Legal Definitions - marketable-product rule

The marketable-product rule is a principle in oil and gas law that defines when the process of "production" is considered complete for the purpose of calculating royalties owed to the owner of mineral rights. Under this rule, the company extracting the oil or gas (the lessee) is responsible for all costs associated with capturing, handling, and processing the raw resource until it becomes a "marketable product"—meaning it is in a condition ready for sale or transport.

Essentially, the rule clarifies that royalties are typically calculated based on the value of the *marketable* product, not the raw, unprocessed resource as it comes directly out of the ground. All necessary steps and associated costs to transform the raw resource into a saleable commodity are borne by the extracting company before the royalty calculation takes place.

• Example 1: Processing Crude Oil

  Imagine an oil company extracts crude oil from a well. This raw crude often contains water, sediment, and dissolved natural gas that must be removed before it can be sold to a refinery or transported via pipeline. According to the marketable-product rule, the oil company must pay for all the costs of separating these impurities from the crude oil. Only once the crude oil is sufficiently clean and meets industry standards for sale (i.e., is marketable) does "production" for royalty calculation purposes occur. The mineral rights owner's royalty is then based on the value of this processed, marketable crude oil, not the raw mixture initially brought to the surface.

• Example 2: Treating Natural Gas

  Consider a situation where a company drills for natural gas, but the gas extracted from the well contains high levels of hydrogen sulfide and carbon dioxide, making it "sour gas" and unsuitable for direct pipeline transport or consumer use. The marketable-product rule dictates that the company is responsible for the costs of treating this sour gas to remove these impurities and make it "sweet gas" that meets pipeline quality standards. These processing costs are borne by the company before the gas is considered a "marketable product." The royalty owed to the landowner is then calculated based on the value of the *sweet*, pipeline-ready natural gas.

• Example 3: Separating Natural Gas Liquids

  Suppose a well produces "wet gas," which is a mixture of natural gas and valuable natural gas liquids (like propane or butane, often called condensate). To sell these products separately and at their highest value, the company must transport the wet gas to a processing plant to separate the gas from the liquids. The marketable-product rule requires the company to pay for the costs of this separation process. Neither the natural gas nor the natural gas liquids are considered marketable until they are separated and meet their respective sales specifications. The mineral rights owner's royalty is calculated on the value of the *separated and marketable* natural gas and natural gas liquids, with the processing costs being the responsibility of the company up to that point.