Oil and Gas Disputes Regarding Post-Production Costs

The Marcellus Shale continues to make news headlines because it offers one of the largest economic opportunities to our region in years. However, whenever significant economic opportunities exist, inevitably disputes arise and the Marcellus Shale will be no exception.

One issue that will be relevant to the Marcellus Shale has already been litigated before the Pennsylvania Supreme Court. In Kimler v. Elexo Land Services, Inc., landowners sued Elexo Land Services, Inc. regarding Elexo’s calculation of royalties owed to the landowners under certain leases. The specific issue in this case was the treatment of post-production costs in determining the appropriate royalty owed to the landowners.

In 1979, Pennsylvania enacted the Guaranteed Minimum Royalty Act (“GMRA”), 58 P.S. § 33. The GMRA provides that an oil and gas lease must pay 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.”

In the Kimler case, the landowners claimed that the royalty owed to them under the GMRA should be one-eighth of the gross sales price, not the net sales price. That is, one-eighth of the sales price before deduction of any post-production costs. However, the Pennsylvania Supreme Court ruled in favor of the gas company and allowed the deduction of post-production costs from the royalties owed to the landowners.

Post-production costs were defined in the lease in Kilmer as “(i) all losses of produced volumes (whether by use as fuel, line loss, flaring, venting or otherwise) and (ii) all costs actually incurred by Lessee from and after the well head to the point of sale, including, without limitation, all gathering, dehydration, compression, treatment, processing, marketing and transportation costs incurred with the sale of such production.”

However, the Pennsylvania Supreme Court also stated that, if the landowner suspects that a gas company is charging higher post-production costs than are actually being paid, the landowner is allowed to seek a court-ordered accounting of those post-production costs.

Given this ruling, it is apparent that there will be numerous disputes regarding the appropriate determination of post-production costs and royalties for gas wells.

Schneider Downs Business Advisors Group can provide the expertise needed to appropriately account for post-production costs and determine royalties on gas wells. Our Business Advisors Group includes specialized practice areas in both forensic accounting and litigation support services. Our professionals have obtained numerous certifications including Certified Fraud Examiners (“CFE”) and Certified in Financial Forensics (“CFF”).

 

 

Schneider Downs provides accountingtax, wealth management and business advisory services through innovative thought leaders who deliver the expertise to meet the individual needs of each client. Our offices are located in Pittsburgh, PA and Columbus, OH. 

This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax-related matter.

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