Background and Parties

Maria Ellen Rolwing and co-plaintiffs collectively own 100% of the surface and mineral estates in two sections of land in Reeves County, Texas. Permian Resources Operating, LLC operates oil and gas wells on the property as successor-in-interest under an Oil and Gas Lease (OGL) and subsequently executed Production Sharing Agreements (PSAs). The PSAs govern only "sharing wells"—wells that extend onto land beyond the leased premises—and expressly "amend the OGL to the extent necessary to conform it to the terms of the PSAs, but not otherwise." The dispute centers on whether these PSAs eliminated the mineral owners' obligation to bear post-production costs for royalties from the PSA wells, and separately, whether Permian Resources improperly allocated costs from dormant wells to actively producing non-PSA wells.

The Core Dispute: Conflicting Royalty Provisions

The underlying OGL contains an "at the mouth of the well" royalty clause, which under Texas law permits the operator to deduct post-production costs when computing royalty payments. However, the PSAs contain what Plaintiffs characterize as a "no-deductions clause" stating that "[Plaintiffs'] share of production shall be without deduction of any pre-production or post-production costs, including without limitation (a) any costs associated with the drilling, completing, or equipping of a Sharing Well, and/or (b) any costs associated with the producing, gathering, storing, separating, treating, dehydrating, compressing, transporting, or marketing of the oil, gas and other products produced from such Sharing Well." Plaintiffs alleged this language freed them from post-production cost burdens on PSA wells, and that Defendant's initial practice of not deducting such costs confirmed this interpretation before Permian Resources "later changed course."

The Court's Heritage Analysis

Magistrate Judge Fannin applied the Texas Supreme Court's seminal decision in Heritage Resources, Inc. v. NationsBank, 939 S.W.2d 118 (Tex. 1996), which established that no-deductions clauses do not conflict with "at the well" royalty formulations. The court noted that Heritage "broadly has stood for the proposition that the commonly understood terms 'royalty' and 'market value at the well' referenced in oil-and-gas leases in Texas rendered clauses allocating post-production costs 'surplusage as a matter of law.'" Citing the Fifth Circuit's decision in Warren v. Chesapeake Exploration, L.L.C., 759 F.3d 413 (5th Cir. 2014), the magistrate judge emphasized that such clauses create a "'night-is-day' feeling to the results in interpreting royalty clauses," where "inserting a statement in a lease to specify who will or who will not bear the post-production costs may have no effect."

"Because postproduction costs are not incurred until after gas leaves the wellhead, and because postproduction costs add value to the gas, backing out the necessary and reasonable costs between the sales point and the wellhead is accepted as an adequate approximation of market value at the well."

The court explained that under Texas law, "'at the well' is as much a valuation method as it is a valuation point," citing Bluestone Natural Resources II, LLC v. Randle, 620 S.W.3d 380, 391 (Tex. 2021). The magistrate judge found that the PSA's no-deductions clause, standing alone, did not change the computation point from "at the well" and therefore "simply meant nothing" under Heritage precedent.

Implications for Production Sharing Agreements

This recommendation carries significant implications for operators and mineral owners negotiating Production Sharing Agreements in Texas. The decision reinforces that Heritage's framework applies with equal force to PSAs as to lease amendments, and that parties seeking to shift post-production cost burdens must do more than include general no-deductions language—they must explicitly alter the valuation point itself. The magistrate judge's analysis suggests that the "straitjacket" Heritage placed on "at the well" royalty calculations remains firmly in place nearly three decades later, despite parties' attempts to contract around it through supplemental agreements. For practitioners drafting PSAs or lease amendments, the opinion underscores that surface-level "without deduction" language will likely prove ineffective absent express modification of the underlying royalty computation point. The court's recommendation to grant the motion to dismiss in part on the PSA wells claim (while denying it as to the non-PSA wells claim involving improper cost allocation from dormant wells) demonstrates the continued vitality of Heritage's formalistic approach to royalty clause construction in the Permian Basin and beyond.