By Natalie Barletta:

            In Shell Oil Co. v. Ross, No. 01-08-00713-CV (Tex. App.—Houston [1st Dist.] February 25, 2010, no pet. h.), Ross, a mineral interest owner, brought a breach of contract, unjust enrichment, and fraud action against natural gas lessee, Shell. Ross alleged that Shell failed to pay royalties in accordance with the lease agreement and that it fraudulently deprived him of royalties by making payments “based on an arbitrary amount even below the internal transfer price.” He further alleged that Shell sent him royalty statements containing false representations that the royalties were based on actual sales prices. The trial court entered a judgment on the jury verdict in favor of Ross and Shell appealed. 

            On appeal, Shell argued that the trial court erred in concluding that it breached the lease by using a weighted average royalty calculation because the lease indicates that “royalty payments should be calculated based on the sale price of the natural gas sold by Shell and any other working interest owners.” The parties stipulated that if the use of a weighted average was in error, Shell underpaid royalties by over $72,000. 

            The lease allowed Shell to pool or unitize its interests. Shell entered into a pooling and unitization agreement and received its share of production based on the amount of land it contributed to the unit. Shell, however, did not calculate royalty payments based on the price it received for the gas. Shell calculated the weighted average price of all gas produced at the mouth of the well by averaging the sale price it received with the prices any other working interest owners received.   Provisions in the lease required that Shell pay royalties based on the production of natural gas allocated to the tract and that the amount of natural gas allocated to the tract “should represent the percentage of the natural gas produced that corresponds to the percentage of ‘the total number of surface acres in the unit’ contributed by the tract.” Nothing in the provisions addressed how the allocated natural gas should be valued for royalty payments. The provision merely stated that payments should be made “in the same manner as though produced from said land under the terms of this lease.”

            Shell agreed to pay royalties on natural gas “produced from” the tract, and it argued that that payments should be calculated based on the amount realized by all working interest owners who are part of the pooled unit because each owner received a portion of the gas “produced from” the tract. The court found, however, that the lease required Shell to pay royalties based on amounts realized by Shell and it did not authorize payments to be based on amounts received by other working interest owners. Shell breached the contract “by paying royalties on a price less than the amount that Shell realized from the sale of the gas.” 

            The court affirmed the trial court’s judgment also finding that the evidence was sufficient to support the fraud claims. The court stated that Natural Resources Code Section 91.502 requires that a royalty statement include the actual price of the gas sold and not an arbitrary number. The court also held that the evidence supported the jury’s finding that Shell fraudulently concealed its wrongful conduct and that the plaintiffs could not have discovered the wrongful conduct in the exercise of reasonable diligence. Although the Rosses could have used available records to discover that the price on some wells was lower than the unit price on other wells, this would not by itself have caused a reasonably prudent person to inquire about the lower price. Further, the price could have been affected by the BTU of the gas and the BTU was not stated on the royalty statements. The jury could have reasonably concluded that there were no other sources by which the royalty owners could have discovered the relevant information.