Replies to This Discussion

Permalink Reply by bo boboski on July 27, 2015 at 9:42pm

It would be nice to be able ,also to get a % figure. As in; if your lease says 18%, will you actually end up with 12%  ? Most people , I hear, are surprised when they start getting their royalties and do the math. It seems that the Producer always seems to take it down one way or another, whether you have a gross lease or not. It seems that 12% is the # they want to get to, whether your lease says 20%, or whether you are HBP.

Permalink Reply by Jeffrey Beunier on July 28, 2015 at 4:52am

Interesting thought, thank you - if I may, let's explore it a little deeper - would like to hear what you think.

The issue that arises, and that most people don't think about, is that the cost producers deduct aren't necessarily all variable costs – in other words, they don’t go up or down with prices.  What you proposed would be interesting but could cut both ways.

While deductions such as taxes (and I realize that's not part of the post production costs we are discussing) are a fixed percentage in some states, as compared to OH where they are fixed per bbl or mcf - so, as the price of the commodity decreases, the % deducted from revenues for taxes increases.  If they were a percentage (like a sales tax) then your percentage deduction would obviously be the same, but when commodity prices dropped, so would taxes, similar when commodity prices rise, so would the taxes.  A lot of the state out west are percentage, WV, as I’m sure you are aware, uses a combination – so their legislator have figured out a way to get you no matter what direction price go.

 

When it comes to post production costs, if you think about things like compression, over time it actually takes more effort to compress the production stream to bring it up to a sufficient level to move it the same distance.  Even without declining production, the electricity or amount of to run a compressor, does not change.  If a compressor is run from the gas stream, then over time it consumes a larger portion of that gas stream, and hence the compression costs as a percentage of the gas stream goes up (this shows up as shrink or an implied deduction).  If the compressor is driven by an electrical motor, then that cost stays relatively constant even as the price you receive for your gas decreases.

 

Gathering fees to third parties are typically fixed at x cents per mcf or mmbtu.  Gathering contracts are designed this way because the company that is building/putting in the pipeline needs to be able to have some sort of guaranteed level of revenue to get the financing or to take the risk to build the system.  The problem is that when prices drop, and gathering fees don't, the deduction becomes a larger portion of the overall revenue stream – and these can be pretty steap.

 

Lately, I have been seeing multiple posts about deductions exceeding 50% and even 60% of the price.  This should to be more pronounced during summer months, when low prices due to seasonality are most apparent - during winter, the opposite will be present.

 

So having deductions as a percentage of revenue sounds great, I doubt that operators will ever agree to it due to multiple factors – a lot of their costs are fixed or increases as a percentage of revenue as production decreases.  But if a mineral owner is able to get a percentage deduction and agrees to it, then that owner risks losing the upside benefit of increasing prices.

 

One area that I'm interested in seeing, is if mineral owners are getting the benefit of firm transportation charges - I have seen a number of revenue statements where the operator is charging for FT or firm transportation - this is to get the gas out of the basin and away from the basin differentials (dominion south is something like $1.60 less than henry hub) - so the operator enters into a firm transport agreement to get the gas on a long hual pipe to Chicago for instance, and therefore should be getting MidCon price - which is some like $0.20 less than henry hub -  I'm wondering if the mineral owners are getting paid the right price.

You see variations of terms like "prevailing price in the area" in leases (and this is more of a pronounced issue in market enhancement or net leases) which would imply that you get dominion south prices or tco pool, but you pay a transportation charge - so one would think you would get the benefit of the price to where the gas was transported.

 

It’s a very interesting area to look at and analyze, but the amount of feedback has been tepid. 

Information asymmetry is the biggest advantage or disadvantage depending on which side of the equation you are on,