In companion decisions released on August 20, 2015, the Supreme Court of Kentucky confirmed that Kentucky follows the “at the well” rule with respect to post-production costs, but held that the payment of severance taxes must be borne solely by the producer.
In Baker v. Magnum Hunter Prod., Inc., the Court affirmed the lower court’s decision in favor of the lessee, holding that the phrase “market value at the well” has an established meaning in Kentucky that allows for the deduction of post-production costs in calculating the value of the lessor’s royalty.
In Appalachian Land Co. v. EQT Prod. Co., the Court addressed the following question certified by the Sixth Circuit Court of Appeals:
Does Kentucky’s “at-the-well” rule allow a natural-gas processor to deduct all severance taxes paid at market prior to calculating a contractual royalty payment based on “the market price of gas at the well,” or does the resource’s at-the-well price include a proportionate share of the severance taxes owed such that a processor may deduct only that portion of the severance taxes attributable to the gathering, compression and treatment of the resource prior to calculating the appropriate royalty payment?
The Court rejected both options presented in the question, instead holding that, in the absence of a specific lease provision apportioning severance taxes, a lessee may not deduct severance taxes or any portion thereof prior to calculating a royalty value.
To learn more about Baker and Appalachian Land Co., read our Client Alert. You can also read the full decision in Baker here and Appalachian Land Co. here.