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Post-Production Costs: Protecting Landowner’s Rights

By February 24, 2014Uncategorized

Post-Production Costs: Protecting Landowner Rights

By J. Richard Emens and Sean Jacobs

 

As oil and gas production from the Utica/Point Pleasant Shale continues to increase in Ohio, many Ohio landowners have been, or soon will be, so receiving royalty payments from oil and gas companies pursuant to the oil and gas leases that they signed.  Therefore, it is more important than ever that Ohio landowners understand the royalty language in their oil and gas leases and the methods used to calculate the royalty payments that they have been or may soon be receiving.  One of the issues Ohio landowners should pay particular attention to is the deduction of post-production costs in the calculation of landowner royalty payments.

Post-production costs are the costs that are incurred between where oil and gas is produced (the well) and where oil and gas is sold (the point of sale).  Post-production costs may include costs for gathering, dehydration, compression, manufacturing, processing, treating, transporting, marketing or other related costs.  Often oil and gas companies will deduct a landowner’s pro rata share of these post-production costs when calculating the landowner’s negotiated royalty set forth in the oil and gas lease.

Whether or not an oil and gas company is permitted to deduct post-production costs when calculating royalties depends on the language contained in the oil and gas lease that the landowner negotiated with the company.  If a lease clearly provides that post-production costs can or cannot be deducted when calculating royalty, courts can be expected to uphold that language.  However, many leases do not clearly address whether post-production costs can be deducted or contain “ambiguous” language as to whether such costs can be deducted.  In these leases it will likely be up to Ohio courts to decide whether post-production costs can be deducted.  Unlike many other states, Ohio does not currently have well defined caselaw on this issue.

Landowners who have not entered into a lease want to be aware of this issue when negotiating the language in their royalty clause.  Language providing that the royalty will be taken on gross proceeds and that post-production costs cannot be deducted can help protect landowners from having such costs deducted in the calculation of their negotiated royalty percentage.  Unless the language in the lease clearly provides that post-production costs may be deducted, Ohio landowners may be leaving themselves at the mercy of Ohio courts as to whether such costs may be deducted from their payments.

Those landowners who have already entered into lease agreements want to be aware of both the royalty language in their lease and whether their royalty payments are subject to deductions for post-production costs.  A landowner whose lease does not clearly provide for post-production costs to be deducted in the calculation of their royalty, but whole royalty is or may be subject to deductions for such costs, should seek legal assistance immediately.  Keep in mind that the statute of limitations in Ohio to bring a claim for breach of an express or implied provision of an oil and gas lease concerning calculation or payment of royalties is only four (4) years (see Ohio Revised Code Section 2305.041).

NOTE: This article has been prepared for informational purposes only and is not legal advice.  This general discussion of the law should not be used to solve individual problems and no person should act upon any information contained in this article with regard to their own unique factual situation without first seeking their his/her own attorney knowledgeable about oil and gas leases and oil and gas royalties.