|August 7, 2013|
Previously published on August 5, 2013
In what may be the first decision on the subject, the United States Fifth Circuit Court of Appeals has rejected an attempt by royalty owners to seek a royalty share of profits made by a lessee from the lessee’s hedging activities.
The case involved a claim made by the Harold P. Chastant, Jr. Trust as lessor against Cimarex Energy Company as lessee under a lease with standard royalty clauses. Based on statements in Cimarex’s SEC filings, Chastant claimed that Cimarex had profited from the hedging of oil and gas production. Relying on (1) the lessee’s obligation to prudently market production; and (2) language from the Louisiana Supreme Court decision in Frey v. Amoco Production Co., 603 So. 2d 166 (La. 1972), Chastant argued that royalties were due on all benefits that the lessee derived from the lease, including profits from hedging activity. Cimarex argued that royalties were only due on the market price or value of the production at the well or lease, and that no royalties were due on Cimarex’s hedging activities, which were purely financial transactions. The parties filed cross-motions for summary judgment on the legal issue of whether a lessor could seek royalties on the lessee’s financial trading activities used to hedge against price fluctuations of its oil and gas production. The United States District Court for the Western District of Louisiana granted summary judgment in favor of Cimarex.
On August 2, 2013, the United States Fifth Circuit Court of Appeals affirmed. The Fifth Circuit reaffirmed long-standing law providing that royalties were due on the price or value of the oil or gas at the wellhead or at the lease. The Fifth Circuit recognized that financial trading activities used to hedge against price fluctuations did not affect the price or value at the wellhead or at the lease, and therefore profits derived from those financial trading activities were not royalty-bearing.
The decision is believed to be the first of its kind expressly recognizing that royalty owners have no claim on profits made from financial trading activities used to hedge against price fluctuations.