R. W. Kennedy, hope you’re still monitoring this site. I and a cousin have rights on a well in McKenzie County. I am a participating owner. He chose not to pay up front, didn’t lease, so is due 16% of his share, cost free: " paid “cost-free” - i.e., free from costs including Processing (PRC), Gathering (GTH), Transportation (TRN;TRN2); Marketing (MKT) and Treating (TRT). " Cousin was just told by our current driller, Triangle, that " The ‘cost free’ language in the statute applies only until the product leaves the unit. Once it has left the unit, the royalty is subject to their share of the costs." So, the question is do you, or anyone else listening, know of “any legal authority such as judicial rulings or interpretive opinions by the North Dakota administrative agency that oversees the NDCC on oil extraction that would permit this clearly self serving application?” Or has Triangle chosen to redefine ‘cost free’ to their advantage?
Hi Ed,
The authority on this issue is Bice v. Petro-Hunt (full North Dakota Supreme Court opinion is here: https://www.ndcourts.gov/court/opinions/20080265.htm)*
Bice v. Petro-Hunt, L.L.C. 9 provides an example of the majority view on deducting post-production costs when the royalty clause contains “at the well” language.10 In Bice , the North Dakota Supreme Court determined whether processing costs for sour gas were properly deducted when calculating the royalty under oil and gas leases that contained “market value at the well” language. The Court noted that the majority of oil and gas producing states have adopted the “at the well” rule and “interpret the term ‘market value at the well’ to mean royalty is calculated based on the value of the gas at the wellhead.”11 The Court also noted that in states that have adopted the “at the well” rule,12 a lessee has the option of calculating the market value at the well through the “comparable sales method” or the “work-back” (a/k/a “net-back”) method.13 The comparable sales method involves “‘averaging the prices that the lessee and other producers are receiving, at the same time and in the same field, for oil or gas of comparable quality, quantity, and availability.’”14 Under the work-back method, the “market value at the well” is determined by deducting reasonable post-production costs (incurred after the product is extracted from the ground) from the sales price received at a downstream point of sale.15
The Court found that the gas at issue had “no discernible market value at the well before it is processed . . . .”16 The Court reasoned that “[s]ince the contracted for royalty is based on the market value of the gas at the well and the gas has no market value at the well, the only way to determine the market value of the gas at the well is to work back from where a market value exists . . . .”17 Adopting the “at the well” rule, the Court held that the operator properly deducted post-production costs for processing prior to calculating the royalty.18
The key take-away here is even if there is language similar to what is provided in the non-consent your cousin received with respect to no deducts bumps up against settled ND law that the market for pricing exists downstream and accordingly is set by transport and deducts that the operator can net back to the mineral owner. As a fellow mineral owner, we hate this case law too.
David, while researching the issue, I came across Bice, and read much of the opinion. Couple things: the opinion concerns specifically sour gas, not oil. To my mind, the oil does have value as it comes out of the ground, so It doesn’t seem that the logic regarding sour gas applies. Since my cousin has no specific contract with the driller, it would seem that only the ND Century Code’s wording should apply. That says that no costs are to be taken from the 16% due him. All costs, and repayment of his share of drilling costs, should therefore come out of the remaining 84%.
I much appreciate your thorough response, and am somewhat surprised that the cost issue regarding oil has not been decided in ND courts, or by the North Dakota Department of Mineral Resources. I think the issue has been litigated in other jurisdictions, with mixed results.
My understanding is that the ND Supreme Court’s logic applies to both gas and oil because notwithstanding the logic that it does have value at the wellhead, the market isn’t determined at the wellhead but rather downstream.
Additionally, although the ND Statute reads one thing typically where the common law (i.e., the decision of the state’s highest court) conflicts with a statute, the common law prevails until such time as the State legislature overrules the court’s opinion by drafting legislation regarding the same. Accordingly, it is kind of in the legislature’s court to modify the conflict.
David, that seems somewhat inconsistent with the statements I receive as a participating owner. The line items I see for gas include as deductions Severance Tax, Gathering, and Processing, all deducted from my Unleased Working Interest. Oil, on the other hand, has only Transportation, Production Tax, and Extraction Tax deducted from my Unleased Working Interest. The point being that neither Gathering nor Processing come out of oil. Every month I receive a separate bill for costs beyond those mentioned above. All of which is to say that gas and oil are looked at differently from a cost accounting/value view by the driller.
Ed, those are effectively the same thing just differences due to the nature of the hydrocarbon. Gas needs to be immediately gathered, transported and processed in order to make it to the market. That is why you would have gathering and processing fees deducts. These costs likely include the transport to get to the processing. The price paid for the gas is likely at the end of the tailpipe of the processing plant. Oil doesn’t require the same gathering and transport logistics as gas since it comes out of the ground in an easier to store fashion (hence being stored in tank batteries at the well site until transport). Accordingly, there is no real additional cost to process the oil, just the transport. That is typically why from a royalty owner perspectively, the only oil deduct you see is transport.
This is all highly dependent too on your operator and third-party midstream providers. Hope this helps.