The Oil and Gas Addendum

The calculation of production royalties and the deduction of post-production costs remains a troubling issue for Pennsylvania landowners.  But there is another frustrating and often confusing royalty-related issue which can, and does, impact the value of the landowner’s royalty.  For example, assume that you sign an oil and gas lease in 2021 with XYZ Drilling regarding your 215 acre family farm in Tioga County.  You spend hours negotiating the lease and insist on a eighteen percent (18%) royalty clause.  In December, you receive your first royalty statement but the royalty is not calculated on eighteen percent (18%) but rather nine percent (9%).  You are shocked, confused and angry.  XYZ Drilling informs you that back in 1912, your great-grandfather conveyed a “royalty interest” to Mr. Pickett, a person you have never heard of.  XYZ Drilling tells you it is paying one half (1/2) of the eighteen percent (18%) royalty to Mr. Pickett’s grandchildren.

To support its royalty calculation, XYZ Drilling provides you with a copy of the 1912 Deed.  It says that your great-grandfather conveyed to Mr. Pickett “one sixteenth (1/16^th) of the oil and gas produced from the land.”  You do some additional research and discover that your great-grandfather had entered into an oil and gas lease with ABC Oil in 1903. But that lease expired years ago.  How is this possible?  How can a transaction in 1912 reduce the royalty you specifically negotiated in 2021?  And how can one sixteenth (1/16^th) now mean one-half (1/2) of your royalty?  As we have written before, this “royalty” vs. “royalty interest” dilemma is rather common and unfortunately affects many landowners each year in Pennsylvania.  See, Federal District Court In Pittsburgh Rules That 1897 Deed Did Not Grant A Non-Participating Royalty Interest (November 18, 2021); See also, Texas Supreme Court Rules That 1924 Deed Conveyed One-Half Of The Oil And Gas Estate (May 17, 2023).  Recently, the Intermediate Court of Appeals of West Virginia addressed this unique and confusing aspect of oil and gas law in Nicholson v. Severin POA Group LLC.

At issue in Nicholson was an April 18, 1902 deed between F.W. Severin and L.D. Nicholson concerning a 117 acre parcel located in the New Milton District, Doddridge County, West Virginia (the “1902 Deed”). Pursuant to the 1902 Deed, Severin conveyed the 117 acre parcel to Nicholson but excepted and reserved “one-sixteenth of all the oil and gas in and under the land.”  At the time of the 1902 Deed, Severin owned a fee simple interest in the entire 117 acre parcel (the “Subject Parcel”).  Prior to executing the 1902 Deed, Severin had entered into two (2) separate oil and gas leases: a 1897 lease with The South Penn Oil Company and a 1898 Lease with Caster Oil and Gas Company (the “Leases”).   Each Lease provided for the traditional “one-eighth” royalty on behalf of Severin.

In 1977, the heirs of Nicholson entered into a new oil and gas lease with Rockwell Petroleum (the “1977 Lease”).  The 1977 Lease was subsequently assigned to Antero Resources Corporation (“Antero”).  In 2017, Antero drilled and completed several horizontal well bores in and through the Marcelles Shale underlying the Subject Property.  Shortly thereafter, Antero began producing hydrocarbons and tendering production royalties to both the Nicholson heirs and the Severin heirs.  Antero, however, interpreted the 1902 Deed as reserving a one-half (½) interest (i.e. 1/2 of 1/8 = 1/16) in the oil and gas estate.  As such, Antero calculated the production royalty under the 1977 Lease as if the Nicholson heirs and the Severin heirs each owned a one-half interest. 

The Nicholson heirs disputed and contested Antero’s interpretation.  They asserted that Severin only reserved a one-sixteenth (1/16^th) interest by virtue of the 1902 Deed.  As a result, Nicholson acquired the balance of the oil and gas estate (i.e., 15/16^th) pursuant to the 1902 Deed.  Under this interpretation, the Nicholson heirs now owned fifteen-sixteenths (15/16^th) of the oil and gas estate.  Given this ownership interest, the Nicholson heirs argued that they should be receiving ninety-three percent (93%), as opposed to fifty percent (50%), of the production royalty.

The Severin heirs disagreed and maintained that they owned fifty percent (50%) of the oil and gas estate.  The parties were unable to resolve the dispute and in October 2020 the Nicholson heirs filed a declaratory judgment action against the Severin heirs and Antero in the Circuit Court of Doddridge County.  In their Complaint, the Nicholson heirs sought a declaration that Severin only reserved a one-sixteenth (1/16) interest in the underlying oil and gas estate. Both the Severin heirs and Antero filed counterclaims seeking a declaration confirming Severin’s reservation of a one-half (1/2) interest.

The Severin heirs defended the suit by relying on what is known as the Estate Misconception Theory.  Specifically, the Severin heirs argued that in 1902 Severin intended to reserve one-half (1/2) of the oil and gas estate from the conveyance to Nicholson.  He was simply bad at math and used the wrong fraction.  Under this theory, the Severin heirs postulated that Severin mistakenly believed he only owned a one-eighth (1/8) interest in the oil and gas estate given his execution of the Leases.  In actuality, he still retained a fee ownership interest in the underlying oil and gas.  Nonetheless, this confusion over what interest was retained by the lessor after signing an oil and gas lease was common around the turn of the century: many landowners thought they only owned a one-eighth (1/8) interest after they signed a lease and mistakenly used the wrong fractions in subsequent deeds.   In other words, in 1902, many deeds inadvertently utilized the wrong fraction of one-sixteenth (1/16) to reflect a conveyance or reservation of one-half of the purported oil and gas estate (i.e. mistakenly believed to only be 1/8^th).  Accordingly, the Severin heirs urged the trial court to recognize this “mistake” and interpret the 1902 Deed as reserving one-half (1/2) of the oil and gas estate.

Given the pervasive confusion in the early 1900’s regarding oil and gas ownership, modern courts have developed the so-called Estate Misconception Theory to aid in the interpretation of ambiguous oil and gas deeds.  Before we address the opinion in Nicholson, a brief review of the Estate Misconception Theory is warranted. The Texas Supreme Court summarized the theory as follows:

“This theory refers to a once-common misunderstanding (perpetuated by antiquated judicial authority) that a landowner retained only 1/8 of the minerals in place after executing a mineral lease instead of a fee simple determinable with the possibility of reverter in the entirety.  For example, a lessor who has leased the entire mineral estate, but desires to sell-one half [sic] of the minerals, would assume that he owned 1/8 of the minerals due to the existing lease. . . [and] would use the fraction 1/16, or a double fraction ½ of 1/8, to convey ½ of what he perceived he owed.”

See, Hysaw v. Dawkins, 483 S.W. 3d, 1 (Tex. 2016). See also, Concord Oil Co. v. Pennzoil Exploration, 966 S.W. 2d 451 (Tex. 1998)(“[U]nder a typical lease providing for a 1/8 royalty, the lessor may think that the interest retained is 1/8 of the minerals including 1/8 of the royalties. This misconception is evidenced in a few decisions….”); Heyer v. Hartnett, 679 P.2d 1152 ( Kan. 1984)(“[A]s the most common leasing arrangement provides for a 1/8 royalty reserved to the lessor, the confusion of fractional interests stems primarily from the mistaken premise that all the lessor-landowner owns is the 1/8 royalty”); Van Dyke v. Navigator Group, No. 21-0146 (Texas Supreme Court, February 17, 2023)(“[T]his prevalent belief and confusion resulted in parties mistakenly assuming the landowner’s royalty would always be 1/8.  Therefore, the parties would use the term 1/8 as a placeholder for future royalties – without anyone understanding that reference to set an arithmetical value”). The rule is not absolute and is employed simply as a device to facilitate the interpretation of ancient deeds that purport to convey or reserve fractional interests. However, the rule does recognize that given the confusion in the early 1900’s regarding what a lessor-landowner retained after signing an oil and gas lease, a strict mathematical and textual approach to deed construction may not reflect the true intent of the original parties.

Returning the Nicholson matter, the trial court agreed with the Severin heirs and granted summary judgment in their favor in April 2022.  The trial court was influenced by the Estate Misconception Theory and opined that the “reservation of 1/16 of the oil and gas operates to reserve 1/2 of the oil and gas estate under West Virginia law in 1902 and the early 1900’s”.  The Nicholson heirs filed an appeal to the West Virginia Intermediate Court of Appeals.

On appeal, the Nicholson heirs essentially argued that the 1902 Deed was unambiguous and, therefore, it was unnecessary and improper to look beyond the express language under the guise of the Estate Misconception Theory.  In other words, Severin meant what he wrote:  he was only reserving a one-sixteenth (1/16) interest.  Nothing more, nothing less.  Conversely, the Severin heirs argued that the “ambiguity” analysis was a red herring and West Virginia law (and the Estate Misconception Rule) required the court to examine the customs and trade usage in place at the time of execution (i.e. 1902) to ascertain the intent of the parties.  This meant giving weight to the customary practice in 1902 of using one-sixteenth (1/16) to effectuate a conveyance or reservation of one-half (1/2) of the oil and gas estate.  The Intermediate Court of Appeals rejected the Severin heirs’ theory and reversed the trial court.

First, the Intermediate Court of Appeals concluded that the 1902 Deed was unambiguous.  Since there was no ambiguity in the instrument itself, the court simply interpreted the language as written:

“. . . we find that based upon the express language contained within the 1902 handwritten deed that the grantee, Mr. Severin, meant what he wrote, in that he reserved only one-sixteenth of all the oil and gas. . .”

Second, the Nicholson panel further observed that resort to the Estate Misconception Theory was unnecessary because there was no other language in the 1902 Deed itself that created doubt or confusion as to the parties intent.  In other words, the Estate Misconception Theory should only be used if there is some other language or text in the underlying instrument that, when combined with a reference to “one-sixteenth”, creates ambiguity.

The author submits that the Nicholson panel got this one right.  Unambiguous deeds should be construed as drafted.  While the Estate Misconception Theory can be a useful tool when evaluating ancient deeds with fractions, it is not an absolute or affirmative rule of law.  It is simply a “guide” that can assist the reviewing court when confronted with an ambiguous turn-of-the-century deed.  If you have a deed in your chain-of-title that references a fraction or have questions about the scope of an oil and gas reservation, please contact Robert J. Burnett at (412) 288-2221 or rburnett@hh-law.com.