Gross Proceeds at Wellhead; Terms, wording, good or bad ?

I am asking for feedback, opinions, recommendations and good or bad experiences with leases or negotiations with involving calculations and compensation based on proceeds at the wellhead.  I have found very little to no information in previous post regarding this type of lease so this would be a very beneficial topic for educating a lot of other members on this topic.

We received a Gross Proceeds Clause in a lease contract as follows:

"Gross Proceeds at Wellhead. It is agreed between the Lessor and Lessee that, notwithstanding any language herein to the contrary, royalties payable on gas and gaseous substances, including casing head gas, shall be based upon the MMBTu value of unprocessed gas at the wellhead, free of all costs, charges or deductions of producing, treating, compressing, transporting and marketing said gas to such purchaser, which royalty, however, shall be subject to such production taxes and severance taxes as are properly allocable thereto."

Questions:

1) How is "Wellhead" gas valued or assigned a value ?

2) How would oil or other liquid substances be valued at the Wellhead ?

3) Is a "Gross Proceeds at Wellhead" an oxymoron being used as there will be no expense for treating, compressing, transporting and marketing.  Also should the production and severance taxes not be allowed on a gross proceeds lease?

Thank you for your replies !

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Permalink Reply by Philip Thackray on December 3, 2015 at 1:49am

Dusty,

Forget "wellhead price" it does not exist.  Royalty should be based on what the Lessee sells the products for then put in all the free of all costs language.  It is normal for the landowner to pay his share of severance taxes.

If the company is truly willing to give you a "no deductions" lease, they should accept a royalty based on their proceeds with no deductions.  The "wellhead" language gives them a LOT of wiggle room.  Here in PA, "wellhead" language pretty much means deductions no matter what else is written into the lease.

Get a good lawyer.

Good luck,

Phil

Permalink Reply by Joseph-Ohio on December 3, 2015 at 1:59am

Thanks for your advice Philip Thackray.

Permalink Reply by Andrea Richlin on December 3, 2015 at 5:10am

At least Chief  Oil and Gas was honest enough that they told us in 2010 that they didnt use the term 'at the wellhead' for royalties in their lease.  I believe their landman said that there really was no actual wellhead price . The lawyers did however insist on the market enhancement clause in their language regarding no deductions, and as most know now that is being used as an excuse to deduct transportation and/or  gathering costs, when originally we were told it was for compression of gas .The difference in royalties was 2% with that no deductions language being used, where the lease with deductions would be 20% and without deductions 18%. In hindsight we may just as well have taken the higher percentage with deductions.That lease expired without going into production , next time we will get rid of that clause , but dont know what other double talk they will come up with in the future.  

In another lease from 2008 with Chief we receive 15% with deductions and that is in production. The gathering costs are reported and deducted on the check stub as GEF ,( gas enhancement fee) so I know that Chief is joining almost all the other payors in this practice . , except for mitsui and statoil , in my particular lease situation. I know this because my family purchased property that had an existing lease in production that used the well known Freindsville lease language , with 'at the wellhead' pricing and a market enhancement clause with arms length transaction and good faith  language regarding transportation costs. This lease was originally with Southwestern but was assigned to pretty much everyone in the industry and is split many ways. When I wrote to these companies to tell them they were in error in deducting gathering costs , I got a lovely letter from Chesapeake's legal department explaining their 'logic' in determining the wellhead price. From the purchase price at the point of sale they deduct back the costs incurred along the way and call that the wellhead price or value, and that the price they received at the pipeline interconnect is an enhanced value , therefore , tada ! gathering can be deducted as a market enhancement!!!  Anadarko explained to me that is the way they do it too. Mitsuii and Statoil however , dont charge for gathering as market enhancement,  until the gas has reached the interstate hub connection where it is actually sold, then it is deducted as transportation cost thereafter , and at that time I talked to them theysaid that was the industry standard.   So in the case of that lease , having the gas valued  was a curse . I really cant see the term ' at the wellhead' now without my blood pressure rising.  The funny thing is that the letter from Chesapeake.s legal department actually made sense when they laid down their logic,  Lucky for them its not their responsibility legally to define their terms before the lease is signed. Makes you really mad when you see how slickly you've been had. At least I didnt sign that lease myself , but it is a real learning curve. I still dont feel confident in getting a fair deal in future leasing , seems like having a good lawyer is not good enough when these guys are making up their own terms.

Permalink Reply by Barry D on December 3, 2015 at 3:24pm

Andrea,

The logic of the Chesapeake explanation also has the backing of case law (unfortunately).

Permalink Reply by Joseph-Ohio on December 3, 2015 at 11:11pm
Barry D,

Are there not instances of all of these tactics including findings still being challenged / elevated to higher courts ? ?
Permalink Reply by Indiana Smith on December 3, 2015 at 6:26am

I've been thinking about this idea lately.  Our lease reads as follows:

To pay lessor 18.5% royalty based upon the gross proceeds paid to lessee from the sale of oil/gas recovered from the leased premises so sold by lessee in an arms length transaction to an unaffiliated bona fide purchaser, or if sale is to an affiliate of lessee, the price upon which royalties are based shall be comparable to that which could be obtained in an arms length transaction and without any deductions or expenses.

We thought that this was good language.  Now we all know what CHK has done.  They are selling to an "affiliate" at a SUBSTANTIALLY reduced price.  Then the affiliate sells to the real buyer at full price and kicks a percentage back to CHK.  Some of these sales are hedged and some are spot priced.  They are arguing that no one else will buy at the wellhead and therefore this affiliate sets the price.  The actual production is also under dispute.  The mineral owner is only receiving about half of the real price and feels cheated.  

So it looks like we need a better royalty clause for the next time we negotiate.  I would like to see a clause that reads something like this (I am not a lawyer):

 To pay lessor 18.5% royalty based upon the gross production calculated by multiplying the Henry Hub spot natural gas price by the total gas produced, multiplying the Brent crude price by total oil produced, and multiplying U.S. Natural Gas Liquid Composite Price by the total natural gas liquids produced during the month that all products were produced and without any deductions or expenses..  All production totals to be verified by ODNR.


I'm not sure if this would put an end to the cheating, but at least they can't make up prices out of thin air.  Not sure that ODNR could police the production (how do they measure the liquids when they are not removed until the co-mingled product is received at the processing plant?).  Who installs, calibrates and reads the meters?  Lots of questions need to be answered before negotiating or signing any new agreements.  We now know these schemes and must protect ourselves.   

Permalink Reply by Joseph-Ohio on December 3, 2015 at 2:52pm

http://www.mineralweb.com/owners-guide/oil-and-gas-basics-for-miner...

Take the above link to another newsletter from 'MineralWise' that within refers to a section that advises that oil and gas must be measured at the well (by law).

Find immediately below the subject paragraph from that MineralWise publication.

"Oil and Gas Measurement

Produced oil and gas is measured prior to leaving the well site, as required by law. The gross volume from which your royalty share is calculated is based on this measurement. Customary industry standard requires that the Operator verifies the measurements of the First Purchaser through a“check” meter for gas, or by rechecking (behind the First Purchaser) the levels in the oil storage tanks. With respect to the risk of you being “shorted” or cheated on your properly due production, it is important to keep in mind that it is in your Operator’s best interest to insure proper product measurement."

FWIW (or not worth) to affected posters.

Permalink Reply by Joseph-Ohio on December 3, 2015 at 11:31pm
Indiana Smith,

Yours doesn't read like a bad idea / method to me.

I agree and also think key to ending the manipulation / evaporation of lessor royalty payments in a 'no deductions' type of lease would be to quantify / install a method to pin down a sell price for the natural gas production.
Permalink Reply by Indiana Smith on December 4, 2015 at 2:26am

Joseph,

Thanks.  Right now, the price paid is being manipulated, but who knows what scheme they will come up with next.  I received a royalty check yesterday for a "no deduction" lease and they again had a negative value on the NGL sold (I think this is the fifth month of negative value NGL).  That sounds like a deduction to me!

Permalink Reply by Joseph-Ohio on December 4, 2015 at 3:24am

'.......but who knows what scheme they will come up with next.'

Good point.

Actually it is the point.

Who knows what tactic they'll try on / employ next ? ?

Is it even possible to permanently set these matters right ? ?

Isn't that the purpose of a contract / law in the 1st place however ? ?

If not what is their (contracts / laws) purpose ? ?

To provide basis for argument / waste time ? ?

How stupid is that ? ?

Sounds like anarchy calling for perpetual turmoil / unrest / chaos (and I'm not an anarchist either) - but it seems to me some if not many of the empowered may be.

Permalink Reply by bungalow_steve on December 3, 2015 at 10:38am

Market_price = Wellhead_price + Processing

so if Market price = $3 and processing is $1, Wellhead is $2

 

Wellhead_price = Market_price - Processing

 

So wellhead_price already deducts for processing, otherwise it would be Market_Price, so yes it's an oxymoron, but the language tricks a lot of people into signing, so they keep using it.

 

Market price is highest value and is what you want, but companies usually won't sign up to that, but you can try. Wellhead_price is the lowest value and thus the worse, but companies like it and will try to sign you up using wellhead_price. Their argument is the raw unprocessed gas is what you own, so that is what they will pay you for.

Permalink Reply by Frank Walker on December 3, 2015 at 10:51am

Dusty

That language is some of the least landowner friendly I've seen.  I would never sign a lease worded that way;  better to hang onto your natural gas and pass it on to your descendants.    

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