West Virginia is sitting on top of vast reserves of natural gas. The advent of hydraulic fracturing means those mineral deposits are now accessible. One of the key questions associated with our still emerging natural gas boom is, “How much will the mineral royalty owners get paid for that gas?”
The answer is not simple, and it does not rely solely on the market price for the resource, though that is an important factor. The more immediate issue is, “How much of the cost of transporting and processing the gas for market can be deducted from the royalties?”
Even that answer is complicated.
Friday the State Supreme Court ruled 4-1 in Leggett v. EQT Production Company that a percentage of certain post-production costs, such as transmission and processing, can be deducted from the mineral owner’s royalty checks. The court’s decision came in a rehearing of the case and is a reversal of the 3-2 decision last November which said those costs cannot be deducted.
The Leggett decision applies to wells on property where the original lease called for the gas company to pay a flat rate fee to the mineral rights holder. Flat rate fees were often very low and the State Legislature passed a law in 1982 that said for any future drilling under that lease the gas company had to pay the royalty owner one-eighth of the value of the gas at the wellhead.
The Leggett decision does not resolve the issue, however. In 2006, the State Supreme Court ruled in Tawney v. Columbia Natural Resources that the gas companies could not deduct post-production costs from royalties. “West Virginia recognizes that a lessee to an oil and gas lease must bear all costs incurred in marketing and transporting to the point of sale unless the oil and gas lease provides otherwise,” wrote Justice Spike Maynard.
There are differences in the facts of the Leggett and Tawney cases; Leggett deals with the statute on royalties while Tawney is about lease contracts. However, the Leggett decision clearly opens the door for a legal challenge to the Tawney ruling. In fact, Chief Justice Allen Loughry almost invites a review of Tawney when he writes that the court will “leave for another day the continued vitality and scope” of the Tawney decision.
The fact that four of the five Justices (Justice Robin Davis dissented) were on one side in the Leggett decision means the court believes there is justification for gas companies to deduct some post-production costs from the royalty owners. But what is reasonable? Could a mineral rights owner find himself getting a negative royalty check because of all the deductions for transmission and processing of the gas?
Justice Margaret Workman addresses those concerns in her concurrence. She urges the Legislature “to enact specific protections to assure fairness and reasonableness in the calculation of post-production costs.” Workman cites Montana and Colorado laws as examples of how public policy makers can codify requirements for royalty payments.
But until and unless the Legislature does that, the conflicting court opinions and the likelihood of additional legal battles over royalties add uncertainty to the natural gas industry. Royalty owners are less certain about how much they will have to pay—if anything—for downstream costs while gas companies cannot accurately plan for their production costs.
This unpredictability is a detriment to what should be a long-term boom for the state, the gas companies and the mineral rights holders. It’s up to the Legislature and the Governor to adopt sound public policy to avoid constant court fights.