Replies to This Discussion

Permalink Reply by adam sorell on July 1, 2014 at 1:35pm

Good question. I'd like to know also. I do know if the company is CHK you don't want a market enhancement.

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Permalink Reply by Chip Snyder on July 1, 2014 at 3:29pm

SWN.

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Permalink Reply by Kevin on July 18, 2014 at 4:54am

It least you are with SWN. I'm not real sure what my lease terms were. The deductions are normally around 10% (SWN) unlike some of the horror stories I have read about Chk. 

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Permalink Reply by adam sorell on July 17, 2014 at 11:47am

 Coming up short: mineral owners challenging underpaid royalties

With production in the Barnett Shale in full swing, it is no surprise that mineral owners have filed a number of lawsuits against operators challenging the amount of their royalty payments.  And although lawsuits across the state name a variety of operators as defendants, one operator, Chesapeake, is a common defendant in suits filed in Tarrant and neighboring counties, perhaps because Chesapeake controls what may be the largest amount of acreage in the area.  The cities of Arlington and Fort Worth, Dallas-Fort Worth Airport, school districts in Arlington and Fort Worth, developer Ed Bass, and a number of individual mineral owners have all brought suit challenging Chesapeake’s royalty calculations and payments.

One common claim among nearly all of the lawsuits is that the operator short-changed the mineral owner by improperly deducting some form of cost before calculating royalties.  The results of such claims can go either way, depending on the facts.  For example, a Texas Supreme Court opinion issued at the end of June affirmed that Occidental Permian could deduct costs of stripping CO2 from casinghead gas.  On the other hand, a recent Court of Appeals decision affirmed a Tarrant County judgment against Chesapeake awarding the royalty owners approximately $700,000 for deducting improper costs, plus attorneys’ fees and interest—all of which ultimately totaled nearly $1 million dollars. Chesapeake is seeking review of the decision by the Texas Supreme Court.  (The two opinions can be found on the internet by searching “French and Occidental Permian Supreme Court” and “Chesapeake Exploration v. Hyder.”)

Another type of underpayment claim against operators can arise when the “sales price” of the gas is measured by a “sweetheart” sale to an affiliate instead of a third party, which then reduces the amount of royalty due.  It is not uncommon for operators to sell minerals to affiliated companies and state laws differ on whether and under what circumstances the practice is permissible.  No Texas court has yet found liability as a result, but at least one has warned that the practice is “inherently suspect.”  Warnings like that can provide all the fodder needed for an operator to face expensive litigation.

More underpayment litigation can arise from royalty owners asserting that operators owe royalties on “lost or unaccounted for gas” (gas lost between the wellhead and point of sale or flared), sales at below-market prices, incorrect calculations, and a number of other items. Every challenge will be a fact-intensive inquiry that will depend on a multitude of interrelated factors and legal interpretation of the precise language of each lease.  From all these challenges, however, the lesson for mineral owners and for operators alike is to be certain that there is careful compliance with all calculation provisions in the documents at issue.

 

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Permalink Reply by 0ym9x5ag7ury2 on July 17, 2014 at 1:56pm

Adam,

     Suing CHK is playing the game the way they have it planned.

Revoking their license to operate in Ohio, PA and WV would solve our royalty problems. In fact if it isn't done CHK will walk away with Billions from our minerals. They plan on going to court some time in the distant future while pick pocketing everyone they are dealing with in the meantime.

Either no one know how to stop them or doesn't want to stop them.  

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Permalink Reply by adam sorell on July 18, 2014 at 12:30am

I'm betting dollars to donuts that McClendon runs the same game with his new company. What do you think??

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Permalink Reply by Frank Walker on July 18, 2014 at 12:40am

No question.  You can take that to the bank.!! 

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Permalink Reply by Tony Yurina on July 1, 2014 at 4:10pm

Assuming you could negotiate a no market enhancement clause with some company, the royalty owner would be perceived to be in better royalty financial position.  Good luck on this one.

Assume both you and the production company both want to avoid market enhancement, hence no cost to either..... in most cases your natural gas would not be marketable because it would not be accepted by the transmission companies tariff regarding gas quality.  And there are good gas quality reasons for the tariff specifications.

Therefore some type of clean up or market enhancement is a necessary evil if you want to make your gas marketable 12 months per year.  

Assuming you  now agree to enhancing the quality of the natural gas product to make it marketable, there are associated costs...longer midstream pipelines, compressors and facilities, gas processing plants, transportation of product, labor and regulatory compliance, etc.  bear in mind the byproduct liquids now generated can bring as much as $50  per barrel added to the natural gas component sold.   You can sell the two products 12 months per year assuming the plants are reliable and no issues arise.  

So far, few shale wells can be sold from the well head directly into the transmission pipelines due to the gas quality make up and the issues the raw gas creates for the transmission pipeline operators.  Not a good thing when large cities are depending upon product delivery on cold winter days and nights. 

So, the moral of the story is, clean up the gas, make it marketable and sell it with no issues and sell liquids also which potentially yield two royalty streams, natural gas and liquids. 

I don't like it either, but the operators want the royalty owners to bear some of the cost burden for the above ME scenario.

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Permalink Reply by adam sorell on July 17, 2014 at 11:48am

SCORE ONE FOR THE GAS COMPANY–”NET-BACK” ROYALTY METHOD RECEIVES BLESSING OF PA SUPREME COURT

The long awaited decision by the PA Supreme Court in Kilmer v. Elexco, et.al, (J-78-2009) is in.  Unfortunately for the property owners, the PA Supreme Court refused to invalidate gas leases which calculated the landowner’s royalty based on a “net-back” valuation method.  The “net-back method,” calculates royalties as one-eighth of the sale price of the gas minus one-eighth of the post-production costs of bringing the gas to market. Post-production costs refer to expenditures from when the gas exits the ground until it is sold. Essentially, the gas is valued when it leaves the ground at the wellhead by deducting from the sales price the costs of getting the natural gas from the wellhead to the market.  The net-back method is also defined in the Code of Federal Regulations at 30 C.F.R. § 206.151 as:

Net-back method (or work-back method) means a method for calculating market value of gas at the lease. Under this method, costs of transportation, processing, or manufacturing are deducted from the proceeds received for the gas, residue gas or gas plant products, and any extracted, processed, or manufactured products, or from the value of the gas, residue gas or gas plant products, and any extracted, processed, or manufactured products, at the first point at which reasonable values for any such products may be determined by a sale pursuant to an arm’s-length contract or comparison to other sales of such products, to ascertain value at the lease. 

The landowners claimed that the net-back method violated Pennsylvania’s Guaranteed Minimum Royalty Act found at 58 P.S. § 33.  That section states that:

A lease or other such agreement conveying the right to remove or recover oil, natural gas or gas of any other designation from lessor to lessee shall not be valid if such lease does not guarantee the lessor at least one-eighth royalty of all oil, natural gas or gas of other designations removed or recovered from the subject real property. 

The Pennsylvania Supreme Court disagreed and reasoned that: “Although the plain language of the GMRA clearly provides that the lessor must receive a one-eighth royalty, it is silent regarding the definition of royalty and the method for calculating the royalty. To the dismay of both Landowners and Gas Companies, the GMRA does not use any of the terms suggested by the parties, such as “at the wellhead,” “post-production costs,” or “point of sale.” The absence of such language is not surprising given the state of the industry at the time the GMRA was enacted, when virtually all royalties to landowners were based on the sale of unprocessed gas from the producer to the pipeline companies at the wellhead.”  As a result of deregulation of the gas pipelines in the 1980’s, the value of gas at the wellhead and the point of sale are no longer the same.  Depending on the point in production where gas is sold, one landowner may receive larger royalties than a neighbor whose gas is sold after it is fully processed. The Supreme Court held that “The use of the net-back method eliminates the chance that lessors would obtain different royalties on the same quality and quantity of gas coming out of the well depending on when and where in the value-added production process the gas was sold.”  The Supreme Court was also unconvinced by landowners’ argument that the gas company would inflate post production costs in order to reduce the royalty owed.  It was noted that the gas company’s incentive is to keep costs at a minimum since it would still be obligated for seven-eighths of post production costs.

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Permalink Reply by adam sorell on July 17, 2014 at 11:49am

Pennsylvania Supreme Court Issues Landmark Opinion in Kilmer v. Elexco Gas Royalty Dispute

On March 24, 2010, the Supreme Court of Pennsylvania issued an opinion of major significance to the oil and gas industry.  The decision in Kilmer v. Elexco Land Services holds that Pennsylvania’s Guaranteed Minimum Royalty Act (“GMRA”), 58 PS. § 33, allows a gas company to calculate the one-eighth minimum royalty due landowners under the GMRA to be based on the value of the gas at the wellhead as opposed to at the point of sale.

 

The GMRA requires that leases guarantee the landowner-lessor “at least one-eighth royalty of all oil, natural gas or gas of other designations removed or recovered from the subject real property.”  58 PS. § 33.  The term “royalty” is not defined in the statute, but many leases calculate the royalty as one-eighth of sale price minus one-eighth of post-production costs of bringing the gas to market, known as the “net-back method.”  The goal of the net-back method is to value the gas at the wellhead.

Kilmer was one of more than seventy similar cases filed in Pennsylvania to invalidate leases entered into prior to recent Marcellus Shale drilling that have yielded more lucrative lease terms for landowners.  The Kilmers sought a declaratory judgment that the net-back method violates the GMRA.  After the trial court entered summary judgment in favor of the defendant gas companies and plaintiffs appealed, defendants petitioned the Supreme Court to exercised “extraordinary jurisdiction” on the argument that uncertainty would stymie economic development.  That uncertainty now no longer exists in Pennsylvania.

The Court observed that the absence of language such as “at the well-head,” “post-production costs” and “point of sale” in the GMRA is not surprising given the state of the industry when the statute was enacted (1979).  At that time, royalties were based on the sale of unprocessed gas from the producer to the pipeline companies at the wellhead.  The wellhead and point of sale are now different following 1980s deregulation in which the federal government required pipeline companies to unbundle their transportation services from natural gas sales.

The Court then turned to interpreting which valuation point is most consistent with the language of the GMRA under Pennsylvania rules of statutory construction.  The Court concluded that the industry’s definition of the term “royalty” should apply since, under Pennsylvania’s Statutory Construction Act, technical words and phrases that have acquired a “peculiar and appropriate meaning or definition” must be accorded that meaning. 1 Pa.C.S. § 1903.  The landowners’ argument for the common, dictionary definition of “royalty” was rejected. 

The Court also agreed with the gas companies that use of the net-back method results in more consistency as it eliminates the chance that a lessor will obtain “dramatically lower” royalties than a neighbor for the same quality and quantity of gas depending on the degree of processing at the time of sale and proximity to high demand markets.  The Court rejected the landowners’ argument that the gas companies might inflate their costs to reduce the royalties as “unconvincing” given that gas companies pay seven-eighths of production costs and have a strong incentive to keep costs down.

Accordingly the Court held that the GMRA should be read to permit the calculation of royalties at the wellhead, as provided in the net-back method, and affirmed the trial court’s grant of summary judgment to the gas companies.

- See more at: http://oilandgas.jacksonkelly.com/2010/03/pennsylvania-supreme-cour...

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Permalink Reply by Zack Smith, Geologist/Appraiser on July 24, 2014 at 1:46am

Historically, wellhead has been around 8% below market, though it varies radically over time and with economic conditions, and I have not seen a company extracting expenses at less than around at 13% rate and that goes as high as 90%. Looking at historical averages, current expensing practices in the Marcellus, and given the two options, wellhead with no deductions should be the more lucrative deal.

Southwestern is a good company to deal with and in many cases I've observed that they do not take expenses even when the lease allows it, but I'd still say wellhead is the safer bet.

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Permalink Reply by adam sorell on July 24, 2014 at 3:01am

Doesn't the company just subtract their  expenses from bring it to market to get wellhead price???

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