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The Legal History of "Royalty": Property or Contract?
A 1995 article, arguing that the implied covenant to market should not be broadened to deny the deductibility of post-wellhead costs for purposes of royalty valuation, contained the following statements:
The landowner's royalty, like the royalty on gold and silver due the Crown under English common law, is understood to be reserved portion of the actual minerals extracted by the lessee. In other words, it is 'a share of production, free of expenses of production.'
. . .As in any commercial context, the common law relationship between the lessor and the lessee can be altered by private contract . . . but there is something in the nature of the property right itself-something in the nature of the "bundle of sticks" that is a royalty that answers the question: The lessor's percentage is a percentage of what? Consistent with the sharing arrangement with
2 PEROLEUM ACCOUNTING AND FINANCIAL MANAGEMENT
the Crown that gave the "royalty" interest its name, the most obvious answer is that the lessor's royalty entitles the lessor to a share of the produced mineral in its natural state, after the mineral has been brought to the surface by the lessee.111*
Although these statements were largely made without citation of authority, the notion that royalty is inherently defined by property-law is not an unreasonable assumption.112 I noted in a 1981 article that property principles could be used to address the question of post-wellhead costs.113
A property law approach to royalty may be illustrated as follows: Suppose a lessor grants an oil and gas lease "for so long as oil is produced" retaining a 1/8 in-kind oil royalty. In Texas and several other states, the lessee would acquire a fee simple determinable estate in the working-interest oil in place beneath the property. In Oklahoma and in most other states, the lessee most often would acquire a profit 6 prendre, i.e., the exclusive right to explore and produce any oil that may lie beneath the property, for the duration of a determinable fee.' Both of these interests would be subject to the lessor's right to receive production royalty in kind. A basic issue is: When, or at what point in the production stream, is the lessor...