07.14.2022

This article is from the McGinnis Lochridge Oil & Gas newsletter, Producer’s Edge – Vol. 4, Issue 1. Read the full newsletter here.

On February 4, 2022, the Texas Supreme Court issued an opinion holding that, based on the terms of the instrument at issue, including use of the phrase “delivered to Grantor’s credit, free of cost in the pipe line,” BlueStone was permitted to reduce the royalty base to account for postproduction costs between the wellhead and the point of sale, and that a gathering system qualified as a “pipe line” as referenced in the instrument.

Significance and Takeaway

Perhaps one of the most significant aspects of the BlueStone opinion, however, is the Court’s clarification of its 2019 opinion, Burlington Res. Oil & Gas Co. v. Tex. Crude En., LLC, 573 S.W.3d 198 (Tex.2019).  In the BlueStone opinion, the Supreme Court indicated that the appellate court had “misconstrued our opinion in Burlington” as establishing a rule that the phrase “into the pipeline” in a lease is “always equivalent to an ‘at the well’ delivery or valuation point.” 

Instead, the Court emphasized that royalty obligations are a matter of construing the language of the lease, as a whole, to ascertain the parties’ intent.  “Although mineral transactions are subject to certain presumptions that state the ‘usual’ rules, we have repeatedly affirmed that parties are free to make their own bargains, and courts are obligated to enforce agreements as the parties intended.”  Thus, although the Burlington case held that the language involved in that case equated “into the pipeline” with an ”at the mouth of the well” valuation, “we did not fashion a rule to that effect.” 

According to the Court, “the decisive factor in each … case is the language chosen by the parties to express their agreement.”  “Just as in Burlington Resources, our analysis here turns not on an immutable construct but on the parties' chosen language.”

Several recent Texas oil and gas cases have repeatedly held that parties are free to make their own bargains, and Texas courts are to construe agreements to ascertain the intent of the parties as expressed in their agreement, viewed in context of the entire agreement and not in isolation, so as to harmonize all provisions and render none meaningless. 

These principles are the driving force underlying most oil and gas disputes.  And these principles extend beyond just royalty disputes.  Words matter, and often control the outcome in most categories of oil and gas litigation.  Through a careful understanding of this approach, and a thoughtful and creative analysis of the instruments at issue, lawyers can develop an effective and persuasive strategy for the courthouse. 

Factual Background

The case involved a 1986 special warranty deed, which reserved:

a free one-eighth (1/8) of gross production of any such oil, gas or other mineral said amount to be delivered to Grantor's credit, free of cost in the pipe line, if any, otherwise free of cost at the mouth of the well or mine…

In 2004, the executive mineral owner executed a lease, and the lessee subsequently drilled thirty-four producing wells.  For several years, the lessee calculated royalties unburdened by any postproduction costs.

In 2016, however, BlueStone acquired the leasehold interest, and began deducting a proportional share of postproduction costs.  This lawsuit followed.

Analysis and Holding

The Court noted that, as a general rule, a nonparticipating royalty interest is free of costs of production, but when it is delivered in kind it generally bears its proportional share of postproduction costs. 

However, as the court noted, parties may deviate from that general rule.  The Court conducted a thorough review of the actual language used by the parties in order to ascertain their intent.

Engler argued that the phrase “in the pipe line” was intended to reference a downstream major transportation pipeline, and not a mere gathering system.  The Court rejected that argument.

The Court noted that the deed does not refer to any particular pipeline, to any particular type of pipeline, nor any particular downstream delivery point.  Moreover, because the deed did not provide a special definition for pipeline, and did not use it in a technical or special way, the Court looked to ordinary and industry definitions.  In that regard, the Court pointed to definitions of “pipeline” within Williams & Meyers, as well as Webster’s dictionary, and the Tex. Util. Code, all of which expressly included a gathering line.

The Court also noted that instruments requiring delivery “into the pipeline” often include additional language saying “to which the lessee connects his wells.”  Indeed, such language was included in the lease at issue in Burlington.  The Court reasoned that, by not including that limiting language in the 1986 deed, the parties actually made the reference to “pipeline” even broader.  Moreover, that common usage reflects that it is not uncommon for the word “pipeline” to refer to a line connected to the well or on the wellsite premises.

The Court also rejected Engler’s argument that the second half of the phrase, reading “otherwise free of cost at the mouth of the well,” reflects a dichotomy between offsite and onsite deliveries.  In Engler’s view, if the lessee delivers at the well then that is onsite, and if the lessee delivers into the pipeline then that must refer to an offsite pipeline.

The Court rejected this argument.  Instead, the Court examined the language of the entire provision and attempted to harmonize its terms to determine the parties’ intent.  The Court held that the proper interpretation is that, if a pipeline exists then the pipeline is the “preferred delivery point,” and that a wellhead delivery is the “default” if no pipeline exists or the produced mineral is not capable of delivery into a pipeline.  The Court reasoned that this construction best harmonized the language and created “internal consistency and parity.”

The Court also refused to consider Engler’s proffered expert testimony on evidence of industry custom and usage.  Engler had offered the affidavit of an attorney, who opined that the phrase “pipe line” refers to the place where title passes to a gas purchaser, and that in 1986 it was not uncommon for gathering systems to be owned by operators. 

The Court did not consider Engler’s expert testimony, reasoning that, although certain evidence of surrounding circumstances can be considered in construing an unambiguous contract, Engler’s proffered expert testimony impermissibly would vary or contradict the plan language of the 1986 deed.  Further, testimony as to how “most” gas was “usually” processed and sold under “traditional” agreements at the time “does not elucidate the meaning of the 1986 deed’s words.”

About the Author

Austin Brister is a partner in our Oil and Gas group. Before lawsuits are filed, Austin helps oil and gas companies analyze complicated issues, and strives to develop creative and practical business solutions. But, when necessary, Austin works hard to implement aggressive, goal-focused strategies in the courthouse. Austin frequently assists clients in resolving problems involving title disputes, injunctive relief, joint operating agreements, accounting issues, royalty disputes, lease termination disputes, surface use and trespass issues, purchase and sale issues, lease saving operations, and a host of other oil and gas issues.

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