Chapter 6B "Fixed vs. Floating" Mineral and Royalty Questions in Texas: Is the End Any Nearer?

• Jurisdiction: United States

Chapter 6B "Fixed vs. Floating" Mineral and Royalty Questions in Texas: Is the End Any Nearer?

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Christopher Kulander¹South Texas College of Law HoustonHouston, TX

CHRISTOPHER S. KULANDER teaches at the South Texas College of Law—Houston and currently serves as Director of the Harry L. Reed Oil & Gas Law Institute. He has taught Domestic Energy Law, Property, Mining Law, and beginning and advanced Oil & Gas Law courses. In addition, he teaches International Energy Law at Vytautas Magnus University, Kaunas, Lithuania, as International Lecturer. He is licensed in Texas and New Mexico. Professor Kulander has published over twenty law review articles, as well as many other articles with a more practical focus in the industry literature, on diverse topics including energy lending, finance, oil & gas law, land use control, American Indian law, as well as on geology, and petroleum seismology. He received his J.D. from the University of Oklahoma, where he was managing editor for the Oklahoma Bar Mineral Law Newsletter and note editor and assisting managing editor for the American Indian Law Review. Before teaching, Professor Kulander practiced for four years in the Houston office of Haynes and Boone, LLP, focusing on energy lending, finance, and bankruptcy. Prior to that, he practiced for two years with Cotton & Bledsoe in Midland, Texas, focusing on oil and gas title, leasing, and litigation support. Before law school, he received his B.S. in geology and M.S. in geophysics from Wright State in Dayton, Ohio, and his Ph.D. in geophysics (petroleum seismology) from Texas A&M University, after which he worked for the U.S. Geological Survey as a geophysicist.

Introduction and Background

Altman v. Blake, cited by some sources² as the definitive Texas case for the proposition that the mineral estate consists of five distinct "sticks" - the right to develop, the right to lease, and the rights to collect royalty, bonus, and delay rentals - helped usher in the modern view of the five-faceted separable mineral estate. In Altman, the Texas Supreme Court held the owner of an entire fee mineral estate retained a fee mineral interest despite having conveyed away the right to collect delay rentals and the executive right.³ The court noted that it had "before recognized that a mineral interest shorn of the executive right and the right to receive delay rentals remains an interest in the mineral fee."⁴

Royalty is likely the most litigated stick within the bundle. Royalty in the oil and gas context in Texas is commonly defined as a nonpossessory interest in real property.⁵ Owners of royalty receive a fraction of the produced hydrocarbons without having to pay any of the exploration, drilling, and production costs.⁶ Because of problems such as shoddy drafting and inconsistent judicial determinations, there has arisen over the decades an enormous amount of litigation, academic analysis, and general hand-wringing centered on whether a conveyed or reserved interest is a royalty or a (generally fractional) interest in the actual minerals.

Royalty interests are often categorized into three distinct groups: One is the lessor's (or landowner's) royalty, a royalty interest that is retained when a mineral owner (the "landowner") executes a mineral lease. This interest is effective during the duration of the lease and is determined through a negotiation between the mineral owner and the lessee, typically an oil and gas company or a broker. It is generally a fixed fraction of the gross production, perhaps varying depending on the volume of production.

Historically, the lessor's royalty began during the early 1900s as a widely varying fraction; by the 1920s it had gradually settled across the industry at 1/8 for both oil and gas produced. This equilibrium lasted until roughly the mid-1970s, longer than the professional memory of lessors

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and lessees alike, when market forces driven by the suddenly rising prices finally overcame tradition and lessor's royalties finally rose. During this stretch of almost fifty years, the idea took hold that lessor's royalties would always be 1/8 for produced oil and gas, even though other produced minerals (such as sulfur) required payment of other fractions, such as 1/10 or 1/16, as described in the very same royalty clauses in the very same leases.⁷

After the 1970s, and through the present, the lessor's royalty for produced oil and gas has most often been 1/6 or greater. Now, with the advent of unconventional onshore plays, lease royalty has increased dramatically, commonly reaching 1/5 or 1/4.⁸ Leases issued by the Texas General Land Office are now typically set at 1/4.⁹ Lease bonuses topped $26,000 per mineral acre in the most prospective portions of the Barnett Shale during the latter half of the 2000s.

In contrast to a lessor's royalty, a non-participatory royalty interest ("NPRI") is an expense-free real-property mineral interest that does not participate (hence the name) in collecting bonus or delay rentals, leasing, or exploring and developing.¹⁰ This interest is "non-possessory in that it does not entitle its owner to produce the minerals himself," as one Texas court described it.¹¹ "It merely entitles its owner to a share of the production proceeds, free of the expenses of exploration and production."¹² The size of an NPRI can be expressed in one of two ways: the NPRI can be reserved or conveyed as a fixed fraction of gross production, commonly 1/16, or it can be dependent upon the lessor's royalty of the existing lease and every lease covering the captioned land thereafter.¹³ In the second instance, the NPRI fraction is typically multiplied by whatever lessor's royalty is found in the existing oil and gas lease covering the captioned land.¹⁴

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The size of a mineral interest or NPRI may be "fixed" or "floating." For example, compare an NPRI that is specified as 1/16 of production and a NPRI that is specified as 1/2 of the lease royalty. The first is "fixed" at 1/16 because the royalty fraction is independent of the lease royalty. But the latter is "floating" because the NPRI fraction of production cannot be determined until one knows the lease royalty fraction.¹⁵ For the latter, if the lease royalty is 1/8, then the NPRI fraction will be 1/16, but if the lease royalty is 1/4, the NPRI fraction will be 1/8. Disputes over whether a royalty is fixed or floating are frequent because deeds executed in the early through middle decades of the Twentieth Century were drafted on the assumption that the 1/8 royalty would remain as the standard lease royalty, which it was until the 1970s when lease royalties began to commonly exceed 1/8—especially in Texas. Thus, some NPRIs were fixed with a single fraction, such as 1/16, but many other NPRIs specified a double fraction, e.g., 1/2 of 1/8. While both formulations yielded a 1/16 royalty, drafters often used the latter double fraction to avoid having the interest misconstrued as a mineral interest. Some other formulations had a single fractional floating royalty—such as 1/2 of the lease royalty. Confusion arose when the NPRI was described in both fixed and floating language, e.g., 1/2 of lease royalty together with other language that specified a 1/2 of 1/8 royalty, —thus mixing apparent references to floating and fixed royalties. The following cases explore this confusion.

The Repugnant-to-the-Grant Theory vs. and the "Two-Grant" Doctrine

The "four corners" rule did not initially carry over to fixed vs. floating royalty or mineral questions. Before the early 1990s, most courts resolved contradictory reservation/conveyance descriptions by utilizing the "repugnant-to-the-grant" theory, made popular in Texas by the case of Alford v. Krum.¹⁶ In that case, the Supreme Court of Texas held that a granting clause conveyed a 1/16 mineral interest despite the fact that the actual language of the instrument later described the interest as a multiple of a fraction—1/2 of 1/8.¹⁷ Specifically, in Alford, a mineral conveyance from 1929 granted a "one-half of the one-eighth interest in and to all of the oil, gas and other minerals."¹⁸ This was followed by a provision noting that the conveyance "covers and includes 1/16 of all the oil royalty and gas rental or royalty due and to be paid under the terms of said lease."¹⁹ Both clauses then recognized that future leases might follow and, in such cases, the grantor and grantee would each own "a one-half interest in all oil, gas and other minerals in and upon said land, together with one-half interest in all future rents."²⁰

Litigation ensued, with courts asked to consider whether the grantee received a 1/2 mineral interest or only a 1/16 mineral interest - 1/2 of 1/8. The Texas Supreme Court majority, its eye seemingly fixed on a policy of title clarity, noted the "clear and unambiguous language of the

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granting clause," and held that the deed conveyed only a perpetual 1/16 mineral interest to the grantee.²¹ The Court formulated a bright-line rule:

In cases involving the construction of mineral deeds, the "controlling language" and the "key expression of intent" is to be found in the granting clause, as it defines the nature of the permanent mineral estate conveyed. It logically follows that when there is an irreconcilable conflict between clauses of a deed, the granting clause prevails over all other provisions.²²

As one commentator opined, the majority ignored the lease clauses covering the present lease and any future leases as they muddied "the clear and unambiguous language of the granting clause."²³ Such a rule empowered Texas courts to declare such "present" and "future" lease clauses as found in Alford unambiguously "repugnant" to the granting clause and thus allowed them to ignore such clauses as a matter of law.²⁴Alford, therefore, essentially ignored language subsequent to the granting clause that may conflict with the express result of the granting clause. While Alford would...