# IN THE SUPREME COURT O F TEX AS

4 4 4 4 4 4 4 4 4 4 4 4 

## N O



## . 12-1002

4 4 4 4 4 4 4 4 4 4 4 4



# M A R C IA 

# F U L L E R 

# F R E N C H 

# , E T A L



# . , P E T IT IO N E R S 

# ,

v

.


# O C C ID E N T A L 

# P E R M IA N 

# L T D



# . , R E S P O N D E N T

4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4



## O N 

## P E T I T I O N F O R 

## R E V I E W F R O M T H E 

## C O U R T O F 

## A P P E A L S F O R T H E 

## E L E V E N T H 

## D I S T R I C T O F 

## T E X A S



### 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4



## Argued F ebruary 5, 2014

C H I E F 

## J U S T I C E 

## H E C H T 

## delivere d the opinion of the Court.

2 

## One method of en h an ce d o i l rec overy is to inject car bon diox ide (CO ) into a rese rvoir to

2 

## swee p the oi l to the production wells. The CO returns to the s urfa ce entraine d in casing head ga s

— g as produce d with the oil. I n this case , roy alty owner s contend that the roy alty d u e on the 1

2 

## casing head g as under the parties’ agr ee m en t s must be deter mined as if the injected CO wer e not

prese nt, an d that they are not require d to share with the working int ere st the ex pense of removing

“ ‘ C a s i n g h e a d g a s ’ i s g e n e r a l l y d e f i n e d a s ‘ [ g ] a s p r o d u c e d w i t h o i l i n o i l w e l l s , t h e g a s b e i n g t a k e n f r o m t h e 1

w e l l t h r o u g h t h e c a s i n g h e a d a t t h e t o p o f t h e w e l l
, a s d i s t i n g u i s h e d f r o m g a s p r o d u c e d f

r o m a g a s w e l l

. ’ ” R a i l r o a d C o m m ’ n o

f T e x

. v

. L o n e S t a r G a s C o

. , 8 4 4 S

. W

. 2 d 6 7 9
, 6 8 4 n

. 5 ( T e x

. 1 9 9 2 ) ( q u o t i n g 8 H

. W IL L IA M S & C

. M E Y E R S , O IL
A N D G A S L A W : M A N U A L O F O I L A N D G A S T E R M S 1 5 6 ( 1 9 9 1 ) ) ; c f

. T E X

. N A T

. R E S

. C O D E A N N

. § 8 6

. 0 0 2 ( 1 0 ) ( “ ‘ C a s i n g h e a d g a s ’ m e a n s a n y g a s o r v a p o r i n d i g e n o u s t o a n o i l s t r a t u m a n d p r o d u c e d f r o m t h e s t r a t u m w i t h o i l

. ” ) ; A m a r i l l o O i l C o

. v

. E n e r g y

- A g r i P r o d s

. , I

n c

. , 7 9 4 S

. W

. 2 d 2 0
, 2 6 ( T e x

. 1 9 9 0 ) ( a p p l y i n g s t a t u t o r y d e f i n i t i o n )

.2



## the CO from the g as. We disag ree and ther efor e af firm the judg ment of the c ourt of appe als. 2



## I

A

Petitioners, collectively “F renc h”, own the roy alty interests under two oil and g as lease s in 3



## the Cogde ll Field, one from the owner s of the Fu l l er R o u gh Creek Ranch in Scurry and Kent

Counties in 1948, and the other from the owner s of the Cogde ll Ranch in Kent C ounty in 1949.

Respondent Occ idental Permian L td. (“Oxy ”) ow ns the working interest.

The Fuller L ease calls for a ro y al t y “o n g as, including casing head g as or other g aseous

substance produce d from said land and sold or used off the premises or in the m an u fac ture of

g asoline or other product there from” equal to “the marke t value at the well of one-e ighth (1/8th) of

the g as so sold or used”. The Cogde ll L ease calls for a roy alty of “1/4 of the net proce eds from the

sale” of “g asoline or other products manufa cture d and sold” from ca singhe ad g as “a fter de ducting

[t he] cost of manufa cturing the same.” Both provisions wer e standard forms in common use at the

time. 4

3 9 1 S

. W

. 3 d 2 1 5 ( T e x

. A p p

. — E a s t l a n d 2 0 1 2 )

.

2

P e t i t i o n e r s a r e M a r c i a F u l l e r F r e n c h ; G i l l i a n F u l l e r ; L e s a O u d t ; F r e n c h C a p i t a l P a r t n e r s , L t d

. ; C o n n i e D e l l e 3
C o g d e l l
, i n d i v i d u a l l y a n d a s t r u s t e e o f t h e D a v i d M

. C o u r t n e y T r u s t , a n d a s t r u s t e e o f t h e J o h n C o g d e l l C o u r t n e y T r u s t ; J o h n C o u r t n e y , t r u s t e e o f t h e C a r o l C

. C o u r t n e y D i s c l a i m e r T r u s t ; P e n n y C o g d e l l C a r p e n t e r , i n d i v i d u a l l y a n d a s c o

i n d e p e n d e n t e x e c u t o r o f t h e e s t a t e o f W i l l i a m M u n s e y ( “ B i l l y ” ) C o g d e l l a n d a s c o

- t r u s t e e o f t h e C o g d e l l M a r i t a l T r u s t ; B i l l y R a n k C o g d e l l
, i n d i v i d u a l l y a n d a s c o

- i n d e p e n d e n t e x e c u t o r o f t h e e s t a t e o f W i l l i a m M u n s e y ( “ B i l l y ” ) C o g d e l l a n d

a s c o

- t r u s t e e o f t h e C o g d e l l M a r i t a l T r u s t ; D i c k M u n s e y C o g d e l l
, i n d i v i d u a l l y a n d a s c o

- i n d e p e n d e n t e x e c u t o r o f t h e

e s t a t e o f W i l l i a m M u n s e y ( “ B i l l y ” ) C o g d e l l a n d a s c o

- t r u s t e e o f t h e C o g d e l l M a r i t a l T r u s t ; J i m D a v i d C o g d e l l ; a n d H a p p y S t a t e B a n k a n d T r u s t C o m p a n y , a s t r u s t e e f o r t h e M a r t h a A n n C o g d e l l H o s p i t a l T r u s t

.

T h e m a r k e t v a l u e r o y a l t y p r o v i s i o n i n t h e F u l l e r L e a s e i s e s s e n t i a l l y i d e n t i c a l t o t h e p r o v i s i o n s w e i n t e r p r e t e d 4
i n E x x o n C o r

p

. v

. M i d d l e t o n , 6 1 3 S

. W

. 2 d 2 4 0
, 2 4 1

- 2 4 2 ( T e x

. 1 9 8 1 ) ( o n e l e a s e p r o v i d e d t h a t t h e r o y a l t y “ o n g a s , i n c l u d i n g c a s i n g h e a d g a s o r o t h e r g a s e o u s s u b s t a n c e s , p r o d u c e d f r o m s a i d l a n d a n d s o l d o r u s e d o f f t h e p r e m i s e s o r i n t h e m a n u f

a c t u r e o f g a s o l i n e o r o t h e r p r o d u c t t h e r e f r o m , s h a l l b e t h e m a r k e t v a l u e a t t h e w e l l o f o n e

- e i g h t h o f

t h e g a s s o



### 2

## Gene rally speaking
, a roy alty is “fr ee of the expenses of producti o n [ b u t] subject to

postproduction costs, including

. . . trea tment costs to rende r [pr o d u ction] marke table”, but “the

parties may modify this g ener al rule by ag re em en t

. ” Un der the Fuller L ease , the roy alty on 5



## casing head g as i s b as ed o n i ts marke t value at the well — “wha t a willing buy er under no
compulsion to buy will pay t o a wi l l i n g seller under no compulsion to sell.” Since g as is a 6



## commodity
, its marke t value at the well does not depend on the individual produ ce r’ s costs of

bring ing the g as to the surfa ce. As a result, the roy alty owner d o es not share in the costs of

production. But postproduction proce ssing that makes the g as marke table enhanc es its va lue afte r

it leaves the w ell. The mar ket price of t he processed ga s ref lects the va lue of the unpr ocesse d g as

at the well only if rea sonable postproduction proce ssing costs are deducte d. I n eff ect, for g as sold 7



## only afte r proce ssing, the roy alty owner share s in those cost s , wh ich may vary depending on the

s o l d o r u s e d
, p r o v i d e d t h a t o n g a s s o s o l d a t t h e w e l l s t h e r o y a l t i e s s h a l l b e o n e

- e i g h t h o f t h e a m o u n t r e a l i z e d f r o m s u c h

s a l e ” )

. T h e p r o c e e d s p r o v i s i o n i n t h e C o g d e l l L e a s e i s s i m i l a r t o t h e a l t e r n a t i v e “ a m o u n t r e a l i z e d ” c l a u s e f o r g a s s o l d

a t t h e w e l l i n M i d d l e t o n

. I d

. , s e e a l s o , e

. g

. , B a d

g e r v

. K i n g , 3 3 1 S

. W

. 2 d 9 5 5 ( T e x

. C i v

. A p p

. — E l P a s o 1 9 5 9
, w r i t r e f ’ d

n

. r

. e

. ) ( “ a r o y a l t y o f o n e

- e i g h t h ( 1 / 8 ) o f t h e v a l u e o f n a t u r a l g a s p r o d u c e d f r o m s a i d p r e m i s e s w h e n s a i d g a s i s s o l d o r

u s e d o f f t h e p r e m i s e s , o r o n e

- e i g h t h ( 1 / 8 ) o f t h e n e t p r o c e e d s o f t h e s a l e o f s u c h g a s a n d a r o y a l t y o f o n e

- e i g h t h ( 1 / 8 )

o f t h e n e t a m o u n t o f g a s o l i n e m a n u f a c t u r e d f r o m n a t u r a l o r c a s i n g h e a d g a s ” ) ; L a d d v

. U p h a m , 5 8 S

. W

. 2 d 1 0 3 7 ( T e x

. C i v

. A p p

. — F o r t W o r t h 1 9 3 3 )
, a f f ’ d
, 9 5 S

. W

. 2 d 3 6 5 ( T e x

. 1 9 3 6 )

.

H e r i t a g e R e s

. , I

n c

. v

. N a t i o n s B a n k
, 9 3 9 S

. W

. 2 d 1 1 8
, 1 2 1

- 1 2 2
, 1 2 3 ( T e x

. 1 9 9 6 ) ( c i t a t i o n s o m i t t e d )

. T h e C o u r t 5

c o n c l u d e d
, h o w e v e r , t h a t b e c a u s e t h e l e a s e s s e t t h e r o y a l t y a s a f r a c t i o n o f m a r k e t v a l u e a t t h e w e l l
, t h e c o m m o n l y

a c c e p t e d m e a n i n g s o f “ r o y a l t y ” a n d “ m a r k e t v a l u e a t t h e w e l l ” r e n d e r e d t h e l e a s e s ’ “ p o s t p r o d u c t i o n ” c l a u s e s

— p r o v i d i n g t h a t t h e r e s h a l l b e n o d e d u c t i o n s f r o m v a l u e o f

t h e r o y a l t y f

o r , e

. g

. , p r o c e s s i n g , t r a n s p o r t a t i o n a n d m a r k e t i n g

c o s t s

— s u r p l u s a g e a s a m a t t e r o f l a w ; m a r k e t v a l u e a t t h e w e l l
, i n t h e a b s e n c e o f e v i d e n c e o f c o m p a r a b l e s a l e s , w a s

e s t a b l i s h e d b y l e s s o r s ’ c o n c e s s i o n s t h a t l e s s e e d e d u c t e d o n l y r e a s o n a b l e m a r k e t i n g c o s t s f r o m m a r k e t v a l u e a t t h e p o i n t

o f s a l e

. I

d

.

I d

. a t 1 2 5 ( O w e n , J

. , c o n c u r r i n g ) ( c i t i n g E x x o n C o r p

. v

. M i d d l e t o n , 6 1 3 S

. W

. 2 d a t 2 4 6 ) ; s e e a l s o Y z a g u i r r e 6

v

. K C S R e s

. , I

n c

. , 5 3 S

. W

. 3 d 3 6 8
, 3 7 4 ( T e x

. 2 0 0 1 ) ( q u o t i n g M i d d l e t o n )

.

H e r i t a g e R e s

. , I

n c

. v

. N a t i o n s B a n k
, 9 3 9 S

. W

. 2 d a t 1 2 2 ( “ m a r k e t v a l u e a t t h e w e l l ” m a y b e d e t e r m i n e d b y 7

“ s u b t r a c t i n g r e a s o n a b l e p o s t

- p r o d u c t i o n m a r k e t i n g c o s t s ”

— i n c l u d i n g t h e c o s t s o f “ t r a n s p o r t i n g t h e g a s t o t h e m a r k e t

a n d p r o c e s s i n g t h e g a s t o m a k e i t m a r k e t a b l e ”

— “ f r o m t h e m a r k e t v a l u e a t t h e p o i n t o f s a l e ” ) ( c i t a t i o n s o m i t t e d )

.


### 3

## quality of the g as coming from the g round. Under the Cogde ll L ease , the roy alty on casing head g as 8



## products is based on the proce eds from their sale, which, ag ain, are unaff ecte d by production

expenses, and expressly net of manufa cturing — i.e. , postproduction — costs. Thus, under bot h

lease s, the ca singhe ad g as roy alty is net of post production ex penses but not production expenses.

Postproduction, as the word itself implies, ordinarily means after production in time, but in this case , the roy alty owner s contend that the produc tion proce ss does not end at the wellhead. The disput e

is over whe ther c erta in expenses are proper ly considere d to be produc tion costs or postproduction

costs.

I n 1954, not long afte r primary production had begun from the Cany on Reef formation, the

lease s wer e pooled to form the Cogde ll Cany on Reef Unit (“CCRU”). The purpose, as stated in the

Un itiz ation Ag ree ment among the working interest owner s and roy alty owner s, was “to ef fe ct

seconda ry rec overy opera tions or pressure maintenanc e for oil and g as from the Cany on Reef

. . . to

incre ase the ultimate r ecove ry of oil ther efr om”. I n the Ag ree ment, the roy alty owner s consented 9

S e e F r e e l a n d v

. S u n O i l C o

. , 2 7 7 F

. 2 d 1 5 4
, 1 5 9 ( 5 t h C i r

. 1 9 6 0 ) ( “ T h e p r i n c i p l e i s

. . . t h a t i n d e t e r m i n i n g 8

m a r k e t v a l u e c o s t s w h i c h a r e e s s e n t i a l t o m a k e a c o m m o d i t y w o r t h a n y t h i n g o r w o r t h m o r e m u s t b e b o r n e p r o p o r t i o n a t e l y b y t h o s e w h o b e n e f

i t

. T o p u t i t a n o t h e r w a y : i n t h e a n a l y t i c a l p r o c e s s o f r e c o n s t r u c t i n g a m a r k e t v a l u e w h e r e n o n e

o t h e r w i s e e x i s t s w i t h s u f f i c i e n t d e f

i n i t e n e s s , a l l i n c r e a s e i n t h e u l t i m a t e s a l e s v a l u e a t t r i b u t a b l e t o t h e e x p e n s e s i n c u r r e d i n t r a n s p o r t i n g a n d p r o c e s s i n g t h e c o m m o d i t y m u s t b e d e d u c t e d

. T h e r o y a l t y o w n e r s h a r e s o n l y i n w h a t i s l e f t o v e r , w h e t h e r s t a t e d i n t e r m s o f c a s h o r a n e n d p r o d u c t

. I n t h i s s e n s e h e b e a r s h i s p r o p o r t i o n a t e p a r t y o f t h a t c o s t , b u t n o t b e c a u s e t h e o b l i g a t i o n ( o r e x p e n s e ) o f p r o d u c t i o n r e s t s o n h i m

. R a t h e r , i t i s b e c a u s e t h a t i s t h e w a y i n w h i c h [ t h e ] l a w

a r r i v e s a t t h e v a l u e o f t h e g a s a t t h e m o m e n t i t s e e k s t o e s c a p e f r o m t h e w e l l h e a d

. ” )

.

S u c h p o o l i n g , w h i c h i s s u b j e c t t o R a i l r o a d C o m m i s s i o n a p p r o v a l
, h a d b e e n a u t h o r i z e d b y t h e L e g i s l a t u r e o n l y 9
f i v e y e a r s e a r l i e r

. A c t o f M a y 1 2
, 1 9 4 9
, 5 1 s t L e g

. , R

. S

. , c h

. 2 5 9
, 1 9 4 9 T e x

. G e n

. L a w s 4 7 9 [ S B 2 4 ]
, f o r m e r l y T E X

. R E V

. C IV

. S T A T

. A N N

. a r t

. 6 0 0 8 b
, n o w c o d i f i e d a s T E X

. N A T

. R E S

. C O D E § § 1 0 1

. 0 1 1

- . 0 1 8

. “ T h e L e g i s l a t u r e h a s m a d e i t t h e p o l i c y o f t h i s s t a t e t o e n c o u r a g e s e c o n d a r y r e c o v e r y o f m i n e r a l s ”

. C o a s t a l O i l & G a s C o r p

. v

. G a r z a E n e r g y T r u s t , 2 6 8 S

. W

. 3 d 1
, 4 6 ( T e x

. 2 0 0 8 ) ; a c c o r d R a i l r o a d C o m m ’ n o f T e x

. v

. M a n z i e l
, 3 6 1 S

. W

. 2 d 5 6 0
, 5 6 9

- 5 7 0 ( T e x

. 1 9 6 2 )

.

“ S e c o n d a r y r e c o v e r y o p e r a t i o n s a r e c a r r i e d o n t o i n c r e a s e t h e u l t i m a t e r e c o v e r y o f o i l a n d g a s , a n d i t i s e s t a b l i s h e d t h a t p r e s s u r e m a i n t e n a n c e p r o j e c t s w i l l r e s u l t i n m o r e r e c o v e r y t h a n w a s o b t a i n e d b y p r i m a r y m e t h o d s

. I t c a n n o t b e d i s p u t e d
t h a t s u c h o p e r a t i o n s s h o u l d b e e n c o u r a g e d
, f o r a s t h e p r e s s u r e b e h i n d t h e p r i m a r y p r o d u c t i o n d i s s i p a t e s , t h e g r e a t e r i s



### 4

## to the injection of extraneous substances into the oil rese rvoir and g ave the working interest complete

discretion in deter

mining whe ther a

nd how to conduct the ope rations:

Roy alties owner s here by g rant unto the wo rki ng interest owner s, at the working interest owner s’ sole discretion,

. . . the rig ht to inject g as, extraneous g as, water , air

or other substances, or any combination of two or more of them, in whateve r amounts the working interest owne rs may deem e x pedient, into the unit are a . . . .

* * *

The working interest owner s shall have full d i s cre tion in deter mining if g as, extraneous g as, air, water or other substances, or any combination of two or more of them, should be injected into the unit are a in connec tion with seconda ry rec overy and pressure maintenanc e opera tions. I n any event the working interest owner s shall be the sole judge s of the kind of seconda ry recovery and pressure maintenanc e opera tions which shall be conduc ted in the unit are a . . . .

The Ag ree ment define d “g as” as “natur al g as (including casing head g as) and all of its

constituent elements produce d from wells on lands and lease s in the Cogde ll Field producing from

the Cany on Reef underly ing the unit are a.” Thus, the working interest owner s wer e g iven discretion

to reinjec t casing head g as into the field as part of the opera tions. The parties ag ree d that no roy alty

would be paid on suc h g as:

All unitiz ed substances

. . . used in connec tion with the opera tion or development of the unit are a [or] in injection opera tions in the unit are a

. . . shall be deducte d befor e the roy alties, overr iding roy alties and other pay ments out of production pay able to roy alt y o wn er s here under are deter mined, calc ulated or paid; and no roy alty
, overr iding roy alty or other pay ment out of production shall be due or pay able to any roy alty owner here under on a

ny unitiz ed substance s so . . . used . . . . 1 0

t h e p u b l i c n e c e s s i t y f

o r a p p l y i n g s e c o n d a r y r e c o v e r y f o r c e s

. ” I

d

. a t 5 6 8

.

T h e A g r e e m e n t a d d e d t h i s p r o v i s o : “ p r o v i d e d
, t h a t , n o t w i t h s t a n d i n g t h e f o r e g o i n g p r o v i s i o n s , i f u n d e r t h e 10
l a w s o f t h e S t a t e o f T e x a s a n y r o y a l t y o w n e r i s e n t i t l e d t o b e p a i d r o y a l t y o n o i l

. . . u s e d i n t h e o p e r a t i o n

. . . , s u c h

r o y a l t y s h a l l b e p a i d t o s a i d r o y a l t y o w n e r u n d e r i t s i n d i v i d u a l l e a s e s i n t h e u n i t a r e a i n a c c o r d a n c e w i t h s a i d l a w s

. ”



### 5

## “Unitized substances” wer e define d to include “all oil, g as,

. . . or any other substance produce d and

saved f rom the Cany on Reef unde rly ing the unit area .”

Finally
, the Agre ement assig ned the c ost of the oper ation to the working int ere st except to

the extent it was alrea dy

to be borne by

the roy alty

interests:

No part of the costs and expenses incurre d in the development and opera tion of the unit are a, including seconda ry rec overy and pressure maintenanc e costs, shall b e char g ed to any roy alty

owner unless such roy alty owner is alre ady obliga ted t o pay
s u ch costs or expenses by the terms of other ag ree ments. Such costs and ex p en s es shall be borne by

the working interest owne rs . . . .

The parties’ only other ag ree ments wer e the lease s. Thus, the costs of seconda ry rec overy wer e not

to be cha rg ed to the roy alty

owner s except as permitted by the lease s — that is, in deter mining the

marke t value of the g as at the well under the Fuller L ease and the cost of manufa cturing casing head

g as produc ts under the Cog dell L ease

.

B

The seconda

ry rec overy opera tion in the CC RU involved injecting water into the rese rvoir

to incre ase and maintain pressure lost throug h primary production and to swee p oil toward producing

wells. The opera tion has proved very succe ssful. The CCR U has produce d more than 270 milli on

b ar re ls of oil and billions of cubic fee t of casing head g as, toge ther valued at more than $ 1

. 1 5 1 1



## billion, with about half the oil rema ining in the rese rvoir. Waterflooding continues, but by the late

1990s, it had become less eff ective. Oil production had declined from some 30,000 barr els per day

at the pea k to about 1,500 barr els per da y

.

T h e d a t a s t a t e d t h r o u g h o u t t h i s o p i n i o n a r e a s o f t h e t i m e o f t r i a l
, F e b r u a r y 2 0 0 9

. 11



### 6

## Since the CC RU w a s f o r me d
, s e v e r a l me thods of enhanc ed oil rec overy have been develope d,

sometimes ref

err ed to as tertiary beca

use they t y

pically follow seconda

ry rec overy

. One is by

2 

## injecting CO into the rese rvoir. This incre ases pressure in the rese rvoir, just as water injection does.

2 

## But more importantly , CO is miscible with water and, under high pressure and temperature
, with

2 

## oil. I n solution with oil and water , CO can act to reduc e oil’s viscosity and reduc e surfa ce tension,

thus e asing separ ation of oil f rom water in the formation, and improving movement of oil throug h

2 2 

## the formation to the production wellbore s. CO flooding require s enormous volumes of CO , and

supplies are limit ed and expensive. Special well equipment must also be used t o wi t hstand the 1 2

2 2 

## corr osive proper

ties of CO

. And the eff

ectivene ss of CO flooding is not assure d; it depends on the

2 

## nature of the oil in the g round and the formations in the rese rvoir. CO flooding is more expensive

and riskier

than wate rflooding

.

2 

## Oxy beg an a CO flood in the CCR U in 2001, and it, too, has proved very succe ssful. The 1 3

2 

## roug hly 106 active wells in the unit produce about 5,800 barr els of oil daily

. Wit hout the CO flood,

oil production would have declined to 200 barr els per d ay and would no longe r have been

economica lly

viable, and mor e than ha lf the oil in the rese rvoir would have been lost for ever

.
The wells also produce daily about 140,000 barr els of water , and casing head g as containing

2 

## about 110 milli on cubic fee t of CO

. Separa ting the oil from the water is relat i v el y s i m p l e. The

mix ture is place d in larg e storag e tanks, wher e the oil floats on the heavie r wa t er and is simply

skimmed off. Emulsifiers are added to assist the proce ss. The water is then reinjec ted into the field.

2 O x y p a y s 6 6 ¢ / m c f f

o r C O

. 12

2 T h e p a r t i e s d o n o t d i s p u t e t h a t t h e C O f l o o d i s p e r m i t t e d a n d g o v e r n e d b y t h e U n i t i z a t i o n A g r e e m e n t

. 13



### 7

## The roy alty owner s have never been char g ed any part of the expense of this proce ss. The working

interest owner s have trea ted the separ ation of water from oil f or reinjec tion into the field as part of

production.

2 

## The CO produce d with the casing head g as is also reinjec ted into th e fi el d, along with

2 

## addit ional purcha sed CO

. More than 10 milli on cubic fee t of casing head g as per day is simply

transporte d in pipelines from the production wells back to the injection wells and pumped back into

the re s er v oir. As noted above, the Unit ization Ag ree ment provides that no roy alty is due on such

g as, and none is paid. All the casing head g as could be reinjec ted the same way , and Oxy considere d

2 2 

## this possibili ty in desig ning the CO flood opera tion, but the casing head g as is only about 85% CO
,
and ideally
, the injection stream should be more highly conce ntrated. Also, the hy droca rbon content

4 

## of the casing head g as stream not only includes methane (CH ) b u t i s rich in natura l g as liquids

2 6 3 8 4 1 0 5 1 2 

## (NGL s) — ethane (C H ), propane (C H ), butane (C H ), pentane (C H ), and natura l g asoline

2 

## (hea vier molecules) — which can be extracted and sold. To incre ase the conce ntration of CO in the

reinjec ted stream, and to rea liz e the value of the NGL s entra ined in the casing head g as, Oxy elec ted

2 

## to proce ss the g as to remove the CO and extract the N GL s.

2 2 

## Be fore the CO flood, the casing head g as produce d from the field was less than 2% CO and

was proce ssed at the Fuller Gasoline Plant to remove other contaminants l i k e hy drog en sulfide

2 2 

## (H S) and nitrog en (N ), and to extract NGL s, which wer e then sold along with the residual g as. 1 4 1 5

H y d r o g e n s u l f

i d e i s a c o l o r l e s s g a s w i t h t h e c h a r a c t e r i s t i c f o u l o d o r o f r o t t e n e g g s

. I t i s h e a v i e r t h a n a i r , v e r y 14

p o i s o n o u s , c o r r o s i v e , f l a m m a b l e , a n d e x p l o s i v e

.

N i t r o g e n i s a c o l o r l e s s , o d o r l e s s , r e l a t i v e l y i n e r t g a s t h a t c o m p r i s e s a b o u t 7 8 % o f E a r t h ’ s a t m o s p h e r e

. 15



### 8

## The proce ssing wa s u n d i sputedly a postproduction expense share d by the roy alty owner s and the

working interest. Fr ench rec eived roy alties based on the value of the NGL s and residual g as net of

the proc essing costs.

But the Fuller plant, like m o s t o rd i nary g asoline plants, could not proce ss g as that is 85%

2 

## CO

. Oxy considere d constructing a field ref rig era tion u n i t t o extract some of the NGL s but

ultimately decide d to opt for full proce ssing of the casing head g as. Oxy contra cted wi t h Ki nder

2 

## Morg an to build a plant that could p ro ce ss CO -lade n g as, an investment of milli ons of dollars.

2 

## Using Cy nara membrane technolog y , the Kinder Morg an plant remove s at least 90% of the CO and

2 

## most of the H S for reinjec tion, and also extracts some of the NGL s, about two-thirds of the total

produce d from the g as stream. Kinder Morg an contra cts in turn with Torch Energ y Marke ting t o

2 2 

## further proce ss the g as at its Sny der Gasoline Plant. There
, the rest of the CO and H S are remove d

for reinjec tion, and the rest of the NGL s are extracted. For its service s, Kinder Morg an rec eives

from Oxy a monthly fee of 33¢/mcf of g as delivere d to Cy nara , plus 30% of the total NGL s in kind

and all the residual g as at the tailgate of the Sny der plant. The residual g as is not marke table beca use
of its high nitrog en and low B tu content, but Kinder Mor g an uses the g as in its electric g ener ation

plant near by

. Kinder Morg an pay s Torch a monthly fee , beg inning a t 25¢/mcf of g as delivered to

Sny der and esca lating over time. Oxy pay s Fr ench a roy alty on 70% of the NGL s, but not on the 1 6



## 30% given to Kinder Mor g an as in-kind c ompensation, or on any of the re sidual g as also g iven as

in-kind compensa tion. Oxy considers the monetary fee paid to Kinder Morg an a production expense

T h e v a l u e o f t h e N G L s p r o d u c e d t h r o u g h t h i s p r o c e s s , f r o m J a n u a r y 2 0 0 2 t h r o u g h F e b r u a r y 2 0 0 9
, i s 16 $ 2 2 6
, 4 9 2
, 4 7 4
, 7 0 % o f w h i c h i s $ 1 5 8
, 5 4 4
, 7 3 2

.


### 9

## and does not c harg e any part of it to Fr ench. 1 7



## C

2 

## Fr ench sued Oxy for underpa y ing roy alties on casing head g as since the beg inning of the CO

2 

## flood. Fr ench c ontends that proce ssing the c asing head g as, except for the re moval of H S and the

extraction of NGL s at Sny der, is all part o f p roduction that must be borne by Oxy as the working

interest owner

. This includes the transporta tion of the casing head g as from its g ather ing point to the

Cy n ar a p l an t some 15 miles awa y , the proce ssing at the Cy nara plant, the transporta tion of the

2 

## partially proce ssed streams of NGL s and g as to the Sny der plant, the remova l of CO there
, and the

2 2 

## transporta tion of the perme ate streams of CO and H S from both plants back to the injection wells.

2 

## Fr ench arg ues that the extraction of NGL s and remova l of H S at Cy nara are mere ly incidental

2 

## by products of the remova l of CO and thus part of production. Fr ench does not contend that the

compensa tio n for Kinder Morg an’s service s is unrea sonable, only that it is not a postproduction

expense she must share

. Fr ench asser ts that her roy alty should be based on the value of 100% of the

2 

## NGL s net of the ex pense of extracting them from the g as and r emoving H S, plus t he value of the

residue g as — or in other words, Fr ench claims a roy alty based on the value of the native casing head

2 

## g as stream that was being proce ssed at the Fulle r P l an t b ef ore the CO flood. Oxy counter s that

2 

## remo v al o f t h e CO is nece ssary to make the casing head g as marke table and is there fore a
postproduction expense that must be share d by the roy alty owners. Oxy acknow ledg es that

pro d u ct i o n activities occur at the Cy nara plant, but it arg ues that the monetary fee it pay s Kinder

K i n d e r M o r g a n ’ s f

e e s t o t a l $ 8 5 m i l l i o n

. 17



### 1 0

## Morg an, no par t of which is cha

rg ed to Fr ench, c overs those a ctivities. 1 8



## After a fo u r- d ay trial to the bench, the trial court ag ree d with Fr ench and awa rded her

$10,074,262.33 in underpa id roy alties, a dec l ar at o ry judgme nt defining Oxy ’s ong oing roy alty

obliga tions consistently with the awa rd, and attorney fee s. The court of appea ls reve rsed, focusing 1 9



## on Fr ench’ s damages ca l cu l ati ons. I t disag ree d with Fr ench that all the proce ssing at the Cy nara

2 

## plant was part of removing CO and thus a production expense. I f nothing else, the court rea soned,

2 

## the cost of removing H S, which Fr ench admitted was a postproduction expense at Sny der, was no

less a post

production expense at Cy nara , to be subtrac ted from the va lue or proc eeds of the NGL s

in calc ulating roy alties. Be ca u s e Fr ench had not proved the amount of that expense, the court 2 0



## conclude d, she had not proved the value o r p ro ce ed s o f the NGL s and residue g as on which her

roy alty should be calc ulated. Thus, the court did not rea ch the issue whether the cost of separ ating 2 1

2 

## CO from the c asing head g as wa s a produc tion ex pense. 2 2

K i n d e r M o r g a n p a y s a p a r t o f t h e f e e t o T o r c h f

o r a l l p r o c e s s i n g a t t h e S n y d e r p l a n t , p a r t o f w h i c h

— t h e 18

2 r e m o v a l o f H S a n d e x t r a c t i o n o f N G L s

— F r e n c h a c k n o w l e d g e s i s f o r p o s t p r o d u c t i o n a c t i v i t i e s

. U n d e r F r e n c h ’ s t h e o r y , O x y w o u l d b e e n t i t l e d t o c h a r g e F r e n c h p a r t o f t h e f e e

. O x y m a k e s n o s u c h c l a i m

.

3 9 1 S

. W

. 3 d 2 1 5 ( T e x

. A p p

. — E a s t l a n d 2 0 1 2 )

. 19

I d

. a t 2 2 3

. 20

I d

. 21

I d

. a t 2 2 4

. F r e n c h a l s o c l a i m s , a n d t h e t r i a l c o u r t f o u n d
, t h a t O x y ’ s r e f

u s a l t o p a y a r o y a l t y o n t h e 3 0 % o f 22

t h e N G L s a n d t h e r e s i d u a l g a s g i v e n t o K i n d e r M o r g a n c o n s t i t u t e d a b r e a c h o f t h e i m p l i e d c o v e n a n t t o m a r k e t u n d e r t h e l e a s e s

. T h e c o u r t o f

a p p e a l s c o n c l u d e d t h a t t h e r e i s n o s u c h c o v e n a n t i n a m a r k e t v a l u e l e a s e , c i t i n g B o w d e n v

. P h i l l i p s P e t r o l e u m C o

. , 2 4 7 S

. W

. 3 d 6 9 0
, 6 9 9 ( T e x

. 2 0 0 8 )
, a n d t h a t F r e n c h h a d n o t p r o v e d a b r e a c h o f t h e c o v e n a n t i n t h e p r o c e e d s l e a s e b e c a u s e s h e h a d n o t p r o v e d a n u n d e r p a y m e n t o f r o y a l t i e s

. B e c a u s e w e h o l d t h a t O x y h a d n o s u c h r o y a l t y

o b l i g a t i o n , n o t m e r e l y t h a t F r e n c h f a i l e d t o p r o v e a b r e a c h
, w e r e a c h t h e s a m e r e s u l t a s t h e c o u r t o f a p p e a l s , t h o u g h f

o r

a d i f f e r e n t r e a s o n

.


### 1 1

## We gr anted F renc h’s petition for re view. 2 3



## II

Roy alty owner s and working interest owner s are , of course , fre e to ag ree on what roy alty is

due, the ba sis on which it is to be calculated, and how expenses are to be allocated. Often, a s in 2 4



## this case , ag ree ments contain provisions that are standard throug hout the oil and g as industry
, provisions that have been judicially interpre ted many times over many y ear s. Caref ul adher ence to
those interpre tations, and consistent applica tion of them, is important to i ndustry stability

.

As we have said, all costs of production are g ener ally borne b y t he working interest, and 2 5



## here the Unitiz ation Ag ree ment assig ned all costs of the enhanc ed rec overy opera t i o n s t o the

working interest “unless [a] roy alty owner is alre ady obliga ted to pay such costs or expenses by the

terms of other ag ree ments.” The lease s are other ag ree ments in which such an obliga tion might be

found, so we tur

n to them.

The Fuller L ease provides for a roy alty on casing head g as base d on its marke t value at the

well. The only marke t va lue evidenc e in this case is of the NGL s and residue g as at the tailg ate of

the Sny der pla

nt, a fter proce ssing is c omplete. Fr ench arg ues that roy alties must be based only on

2 

## the value of the non -C O g as, the “native” g as, at the well, deter mined by deducting only the

2 

## proce ssing costs unrela ted to the remova l of CO from the value of the final products. The Cogde ll

5 7 T e x

. S u p

. C t

. J

. 1 5 4 ( J a n

. 1 5 , 2 0 1 4 )

. 23

H e r i t a g e R e s

. , I

n c

. v

. N a t i o n s B a n k
, 9 3 9 S

. W

. 2 d 1 1 8
, 1 2 1

- 1 2 2 ( T e x

. 1 9 9 6 ) ( “ R o y a l t y i s c o m m o n l y d e f i n e d 24

a s t h e l a n d o w n e r ’ s s h a r e o f p r o d u c t i o n , f r e e o f e x p e n s e s o f p r o d u c t i o n

. A l t h o u g h i t i s n o t s u b j e c t t o t h e c o s t s o f
p r o d u c t i o n , r o y a l t y i s u s u a l l y s u b j e c t t o p o s t

- p r o d u c t i o n c o s t s , i n c l u d i n g t a x e s , t r e a t m e n t c o s t s t o r e n d e r i t m a r k e t a b l e , a n d t r a n s p o r t a t i o n c o s t s

. H o w e v e r , t h e p a r t i e s m a y m o d i f y t h i s g e n e r a l r u l e b y a g r e e m e n t

. ” ) ( c i t a t i o n s o m i t t e d )

.

S e e P a r a d i g m O i l

, I

n c

. v

. R e t a m c o O

p e r a t i n g , I

n c

. , 3 7 2 S

. W

. 3 d 1 7 7 , 1 8 0 n

. 2 ( T e x

. 2 0 1 2 )

. 25



### 1 2

## L ease provides for a roy alty based on the sales proce eds of casing head g as products net of the cost

2 

## of manufa cturing them. Fr ench arg ues that that cost does not include the expense of removing CO

2 

## from the g as. Fr ench contends that removing CO for reinjec tion is part of production, the expense

of which is solely that of the working interest. Oxy arg ues that for both lease s, the cost of removing

2 

## CO is a postproduction expense involved in extracting the NGL s that must be deducte d from their

marke t price in de termining roy alties.

Fr ench relies principally on our decision in Humble Oil & Refining Co. v. W est

. That case 2 6



## involved a water drive natura l g as rese rvoir that was being depleted by production and could be used

for storag e of extraneous g as but only if that g as wer e injected befor e the native g as was completely

produce d, to preve nt water from encr oaching into the field and destroy ing it. The roy alty owner s, 2 7



## the Wests, sued Humble, the owner -oper ator of the field, to enjoin injection of extraneous g as until

all the native g as had been produce d. We held that Humble had the rig ht to proce ed. The Wests 2 8 2 9



## then arg ued that all the gas in the field, native and injected, wa s subject to their roy alty interest. 3 0



## We disag ree d, holding that the injected g as rema ined Humble’s proper ty on which no roy alty would

be due when such g as was remove d from storag e, but also that Humble, beca use it had commingle d

its injected g as with the native g as, had the burden of showing when production of the pre- injection

5 0 8 S

. W

. 2 d 8 1 2 ( T e x

. 1 9 7 4 )

. 26

I d

. a t 8 1 3

. 27

I d

. a t 8 1 3

- 8 1 4

. 28

I d

. a t 8 1 6

. 29

I d

. a t 8 1 6

- 8 1 7

. 30



### 1 3

## volume of native g as wa s complete a nd the roy alty

obliga tion ex tinguished. 3 1

2 

## Under W est , the CO injected into the Cogde ll Field rema ins O x y ’s proper ty , and Fr ench is

not entitled to a roy alty based o n i t s value when it is produce d with the casing head g as. Fr ench

2 

## arg ues, corr ectly
, that under W est she is entitled to a roy alty on the value of the non-CO portion of

2 

## the casing head g as. But that value is far less while the hy droca rbons and CO are commingle d, and

whether a roy alty owner must share in the cost of separ ation was not in issue or addre ssed in W est

.

2 

## The parties ag ree that removing contaminants indige nous to the prod u cti on field, like H S, from

casing head g as is not part of production, and the roy alty owner s must share in the expense. But they

have cited no case , and we have found none, involving separ ation of extraneous substances injected

into the field.

2 

## Fr ench analog izes the proce ss of separ ating CO injected into the field from the casing head

g as to the proce ss of separ ating water injected into the field from the oil. Oxy has alway s trea ted this

oil proce ssing as part of production, char g ing no part of the expense to Fr ench. Fr ench arg ues that

the g as proce ssing should be trea ted the same way

. But oil and water are immis cible, and separ ating

2 

## them is a rela tively simple proce ss compar ed to separ ati ng CO from g as, which require s specia l

technolog y

. More saliently
, separ a ti n g w a te r f rom oil is essential to continued economic production.

T h e re sult of water flooding
, which is critica l to rec overing the oil from the g round, is th at an

enormous amount of w ater is produced w ith the oil — more than 23 ba rre ls of water

to one bar

rel

of oil. Separa ting the water is not only for reinjec tion into the rese rvoir; it is nece ssary to make the

I d

. a t 8 1 8

- 8 1 9

. 31



### 1 4

## oil marke table. Wit hout water flooding and the separ ation of oil and water , oil production would not

2 

## be viable. The CO flood is also critica l to continued oil production, perha ps even essential, and the

2 2 

## result is that the casing head g as stream is more than 85% CO

. But separ at i n g t h e C O from the

casing head g as is not nece ssary for the continued production of oil, which is the purpose of both the

2 

## water flood and the CO flood. The ga s can be re injected dire ctly into the field, and some of it is.

The g as proce ssi n g i s cer tainly economica lly benef icial to Fr ench and Oxy

. Oxy obtains a

2 

## conce ntrated stream of CO for reinjec tion, and Fr ench and Oxy share in the value of the extracted

NGL s. But the g as proc essing is not essential to the opera tion of the field as the oil processing is.

2 

## Not only is it unnece ssary for continued o i l production to separ ate the CO from the

casing head g as, Oxy has no obliga tion to do so. The Unitiz ation Ag ree m en t gives it the rig ht to

2 

## reinjec t the entire production of casing head g as into the field, and in developing the CO flood, Oxy

considere d that option. Had it pursued that cour se, Fr ench would not be entitled to any roy alty on

the ca singhe ad g as. I nstead, Oxy decide d to proce ss the g as t o obtain a more conce ntrated stre am

2 

## of CO for r einjection and to e x trac t the NGL s to be marke ted. Even so, it ac tually reinjec ts more

than 10% of the g as produc ed dire ctly back into the f

ield. 3 2



## I n these circ umstances, we think that under the parties’ ag reem en t s , French, having g iven

Oxy the rig ht and discretion to decide whether to reinjec t or proce ss the casing head g as, and having

2 

## benef itted f rom that decision, must shar e in the cost of CO remova l. Under the Fuller L ease , that

cost must be considere d in determining the marke t value of the g as at the well, on which F renc h’s

W e n o t e t h a t O x y ’ s d e c i s i o n a p p e a r s t o f u r t h e r t h e S t a t e ’ s p o l i c y o f e n c o u r a g i n g f u l l r e c o v e r y o f h y d r o c a r b o n s 32

a n d p r e c l u d i n g w a s t e

. S e e T E X

. N A T

. R E S

. C O D E § § 8 5

. 0 4 5

- . 0 4 7

.


### 1 5

## roy alty is ba sed, and under the Cogde ll L ease , it must be included in the cost of manufa cturing the

2 

## NGL s and residue g as. Oxy acknow ledg es that the g as proce ssing activities aimed at returning CO

to the rese rvoir are part of p ro duction and contends that the monetary fee it pay s Kinder Morg an,

which is not char g ed to Fr en ch
, covers those expenses. Fr ench does not contend that the 30% of

NGL s Oxy g ives Kinder Morg an in kind overpa y s for her s h ar e of the postproduction expense of

2 2 

## CO remova l; she arg ues only that no part of the CO remova l is a postproduction expense. Since

we disag ree , her c laim fails.

* * * * *

For these re asons, the judg ment of the c ourt of appe als is

Affirmed

.

Nathan L . Hec ht Chief J ustice

Opinion delivere d: J une 27, 2014

1 6