Beware of all the gas companies!

I signed two lease's back in 2011 with Gulfport Energy on 80 acres that I own in Belmont County, Ohio. Let me start by saying don't believe anything that any of the land men tell you, the are working for the gas companies and their own benefit not yours period. While I was negotiating my lease with several companies at the time in 2011. I clearly explained to them that any lease I would sign would require a Pugh clause, and that I would not except any lease that required me to pay any of the cost associated with the production or marketing of the finished product from any wells drilled onto my property. I ultimately ended up signing with Gulfport Energy because of the higher bonus payment and higher royalty percent, and the land man assured me the Pugh clause and the deduction clause weren't a problem, that a lot of people were requesting it. Well the land man was lying through his teeth after receiving my first royalty check and statement there were $14,574.11 in total deductions. Beware of any lease that includes the language below.

 

"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."

 

It was explained to me that this was exactly what I wanted and that the second part of this clause only meant if they did any advertising to enhance the selling price of the finished product I would have some associated cost from that. Well I have since found out that this is the language that the big oil companies have adopted to lead land owners to believe that they are getting a no expense deducted clause in their lease. If you find this language in your current lease be assured be ready to pay every single cost that is associated with bringing the product to market. Don't sign it! Ask clearly for a no production cost clause and have it reviewed by a gas royalty attorney.

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Permalink Reply by Kevin in Belmont County on January 6, 2014 at 3:13am

Jimmy,

It would be very hard for me to give you a fair answer to that question. The company that drilled the initial well that I have been receiving royalties from has been in the process since June 2013 of drilling three additional wells on that pad, bringing the total number of wells on that pad to 4 when completed. The royalty checks have dropped by about 50% while these wells are being drilled, fracked and flared which is just being completed right now. I have been informed by the O&G company that the state is very specific about closing down production of existing wells during certain operations that are completed with the drilling and completion of additional wells, but they were not specific of which operations they have to stop production for. I know with all the equipment that has been on the pad it has been very hard for trucks to get access to the pad for certain products. They have been flaring the wells for the last 3 weeks, so I guess I am in the dark about it as much as everyone else. There is no way for me to tell if it is a steep decline in the production curve or its all from the drilling of new wells on the pad. I can say this though, the month after they started the drilling of the additional wells is when the drop occurred and it dropped by 50% immediately. So I guess it would lend to thinking it has to do with the new wells. But I guess time will tell and when I know for sure I will be glad to let everyone know.

Permalink Reply by RB on January 6, 2014 at 5:49am

Jimmy,

I may have read of this previously, but would you confirm your suggestion.  That after having deductions of around 20% on royalties, we could then incur a 40% tax on the gross amount, thereby netting next to nothing?? EX: $1000 check could be reduced to $400? (1000-20% O&G deductions plus another 40% on the 1k for taxes)

Permalink Reply by Philip Brutz on January 6, 2014 at 2:44am

Kevin, I am also leased with Gulfport.  The offers that we are getting are to sell our mineral rights. We would be selling all future royalties for a lump sum of $14,600 per acre.  I have 82 acres just east of Quaker city so my royalty checks would be similar to yours.  Based on your experience does it make financial sense to sell?  I am 50 years old, in good health and I don't need the money right now.  I would rather have good source of income in my retirement.

Permalink Reply by evan on January 6, 2014 at 2:57am

I too am on the bubble of selling or not .  It is so tempting , I know I'll regret either choice if I do or don't.  Help

Permalink Reply by Joseph-Ohio on January 6, 2014 at 3:13am

No skin in the game myself but just to keep my head screwed on as straight as possible on these kinds of matters, I'll offer (in my most humble landowner / prospective lessor opinion) that the most correct thing for any landowner to do will vary with each personal circumstance.

Also, there are unknowns / gray areas that may crop up. For instance, will the production be throttled ?  Or will the production be shut-in and if so is the landowner's 'delay rental' / shut-in stipend sufficient ? ?

Also, although nobody enjoys paying taxes, there are worse things than having to pay them.

There's really no one answer to what's best for each individual landowner / lessor - it's going to vary.  Every landowner / lessor is the Captain of his own ship. Try to avoid all of the torpedo's.  Good luck as there seems to be plenty of them.

Permalink Reply by Kevin in Belmont County on January 6, 2014 at 4:19am

Philip,

I really cant answer that Phillip. I can only say or feel on what circumstances have governed my decisions. After these other 3 wells are in production and the fourth is able to be in production everyday and not hit and miss I think I will have a better idea of where everything stands for me. There are so many factors to take into account. If you sell your mineral interest as a lump sum and it's all paid to you at once the tax burden will be greater than it would be if it was paid out over time. Your in a really good location. From what I have been reading I understand that Guernsey county is going to be a pretty big oil play and from the area your describing to me you are probably close to the Belmont/Guernsey county line. I also know that Gulfport is making a move towards the river to be in the dry gas area because they can get the product to market quicker and even at current prices they are making money. But I also just pulled up on the ODNR site and seen where Gulfport has permits for more well pads south of Barnesville so it appears they are also staying in the wet gas window. I had a discussion about a month or so ago with one of the Mark West line inspectors for a couple of hours. He was probably the most honest person I have talked to in O&G industry. He straight out told me that the O&G companies will be lucky to have the infrastructure in place within six years to handle the volume of gas and oil in this area. He said that the O&G companies never expected the kinds of pressure and volumes that they are running into. There are just so many aspects to consider I think it has to be an informed decisions by someone knowing their own circumstances. Hope some of this info helps you make the right decision for you and your family.

0i7okn54zwbdoPermalink Reply by 0i7okn54zwbdo on January 6, 2014 at 5:31am

"Based on your experience does it make financial sense to sell?  I am 50 years old, in good health and I don't need the money right now.  I would rather have good source of income in my retirement."

If on January 1, 2013 you had sold for that price, paid cap gains and Ohio state income tax, and immediately put that money into an index fund your financial picture would look like this:

82 x 14,600 = $1,197,200

Cap gains (assuming you're not in the top marginal bracket for individuals) = $179,580

Ohio state income tax = $62,268

You walk away with $937,352.  Then you put that in a boring old large-cap mutual fund and make an astonished 32%.  And here's what you're left with when you close the books on 2013:

$1,237,304

 


What happens if the bull market slows down and you only make 3% a year for the next 10 years?  This : $1,662,833  That's equal to $20,278/acre.  So if you don't want to sell that's fine, I don't think selling is for everyone.  Frankly it's none of my--or anyone else's--business how you run your life.  But the notion that somehow selling is dumb and a sucker bet is way off, especially if you have even a modicum of common financial sense.  

Permalink Reply by Philip Brutz on January 6, 2014 at 5:49am

Kevin and Marcus, Thank you for your advise.

Permalink Reply by Kevin in Belmont County on January 6, 2014 at 5:52am

Marcus,

I am not trying to be argumentative here, but where do you come up with your tax number of $179,580? According to the IRS calculator the tax would be in the neighborhood of $445,000 federal tax. If you know something I don't please let me know.

0i7okn54zwbdoPermalink Reply by 0i7okn54zwbdo on January 6, 2014 at 6:40am

Cap gains is 15% (assuming he's not in the top individual bracket, in which case it's 20%), so that's where I get that federal number from.

Permalink Reply by Kevin in Belmont County on January 6, 2014 at 7:05am

Marcus, 

Are you saying that the IRS treats payments from the selling of future mineral royalties different from royalties paid on mineral rights? Because I know the IRS considers  royalties as " unearned income" and treats its as "ordinary income". And please don't think I am being argumentative about this. If they are treated differently it would benefit anyone to sell their mineral interest over paying taxes on royalties paid to them. The total amount of the payment from last years brackets would put someone in a 39% bracket if it was viewed as ordinary income.

0i7okn54zwbdoPermalink Reply by 0i7okn54zwbdo on January 6, 2014 at 9:22am

"Are you saying that the IRS treats payments from the selling of future mineral royalties different from royalties paid on mineral rights? "

Yes.  Sales of minerals or royalty are treated as a long term capital gain (if you're owned those rights over one year).  Royalty income is indeed "ordinary income".  The only way around that is taking royalty to a 1031 exchange, but now we're getting more complicated.  

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