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March 18, 2014

Pennsylvania House Committee Sends Minimum Royalty Bill To The Floor

Following a failed attempt last week to advance the bill, on Monday, March 17, 2014, the House Environmental Resources and Energy Committee voted 15 to 10 to clear a bill intended to ensure that landowners receive fixed minimum royalties from unconventional gas leases by preventing operators from lowering royalties below the minimum by deducting post-production costs and send it to the floor for consideration.

House Bill 1684 (Everett, R-Lycoming) was introduced to ensure that landowners receive fixed minimum royalties from unconventional gas leases.  The concept of a minimum royalty is not new.  Pennsylvania’s Guaranteed Minimum Royalty Act (Act 60 of 1979) provides royalty owners with a guaranteed minimum one-eighth royalty.  However, the use of post-production deductions (i.e., costs that are incurred between the wellhead and a final market point of sale and typically include dehydration and transportation) by some companies across the Commonwealth has resulted in royalties for certain landowners being reduced below the statutory minimum royalty of one-eighth.

House Bill 1684 seeks to remedy this issue by amending the Guaranteed Minimum Royalty Act as follows:

  1. Any lease that does not guarantee at least one-eighth royalty would be invalid.
  2. The deduction of any production costs, effectively defined as severance or other taxes or fees and costs, would be prohibited for unconventional wells.  Any lease allowing for such production costs would be invalid.
  3. Postproduction costs, including third party costs, shall not be taken if the deduction results in a royalty of less than one-eighth for unconventional wells.
  4. The royalty calculation for unconventional wells shall be based on the price received by the lessee at the point at which the production enters the commercial market and ownership transfers to a business entity nonrelated to the lessee in an arm’s-length transaction.

The impetus for this legislation began with the Pennsylvania Supreme Court’s 2010 decision in Kilmer v. Elexco Land Services, Inc. where it determined that the “General Assembly is the branch of government best suited to weigh the public policies underlying the determination of the proper point of royalty valuation.”  After finding that Pennsylvania landowners who signed leases with a one-eighth royalty assumed that an eighth is an eighth and not something less than that once deductions were made, the Court determined that that it was within the Commonwealth’s legitimate police power to address and clarify this issue.   And, the more recent reports of post-production deductions only bolstered the bill’s backers.

The floor vote on House Bill 1684 will be interesting.  And, assuming passage, one can expect litigation to follow as supporters and opponents of the bill are already at odds regarding the legal validity of the bill and whether the Court erred in Kilmer by referring the issue to the Legislature for it to address.  One thing made clear by Monday’s amendments, the bill will not retroactively apply to royalty payments that have already been made.  It will, however, if passed apply to all existing leases.

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