## Facts

- Piney Woods Country Life School and other Mississippi mineral owners (lessors), acting as a certified class, leased gas rights in Rankin County fields to Shell Oil Company (lessee) using several lease forms.
- The leases required Shell to pay gas royalties measured by “market value at the well,” and some forms included a proviso that for gas “sold at the well” royalty would be based on “amount realized.”
- Shell produced “sour” gas containing hydrogen sulfide, which had to be processed at Shell’s Thomasville plant before it could be sold into commercial markets.
- Shell entered into long-term gas purchase contracts with third parties at fixed (and later regulated) prices; the contracts provided for title to pass in the field.
- For royalty payments, Shell treated its contract receipts as the relevant wellhead value and, in calculating royalties, deducted a proportional share of post-production processing costs attributable to the royalty owners’ gas.
- After natural gas prices rose sharply in the 1970s, the lessors sued, alleging Shell underpaid royalties by using below-market contract prices rather than current market value at production and by improperly deducting processing costs under the “market value at the well” language.
- The district court largely ruled for Shell, and the lessors appealed; liability issues were addressed before damages.

## Issues

1. Under a lease requiring royalties based on “market value at the well,” may the lessee base royalty payments on the fixed prices it receives under long-term gas sales contracts rather than the prevailing market value at the time of production?
2. Under “market value at the well” (and related “amount realized at the well”) royalty language, may the lessee deduct a proportionate share of reasonable post-production processing costs necessary to treat sour gas so it can be marketed?
3. Are Shell’s transactions “sales at the well” for royalty purposes merely because title passes at or near the well, when the contracted price reflects downstream processing and delivery obligations?

## Decision

- The Fifth Circuit affirmed in part, reversed in part, and remanded.
- The court held that “market value at the well” means the prevailing market value of the gas at the time of production at the wellhead, and Shell could not satisfy that obligation solely by using fixed long-term contract prices when those prices differed from market value.
- The court held that whether gas is “sold at the well” for royalty purposes is a valuation question, not controlled just by where title passes; a contract price reflecting post-well services does not automatically establish a wellhead price.
- The court held that, because the royalty measure is “at the well,” Shell may deduct a proportionate share of reasonable post-production processing costs required to make the sour gas marketable in order to determine the value “at the well.”
- The case was remanded for further proceedings consistent with the court’s lease interpretations, including determining the proper market value at the well and resulting damages.

## Legal Principles

- “Market value at the well” is determined at the time of production and reflects what a willing buyer and willing seller would agree to in an arm’s-length transaction for gas at the wellhead.
- The price actually received under a long-term gas contract may be evidence of value but does not control when it does not reflect current market value at production.
- “At the well” identifies the valuation point and condition of the gas at the wellhead; it is not decided solely by contractual language about where title transfers.
- When gas must be processed after production before it can be sold, reasonable post-production costs (including processing needed to treat sour gas) may be netted back from downstream values to reach “market value at the well,” and royalty owners bear their proportionate share of those costs under an “at the well” clause.

## Conclusion

Piney Woods holds that Mississippi leases calling for royalties based on “market value at the well” require payment based on current wellhead market value at the time of production, not simply the lessee’s fixed long-term contract receipts, while also permitting the lessee to deduct a proportional share of reasonable post-production processing costs necessary to make sour gas marketable in order to compute the wellhead value; the court therefore affirmed in part, reversed in part, and remanded for valuation and damages calculations consistent with those rules.


Piney Woods Country Life School v. Shell Oil Co., 726 F.2d 225 (5th Cir. 1984)