BlueStone Redux: Another Texas Supreme Court Decision on Postproduction Deductions
By Christopher M. Hogan, Trial Attorney & Founding Partner, Hogan Thompson LLP
02/16/22 – The Texas Supreme Court seems to have taken an interest in postproduction deduction cases as of late. Twenty-six years passed between the Texas Supreme Court’s decision in Heritage Resources, Inc. v. NationsBank, 939 S.W.2d 118 (Tex. 1996) and its next major opinion on postproduction deductions, Chesapeake Exploration, L.L.C. v. Hyder, 483 S.W.3d 870 (Tex. 2016).
But since Hyder, the Texas Supreme Court has returned to the topic multiple times. In 2019, it decided Burlington Resources Oil & Gas Co. LP v. Tex. Crude Energy, LLC, 573 S.W.3d 198 (Tex. 2019). Last year it issued its decision in BlueStone Natural Resources II, LLC v. Randle, 620 S.W.3d 380 (Tex. 2021). And this month issued its most recent postproduction deduction decision: Nettye Engler Energy, LP v. BlueStone Natural Resources II, LLC, No. 20-0639, 2022 WL 333368 (Tex. Feb. 4, 2022).
The Texas Supreme Court examined a Fort Worth Court of Appeals’ decision that I examined back in November 2020 (you can read that analysis here). As I suspected, the Texas Supreme Court affirmed the appellate court’s decision that BlueStone was permitted to take postproduction deductions under the deed at issue. But unfortunately for oil and gas practitioners in Texas, the Court likely muddied the waters of deed and lease interpretation going forward.
At issue in the case was a 1986 deed that reserved a 1/8 nonparticipating royalty interest (“NPRI”) for the predecessor of Nettye Engler Energy, LP (“Engler”). The NPRI described the royalty as “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.” Id. at *2.
The original operator of a well on Engler’s property did not take any deductions for postproduction costs before gas from the well entered the major gas-gathering pipeline. But when BlueStone Natural Resources II, LLC (“Bluestone”) took over the lease, it began to deduct for postproduction costs incurred after gas from the well entered the gathering system. This resulted in Engler receiving substantially less in royalty payments and ultimately led to a lawsuit.
They key dispute for the parties was what the deed meant when it said that gross production of gas was “to be delivered to Grantor’s credit, free of cost in the pipe line.” Id. (emphasis added). The parties appeared to agree that the “pipe line” was the “valuation point” for determining postproduction-cost deductions.1 But the parties did not agree on which pipeline the deed was discussing. Engler argued “that ‘in the pipe line’ refers either to the distribution pipeline at the point of sale or to the offsite transportation pipelines, while BlueStone argued that the delivery obligation under the deed is satisfied by delivery in the gathering pipelines comprising the onsite gathering system.” Id. at *3.
The Texas Supreme Court ultimately sided with BlueStone for a few key reasons:
Looking at dictionaries and treatises from the date of the deed at issue, the Court found that “pipe line” could refer to a gathering system pipeline on the lease. Id. at *7–8.
Caselaw, including a recent case from the North Dakota Supreme Court,2 was in line with the view that “pipe line” could be the gathering system. Id. at *9–10.
Nothing in the deed prohibited delivery of gas at or near the well. Id. at *10. The Court would have to add additional words of limitation to the deed to arrive at such a reading, and that would violate the Court’s rule that it cannot rewrite instruments as part of interpreting them. Id.
The deed had a delivery point for oil and gas if no pipeline existed: “at the mouth of the well or mine.” Id. The Court found that this alternative delivery point supported that the parties’ intent was that delivery could take place at pipelines on the wellsite, rather than just downstream at a trunk pipeline.
I think the Supreme Court got this decision right. But in its opinion, the Court took issue with the Court of Appeals’ interpretation of the “into the pipe line” language. The appellate court decision noted that the Texas Supreme Court’s opinion in Burlington Resources Oil & Gas Co. LP v. Texas Crude Energy, LLC, 573 S.W.3d 198 (Tex. 2019) was critical to determining the outcome of the case because it equated “into the pipeline” with a valuation point at or near the wellhead:
We reject Engler's attempted distinguishing of Burlington Resources. First, the Burlington Resources court did in fact focus heavily on the singular phrase “into the pipeline.” Burlington Resources, 573 S.W.3d at 208–11. Indeed, the court consistently referred to the provision as the “‘into the pipeline’ provision” and equated it with a valuation point “at or near the well.” See id. at 211 (“[A]s we conclude, these parties intended their ‘into the pipeline’ clauses to place the royalty valuation point at or near the well.”).
BlueStone Nat. Res. II, LLC v. Nettye Engler Energy, LP, No. 02-19-00236-CV, 2020 WL 3865269, at *5 (Tex. App.—Fort Worth July 9, 2020). With a valuation point at or near the wellhead, BlueStone could properly deduct most postproduction costs.
The Texas Supreme Court, however, stated that the Court of Appeals “misconstrued” Burlington Resources with this conclusion:
The court of appeals reached the correct result but misconstrued our opinion in Burlington Resources Oil & Gas Co. v. Texas Crude Energy, LLC as establishing a rule that delivery “into the pipeline,” or similar phrasing, is always equivalent to an “at the well” delivery or valuation point. Rather, the opinion merely emphasized that all contracts, including mineral conveyances, are construed as a whole to ascertain the parties’ intent from the language they used to express their agreement.
Nettye Engler Energy, 2022 WL 333368, at *1 (footnote omitted).
This discussion will be frustrating for oil and gas practitioners looking for certainty when it comes to determining whether a lessee can take postproduction deductions under a lease or deed. Rather than provide fixed, concrete rules, the Court again emphasized need to take a holistic look at the parties’ agreement to answer questions about whether postproduction deductions are permitted. It sounds good in theory. But in practice, the Court’s refusal to embrace more bright-line rules will likely result in more lawsuits over the question of when lessees can take these deductions (and likewise more petitions to the Texas Supreme Court to answer those questions).
1. This is the term used in BlueStone Nat. Res. II, LLC v. Randle, 620 S.W.3d 380, 387 (Tex. 2021).
2. Blasi v. Bruin E&P Partners, LLC, 959 N.W.2d 872 (N.D. 2021).
Christopher M. Hogan Trial Attorney & Founding Partner chogan@hoganthompson.com | 713.671.5642
Chris Hogan focuses his litigation practice on resolving complicated disputes for corporate and individual clients, particularly those in the energy industry. Chris has substantial first-chair experience in federal court, state court, and arbitration proceedings. is honored to represent as lead counsel major energy companies such as Apache, BPX, Chevron, ConocoPhillips, Devon, EOG, Marathon Oil, Mewbourne, and Ovintiv.