An extremely hot issue at the present time involves “post-production” costs and “deductions” that are being taken by gas companies from landowner’s royalty checks. Most landowners receiving royalty checks over the last few years have been receiving royalty payments under standard gas company “form” or “boilerplate” Leases. These “form” or “boilerplate” Leases do not seek to address royalty calculation issues by way of an added “Addendum” to the Lease.

Typically “form” Leases clearly permit the gas company to take “post-production costs” and “deductions” for the cost of producing, gathering, storing, separating, treating, dehydrating, processing, transporting and marketing the oil and gas. In the 2010 Pennsylvania Supreme Court’s decision in Kilmer v Elexco Land Services, Inc. et al., 605Pa.413, 990 A.2D 147, (Pa. 2010), the Pennsylvania Supreme Court held that post-production costs such as gathering, compression, transportation and others are properly shared by royalty owners through proceeds deductions unless the Oil and Gas Lease expressly provides otherwise.

Again, most Leases before 2008 did not have Addendum language seeking to address royalty calculation issues and “post-production costs” and “deductions”. Beginning around 2008, Oil and Gas Leases began to be heavily negotiated as gas company competition for leaseholds in certain areas became fierce. As a result of these negotiations and bargaining, landowners began to negotiate royalty provisions in the form of an Addendum in efforts to eliminate or reduce “post-production costs” and “deductions”.

One common provision, often referred to as a “Market Enhancement Clause” or “Market Enhancement Provision”, began to surface in many Oil and Gas Lease Addendum offered by various companies across Pennsylvania. A typical “Market Enhancement Clause” provides as follows, or something substantially similar:

MARKET ENHANCEMENT CLAUSE

All oil, gas or other proceeds accruing to Lessor under this lease or by state law shall be without monetary deduction, directly or indirectly, for the cost of producing, gathering, storing, separating, treating, dehydrating, compressing, processing, transporting, and marketing the oil, gas and other proceeds produced hereunder to transform the product into marketable form; however, any such cost which result in enhancing the value of the marketable oil, gas or other products to receive a better price may be deducted from Lessor’s share of production so long as they are based on Lessee’s actual cost of such enhancements. However, in no event shall Lessor receive a price that is less than, or more than, the price received by Lessee.

(Emphasis added).

It was often represented by gas company landmen that the foregoing language meant that there would be “no post-production costs” and “no deductions” from the landowner’s royalty. However, at least one company has construed the Market Enhancement language to permit certain “post-production costs” and “deductions”.

Specifically, at least Chesapeake Appalachia, LLC appears to take the position that the “Market Enhancement” language allows the company to deduct certain post-production costs from the landowner’s royalty if the gas is in “marketable form” and such costs “enhance” the value of marketable gas. The company apparently takes the position that the gas produced from the well(s) is in a “marketable condition” at the well head. However, natural gas is not sold at the well head. Instead, the gas is gathered and transported to the interconnect with the interstate pipeline where it is typically sold. The value of the gas at this point of sale is higher than the value of the gas at the well head. The company then concludes that under the Market Enhancement Clause it is allowed to deduct a propionate share of the cost in moving (gathering and transporting) the gas from the well head to the point of sale as it is “enhancing” the marketable gas at the wellhead.

Many landowners who have Market Enhancement language are starting to receive royalty checks and are suffering from sticker shock as they believed the Market Enhancement language would reduce or eliminate deductions. Some landowners are reporting substantial deductions in their royalty checks for post-production costs taken under the Market Enhancement language.

Interestingly, it does not currently appear that all oil and gas companies are interpreting the Market Enhancement language in the same fashion. Current information indicates that several companies are not construing the Market Enhancement language as permitting post-production costs and deductions prior to the point of sale. At The Clark Law Firm, PC we are currently reviewing royalty provision language and investigating how different companies are construing the same or substantially similar Market Enhancement royalty provisions.

It appears that legal action may ultimately be necessary in order to obtain a definitive answer as to the proper interpretation of the Market Enhancement language and its impact on landowner royalties. This issue simply involves too much money not to be addressed.

If you are a landowner with Market Enhancement language and are currently receiving royalty income, we are very interested in hearing from you regarding how your gas company is interpreting this language and whether certain “post-production costs” and “deductions” are being subtracted from your royalty payments. If you are interested in discussing this issue further, please feel free to contact the office directly by telephone at (570) 307-0702 or contact us through our websites. We are committed to gathering information on this topic and exploring landowner’s options to address these post-production costs and deductions.

Douglas A. Clark, Esq. – Protecting Pennsylvania Landowners