In Texas, a landowner’s royalty is free of production costs incurred in drilling for and bringing minerals to the surface, but typically bears its proportionate share of postproduction costs. However, parties may contract to change this cost allocation. To that end, countless variations of “cost-free” and “no deducts” royalty provisions have been included in leases, though questions linger about what language truly yields “cost-free” royalty.
In the 1996 opinion Heritage Resources v. NationsBank, the Texas Supreme Court interpreted leases calling for gas royalties based on the “market value at the well” with “no deductions from the value of the Lessor’s royalty by reason of any required processing, cost of dehydration, compression, transportation or other matter to market such gas.” The Heritage court first reasoned that because the royalty provision required the market value to be determined “at the well,” by definition that value was calculated by “netting back” or deducting reasonable postproduction costs from the market value at the point of sale. The court concluded royalties were correctly paid because no costs were deducted from “the value of Lessor’s royalty” and labeled the “no deductions” provision as “surplusage.”
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