The Hidden Cost of Low Prices | Russell T. Rudy Energy LLC
In a recent article entitled “Mineral Owners-Sitting Ducks for Bankrupt Oil Companies”, author and Certified Appraiser, Terrel Shields, points out the obvious and not so obvious downsides for royalty owners in a depressed oil market.
Obviously, when the price of oil falls by 50% or more, your royalty check will decrease accordingly. Not as readily apparent is the exposure to creative calculation of post-production expenses and bankruptcy liability.
As oil and gas operators struggle to remain solvent in a down market, they are tempted to engage in creative accounting practices to add post-production expenses which can be deducted from royalty settlements. This shifts part of the burden of these costs from the working interest owners to the royalty owners. Shields contends that this is happening on a regular basis and can amount to over 50% of the gross royalty.
However, in a post by John B. McFarland on “Oil and Gas Lawyer Blog”, he cites the recent case of Chesapeake vs. Hyder. In this case, the Texas Supreme court confirmed the rulings of the trial and appellate courts that royalty owners, at least in the state, are exempt from post production costs other than production and severance taxes. Admittedly, the Hyder lease was explicit as to the exclusion of all other post production from the calculation of royalties due to the lessor. However, the State Supreme Court went further by saying that if a lease simply says that royalty will be based on the price received by the lessee, the latter cannot deduct post production costs from the royalty. Further, explicit clarifications are not necessary.
While this is clearly good news for Texas royalty interest owners, it should be noted that federal bankruptcy courts have far reaching powers, and might try to act contrary to the tenets of Chesapeake vs. Hyder, even within Texas.
As small operators, gatherers, transporters, purchasers, and co-owners go bankrupt, the royalty interests are threatened as well. In some cases, bankruptcy trustees have even asked for the last six months of royalty proceeds to be refunded to the court. In a best case, royalty checks might be delayed or production halted. Either way, legal fees to restore an equitable stream of royalty income can easily offset the income itself for quite some time.
In the lawyer’s opinion legislative intervention will insure that no matter what happens, royalty settlements will never be less than 1/8 of gross production.
To read the Shields article in its entirety, please go to http://www.roxnoil.com/wpadmin/index.php/2015/08/03/mineral-owners-sitting-ducks-for-bankrupt-oil-companies/ .
To read the McFarland article re: Chesapeake vs. Hyder, please go to http://www.oilandgaslawyerblog.com/category/post-production-costs .
