gas production, wherever the sales location may be.

The parties in BlueStone entered into a lease addendum specifying that the royalty owners were entitled to receive royalty payments in the amount of their fractional share of the “gross value received.” The lease addendum superseded the parties’ original lease agreement, which contained a “market value at the well” royalty clause. The petitioner in BlueStone argued that because the lease addendum did not specify a royalty “valuation point,” the supreme court should infer from the “at the well” language in the original lease agreement that the parties intended for the lessee to calculate its royalty payments on the basis of the value of its oil or gas production “at the wellhead.” The Texas Supreme Court rejected the petitioner’s argument.

The petitioner asserted that it was entitled to use a workback methodology to calculate the amount of its royalty payments. A workback methodology is a common means for a lessee to determine the market value of its oil or gas production at the wellhead. See BlueStone, 2021 WL 936175, at *5 (noting that the workback methodology is “accepted as an adequate approximation of market value at the well”). It rests on the premise that because oil and gas production is more valuable after a lessee incurs the cost to place it in a marketable condition and transport it to a downsteam market, a lessee may calculate the market value of its production at the wellhead by subtracting its post-production expenses from its downstream sales price for the production. Id. (citing Byron C. Keeling, In the New Era of Oil and Gas Royalty Accounting: Drafting a Royalty Clause that Actually Says What the Parties Intend It to Mean, 69 Baylor L. Rev. 516, 520 (2017)).

However, the supreme court in BlueStone noted that a “gross value received” royalty clause does not require a lessee to calculate the market value of its production. A gross value royalty clause entitles the royalty owner to receive a share of the gross value that the lessee receives for its production on sale. There is simply nothing to calculate. The gross value of the production is based on the sales price that the lessee actually receives on selling the production. “When proceeds are valued in ‘gross,’ . . . the valuation point is necessarily the point of sale because that is where the gross is realized or received.” Id. at *7.

The Texas Supreme Court declined to engraft any “at the well” language into the “gross value received” royalty clause in the parties’ lease addendum, emphasizing that “joinder of the terms ‘gross proceeds’ and ‘at the well’ gives rise to an ‘inherent conflict’ that renders a royalty clause ambiguous.” Id. (quoting Judice v. Mewbourne Oil Co., 939 S.W.2d 133, 136 (Tex. 1996)). The supreme court noted that its prior precedent did not impose any “rule of ‘at the well’ supremacy.” Id. at *8. Instead, the court reiterated that its prior precedent merely “applied the unremarkable principle that contracts must be construed according to their terms.” Id. And where the parties’ agreement specified that the royalty owners are entitled to a royalty share of the “gross value received,” the plain terms of the parties’ agreement required that the lessee calculate its royalty payments on the basis of the gross value it actually received for its oil and gas production at the point of sale. Id.

In my opinion, the Texas Supreme Court reached the correct result in BlueStone. As I observed in my blog post on November 19, 2020, “the term ‘gross’ suggests that the lessee may not deduct any post-production costs or expenses from the gross sales price that it received for its oil and gas production. . . . If a royalty clause is unambiguous, it should be enforced as written.” K&F Blog, Nov. 19, 2020, at point 3 (emphasis in original).

By: Byron C. Keeling

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