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Calculating the Lessor's Royalty Payment: Much More Than Mere Math

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Calculating the Lessor's Royalty Payment: Much More Than Mere Math LSU Journal of Energy Law and Resources Volume 6 Issue 1 Fall 2017 3-23-2018 Calculating The Lessor's Royalty Payment: Much More Than Mere Math Patrick S. Ottinger Repository Citation Patrick S. Ottinger, Calculating The Lessor's Royalty Payment: Much More Than Mere Math, 6 LSU J. of Energy L. & Resources (2018) Available at: https://digitalcommons.law.lsu.edu/jelr/vol6/iss1/5 This Article is brought to you for free and open access by the Law Reviews and Journals at LSU Law Digital Commons. It has been accepted for inclusion in LSU Journal of Energy Law and Resources by an authorized editor of LSU Law Digital Commons. For more information, please contact [email protected]. Calculating The Lessor’s Royalty Payment: Much More Than Mere Math Patrick S. Ottinger* TABLE OF CONTENTS I. Introduction...................................................................................... 3 A. Preface ...................................................................................... 3 B. Basic Formula for the Calculation of the Lessor’s Royalty Payment ..................................................................................... 5 C. The Lessee’s Duty to Pay Royalty, and the Time for Payment ...................................................................... 6 D. Obtaining Information in Support of the Royalty Payment....... 7 1. The Check Stub................................................................... 8 2. Sophisticated Lease........................................................... 10 3. Online Data ....................................................................... 11 4. Direct Requests to the Lessee............................................ 12 E. Determining the Products to Which Royalty is Applied Pursuant to the “Royalty Clause” ............................................ 12 F. Determining and Expressing the Royalty Interest ................... 15 G. Determining from Whence Production is Obtained................. 15 1. Preface............................................................................... 15 2. The “Vertical” Consideration: Determining the Land from Which Production is Obtained ........................ 17 a. Understanding “Tracts of Land”................................. 17 b. Mineral Royalty Burdening Distinct Portions of the Leased Premises.................................................... 20 c. “Community Leases”.................................................. 22 3. The “Horizontal” Consideration: Determining the Subsurface Depth from Which Production is Obtained.... 26 II. The Factors and Considerations Involved in the Calculation of the Gross Royalty Payment........................................................ 28 A. Preface .................................................................................... 28 B. Quantity of Product in Measured Units ................................... 28 1. Measurement of Oil and Gas............................................. 30 a. Rules on the Metering of Oil ...................................... 30 b. Rules on the Metering of Gas ..................................... 31 2. Other Conservation Issues................................................. 34 a. Commingling of Oil and Gas...................................... 34 b. “Cross Unit Wells” ..................................................... 35 c. Conditional Allowables .............................................. 36 2 LSU JOURNAL OF ENERGY LAW AND RESOURCES [Vol. VI 3. Adverse Legal Consequences of Inappropriate or Inaccurate Measurement of Oil and Gas ........................... 38 4. Produced Gas on Which No Royalty is Due..................... 42 a. Production Used as Fuel in Well Operations.............. 42 b. Lost and Unaccounted for Production ........................ 44 C. Price per Unit of Product ......................................................... 44 1. Basis of Royalty Determination ........................................ 45 a. Market Value .............................................................. 45 b. Price Realized............................................................. 46 2. Source for Determination of the Relevant Benchmark Price ............................................................... 47 a. Posted Price ................................................................ 47 b. Marketing through Affiliates ...................................... 50 D. Lessor’s Fractional Interest in Minerals .................................. 51 1. Preface............................................................................... 51 2. Outstanding Burdens on Interest of the Lessor ................. 52 3. Freeing of the Lessor’s Land from a Burden .................... 57 4. “Estimated Acreage Clause” ............................................. 60 5. “Notice of Change of Ownership Clause” ........................ 61 E. Royalty Interest Stated in Mineral Lease................................. 67 1. The “Royalty Clause” of the Mineral Lease ..................... 67 2. Role of Division Orders .................................................... 69 III. The Factors and Considerations Involved in the Calculation of the Net Royalty Payment ........................................................... 70 A. Preface .................................................................................... 70 B. “Post-Production Costs” .......................................................... 70 C. Severance Taxes ...................................................................... 71 IV. The Effect of Unitization................................................................ 74 A. Types of Units.......................................................................... 75 B. Basis of Allocation of Unitized Production to Royalty Owners .................................................................................... 75 C. Basis of Participation in Unitized Production.......................... 76 D. Calculation of Proportionate Share of Unitized Production .... 77 E. Freezing Effect......................................................................... 77 1. Declared Unit .................................................................... 78 2. Voluntary Unit .................................................................. 79 V. Other Factors or Considerations Affecting the Amount of the Royalty Payment ............................................................................ 80 A. Preface .................................................................................... 80 2017] CALCULATING THE LESSOR’S ROYALTY PAYMENT 3 B. Subrogation of Taxes and Privileges Discharged by Lessee ... 80 C. Recoupment of Prior Overpayments........................................ 83 D. Withholding of Federal Income Taxes .................................... 85 VI. Lessor’s Remedies Concerning the Royalty Payment ................... 85 A. Notice of Non-payment ........................................................... 86 B. Prescription.............................................................................. 86 C. Right to an Accounting............................................................ 87 D. Security for Payment of Royalty ............................................. 89 E. Production in “Paying Quantities”........................................... 90 VII. Conclusion...................................................................................... 90 I. INTRODUCTION1 A. Preface The mineral lease is the basic development contract utilized in the oil and gas industry in Louisiana. It is, as noted by one court, “the most common vehicle used to obtain development of lands for oil, gas, and other minerals . .”2 Under the Louisiana Mineral Code, a “mineral lease is a contract by which the lessee is granted the right to explore for and produce minerals.”3 It is a “real right”4 and “an incorporeal immovable” that “is alienable and heritable.”5 The mineral lease grants the lessee the legal right and authority, for a term of time, to enter a tract of land and conduct operations on such land for the exploration and production of oil, gas, or other minerals, and to produce such minerals as might be discovered. Copyright 2017, by PATRICK S. OTTINGER. * Ottinger Hebert, L.L.C., Lafayette, Louisiana; Member, Louisiana and Texas Bars; Adjunct Professor of Law, Paul M. Hebert Law Center, Louisiana State University, Baton Rouge, Louisiana. 1. Portions of this article are an adaptation of material contained in PATRICK S. OTTINGER,LOUISIANA MINERAL LEASES:ATREATISE (2016) [hereinafter OTTINGER,MINERAL LEASE TREATISE]. 2. Mire v. Sunray DX Oil Co., 285 F. Supp. 885, 888 (W.D. La. 1968). 3. LA.REV.STAT.ANN. § 31:114 (1975). 4. Id. at § 31:16. 5. Id. at § 31:18. 4 LSU JOURNAL OF ENERGY LAW AND RESOURCES [Vol. VI No one undertakes the cost, risk, and expense of drilling a well without the fervent hope and anticipation that production will be obtained in commercial quantities. To be sure, the Louisiana Supreme Court has articulated “the main consideration of a mineral lease is the development of the leased premises for minerals.”6 Concomitantly, it is understood that “[r]ent is, from the standpoint of the lessor, the primary motive for the contract . .”7 When the lessee’s exploration and production (E&P) efforts are successful,8 and oil or gas is produced from or attributable to the leased premises, the production of such minerals gives rise to the obligation on the part of the lessee to pay royalties to its lessor and the other parties entitled thereto.9 The “Royalty Clause” of
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