Keith B. Hall
LSU Law School
In The Grissoms, LLC v. Antero Resources Corp., 133 F.4th 605 (6th Cir. 2025), the United States Sixth Circuit held that the market enhancement clause in certain oil and gas leases in Ohio did not authorize the lessee to deduct the costs of natural gas processing and the costs of fractionating natural gas liquids from the gross proceeds of sale for purposes of calculating the lessors’ royalties.
Background
The United States District Court for the Southern District of Ohio certified a class action in an oil and gas despite over lease royalties in which Antero is the lessee. The royalty clauses in the leases at issue are not “at-the-well” clauses. Under Ohio law, when an oil and gas lease contains an “at-the-well” royalty clause, the royalty on natural gas is calculated based on the value that natural gas has at the well—considering both the location of the well and the pressure and composition of the gas at the well. This contrasts with the possibilities of calculating the royalty based either on gross proceeds from selling the gas or on the value of the natural gas at some downstream point, where the gas generally will have a higher value because it has been processed, dehumidified, compressed, and transported to a location nearer a buyer. In this case, the leases at issued provide for the lessors’ royalties to be based on gross proceeds from the sale of the gas. But as an exception to the general rule that the royalty should be calculated based on gross proceeds, the leases contained a “market enhancement clause” which authorized the lessee to deduct the costs of performing certain value-adding activities from the gross proceeds, before calculating the royalty. Specifically, the clause provided: C) Market Enhancement Clause. It is agreed between the Lessor and Lessee that, notwithstanding any language contained in A) and B) above, to the contrary, all royalties or other proceeds accruing to the Lessor under this lease or by state law shall be without deduction directly or indirectly, for the cost of producing, gathering, storing, separating, treating, dehydrating, compressing, processing, transporting, and marketing the oil, gas and other products produced hereunder to transform the product into marketable form; however, any such costs which result in enhancing the value of the marketable oil, gas or other products to receive a better price may be proportionally deducted from Lessor’s share of production so long as they are based on Lessee’s actual cost of such enhancements. However, in no event shall Lessor receive a price per unit that is less than the price per unit received by Lessee. In calculating the lessors’ royalties, Antero subtracted the costs of natural gas processingand the costs of fractionating natural gas liquids, as well as transportation costs for the processed natural gas. The plaintiffs did not dispute Antero’s deduction of transportation costs for the processed natural gas, but they complained that Antero had no right to deduct the gas processing costs or the fractionation costs. Antero argued that the market enhancement clause authorized the deduction of those costs because gas processing and the fractionation of natural gas liquids enhance the value of the hydrocarbon products. The plaintiffs disagreed, arguing that the market enhancement clause does not authorize the deduction of the expenses for all activities that enhance value. Rather, they asserted that the clause only authorizes the deduction of costs for activities that enhance the value of an already-marketable product. They further argued that natural gas is not marketable prior to gas processing and an unfractionated, so-called “Y-Grade” mixture of natural gas liquids, is not marketable. The plaintiffs filed a putative class action, and the federal district court granted class certification. Later, when the plaintiffs moved for summary judgment, the district court agreed with the plaintiffs’ argument on the merits and granted a judgment in their favor on liability. The parties stipulated that the quantum of plaintiffs’ alleged damages was $10 million.
The Appeal
Antero appealed the district court’s grant of summary judgment in favor of the plaintiffs on liability, but the Sixth Circuit affirmed. Here, the royalty clause clearly provided that the royalty on natural gas generally should be based on gross proceeds. Further, noted the court, the market enhancement clause authorized the deduction of expenses for certain activities that enhance the value of the hydrocarbons extracted from the well, but the clause only applies to expenses that enhance the value of a product that already is marketable. The court reasoned that,for a product to be considered marketable, it is not sufficient that there is some possibility of finding a buyer. The appellate court explained that there is always some possibility of selling an unfinished product to someone who will finish putting the product into a condition that makes it more readily marketable. The court noted that natural gas that has not been processed generally cannot be put into interstate pipelines and that there is not a broad market for unprocessed natural gas. The court similarly concluded that there generally is not much of a market for an unfractionated, “Y-Grade” mixture of natural gas liquids. Although it might be possible to find a company that will buy such a mixture, then fractionate it and sell the resulting products, there is not a true market for an unfractionated mixture. Further, the court reasoned that Antero’s interpretation of the royalty clause would effectively make the clause an “at-the-well” royalty clause because virtually all post-production costs add value to the product stream, and clearly the parties in this case had not intended to enter an -at-the-well lease. The gross-proceeds provision showed that they intended something else. Therefore, the Sixth Circuit affirmed the $10 million judgment for the plaintiffs.