The New Mexico Supreme Court on Friday sided with a challenge from ConocoPhillips and Burlington Resources Oil and Gas Co. regarding royalties they allegedly owed from past oil and natural gas production on state lands.

At issue was how royalty payments should be calculated under decades-old state lease provisions. The state's highest court upheld an earlier ruling by a state district court in favor of the two operators, who challenged royalty assessments by State Lands Commissioner Patrick Lyons.

Lyons' office had calculated that ConocoPhillips owed $18.9 million and Burlington $5.6 million. The State Lands Office manages oil/gas production leases as well as livestock grazing on state lands.

The district court earlier had denied Lyons' motion for reconsideration of its previous dismissal of the lands commissioner's "implied covenant to market claim." The district court reasoned that to imply a covenant that forces oil/gas operators to bear the costs of placing gas in a marketable condition would require the district court to alter the express terms of the lease, and ruled it had no power to change the lease.

The district court had found, and the Supreme Court now has upheld, that ConocoPhillips and Burlington were permitted to "net the costs associated with placing the gas in a marketable condition." Both the courts have upheld the operators' right to deduct the cost of post-production services "to the extent it is reasonable."

"The district court found that based on the statutory and regulatory history, the New Mexico Legislature and the Commissioner of Public Lands intended both affiliated and nonaffiliated transactions to be treated the same," the Supreme Court said. "Therefore, [the operators] were permitted to deduct reasonable costs incurred for post-production services. We agree with the district court's finding that there was no support for [Lyons'] contention that deductions for affiliated transactions must be limited to actual costs."

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