Pennsylvania Minimum Royalty Act and post-production costs

Forensic observation

The Marcellus Shale gas formation stretches across New York, Pennsylvania, West Virginia, Ohio and Maryland, and is estimated to contain more than 410 trillion cubic feet of natural gas which could supply United States’ energy needs for hundreds of years. In 2013, Pennsylvania’s 4,904 wells released 3.1 trillion cubic feet of natural gas. Pennsylvania has also generated more than $600 million in natural gas revenue in the last three years. The industry’s growth in Pennsylvania is evidenced by the construction of the high technology park in Southpointe / Canonsburg, home to many of the largest natural gas producers, including Range Resources, CONSOL Energy, DPS Property, Chesapeake Energy and Columbia Gas.

The increased natural gas related activity in the Marcellus Shale region has led to a corresponding increase in the number of lawsuits related to oil and gas disputes. Since 2008, 70 different lawsuits involving hundreds of leases have been filed in Pennsylvania state and federal courts. Pennsylvania legislation governing royalties stems from the 1979 Pennsylvania Minimum Royalty Act (the Royalty Act), which entitles leaseholders to a minimum of one-eighth (12.5 percent) royalty of all oil and natural gas removed or recovered from the property. However, since the Royalty Act does not define the term “royalty,” the gas industry uses its own definition of what a royalty payment is, as well as their own determination of what costs are deductible. Landowners, in turn, are filing suit to dispute the calculations performed by the gas companies. For example, in a class action lawsuit filed in federal court in the middle district of Pennsylvania against Chesapeake Energy and other parties in March 2014, the plaintiffs allege that the defendants engaged in a conspiracy to pass on to Pennsylvania oil and gas lessors vastly inflated gathering and transportation costs, essentially decreasing monthly royalty payments to the lessors.

Legislation has been introduced to help clear up post-production issues in Pennsylvania. Lycoming County Republican House Representative Garth D. Everett and others have introduced House Bill 1684 in 2013 in an attempt “to clarify that any deduction for postproduction, market-enhancement or similar costs should never result in royalty owners receiving less than the guaranteed minimum 1/8 royalty provided by the Oil and Gas Lease Act.”  Although the measure was approved March 2014, Bill 1684 faces strong opposition from the natural gas industry which argues the bill is legislative overreach that would require unconstitutional changes to terms of contracts.

As natural gas production increases, the Marcellus Shale region will experience more activity surrounding the clarification of post-production deductions of royalty payments.

For more information on this topic, or to learn how Baker Tilly energy and utility specialists can help, contact our team.

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