Taking the Mystery out of Calculating Royalties

 

Taking The Mystery Out of Calculating Royalties

By Emens & Wolper Law

In our correspondence with hundreds of landowners, it is apparent many landowners are uncertain how to calculate royalty payments, especially when their acreage is pooled with neighboring landowner’s property. Calculating royalties can be very complex as often oil and gas lease language is unclear in many respects. However, it is best to start with the basic formula for calculating royalties and work into the more difficult items. For the basic formula, a landowner will need to know five items: (1) the total size of the oil and gas production unit from which he/she is receiving royalties, (2) the number of acres the landowner owns in that production unit, (3) the percentage royalty indicated in the lease, (4) the total amount of production, and (5) the post production costs, taxes, and other deductions the oil and gas company is taking. A landowner should be able to receive items (1), (2), (4), and (5) by asking the oil and gas company, reviewing a division order or declaration of pooling, or from the ODNR records. A landowner should be able to receive item (3) by reviewing their lease terms. A landowner may have some trouble knowing the total amount of production, (4) above, but that amount should be listed on the check stubs for royalty payments or ODNR records, where production on horizontal Utica/Point Pleasant Shale wells is reported quarterly.

The basic royalty calculation is: the landowner’s acreage in the unit / (divided by) total number of acres in the unit x (multiplied by) royalty rate x (multiplied by) production = (equals the) gross royalty. An example may be helpful. Assume you own 60 acres and all of your land has been pooled into a unit totaling 640 acres. Assume you signed a lease with an oil and gas company and you are to receive 20% of the gross production in 365 days. Assume one well was drilled on the unit and it produced 22 barrels of oil, which was sold for $95 per barrel, and 1,249,739 MCF of gas, which was sold at $4 per MCF, for an estimated total gross production of $5,001,046 in 90 days. In this situation, a landowner would receive a gross royalty of $93,769.61 (60 / 640 x .20 x $5,001,046).

Now that we have the gross royalty, compare the gross royalty to the amount listed on the check stub. If the check stub lists a number smaller than that of the gross royalty, it is likely the oil and gas company is reducing your royalty for some cost or expense, colloquially known as post-production costs, and/or for taxes. 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.  The issues of whether or not, and to what extent, an oil and gas company can reduce a landowners royalty for post-production costs is unsettled law in Ohio. We fully expect many controversies over royalty payments over the next few years. We would be happy to discuss this more if you have any questions.