The Oil Royalty Clause

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The Oil Royalty Clause

 A typical industry lease oil royalty clause looks like:

As a royalty, lessee covenants and agrees: (a) To deliver to the credit of lessor, in the pipe line to which lessee may connect its wells, the equal one-eighth part of all oil produced and saved by lessee from said land, or from time to time, at the option of lessee, to pay lessor the average posted market price of such one-eighth part of such oil at the wells as of the day it is run to the pipe line or storage tanks, lessor’s interest, in either case, to bear one-eighth of the cost of treating oil to render it marketable pipe line oil;


         Some of the issues presented by the typical oil industry oil royalty clause include:

 •        whether lessor can take its oil production in-kind;

whether the oil company must pay market value or posted market price if it purchases the oil*;

[*Posted prices are simply “lists of prices published in price bulletins by companies in the oil industry which they will pay for crude oil of a certain quality from particular fields.” Beacon Oil Co. v. O’Leary, 71 F.3d 391, 394 (Fed. Cir. 1995).  The posted price may or may not equal market value.]


 •        whether the oil company must deliver the royalty oil free of costs;

 •        whether the oil company must ratably  market the royalty oil if not taken in-kind.

 A lessor-friendly oil royalty clause that addresses these issues and that has been accepted by oil companies is set out below:

 Production Royalty.  Subject to the favored nation royalty escalation provisions of this Lease,  the base production royalty (the “Production Royalty”) to be paid to Lessor by Lessee for oil, gas, other non-coal hydrocarbons, and other valuable components extracted from the Leased Premises shall be:


 (1)        Oil. On oil, including condensate or other liquid hydrocarbons, Twenty Five percent (25%) of that produced and saved from the Leased Premises, to be delivered to the credit of Lessor free of cost into the pipeline or other transportation facility to which Lessee may connect its wells; provided, however, that:


 (1.1)        Lessee may purchase Lessor's royalty oil, paying therefor the market price prevailing for the field where produced on the date of purchase, until sixty (60) days after Lessor has given Lessee written notice that Lessor elects to take its royalty oil in kind (which right so to elect Lessor may exercise and countermand from time to time, on like written notice, but Lessor's election to receive its royalty oil in kind shall not become operative until Lessor shall furnish, at its own cost, facilities to remove from the Leased Premises, and/or store, Lessor's royalty oil currently as produced); and


 (1.2)  If Lessor does not elect to take in kind and Lessee elects not to purchase Lessor's royalty oil, Lessee shall handle and dispose of the same ratably with and on the same basis on which Lessee disposes of its own oil produced from the Leased Premises.


Copyright 2011 by Edward G, Hawkins. All rights reserved.