A basic and well-settled principle of Texas oil and gas law holds that an unleased mineral owner is entitled to their proportionate share of production less the necessary and reasonable costs of production and marketing. An issue that sometimes arises is which costs are considered related to production and marketing. Stated differently, which costs can an operator properly deduct from an unleased cotenant’s share of production?
A recent opinion issued by Tenth Court of Appeals sheds some light on the issue. In Bomar Oil & Gas, Inc. v. Loyd 1 , Bomar Oil & Gas, Inc. operated a well in which Loyd owned an unleased mineral interest. Loyd sued Bomar, alleging that improper expenses were charged against his proportionate share of production. First, Loyd argued that overhead, supervision, and engineering fees were costs unrelated to producing or marketing and that the costs were assumed by Bomar and its investors. The court determined the fees related to overhead, supervision, and engineering were not properly chargeable against Loyd, since the expenses were not directly related to production, but rather were expenses which would continue regardless of whether the well was producing.
The court also found that Bomar’s purchase of drilling equipment was not an operating and marketing expense and should not have been charged to Loyd’s interest, since the expenditure was a one-time investment expense. Further, the court found that Loyd was not responsible for unsuccessful testing because it was an exploration cost that did not actually extend the leasehold estate. Finally, the court determined that Loyd was not responsible for expenses relating to hydraulic fracturing that the jury found to be unnecessary and unreasonable.
This case provides valuable guidance as to which costs can be properly charged against an unleased owner. In determining whether a cost is properly chargeable, some issues to keep in mind are:
- Whether the expense is directly related to production
- Whether the expense would continue should the well cease producing
- Whether the expense is a one-time capital investment
- Whether the expense extends the leasehold estate; and finally
- Whether the expense is necessary and reasonable
Perhaps more importantly, this case also illustrates the importance of leasing unleased interests in order to avoid disputes about what costs may be properly chargeable to unleased owners.
Should you have questions regarding expenses chargeable to an unleased mineral owner, or any other oil and gas related questions, please contact a member of the Underwood Law Firm Oil & Gas Section.
1 BoMar Oil & Gas, Inc. v, Loyd, 2009 Tex. App. LEXIS 5505 (Tex. App.–Waco July 15, 2009) (mem. op.), opinion on motion for rehearing, 298 S.W.3d 832 (Tex. App.–Waco 2009, pet. denied).
This column is published for informational purposes only. It should not be construed as legal advice and is not intended to create an attorney client relationship. The views expressed are those of the author and do not necessarily reflect the views of the author’s law firm or its individual partners.