PPROA Pipeline ~ July 2015
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CASENOTE
Chesapeake Exploration, L.L.C. v. Hyder, 427 S.W.3d 472 (Tex. App.—San Antonio 2014, pet. filed), held
that post-production costs are not deductible if the royalty clause contains the words “free and clear” or “cost
free.” Chesapeake, as lessee, produced gas and sold it at the well to a Chesapeake affiliate, which took title.
The affiliate gathered and transported the gas to a “delivery point,” where an unaffiliated third party took
possession and transported downstream to a “point of sale,” where another unaffiliated third party purchased
the gas and took title. Chesapeake accounted to the royalty owners on the sales price at the point of sale. The
lease contained a royalty clause applicable to production from wells located on the lease and an overriding
royalty clause applicable to certain nearby wells located off lease. The issue was whether the lessors must bear
post-production costs under the two royalty clauses.
The royalty clause provided that Chesapeake would pay royalty as a percentage of the price “actually
received by [Chesapeake] for such gas” and that the royalty would be “free and clear of all production and post
-production costs and expenses . . . incurred between the wellhead and point of delivery or sale . . . to a third
party.” In addition, the royalty clause specifically stated that “Heritage Resources, Inc. v. NationsBank . . .
shall have no application to the terms and provisions of this Lease.” The royalty owners contended that this
language indicated that their royalty interest was not subject to any post-production costs and expenses,
regardless of where such costs were incurred. Chesapeake contended that post-production costs between the
point of delivery and the point of sale (i.e., third party costs) should be deducted. Chesapeake pointed to the
“or” language in the royalty clause, arguing that it was disjunctive and allowed Chesapeake to deduct
post-production costs incurred after the point of delivery, but before the point of sale.
The court acknowledged the general rule that post-production costs are deductible from royalty, but the
parties may modify the general rule by agreement. Heritage interpreted a no-deduct provision from the “value
of the Lessor’s royalty” as surplusage as a matter of law because the “value of the Lessor