Wellhead price VS market price

Does anyone know if you are better off with the wellhead price with no deductions or the market price with transportation deduction. No processing or "market enhancement" deductions would be made.
Thank you in advance for your replies.

Chip

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Permalink Reply by Zack Smith, Geologist/Appraiser on July 24, 2014 at 4:29am

If you use a national average wellhead price rather than a market minus expense value it will be more lucrative.

There are two general categories of expenses that appear to be in the process of being redefined by the operators, courts, and legislatures (at least in PA), operating expenses and market enhancement expense. Market enhancement expenses are not generally reflected in historical data because they have seldom been used or expense practices have been prescribed by regulatory agencies in the states where production occurred. For shale plays the operators have been allowed to deduct more expenses than they have previously.

There are locational factors as well - for example, in Bradford County, PA you would be paid $1/Mcf less than the national average under a standard lease, so it may be in your interest to specify the benchmark rather than accepting "revenue realized by from sale" as many leases read. NYMEX is the most commonly cited benchmark for natural gas prices, for example.

Permalink Reply by adam sorell on July 24, 2014 at 5:11am

What do you think about this language??

 lessee  agrees to pay lessor as royalty for the oil gas hydrocarbons and by products produced and marketed from leased premises. the price upon which royalty is calculated shall not be less than fair market value for gas oil and hydrocarbons  so produced based on arms length transaction for similarly situated wells in the area producing the same quantity ,quality ands being sold at the same point of sale.Payments of royalties for gas oil and other hydrocarbons marketed during any calender month to be on or about the 30th day after receipt of such funds by the lessee. There shall be no deductions from said royalty payment for any reason,directly or indirectly,including but not limited to costs Lessee incurs for producing,gathering,storing ,seperating,treating,transporting,dehydrating,compressing,processing, marketing such  oil and or gas, nor shall there be any deductions for taxes, assessment,or any other pre -post production costs. Production from the leased premises shall be measured in accordance with Boyle's Law for the measurement of gas at varying pressures,on the basis of 10 ounces above 14.73 pounds of atmospheric pressure, at a standard base temperature of 60F degrees and stipulated flow temperature of 60degrees,without allowance for temperature and barometric variations. This measurement  shall be at the well head. Reports, in reasonable and customary format,pertaining to the calcualtion of Lessor's royalty for any and all wells drilled on the leased premises or lands unitized or pooled with the Leased Premises shall be made reasonably available to Lessor."

Permalink Reply by Zack Smith, Geologist/Appraiser on July 24, 2014 at 10:20am

That language parallels some of the stronger leases negotiated by landowner coalitions and should effectively shield you from all expense deductions.

The Boyle's Law language is taken from American Petroleum Institute standards and should be common practice in the industry. One additional point that I've seen is to require calibration/maintenance at the wellhead every 12 months - the meters have an orifice plate that if damaged or not maintained will bias the readings progressively lower over time.

Permalink Reply by Joseph-Ohio on December 26, 2015 at 3:10am

Adam Sorrel,

Were you able to incorporate the language into a lease ?

Developed / Drilled ?

If so how has it worked out for you ?

Would like to read some positive feedback on Wellhead Price specifications in leases myself.

Plenty of naysayers.

Good luck.

J-O

Permalink Reply by bungalow_steve on July 24, 2014 at 7:01am

The equation is (using net back philosophy which courts support)

Wellhead_Price = Market price - (Transportation_costs + processing  +market_enhancement)

The above assumes two different operating expenses, could be more, or less and that market_enhancements are allowed in the lease

So for example

$3 = $4  - (.2 + .6 + .2)

 

So do you want $3 or $4-.2 = $3.8?

Permalink Reply by adam sorell on July 24, 2014 at 2:03pm

Zack said it a stronger lease but steve is saying it worse than a lease with market enhancements. Stever where is the market enhancement?? is that the ' more or less" part??

What about no deductions for pre-post production costs??

Permalink Reply by Zack Smith, Geologist/Appraiser on July 24, 2014 at 2:29pm

"Market enhancement" is what the operator subtracts from your royalty income before they pay you and your lease language prohibits market enhancement deductions, so you will receive more income.

Permalink Reply by adam sorell on July 24, 2014 at 2:33pm

so Zack then that royalty agreement above  is a good one??

Permalink Reply by bungalow_steve on July 25, 2014 at 11:00am

Adam, your lease language is good. You want market price not wellhead price. But you have to get the company to sign! Hard part. They always want to pay the lower wellhead price, reason is they figure that is what they are buying from you, unprocessed gas out of your land. There is some logic to that statement and that is what the PA courts agreed to in Kilmer v. Elexco IF the lease language was vague.In that case the landowners wanted 12.5% of market price but gas companies wanted 12.5% of wellhead price.

Some state laws require market price always be paid and overrides anything in the lease, so there is some precedent to demand market price.

Permalink Reply by Zack Smith, Geologist/Appraiser on July 25, 2014 at 11:31am

Yes, that's a good royalty agreement - and to expand upon what Steve said below, both chambers of the PA legislature currently have bills pending that clarify the definition of expenses and that do not permit expenses to be deducted if it would reduce payment to the landowner to less than 12.5%. The senate passed their bill unanimously and the house bill made it out of committee unanimously, so states are working on better landowner protections.

Permalink Reply by Jeffrey Beunier on August 3, 2014 at 2:33pm

you never want 'deductions' if you can negotiate your lease that way - also, if they hold tight, make sure that you have an exemption for affiliated companies - where the producer use a separate subsidiary - they can abuse post production costs to shift the capture of value to their benefit.

Permalink Reply by adam sorell on August 3, 2014 at 2:43pm

So what about the language above??

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