Severance Tax Refunds and your protection

Blogs
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Coll v. Abaco Operating, LLC, et al., in the U.S. District Court for the Eastern District of Texas, Marshall Division, C.A. No. 2:08-CV-345 TJW

This is a class action suit dealing with refunds of severance tax rebates/reductions allowable by Texas State Law if proper application is made and the application is approved.

Operators for some time have lobbied the Texas legislature to allow relief on certain classes of wells to make them more profitable for the Operator and to increase the ultimate recovery of oil and/or gas.

Here is the way the law works.

1. The Operator pays the severance tax on 100% of production, including your royalty share. How much is severance tax? 7.5% on gas and 4.6% on oil.

2. Tax rebates can be applied for as I have discussed elsewhere, notably the deduction for tight gas as defined in the FERC regulations. All shales and for example the Cotton Valley are tight gas sands.

3. The well is producing and the Operator applies for the tax reduction. After a period of time, the application is approved and the severance tax rate is dropped from 7.6% to 2.6% for a certain time period (recoupment of certain costs, etc.),

4, The State sends a check to the Operator for taxes overpaid prior to the application being approved.

5. The Operator pockets the royalty owner's share of the rebate.

6. The class action suit was filed, of course. It has to be a class action. Far too few royalty owners have the resources or the stamina to take on big oil on such a technical suit.

7, One of the arguments that has been made is that the lease form does not provide for a refund of severance taxes.

How much money are we talking about? Let us define a royalty of 20%. If the rebate drops the severance tax by 5%, you should be entitled to 20% of 5%, or 1%. Therefore your effective royalty rate goes from 20% to 21%, or an increase of 5% of your check. Therefore a $20,000.00 check becomes magically a $21,000.00 check. Now, take the rebate back 18 months or so and you get a windfall of $18,000.00.

REMEDY?

Ensure that YOUR lease form has language to protect you. Ask your attorney or oil and gas professional for advice on how to best protect your interest, PARTICULARLY if your lands are in tight gas territory. I think it would be a good idea to have it in all lease forms or addendum. You never know what the oil lobby might do to influence the legislature to allow them a break here and there - and if they win, you want to be part of it to.

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I think this is the first time I have ever replied to myself.

It's dangerous when I start trying to think.

So, following up on my blog post on Severance Tax Refunds, there are also all manner of considerations available to the Lessee for production that are not available to the Lessor - typically. An example would be a buy out on a settlement of a take or pay provision in a gas sales contract. The Lessee receives a buy out and the Lessor receives nothing. Another would be a marketing credit for exceeding deliverability thresholds.

I gar-on-tee (with apologies to Cousin Justin Wilson) that the Lessee will never in its accounting pick up this clause and voluntarily rebate or credit you back for those compensations, credits or benefits. But that may change. AND, if you are smart enough to have audit privileges, your auditor can pick them up and pay for the cost of the audit.

In all my years, I have never seen a case of a joint interest billing audit that did not pay for itself. Likely, the same would happen if a royalty owner performed an audit. If it were me, I would consider an audit right before the Statute of Limitations for items under contract (4 years in Texas, check your own state). However, you have to plan way ahead and have audit rights in your lease form itself.

Here is a stab at a clause that may work. Run it past your attorney and see if it makes sense to him. I have not finished refining the clause. I have more research to do, but you can see where it is going.

"All royalties paid on the products covered by this Lease shall be payable on an amount never less than the full value of all consideration for such products in whatever form or forms, which directly or indirectly compensates, credits, or benefits Lessee."

It is very dangerous to just start adding clauses to lease forms willy nilly. I see lots of mineral owners just start pulling clauses out of the air or from other lease forms with no real thought as to the implication of inserting them in a form. Flow can be disrupted, conflicting provisions can arise and a Frankenstein style lease form is created that cannot be interpreted because it contradicts itself at every turn.

Therefore my business recommendation is to talk to the attorney who prepared your form about this clause and see if it works in your form and if not, how to properly word the language to give the lessor the positive benefit of a clause such as this.

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Thank you for taking the time to reply to yourself! Very valuable feedback!