Market Enhancement, Formerly Known as Post-Production Costs

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SOME REALLY BASIC CONTRACTS LAW

In law school we learn quite a few things that I think everyone should be taught in high school.  One of those things is that the heading of a contract, or the heading of a clause in a contract, does not control what the contract or the clause actually says.  For example, I’ve seen plenty of documents that say they’re wills, but when you read through them, they actually set up trusts.  While the will still has to go through probate, it’s going to create a trust in the end.

APPLIED TO OIL AND GAS LEASES

Most oil and gas companies will give a name to their document that roughly describes what it actually is.  A lease is usually just a lease, a modification is usually just a modification, etc.

But when it comes to the clauses in a lease, it’s a different story.  The heading will always tell you the main point to that clause.  Except when it doesn’t.  But the devil is in the details.

THE POST-PRODUCTION COSTS CLAUSE

For example, for decades there has been a post-production costs clause in almost every gas lease. It gave the producer the right to deduct some of their costs from the royalty. Those costs included things like transporting the gas through a pipeline, dehydration, compression, cleaning up the gas, and separating the different types of gasses for marketing, to name a few.

WEST VIRGINIA LAW ABOUT POST-PRODUCTION COSTS

Here in West Virginia a couple years ago there was a big, high profile case (Tawney v. Columbia Natural Resources) about royalties and post-production costs that went to the West Virginia Supreme Court.  The Court sided with the royalty owners and said that post-production costs could not be passed on to the royalty owner unless they were specifically spelled out in the lease.  It got a lot of press because it was a $404 million dollar settlement (which was negotiated down to $380 million.)

MARKET ENHANCEMENT IS BORN

Everybody heard about the Tawney case.  Royalty owners got wise and started asking for no post-production costs or deductions.  Oil and gas companies didn’t like that.

So instead of putting a Post-production Costs clause in their leases, they put in a Market Enhancement clause.  Their landmen could point to their lease and say, “we don’t include a post-production costs clause.”

While it was true, it was also a blatant lie.

WHAT MARKET ENHANCEMENT REALLY IS

The Market Enhancement clause was nothing more than the old Post-production Cost language, changed around a bit, with an emphasis on how the costs being deducted actually increased the value of the gas.  If you parsed the old language and the new language, there was almost no difference.

When someone called the landmen on it, the landmen would respond, “those costs actually increase the amount of royalty you get because they increase the value of the gas.”

POST PRODUCTION COSTS REDUCE YOUR ROYALTY

While that statement is (possibly) true, you have to remember that everything the producer does increases the value of the gas.  Building a pad, drilling the well, flaring the well, even the title work increase the value of the gas because if none of those things happen, the gas will have literally no value.  That’s the argument that the landmen are making, and it’s just wrong.  You will get more royalty when no post-production costs are deducted from it.  A post by John McFarland from Oil and Gas Lawyer Blog does an excellent job of explaining how.  It’s a long post, but I highly recommend you take the time to read it.

HOW TO POLICE THE OIL AND GAS COMPANY

It’s nearly impossible for you to ever be sure that the oil and gas company is only deducting those costs that are increasing the value of the gas.  You can’t even be sure they are deducting only what they say they are deducting.  Unless you audit them, you just have to take them at their word.  I can think of three ways of checking up on them.

First, you can audit their books.  This requires that you go to their office and spend time figuring out their record keeping system.  Because you probably don’t know much about oil and gas accounting systems, you’ll need to hire an expert to go with you.  In short, you’ll need to time and money to audit them.

Second, you can check the WV DEP’s web site for the oil and gas company’s reported production.  But if you want current numbers you’re going to have to wait a while because the oil and gas company only has to report once a year, by the 31st day of March.  And wait a little longer because the DEP takes a while to post those numbers to the internet.  Note, also, that the most recent numbers are going to be at least four months old.

Third, you can go out to the well site and check the gauges.  This is the simplest and most reliable method.  But it really only works to get the total production from the well.  That’s why the lease needs to say that royalties will be calculated based on the total production from the well, with no deductions.  It’s simple and you don’t have to rely on anyone else to get or give you information.  Of course, for all you out-of-state mineral owners this is not really an option.

The takeaway here is that you really need to read everything that’s in a lease.  You can’t skim the headings and know for sure what you’re signing.

And always get no post-production costs.

 

Three Super-Simple Tips for West Virginia Surface Owners

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There are three simple things that every surface owner in West Virginia should always do.

If everything goes according to plan you won’t need this advice, but things don’t always go according to plan.  Oil and gas businesses are run by human beings, and if there’s one thing we humans do, it’s make a mess of things.  Better safe than sorry, right?

Tip Number One: Get Water Samples

Get a water sample from every water source on your property.  Get samples from your neighbors, too, if you can.  One of the reasons there is still a huge controversy around hydraulic fracturing is that very few people have been able to prove what their water was like before fracing started.  Everybody thinks it can’t happen to them, or that they’ll do it when the rig shows up.  The problem with waiting until the rig shows up is that the horizontal legs on these wells are often a mile long – you might not ever know the rig was there.

The best way to do this is to get a testing company to take the sample for you.  If, like most, you can’t afford that, then you’ll have to get creative.  The important thing here is to make sure you can admit your sample in court.  You’ll want to be able to prove to a judge that you got the sample where you said you got it, on the date you said you got it, and that it hasn’t been tampered with in any way since then.  You could get a couple neighbors to come along and take video and pictures of the process.  If you tell them you’re doing this so you can stick it to the oil and gas company, you shouldn’t have too much trouble finding friends.

Milk jugs won’t do for this kind of thing.  They decompose too quickly.  A fresh plastic two-liter pop bottle or juice bottle might work if you could get it really clean.  A Mason jar would probably be better since it’s glass and won’t decompose, but you’d have to be careful not to break it.  The best would probably be a gas can.  It’s hard to break and definitely won’t decompose when exposed to water.  But really, any container can work as long as it won’t break and won’t decompose.

You’ll have to find a way of proving that the sample hasn’t been tampered with after you collect it.  You could paste that day’s newspaper to the container in a way that you can’t remove the lid without ruining the paper.  You could maybe even do like they did in the old days with letters and drip melted wax on the opening.

You’ll also have to store it someplace safe.  Cool, dark, and undisturbed are the things to look for here.  The fridge, the freezer, a root cellar, or wherever you bury your money should work.  Or you could give it to your attorney for safe keeping.

Tip Number Two: Take Pictures

Spend a hundred bucks on a decent camera.  You can look at that money spent as if it were an insurance policy.  If nothing goes wrong, well, at least you were covered.  And hey, you’ve got a camera now.

Take pictures of your property before any work starts.   When the bulldozers show up, take more pictures.  When the rig shows up, take pictures.  When the water trucks show up, take pictures.  Take as many pictures as you can.  Take pictures of everything from every angle.  When something goes wrong you’ll have photographic evidence.  You might not even have to go to court if you have the right pictures.

Tip Number Three: Keep Records

Record all your dealings with the oil and gas company in a journal or blog.  The more you document, the easier it will be to deal with the company in the long run.  Write down the date and time, who you talked to, and what they said.  Write down what they did.  Write down what you said and did.  Record everything!

Oh, and make sure they know you’re keeping records and taking pictures.  When we humans know we’re being scrutinized we are less likely to be lazy, cut corners, and forget things.

Luck favors the prepared.

Classic First Post

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Most first posts introduce the author and explain what the purpose of the blog is.  It seems like a good tradition, so I won’t break with it.

I’m Kyle Nuttall.  I grew up in rural Oregon, in the foothills of what’s called the Coastal Range.  I’ve lived in a number of different states, and Italy.  I went to college at George Wythe University in southwest Utah, and got my law degree at the University of Oklahoma.

I took my first oil and gas class during my second year of law school.  A couple things about that class fascinated me.  I’m one of those odd people that actually likes reading contracts, and oil and gas law deals with a lot of contracts.   Plus, it turned out that oil and gas law touched on a surprisingly large number of other legal disciplines; torts, property, Constitutional law, wills and trusts, corporations, federal regulations, taxes, state regulations, land use, municipal laws, even Native American law.  It appealed to my jack-of-all-trades personality.  I took every class the school offered on oil and gas.

While I was taking that first class I asked the professor what I should do to get into the oil and gas field.  He suggested I spend a few years working as a landman.  I also spoke with an attorney who was practicing in the field, and he suggested the same thing.  So while my law school buddies were looking for clerkships and summer intern positions, I tracked down a job working as a landman.  I worked for several years as a landman, and I enjoyed it.  More importantly, I learned about the oil and gas patch from the inside.

Now I’m a full-time oil and gas attorney.  Most of the people that come to me need advice about property (surface rights) and contracts (leases, ratifications, modifications, etc.).  It would be helpful for people to know something about it all before they talk to me.  So I’m going to do my best to put some basic property and contract law into plain English that the Average Joe will be able to understand.  There will be plenty of posts on other subjects as well.  But this is what will be the meat and potatoes of the blog.

Enjoy.

Kyle Nuttall

Is that Oil and Gas Lease a Scam?

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One of the most common questions I get from mineral owners is, “have you heard of XYZ Oil Company?”  I get calls from California to New Jersey to Florida.  They’re people who had no idea they owned minerals because they inherited them, so it sounds too good to be true.  In this modern world, too good to be true is usually just that.  Surprisingly, I haven’t run across a scam where someone represents themselves as an oil and gas company to mineral owners.  However, if it’s not happening now it will happen in the future, so some due diligence research is in order.  Here’s how I would go about figuring out if I’m dealing with a reputable company.

Get the Oil and Gas Leasing Company’s Name

It won’t be hard to find out what company you’re dealing with.  When the landman contacts you for the first time, one of the first things he’ll tell you is who he represents.  (If he won’t tell you who he works for, tell him to get lost.)  The company’s name will be all over the paperwork, too.

Sometimes the landman will be working for a lease broker. Lease brokers deal in title issues and leasing, and turn their work over to developers.   It’s OK.  It’s common.  In fact, when I was a landman I only worked for lease brokers, and worked on projects for several different companies.  Just make sure you know who the lease broker is working for.

Also, find out where the company is headquartered.  Many of the large companies are based in Oklahoma, Texas, and other states.  If the landman doesn’t know this, he or she can find out for you.  They’ll be glad to have an excuse to call you back.

Research the Oil and Gas Company

With name (or names) in hand, head to the internet.  Of course, you’re going to want to check the forums here on MRF to start with.  Here’s a quick search tip: in Google, type “site:www.mineralrightsforum.com XYZ”.  Replace XYZ with the name of the company you’re researching, and don’t include the quote marks.  Google will bring up only hits from MRF, and you’ll be able to see quickly what people are saying about that company.

If you’re dealing with a large national or large local company, a quick Google search will turn up the company website with a phone number and address.  If it’s a smaller local company there sometimes won’t be a website, but you should at least be able to find them in the phone book.

Don’t call them quite yet.  The next step is to go to the West Virginia Secretary of State’s Business Organization Search page.  If a company is organized or licensed in West Virginia, the information will be there.  You can find out where they’re based and how long they’ve been around.

For those companies based in other states, look up the Secretary of State’s web site and call the main office.  You’ll probably get bounced around a bit, but the time will be well spent.  Ask how long that particular company has been in business.

Research the Landman

Now that you know the leasing company is real, you should check up on the landman.  One phone call to the company will tell you whether he or she works for them.

At this point you can stop, knowing that you’re dealing with a real company and one of their actual representatives.  But if you want to push it a little farther you can try to figure out what their reputations are like.

Additional Oil and Gas Leasing Research

Check out the landman.  While there are a couple forums out there that try to rate landmen, there are so few landmen listed (as of June 2013) that they’re just not helpful.  A Google search is still worth a try just in case your landman is listed and has a really bad reputation.  And if you get involved on the forums I’ll help you find below, you might find people who have had dealings with your landman.

Check out the company.  Unfortunately, there isn’t a centralized database for complaints and compliments.  You’re going to have to rely on what can sometimes be pretty unreliable sources of information – internet forums.

Do a Google search for “West Virginia oil and gas” to get you started.  I’ve also found that a Google search of the company name and the county where your mineral property is located (“Antero Harrison”) will usually bring up a local forum or two where you can contact West Virginians who have real world experience with the company.  That’s how I found www.mineralrightsforum.com and www.gomarcellusshale.com.

If that doesn’t give you any good results, try replacing the company name with that of another company (Chesapeake, Range Resources, EQT, Dominion, etc.) and you should get some results that will lead you to a forum.  Once there, you’ll have to get involved on the forum by asking questions about your particular company.   It may take a while to get an answer.  Mineral owners seem to be pretty friendly and helpful with each other, but those from West Virginia don’t always seem to be extremely involved in the internet.  You’ll find more Ohioans and Pennsylvanians on the internet at this point.

A word of warning about forums.  Anybody can post anything, so take everything you read on a forum with a grain or ten of salt.  What you’re looking for is not a perfect reputation, but a general sense that they’re in the business and actively working to do their job.

You can also get in touch with the Office of Oil and Gas in Charleston.  They only have complaints about environmental issues, but it’s something.  A long line of complaints from a diverse set of people is a big red flag.

You would think you could go check with the Better Business Bureau, but lots of real oil and gas companies are not accredited with them, e.g. Chesapeake Appalachia, Antero Resources, Energy Corporation of America, and Mountain V Oil and Gas.  Those are some pretty well-known and established companies.

Best of luck in the oil patch!