Oil and gas attorney survey indicates reduction in potential post production cost by negotiation

MSU Extension surveyed oil and gas attorneys indicating that 56 percent reduced potential royalty deductions from post production costs by at least 75 percent.

During the summer of 2013, a survey was mailed by Michigan State University Extension to Michigan oil and gas attorneys that represent private landowners. The survey measured oil and gas lease terms before and after negotiations to determine what, if any financial or environmentally related lease terms were negotiated to benefit their clients. This is the third in a series of articles that discusses the survey results.

Oil and gas leases normally contain clauses that allow the Lessee to calculate and charge what are known as post production costs from the Lessor’s (mineral owner) royalty. Examples of some from the Producers 88 lease are: “(f) sales charges, commissions and fees paid to third parties (whether or not affiliated) in connection with the sale of the gas”; “(g) any and all other costs and expenses of any kind or nature incurred in regard to the gas, or the handling thereof, between the wellhead and the point of sale” This is important to a mineral owner because the royalty amount, such as 1/6 can be reduced significantly by post production cost deductions. As with most clauses in an oil and gas lease, mineral owners can negotiate a reduction, or total elimination of post production cost charges.

Pennsylvania mineral owners brought forth evidence of post-production costs deductions at a Senate Environmental Resources and Energy committee hearing on June 27, 2013 Pennsylvania House of Representatives House Co-Sponsorship Memoranda, Representative Jesse White, June 28, 2013.

 Bradford County Commissioners Chairman Doug McLinko said, “Our constituents have shown us evidence of extraordinary post-production costs in Bradford County, with deductions of 40 and 50 percent all the way up to as much as 90 percent … we have seen checks come with zero payment. We have seen retroactive charges being billed to landowners for tens of thousands of dollars where the property owners actually have a bill sent to them and they have to go without any royalty payments until it is paid in full.”

The article “Acting to Protect Royalty Payments,” The Daily Review, 5 May 2013 stated that five different Bradford County residents had a 12 1/2 percent royalty rate written on their lease, but, due to deductions for post-production costs, their most recent royalty payments actually ranged from 1.47 percent to 3.11 percent. A paid royalty of 3.11 percent is a reduction of 75 percent from 12.5 percent.

In the article Survey indicates significant positive financial results from lease royalty negotiations: Part 2, a sample oil and gas well was used to demonstrate the royalty.

For that sample well, we assumed the landowner was the sole owner of 40 acres and a successful well was drilled that produced 25 barrels/day. It operated for 200 days during the year and the oil sold for $90/barrel. This well will produce $450,000 in gross income (25 barrels/day x 200 days x $90/barrel = $450,000) in the first year. If the royalty was .167 (1/6) the leaseholder would receive $75,150/yr. ($450,000 x .167 = $75,150) prior to post-production cost deductions.

Using the sample well, if lease negotations reduced post-production costs charges by 50 percent, the savings would be $37,525 (50 percent of $75,150) for each well each year.

For more information about oil and gas leasing, contact the author or visit the Michigan State University Extension Oil and Gas program page.

Resources, such as the video “Understanding and Negotiating the Oil and Gas Lease” and other free downloadable resources provide information to assist mineral owners in understanding in layman’s terms the oil and gas lease and their options in negotiating changes that put the agreement in line with their financial and environmental goals.

Other stories in this series:

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