(02/23/2007)
A bill that would allow gas production companies to charge post production costs back to the royalty owner has been introduced in the WV Senate.

It would affect the future of all royalty payments in the future, and appears to be back dated to the 1990s:

Senate Bill No. 731

By Senators McCabe and Bailey

Introduced February 19, 2007; referred to the Committee on Energy, Industry and Mining; and then to the Committee on the Judiciary.

A BILL to amend the Code of West Virginia, 1931, as amended, by adding thereto a new article, designated 22-7A-1, 22-7A-2, 22-7A-3, 22-7A-4 and 22-7A-5, all relating to oil and natural gas production royalty payments; and the calculation of production royalty payments.

Be it enacted by the Legislature of West Virginia: That the Code of West Virginia, 1931, as amended, be amended by adding thereto a new article, designated 22-7A-1, 22-7A-2, 22-7A-3, 22-7A-4 and 22-7A-5, all to read as follows:

ARTICLE 7A. FAIRNESS IN OIL AND NATURAL GAS PRODUCTION ROYALTY PAYMENTS ACT.

22-7A-1. Short Title.

This article may be cited as the "Fairness in Production Royalty Payments Act."

22-7A-2. Legislative findings and declarations.
(a) The Legislature hereby finds and declares that:

(1) The citizens of West Virginia benefit greatly from economic activity generated by the oil and natural gas industry, from capital investment attracted to our state, from employment attendant to investment and production, from the income from payments to royalty owners, and from taxes paid by the oil and natural gas industry that enable the government to provide essential services.

(2) A significant portion of oil and natural gas underlying the state is subject to development pursuant to leases or other continuing contractual agreements whereby the owners of such oil and natural gas are paid a royalty or rental inherently related to the volume of oil and natural gas produced or marketed, and which often provide for the royalty owner to receive a share of either the proceeds received from the sale of oil and natural gas, or of the value of the oil and natural gas produced.

(3) In recent years, due to fundamental changes in federal regulation that restructured the oil and natural gas industry, uncertainty has developed over the proper calculation of the value to be used to determine natural gas royalties. This uncertainty has lead to a substantial increase in litigation, for example, the case of Estate of Garrison G. Tawney, et. al. v. Columbia Natural Resources, et. al., that not only represents a significant cost to the oil and natural gas industry in this state, but the unpredictable results of such litigation has increased the risk of investing in the oil and natural gas industry in West Virginia to the point such litigation acts as a significant impediment to the industry, and by extension, the economy of this state.

(4) It is in this state's interest to promote a stable business environment and to ensure that changes in federal regulations and unsettled law do not impede development of the West Virginia oil and natural gas industry and do not lead to uncertainty and expensive litigation of existing business relationships.

(5) The Federal Energy Regulatory Commission implements national policy regarding the transportation and sale of natural gas, and pursuant to law, regulates the natural gas industry in the United States. The Federal Energy Regulatory Commission's Order 436, issued in one thousand nine hundred eighty-five, began the process of fundamentally restructuring the natural gas industry in the United States. As of the eighth day of April, one thousand nine hundred ninety-two, the Federal Energy Regulatory Commission implemented the restructuring of the natural gas industry by issuing Order No. 636.

(6) Before the Federal Energy Regulatory Commission changed its regulatory policy and restructured the natural gas industry, major integrated interstate pipeline companies typically provided a bundled sales service that included not only the cost of the gas produced, but also the cost of all services necessary to move natural gas from the wellhead to the consumer. These costs include gathering, processing, dehydration, compression, fuel, transportation, line loss, storage and distribution (collectively hereinafter "post-production expenses"). Before restructuring, oil and natural gas producers generally sold natural gas to major integrated interstate pipelines in the field, generally at or near the well location, before any post-production expenses were incurred. This wellhead price was then used to calculate royalties. Costs occurring downstream of the wellhead were embedded in the sales rate charged by the interstate pipeline and paid for by the customer who ultimately received the gas. Consequently, producers generally did not receive revenue in connection with, or pay royalty on, post-production expenses.

(7) As a result of unforeseeable, fundamental changes to the industry, interstate pipelines no longer buy natural gas from producers. After deregulation, many post-production expenses incurred by interstate pipelines were allocated to and borne by producers. Today natural gas is normally sold by the producer to a natural gas marketer or broker who buys at the well or at a point substantially remote from the well. The price paid producers can vary with the point of sale, and some of the revenue received by a producer upon sale often includes recovery of post-production expenses incurred to deliver gas to the point of sale. When post-production expenses are excluded from producer sales today, the net amount is today's wellhead value.

(8) Most leases for oil and natural gas in West Virginia were executed before the fundamental changes to the industry that deregulated the wellhead price and restructured pipelines. As a result, most leases generally only refer to wellhead price or value and are silent as to the treatment of post-production expense. To require payment of royalty based on the full price at delivery when the price includes post-production expense results in the producer/lessee paying royalty on revenues it does not receive, or cannot retain, resulting in a penalty to the producer and a windfall to the royalty owner who was not paid royalty on such costs before deregulation occurred.

(9) After deregulation, the value of natural gas at the wellhead can still be determined by adjusting the sales price to exclude post-production expenses embedded within that price. The use of such "net back" calculations yields a current wellhead value for the payment of royalty.

(10) In the natural gas industry today, published prices for natural gas delivered to interstate pipelines are widely available. The cost of moving natural gas from the wellhead to the pipeline is often known because the rates for these services are either regulated by Federal Energy Regulatory Commission (in the case of gathering services provided by interstate pipeline companies), or by the Public Service Commission of West Virginia (in the case of intrastate pipeline gathering services). It is possible to determine the wellhead price of gas by deducting post-production expenses from published prices.

(11) The use of such "net back" calculations make it possible to determine the value of natural gas at the same point where the value was established for the payment of royalty prior to deregulation and restructuring.

(12) Courts in other jurisdictions have interpreted leases and continuing agreements in a manner that permits deduction of post-production expenses when calculating royalty payable at the wellhead.

(13) Just as the Legislature acted to change common law by adopting the Oil and Gas Production Damage Compensation Act (now West Virginia Code, chapter twenty-two, article seven), and to prevent drilling on flat rate royalty leases (now West Virginia Code chapter twenty-two, article six, section eight), and to presume when leases are cancelled (now West Virginia Code, chapter thirty-six, article four, section nine-a), the Legislature must now act to strike a fair balance with respect to royalty payments. (b) While being fully cognizant that the provisions of section ten, article one of the United States Constitution and of section four, article three of the Constitution of West Virginia, proscribe the enactment of any law impairing the obligation of a contract, the Legislature further finds that it is a valid exercise of the police powers of this state and in the interest of the State of West Virginia and in furtherance of the welfare of its citizens, to eliminate expensive, burdensome and wasteful litigation and to promote investment in West Virginia and the stability of the economy of the State of West Virginia.

22-7A-3. Meaning and application of "at the wellhead" and similar terms.

(a) The terms "at the wellhead," "at the well," "at the mouth of the well," "in the field," "on the lease," "wholesale price," "at the well mouth" or similar language in a lease or other continuing contractual agreement related to oil or natural gas are not ambiguous and mean the place where oil or natural gas reaches the surface of the earth and is captured on the well location. The wellhead is an easily recognizable physical location that demarks where oil and natural gas are brought to the surface and captured, before oil or gas begins the journey to the ultimate end user; the wellhead logically demarks where production ends and post-production transportation, compression, line loss, processing and marketing activities begin. Use of the wellhead as the point of valuation for royalty calculation minimizes disputes because the wellhead can easily be identified.

(b) The terms "at the wellhead," "at the well," "at the mouth of the well," "in the field," "on the lease," "at the well mouth," "well mouth" and "well head" are synonymous and mean where oil and gas come to the surface of the earth at an oil and gas well and are captured. Those terms define both the location (before transportation begins) and condition (before processing) of the oil and natural gas before post-production expenses are incurred. The wellhead includes valves and fittings attached to the well, pumping units, lift assemblies, heaters, injection pumps, and all on location tanks, oil and gas separators, water separators, drips, dehydration units, regulators and meters, and the pipe on the well location that is between the well and any tank, separator, dehydrator, regulator or meter situated on the well location. For natural gas, the point where pipe leaves the equipment on the location is the beginning of transportation and the beginning of post-production expenses. For oil, the point where the product leaves the tank on location is the beginning of transportation and the beginning of post-production expenses.

22-7A-4. Implied covenants in oil & natural gas leases and calculation of production royalty. (a) There shall be a presumption in all leases and agreements regarding oil and natural gas royalty and overriding royalty that in the absence of clear express language to the contrary, all costs incurred in drilling the well and producing and capturing oil and natural gas at the wellhead are borne by the producer/lessee. There shall also be a presumption that to the extent the sales price received for gas is at a point downstream of the wellhead, reasonable post-production expenses incurred directly or indirectly by the producer/lessee should be excluded from the sales price when calculating the amount due as production royalty. (b) An implied covenant to market oil and natural gas production shall not be construed in contravention of this statute, nor may it require the producer to bear all of the costs necessary or convenient to treat, transport or process the product to marketable condition or to determine the amount of rental or royalty due in connection with oil and natural gas.

(c) The implied covenant to develop the lease shall not be construed in contravention of this statute, nor may it require the producer to bear all of the costs necessary or convenient to treat, transport, or process the product to marketable condition or to determine the amount of rental or royalty due in connection with oil and natural gas. Production and post-production expenses may be allocated between the parties by contract. A presumption shall exist that in the absence of clear, express agreement otherwise, the amount of production royalty and overriding royalty due in connection with oil and natural gas shall be measured at the wellhead, and the value of the gas is to be determined by deducting any post-production expenses embedded within the sales price.

(d) In the absence of express terms to the contrary, leases and other contractual agreements that provide that a production royalty or overriding royalty is due with reference to "amount realized," "amount received," "amount paid," "proceeds," "net proceeds," "receipts," "net receipts," "wholesale price," "gross receipts" or similar terms related to, or calculated or payable with reference to, terms such as "at the well," "at the well head," "at the well mouth," "in the field," "on the lease," "at the mouth of the well," "free of costs," "in the pipeline," or similar language, all contemplate deduction of post-production expenses incurred by producers from actual first sales proceeds when calculating royalty and overriding royalty, and shall be construed in accordance with the principle that the activity of production of oil and natural gas ends when the oil or natural gas is captured in tanks or pipes on the surface at the well location. The same principle shall also apply when the lease or agreement does not specify the place or manner of calculation of royalty.

(e) Additionally, to make certain the rights of the parties under market value leases, in the absence of express terms to the contrary, leases and other contractual agreements that provide that a production royalty or overriding royalty is due with reference to "market value," "market price," "wholesale market value," "wholesale price," "average prevailing price," "field price at the well," "prevailing price in the field," "value," or similar terms, all contemplate deduction of reasonable post-production expenses incurred by producers from actual first sales proceeds when calculating royalty and overriding royalty.

(f) Unless a written agreement clearly provides otherwise, production royalty shall not be due or payable on reasonable costs incurred by the producer or paid to third parties for gathering, line loss, fuel, processing, compression, transportation, distribution or storage, regardless of whether such costs are incurred before or after the oil or natural gas reaches the point of first sale. The cost of post-production expenses as determined in connection with proceedings of regulatory agencies, or amounts not exceeding cost amounts approved by regulatory agencies for reasonably comparable services, shall be deemed reasonable.

(g) Unless a written agreement clearly provides otherwise, production royalty or rental shall not be due or payable with respect to natural gas not sold because the natural gas is:

(1) Used or consumed transporting, treating, dehydrating, processing or compressing natural gas; or

(2) Lost or unaccounted for during normal operations.

(h) The value, market value, proceeds and amount received for natural gas sold by a producer pursuant to a short or long-term contract is the price provided in the contract where the contract was entered into in good faith and was commercially reasonable at the time the contract was formed.

(i) This article shall not be applicable to cases in which a jury verdict has been returned, or a final decision rendered, before its passage, but otherwise shall be fully retroactive to the eighth day of April, one thousand nine hundred ninety-two, the date of issuance of Federal Energy Regulatory Commission Order No. 636, and shall be effective upon passage.

(j) If any provision of this act or the application thereof to any person or circumstance is held invalid, such invalidity shall not affect other provisions or applications of this act that can be given effect without the invalid provision or application, and to this end the provisions of this act are declared to be severable. 22-7A-5. Production royalty reporting requirements.

(a) Effective as soon as practical, but not later than nine months after this article is enacted, the following information shall be furnished to the royalty owner with, or as part of, a royalty statement:

(1) Identification by name or number of the lease or well that is the subject of the royalty statement and production period covered by the royalty statement.

(2) Volume of gas sold in mcf or decatherm, identified as mcf or decatherm.

(3) The payee's royalty interest expressed in the form of a decimal.

(4) Whether or not any post-production expenses are deducted from the sales price when the royalty was calculated or paid. If any post-production expenses were deducted, an explanation of the manner of calculation of royalty shall be provided to the royalty owner at least once each year.

(b) From and after the date this article is enacted, producers shall make reasonable efforts to respond to written inquires by royalty owners regarding royalty statements, the calculation of royalties and post-production expenses deducted from the sales price paid to the producer.

(c) In the event the producer fails to reasonably respond to written inquiries from a royalty owner, the producer shall be liable to the royalty owner in the sum of two hundred fifty dollars for each such failure to respond, which liability shall be the sole remedy for violation of this section.

NOTE: The purpose of this bill is to create an act which sets forth the manner of calculating royalty when the parties have not specifically agreed otherwise. The bill also declares that the producer does not pay royalty on gas not sold, while permitting deduction of post-production costs incurred by the producer.

This is a new article; therefore, underscoring and strike-throughs have been omitted.


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