Class Certification of Texas Royalty Owners Upheld

The Texas Supreme Court recently affirmed the certification of a class of royalty owners who claim their royalties were incorrectly calculated under identical language in their Gas Royalty Agreements (“GRAs”). Bowden v. Phillips Petroleum Co., 247 S.W.3d 690 (Tex. 2008).

The three to four thousand class members are royalty owners in the Texas Panhandle who leased their property to Phillips Petroleum Company for natural gas production, and are now alleging underpayment of royalties due under the leases through self-dealing transactions. Their claims deal with the methods for measuring gas production for royalty calculations. The GRAs provide that Phillips shall pay a royalty on gas produced from the leases and “sold or used off the premises.” Phillips produces natural gas and its affiliate processes liquid products at a distant processing plant. The liquid products are then sold separately from the dry residue gas. The formula for paying royalties is the volume of gas production multiplied by the weighted average price, adjusted for the interest owned. Relying on the phrase “delivered by [Phillips] in the form of gas,” Phillips interprets the GRAs to require royalty payments without accounting for the prices received for natural gas liquids, which its affiliate processes miles away. The class members complain that Phillips’s calculation of the royalties based only on the dry residue natural gas production and excluding the liquid components constitutes a breach of the GRAs. The royalty owners want the liquid components to be included because they are more valuable than the dry gas, and their inclusion would increase the weighted average to be used in the royalty formula. Inversely, the price factor is lower when the liquid components are not included.

The Court held that the language in the GRAs was not ambiguous, and that in determining the weighted average price, all the natural gas metered at the wells should be included, before any later extraction of natural gas liquids. “The royalty owners are entitled to a royalty based on the value of the natural gas, including all of its components.” Thus, subject to the language in their specific agreements, royalty owners are generally entitled to a royalty on the total amount of minerals they sell from their mineral estate, including all components of those materials – no less no more.