Common Oil Royalty Provision Establishes Valuation Point at the Well

June 23, 2021

By Andrew J. Neumann

Oil drilling derricks at desert oilfieldThe expenses the operator of an oil and gas well can rightfully deduct from royalties due to a mineral owner under the terms of an oil and gas lease has been a point of contention for years. However, even before deciding which expenses can be rightfully deducted, the point at which the value of the oil is established must be identified. While the terms of oil and gas leases attempt to establish this point of valuation, those terms are not always entirely clear, and there can occasionally be disputes over their interpretation.

In Blasi, et al. v. Bruin E&P Partners, et al., 2021 ND 86, the North Dakota Supreme Court addressed an issue of first impression related to the valuation point of oil for purposes of determining royalty due to a mineral owner. The language of the oil royalty provision in question states:

Lessee covenants and agrees:

To deliver to the credit of the Lessor, free of cost, in the pipeline to which Lessee may connect wells on said land, the equal [fractional] part of all oil produced and saved from the leased premises.

Based on the language of this provision, the Court concluded the valuation point of produced oil is at the well.

This relatively common language frequently appears in oil and gas leases and has been in use for many years by the oil and gas industry in North Dakota. Recently though, it has spawned multiple class action cases in federal court with mineral owners alleging operators have underpaid oil royalties by wrongfully deducting expenses associated with gathering, transporting and treating produced oil incurred prior to the point of valuation.

In this case, Blasi and other plaintiffs focused on the phrase “the pipeline” and argued the phrase referred to the type of pipeline used by the oil and gas industry to transport oil hundreds or thousands of miles to a refinery, not just a pipe at the well location for moving oil a few feet from the wellhead to a tank or truck.

However, the Court rejected Blasi’s arguments and found the language at issue in the royalty provision unambiguous, stating it “establishes a valuation point at the well.” Noting produced oil may “never reach the type of commercial pipeline Blasi envisions[,]” the Court identified the location of “the pipeline” referenced in the provision. The Court described the location as: “the place where the lessee ‘may connect’ a pipeline. That place is at the ‘wells on said land.’” After identifying the pipeline in the oil royalty provision based on its “proximity to the wells,” the Court explained it was to this pipeline the lessee’s obligation to deliver produced oil “free of cost” applied.

The degree of certainty provided by the Court’s decision in Blasi can be appreciated by both mineral owners and operators. It is worth noting, however, this decision is an interpretation of a single oil royalty provision. Differently worded provisions may not be interpreted to have the same meaning and effect. If you have any questions or concerns regarding the impact of this decision, your own oil royalty provision or any other terms in an oil and gas lease, please feel free to contact Andrew Neumann or Lawrence Bender.