The West Virginia Royalty Mess

Constitution Pipeline - MarkindDaniel B. Markind, Esq.
Weir and Partners, LLP

 

The law on West Virginia royalty payments has been much like a yo-yo but don’t expect lawmakers to straighten it out.

On Friday, the West Virginia Supreme Court changed its State’s law with regard to royalty payments to landowners. In the case of Leggett v. EQT Production Company, the Court moved West Virginia from a “Marketable Product” state to an “At the Wellhead” state, bringing it in line with the majority.

At issue in Leggett was the deduction of post-production costs. Specifically, can a natural gas producer deduct from royalty payments made to a landowner costs incurred by the producer from the time the gas reaches the wellhead at the surface until the time the gas is sold – often at the interstate pipeline. Until Friday, West Virginia law was that the producer could not. Following Leggett, it can.

West Virginia Royalty

The case revolved around the 1982 West Virginia law that placed a floor of 12.5% of the value of the gas sold “at the wellhead”. The law was enacted to prevent the exploitation of landowners by producers using older leases or poorly negotiated ones.

The West Virginia Legislature declared that the 1982 statue was enacted because:

“continued exploitation of the natural resources of this state in exchange for such wholly inadequate compensation is unfair, oppressive, works an unjust hardship on the owners of the oil and gas in place, and unreasonably deprives the economy of the State of West Virginia of the just benefit of the natural wealth of the State.”

The Leggett lease was from 1906 and required the payment of a flat fee of $500 to the landowner regardless of how much gas was produced. The 1982 law changed those terms. It was precisely the type of lease for which the law was enacted.

Unfortunately, the 1982 law was enacted shortly after the Carter Administration began deregulating interstate pipelines. In 1978, the Federal Government enacted the Natural Gas Policy Act which was designed to phase out regulation of wellhead prices charged by producers of natural gas. Over time, gas pipelines became common carriers. No longer was gas typically sold “at the wellhead”, with the pipeline company being responsible for the costs of getting it to market. Now, the producer paid those costs and sold the gas to the pipeline downstream from the wellhead. Therefore, the language of the statute no longer reflected the reality of the market, and the States had to decide how to handle the ambiguity.

On the one hand, the 1982 law was supposed to provide price certainty. The floor was clear and hopefully free from manipulation. On the other hand, the price floor no longer reflected economic practice. The statute clearly used the terms “at the wellhead”. So what is the price “at the wellhead” when the gas no longer is sold there? EQT argued that the only way to truly determine the “at the wellhead” price would be to deduct a fair share of the costs EQT incurred in transporting, refining, compressing, liquefying, and doing whatever else is necessary to get the gas to the pipeline where it can be sold. These “post-production” costs must be “net-back” or “worked-back” to obtain the true “at the wellhead” price. Of course, in doing so, you lose certainty in pricing and computing and enter the world of subjective “reasonable” costs incurred.

West Virginia royalty

As with most difficult decisions, there is no right answer here. Either way you go means losing something important to the State – certainty in royalty calculation to the landowner or fairness in payments from the gas producer.

The West Virginia Supreme Court ruled that the 1982 statute permitted the producer to deduct the fair value of those post-production costs from the royalty payments. It means that landowners will get less and producers will pay less.

The proper way to handle this situation at this point is for the West Virginia Legislature (and other legislatures) to amend its law and state exactly what it wants reflecting current reality. It could, for example, lower the minimum royalty to 10% without permitting deductions (although there still would be disputes over what constitutes a “marketable product”). In our current brain-dead politics this might be a bridge too far. It is instructive that the deregulation which is the underlying cause of this situation was done by the liberal Carter Administration supported by a Democratic Congress. Those were the days when politics didn’t need to be as doctrinaire as it does now.

Perhaps West Virginia will surprise us and its legislature will provide some coherence. Don’t bet on it. To do so would be to break with modern political orthodoxy and exhibit courage and compromise. It is more likely we will continue to dump these issues where they don’t belong, on the courts. In West Virginia, those courts now will get busier dealing with all the royalty dispute cases concerning “reasonable post-production costs” the legislature could limit with a little clarity.

The post The West Virginia Royalty Mess appeared first on Natural Gas Now.

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