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St. Mary's Law Journal

Abstract

Oil and gas leases normally do not set a fixed price for calculating royalty payments. Instead, oil and gas leases commonly tie royalty calculations to a more flexible yardstick, including “market value” or “net proceeds”. This flexibility allows the lease relationship to survive any dramatic volatility in oil and gas prices, while the same fixed price may be inadequate in shifting markets. Conversely, the flexibility may place lessors and lessees in a position of inherent conflict. In particular, parties vehemently disagree about the proper location for applying the yardstick. Historically, lessees have enjoyed the better side of the argument; though, recently the tide has turned against them. Courts in several states have adopted variations for the “first marketable product doctrine,” which holds that lessees must calculate the value or its price of production at the location where the lessee first obtains a marketable product. Yet, one of the glaring flaws was the courts’ failure to clearly define the term “product”, which created problems surrounding situations where multiple “products” were produced. Lessors have taken advantage of this flaw in the case law, arguing the doctrine requires a lessee to apply the yardstick at not simply the first location but at each separate location where “product” is produced. Although the relationship between lessors and lessees focuses on the leased premises, the first market production doctrine serves more harm than good. The doctrine lacks a sound legal foundation. While it purports to rely on rules of contract construction, it does not give effect to the plain meaning of the term “at the well” in the standard royalty clause. While it claims to rely on implied covenant to market, it improperly uses the covenant to reach a different result from what the parties contemplated in the express terms of their agreement.

Publisher

St. Mary's University School of Law

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