Fasken Ranch Ltd et al v. Puig et al featured a reservation in the sale of a ranch of an undivided 1/16 non-participating royalty interest “free of cost forever.” What does that mean? In particular, does it mean that the royalty owners must bear their share of post-production costs? The answer is No. Read on to know why.
Fasken is the operator of wells on the aforesaid ranch and the Puig parties are royalty owners. The parties agreed that the term exempts the royalty owner from paying production costs (as it always does) but, no surprise, disagreed about postproduction costs. The trial court and the court of appeals both concluded that “free of cost forever” applies equally to production and post-production costs.
As you know, investment in post-production costs makes oil and gas production more valuable for both the producer and the royalty owner. Generally, royalty owners must pay their proportionate share of post-production costs, but that rule can be modified by agreement.
In denying Fasken’s position that the free-of-cost language referred to production costs only, the court was guided by Chesapeake Exploration v. Hyder. There, the Supreme Court considered a “… cost-free (except only its portion of production taxes) overriding royalty of [5%] of gross production obtained …” and concluded that the royalty owner did not bear post-production costs. The Hyder court deemed taxes to be post-production costs and it would make no sense for the cost-free language to refer only to production costs, yet except post-production costs from its application. That led to Chief Justice Hecht’s entertaining “no dogs allowed, except for cats” reference.
The language in the Fasken/Puig deed did not distinguish between production and postproduction costs and literally refers to all costs. The court gave “cost free” its normal meaning and applied the term to both kinds of costs.
Fasken argued that “free of cost forever” was mere surplusage referring to production costs that are already exempt from royalty because, said Fasken, this royalty provision already values royalty at the wellhead. The court responded that the argument would have merit if the deed provided a valuation at the wellhead because a royalty valued at the well bears post-production costs. This reservation did not identify a valuation point.
Fasken also argued that by using the word “produced” the parties meant that the valuation point was at the wellhead. The court considered that to be a strained extension of current law and Fasken offered no authority for the proposition. The court noted that valuation of a point-of-sale royalty also would likely use the word “produced” in the granting clause.
Because Fasken was unable to show that “free of cost forever” refers only to production costs, the NPRI reserved by Puig was free of both production and postproduction costs.
Quincy Jones, RIP.
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