© 2012 The Texas Lawbook.
By Janet Elliott
Staff Writer for The Texas Lawbook
The Eastland-based 11th Court of Appeals reversed a $10.5 million judgment against Occidental Permian Ltd. in a royalty dispute involving an enhanced oil recovery project.
Lawyers for both sides say the opinion sets new precedent for valuing gas containing high content of injected carbon dioxide, which is then separated out to make marketable hydrocarbon products.
“The court is holding that, for royalty purposes, you must value gas as it comes out of the ground, including the fact that it is heavily laden with carbon dioxide,” said Marie Yeates, a partner and co-head of Vinson & Elkins’ appellate practice, who argued for the oil company.
Bob Grable,a partner in the oil and gas section of Fort Worth-based Kelly Hart & Hallman, represented a group of royalty owners from West Texas. He is planning to appeal.
“The case is unprecedented on the main issue: is removal and reinjection of extraneous CO2 injected as part of an enhanced recovery project a production expense not deductible from royalty, or is it a post-production expense that can be deducted?” said Grable, who is one of the seven founding partners at Kelly Hart.
“The court implicitly held the latter, without a reasoned discussion of the issue,” he said. “This is an important and novel issue which we hope the Supreme Court will review and hold that it is a non-deductible production expense.”
The dispute dates to 2001 when Oxy initiated a carbon dioxide tertiary recovery operation to enhance production from depleted oil and gas leases in Scurry and Kent counties. Yeates said the royalty owners agreed to the injection and benefitted from greater oil recoveries and a marketable gas stream.
The injected CO2 would emerge from the reservoir as part of the casinghead gas stream, and Oxy would then incur significant costs separating the carbon dioxide off-site to produce marketable natural gas liquids.
Oxy deducted from the royalties a portion of the expense required to remove the injected CO2. The owners contended that the cost was a production expense which Oxy must bear rather than a postproduction expense it could share.
Following a bench trial in Midland, the trial court entered a judgment against Oxy for $10.5 million. The court of appeals reversed and rendered judgment for Oxy, holding that the royalty clauses in the leases require Oxy to value the gas stream as it leaves the well and before it has been processed to remove the injected CO2. The court held that Oxy must pay royalties on the less-valuable gas stream that is actually produced at the well.
The Oct. 31 opinion was written by Chief Justice Jim R. Wright and joined by Justice Terry McCall and John G. Hill, former chief justice of the Fort Worth court of appeals, who was sitting by assignment.
The court reached its decision without deciding whether the offsite costs of removing the carbon dioxide is a postproduction expense.
“Because we have held that the evidence is insufficient to prove that [Occidental] underpaid royalties, we do not need to decide and do not decide [Occidental’s] first issue concerning whether any or all of the costs of separating CO2 from the casinghead gas stream is a postproduction expense,” Wright said.
Yeates, managing partner of V&E’s Houston office, was joined by associate Mike Heidler. It was the 100th appeal she has argued.
© 2012 The Texas Lawbook. Content of The Texas Lawbook is controlled and protected by specific licensing agreements with our subscribers and under federal copyright laws. Any distribution of this content without the consent of The Texas Lawbook is prohibited.