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PA Royalty Decision

By Greg Russell

The Pennsylvania Supreme Court recently upheld the lower court's decision in Kilmer v. Elexco Land Services, Inc., Docket No. 63-MAP-2009, which found that the net-back method for calculating natural gas royalties did not violate the state's Guaranteed Minimum Royalty Act (GMRA) (which requires that leases guarantee a landowner-lessor at least a 1/8th royalty).  See here (go to Supreme Court Opinions).  After going through the parties' arguments in detail, the Court reasoned, in part, that the term royalty must be construed according to its industry meaning, and that:

The term royalty has been defined in the oil and gas industry as “[t]he landowner's share of production, free of expenses of production.” *** In the industry, as referenced above, the “expenses of production” relate to the costs of drilling the well and getting the product to the surface, but do not encompass the costs of getting the product from the wellhead to the point of sale, as those costs are termed “post-production costs.” “Although the royalty is not subject to costs of production, usually it is subject to costs incurred after production, e.g., production or gathering taxes, costs of treatment of the product to render it marketable, costs of transportation to market.” Id.; see also George A. Bikikos and Jeffrey C. King, A Primer on Oil and Gas Law in the Marcellus Shale States, 4 TEX. J. OIL, GAS, & ENERGY L. 155, 168-69 (2008-2009) (explaining post-production costs and noting that a majority of jurisdictions authorize the deduction of post-production costs in the calculation of royalties).

This, bolstered by the fact that the GMRA was intended to apply to both natural gas and oil royalties, and that oil royalties can be taken in-kind, persuaded the court to agree with the lower court that the GMRA should be read to permit the calculation of royalties at the wellhead, consistent with the net-back method in the lease at issue.

Tags: Energy, Royalty

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