Energy Law Update: North Dakota Follows Majority View of "At the Well" Leases
as Allowing Deduction of Post-Production Expenses
The North Dakota Supreme Court recently joined the majority of jurisdictions in finding that lease language that provides for royalty to be based on the value of gas "at the well" unambiguously means that a producer is entitled to deduct post-production costs incurred between the well and point of sale.
In its unanimous decision in Bice v. Petro-Hunt, LLC, 768 N.W. 2d 496 (N.D. 2009), the Court joined the majority of states including "[t]he three major oil and gas producing states, Louisiana, Mississippi and Texas," as well New Mexico, Montana, California and Kentucky, in holding that the "at the well" rule allows a lessee to deduct post-production costs prior to calculating royalty. In making its ruling, the Court expressly rejected the "first marketable product doctrine" adopted by Colorado, Kansas, Oklahoma, Arkansas and West Virginia.
The casinghead gas at issue in Bice was sour gas, which contains hydrogen sulfide and other liquid hydrocarbons and is therefore not marketable at the wellhead. Petro-Hunt contended that it was entitled to deduct the expenses incurred to make the sour gas into marketable sweet gas before calculating the royalty due because its leases required it to pay royalty on the "market value at the well." Petro-Hunt used a work-back method to establish the market value of gas "at the well," deducting all post-production costs incurred to make the gas marketable from the sale proceeds before calculating royalties.
A class of more than 300 royalty owners argued that Petro-Hunt was not entitled to deduct post-production costs incurred in preparing the gas for market. Rather, the plaintiffs urged the Court to adopt the minority rule known as the "first marketable product doctrine," which places the entire cost of preparing the gas for market on the lessee. Because the casinghead gas has no discernible value at the wellhead, the royalty owners argued that the language "market value at the well" means that the producer should pay royalties on the value of the gas only after it has been made marketable. The Court rejected this argument, stating that "the term market value at the well is not ambiguous," and holding that "at the well" should be defined by its plain meaning, which establishes the wellhead as the point of valuation, thereby entitling the lessee to deduct all post-production costs prior to calculating royalty payments.
The Bice decision represents a significant victory for oil and gas producers and serves as a direct challenge to the minority "first marketable product doctrine." The Court expressly rejected the minority rule and criticized the jurisdictions using this doctrine for failing "to articulate a clear standard for determining when a marketable product has been created."
Patricia Proctor
Chase Center - Second Floor
1000 Fifth Avenue, Suite 250
Huntington, WV 25701
patricia.proctor@steptoe-johnson.com
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