The U.S. domestic oil and gas industry is still reeling from the drop in demand and ongoing price uncertainty due to the pandemic. These unique circumstances have illuminated critical issues regarding the valuation of oil and gas reserves, which can be seen in the bankruptcies within the industry over the last couple of years. Despite how impactful the valuation process is, experts in the industry explain that it is subjective, leading to regular disagreements and litigation. More specifically, royalty disputes have been a consistent issue within the oil and gas industry, fluctuating in frequency along with the prices of the commodities. As prices become lower, more eyes are focused on them, and disagreements tend to arise.
Texas is a major hub within the oil and gas industry, and thus home to much of the related litigation. One of the current challenges in Texas and beyond, is the variety of rulings specific to each unique case, and how this array of decisions leads to uncertainty overall. The contention typically arises around the precise methodology used to calculate and pay royalties.
To bring clarity to this methodology, several questions are commonly asked.
These questions are important because the complex nature of oil and gas production results in a lack of transparency around the costs of production, processing, transportation, marketing, and more. Professionals within the industry are looking for solutions in the form of improved royalty and lease agreements that should bring clarity to all accounting related to the movement of cash.
In Texas specifically, there are yearly royalty dispute cases, and often the rulings can be tied to the language used within royalty and lease documents. If agreements are optimized for the purposes of cash flow clarity, disputes will reduce in number.
A particular case in Texas that has received a significant amount of attention is BlueStone Natural Resources II, LLC v Walker Murray Randle. Oil producing states across the country looked to this case for a clearer articulation of the legal differences between specific pieces of language within common royalty agreements. The language being dissected is “gross value received” and “gross proceeds,” and whether these are considered the exact same thing. Which of these (if not both) determines the valuation point for a sale? Furthermore, many are looking for a better understanding of how to compose royalty agreements to avoid litigation.
The court ruled in favor of royalty owners while bringing some clarity to these issues and reducing the precedential value of previous cases that inadequately addressed oil and gas production costs. This clarity came in the form of acknowledgement that “When used in conjunction with ‘amount realized’ or similar language, ‘at the well’ is as much a valuation method as it is a valuation point. When proceeds are valued in “gross,” however, the valuation point is necessarily the point of sale because that is where the gross is realized or received.”
The outcome of this case in Texas helped resolve some common conflicts because of the previous decisions by the court that left these reoccurring industry issues undetermined. Despite the potential progress that this case represents, there are still concerns regarding valuation of these commodities that will unquestionably result in future litigation.
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