Determining the Lessor's Royalty Share of Post-Production Costs: Is the Implied Covenant to Market the Appropriate Analytical Framework?

Changes in the gas market resulting in fewer wellhead sales and divestiture by the pipelines of their historic merchant function have brought to the forefront the issue of what postproduction costs are properly shared by the lessor in calculating the lessor's royalty. The issue of post-production costs is by no means a new one,1 and we do not intend in this paper to present an exhaustive analysis of post-production costs or provide the reader with anything so useful as an up-to-date list of which costs are deductible in which states. Rather, what concerns us is an approach exemplified in recent Colorado, Kansas, and Oklahoma2 cases wherein the determination of which post-production costs are to be shared by the lessor rested, in large part, upon the courts' finding that the lessee has an implied duty to place gas in marketable condition at [12-4] no cost to the lessor. This duty, according to these recent decisions, arises as part of the lessee's implied duty to market.

Your authors, having collectively practiced oil and gas law for many years in many states, were intrigued by what we perceived to be an unwarranted and unworkable expansion of the duty to market. After investigating the origins and evolution of the duty, our perceptions are unchanged.

We begin in § 12.02 with a general discussion of the basic nature of the royalty interest and some basic rules