Introduced Version
Senate Bill 731 History
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Key: Green = existing Code. Red = new code to be enacted
Senate Bill No. 731
(By Senators McCabe and Bailey)
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[Introduced February 19, 2007; referred to the Committee on
Energy, Industry and Mining; and then to the Committee on the
Judiciary.]
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A BILL to amend the Code of West Virginia, 1931, as amended, by
adding thereto a new article, designated §22-7A-1, §22-7A-2,
§22-7A-3, §22-7A-4 and
§
22-7A-5, all relating to oil and
natural gas production royalty payments; and the calculation
of production royalty payments.
Be it enacted by the Legislature of West Virginia:
That the Code of West Virginia, 1931, as amended, be amended
by adding thereto a new article, designated §22-7A-1, §22-7A-2,
§22-7A-3, §22-7A-4 and §22-7A-5, all to read as follows:
ARTICLE 7A. FAIRNESS IN OIL AND NATURAL GAS PRODUCTION ROYALTY
PAYMENTS ACT.
§22-7A-1. Short Title.
This article may be cited as the "Fairness in Production
Royalty Payments Act."
§22-7A-2. Legislative findings and declarations.
(a) The Legislature hereby finds and declares that:
(1) The citizens of West Virginia benefit greatly from
economic activity generated by the oil and natural gas industry,
from capital investment attracted to our state, from employment
attendant to investment and production, from the income from
payments to royalty owners, and from taxes paid by the oil and
natural gas industry that enable the government to provide
essential services.
(2) A significant portion of oil and natural gas underlying
the state is subject to development pursuant to leases or other
continuing contractual agreements whereby the owners of such oil
and natural gas are paid a royalty or rental inherently related to
the volume of oil and natural gas produced or marketed, and which
often provide for the royalty owner to receive a share of either
the proceeds received from the sale of oil and natural gas, or of
the value of the oil and natural gas produced.
(3) In recent years, due to fundamental changes in federal
regulation that restructured the oil and natural gas industry,
uncertainty has developed over the proper calculation of the value
to be used to determine natural gas royalties. This uncertainty
has lead to a substantial increase in litigation, for example, the
case of Estate of Garrison G. Tawney, et. al. v. Columbia Natural
Resources, et. al., that not only represents a significant cost to the oil and natural gas industry in this state, but the
unpredictable results of such litigation has increased the risk of
investing in the oil and natural gas industry in West Virginia to
the point such litigation acts as a significant impediment to the
industry, and by extension, the economy of this state.
(4) It is in this state's interest to promote a stable
business environment and to ensure that changes in federal
regulations and unsettled law do not impede development of the West
Virginia oil and natural gas industry and do not lead to
uncertainty and expensive litigation of existing business
relationships.
(5) The Federal Energy Regulatory Commission implements
national policy regarding the transportation and sale of natural
gas, and pursuant to law, regulates the natural gas industry in the
United States. The Federal Energy Regulatory Commission's Order
436, issued in one thousand nine hundred eighty-five, began the
process of fundamentally restructuring the natural gas industry in
the United States. As of the eighth day of April, one thousand
nine hundred ninety-two, the Federal Energy Regulatory Commission
implemented the restructuring of the natural gas industry by
issuing Order No. 636.
(6) Before the Federal Energy Regulatory Commission changed
its regulatory policy and restructured the natural gas industry,
major integrated interstate pipeline companies typically provided a bundled sales service that included not only the cost of the gas
produced, but also the cost of all services necessary to move
natural gas from the wellhead to the consumer. These costs include
gathering, processing, dehydration, compression, fuel,
transportation, line loss, storage and distribution (collectively
hereinafter "post-production expenses"). Before restructuring, oil
and natural gas producers generally sold natural gas to major
integrated interstate pipelines in the field, generally at or near
the well location, before any post-production expenses were
incurred. This wellhead price was then used to calculate
royalties. Costs occurring downstream of the wellhead were
embedded in the sales rate charged by the interstate pipeline and
paid for by the customer who ultimately received the gas.
Consequently, producers generally did not receive revenue in
connection with, or pay royalty on, post-production expenses.
(7) As a result of unforeseeable, fundamental changes to the
industry, interstate pipelines no longer buy natural gas from
producers. After deregulation, many post-production expenses
incurred by interstate pipelines were allocated to and borne by
producers. Today natural gas is normally sold by the producer to
a natural gas marketer or broker who buys at the well or at a point
substantially remote from the well. The price paid producers can
vary with the point of sale, and some of the revenue received by a
producer upon sale often includes recovery of post-production expenses incurred to deliver gas to the point of sale. When
post-production expenses are excluded from producer sales today,
the net amount is today's wellhead value.
(8) Most leases for oil and natural gas in West Virginia were
executed before the fundamental changes to the industry that
deregulated the wellhead price and restructured pipelines. As a
result, most leases generally only refer to wellhead price or value
and are silent as to the treatment of post-production expense. To
require payment of royalty based on the full price at delivery when
the price includes post-production expense results in the
producer/lessee paying royalty on revenues it does not receive, or
cannot retain, resulting in a penalty to the producer and a
windfall to the royalty owner who was not paid royalty on such
costs before deregulation occurred.
(9) After deregulation, the value of natural gas at the
wellhead can still be determined by adjusting the sales price to
exclude post-production expenses embedded within that price. The
use of such "net back" calculations yields a current wellhead value
for the payment of royalty.
(10) In the natural gas industry today, published prices for
natural gas delivered to interstate pipelines are widely available.
The cost of moving natural gas from the wellhead to the pipeline is
often known because the rates for these services are either
regulated by Federal Energy Regulatory Commission (in the case of gathering services provided by interstate pipeline companies), or
by the Public Service Commission of West Virginia (in the case of
intrastate pipeline gathering services). It is possible to
determine the wellhead price of gas by deducting post-production
expenses from published prices.
(11) The use of such "net back" calculations make it possible
to determine the value of natural gas at the same point where the
value was established for the payment of royalty prior to
deregulation and restructuring.
(12) Courts in other jurisdictions have interpreted leases and
continuing agreements in a manner that permits deduction of
post-production expenses when calculating royalty payable at the
wellhead.
(13) Just as the Legislature acted to change common law by
adopting the Oil and Gas Production Damage Compensation Act (now
West Virginia Code, chapter twenty-two, article seven), and to
prevent drilling on flat rate royalty leases (now West Virginia
Code chapter twenty-two, article six, section eight), and to
presume when leases are cancelled (now West Virginia Code, chapter
thirty-six, article four, section nine-a), the Legislature must now
act to strike a fair balance with respect to royalty payments.
(b) While being fully cognizant that the provisions of section
ten, article one of the United States Constitution and of section
four, article three of the Constitution of West Virginia, proscribe the enactment of any law impairing the obligation of a contract,
the Legislature further finds that it is a valid exercise of the
police powers of this state and in the interest of the State of
West Virginia and in furtherance of the welfare of its citizens, to
eliminate expensive, burdensome and wasteful litigation and to
promote investment in West Virginia and the stability of the
economy of the State of West Virginia.
§22-7A-3. Meaning and application of "at the wellhead" and
similar terms.
(a) The terms "at the wellhead," "at the well," "at the mouth
of the well," "in the field," "on the lease," "wholesale price,"
"at the well mouth" or similar language in a lease or other
continuing contractual agreement related to oil or natural gas are
not ambiguous and mean the place where oil or natural gas reaches
the surface of the earth and is captured on the well location. The
wellhead is an easily recognizable physical location that demarks
where oil and natural gas are brought to the surface and captured,
before oil or gas begins the journey to the ultimate end user; the
wellhead logically demarks where production ends and
post-production transportation, compression, line loss, processing
and marketing activities begin. Use of the wellhead as the point
of valuation for royalty calculation minimizes disputes because the
wellhead can easily be identified.
(b) The terms "at the wellhead," "at the well," "at the mouth of the well," "in the field," "on the lease," "at the well mouth,"
"well mouth" and "well head" are synonymous and mean where oil and
gas come to the surface of the earth at an oil and gas well and are
captured. Those terms define both the location (before
transportation begins) and condition (before processing) of the oil
and natural gas before post-production expenses are incurred. The
wellhead includes valves and fittings attached to the well, pumping
units, lift assemblies, heaters, injection pumps, and all on
location tanks, oil and gas separators, water separators, drips,
dehydration units, regulators and meters, and the pipe on the well
location that is between the well and any tank, separator,
dehydrator, regulator or meter situated on the well location. For
natural gas, the point where pipe leaves the equipment on the
location is the beginning of transportation and the beginning of
post-production expenses. For oil, the point where the product
leaves the tank on location is the beginning of transportation and
the beginning of post-production expenses.
§22-7A-4. Implied covenants in oil & natural gas leases and
calculation of production royalty.
(a) There shall be a presumption in all leases and agreements
regarding oil and natural gas royalty and overriding royalty that
in the absence of clear express language to the contrary, all costs
incurred in drilling the well and producing and capturing oil and
natural gas at the wellhead are borne by the producer/lessee. There shall also be a presumption that to the extent the sales
price received for gas is at a point downstream of the wellhead,
reasonable post-production expenses incurred directly or indirectly
by the producer/lessee should be excluded from the sales price when
calculating the amount due as production royalty.
(b) An implied covenant to market oil and natural gas
production shall not be construed in contravention of this statute,
nor may it require the producer to bear all of the costs necessary
or convenient to treat, transport or process the product to
marketable condition or to determine the amount of rental or
royalty due in connection with oil and natural gas.
(c) The implied covenant to develop the lease shall not be
construed in contravention of this statute, nor may it require the
producer to bear all of the costs necessary or convenient to treat,
transport, or process the product to marketable condition or to
determine the amount of rental or royalty due in connection with
oil and natural gas. Production and post-production expenses may
be allocated between the parties by contract. A presumption shall
exist that in the absence of clear, express agreement otherwise,
the amount of production royalty and overriding royalty due in
connection with oil and natural gas shall be measured at the
wellhead, and the value of the gas is to be determined by deducting
any post-production expenses embedded within the sales price.
(d) In the absence of express terms to the contrary, leases and other contractual agreements that provide that a production
royalty or overriding royalty is due with reference to "amount
realized," "amount received," "amount paid," "proceeds," "net
proceeds," "receipts," "net receipts," "wholesale price," "gross
receipts" or similar terms related to, or calculated or payable
with reference to, terms such as "at the well," "at the well head,"
"at the well mouth," "in the field," "on the lease," "at the mouth
of the well," "free of costs," "in the pipeline," or similar
language, all contemplate deduction of post-production expenses
incurred by producers from actual first sales proceeds when
calculating royalty and overriding royalty, and shall be construed
in accordance with the principle that the activity of production of
oil and natural gas ends when the oil or natural gas is captured in
tanks or pipes on the surface at the well location. The same
principle shall also apply when the lease or agreement does not
specify the place or manner of calculation of royalty.
(e) Additionally, to make certain the rights of the parties
under market value leases, in the absence of express terms to the
contrary, leases and other contractual agreements that provide that
a production royalty or overriding royalty is due with reference to
"market value," "market price," "wholesale market value,"
"wholesale price," "average prevailing price," "field price at the
well," "prevailing price in the field," "value," or similar terms,
all contemplate deduction of reasonable post-production expenses incurred by producers from actual first sales proceeds when
calculating royalty and overriding royalty.
(f) Unless a written agreement clearly provides otherwise,
production royalty shall not be due or payable on reasonable costs
incurred by the producer or paid to third parties for gathering,
line loss, fuel, processing, compression, transportation,
distribution or storage, regardless of whether such costs are
incurred before or after the oil or natural gas reaches the point
of first sale. The cost of post-production expenses as determined
in connection with proceedings of regulatory agencies, or amounts
not exceeding cost amounts approved by regulatory agencies for
reasonably comparable services, shall be deemed reasonable.
(g) Unless a written agreement clearly provides otherwise,
production royalty or rental shall not be due or payable with
respect to natural gas not sold because the natural gas is:
(1) Used or consumed transporting, treating, dehydrating,
processing or compressing natural gas; or
(2) Lost or unaccounted for during normal operations.
(h) The value, market value, proceeds and amount received for
natural gas sold by a producer pursuant to a short or long-term
contract is the price provided in the contract where the contract
was entered into in good faith and was commercially reasonable at
the time the contract was formed.
(i) This article shall not be applicable to cases in which a jury verdict has been returned, or a final decision rendered,
before its passage, but otherwise shall be fully retroactive to the
eighth day of April, one thousand nine hundred ninety-two, the date
of issuance of Federal Energy Regulatory Commission Order No. 636,
and shall be effective upon passage.
(j) If any provision of this act or the application thereof to
any person or circumstance is held invalid, such invalidity shall
not affect other provisions or applications of this act that can be
given effect without the invalid provision or application, and to
this end the provisions of this act are declared to be severable.
§22-7A-5. Production royalty reporting requirements.
(a) Effective as soon as practical, but not later than nine
months after this article is enacted, the following information
shall be furnished to the royalty owner with, or as part of, a
royalty statement:
(1) Identification by name or number of the lease or well that
is the subject of the royalty statement and production period
covered by the royalty statement.
(2) Volume of gas sold in mcf or decatherm, identified as mcf
or decatherm.
(3) The payee's royalty interest expressed in the form of a
decimal.
(4) Whether or not any post-production expenses are deducted
from the sales price when the royalty was calculated or paid. If any post-production expenses were deducted, an explanation of the
manner of calculation of royalty shall be provided to the royalty
owner at least once each year.
(b) From and after the date this article is enacted, producers
shall make reasonable efforts to respond to written inquires by
royalty owners regarding royalty statements, the calculation of
royalties and post-production expenses deducted from the sales
price paid to the producer.
(c) In the event the producer fails to reasonably respond to
written inquiries from a royalty owner, the producer shall be
liable to the royalty owner in the sum of two hundred fifty dollars
for each such failure to respond, which liability shall be the sole
remedy for violation of this section.
NOTE: The purpose of this bill is to create an act which sets
forth the manner of calculating royalty when the parties have not
specifically agreed otherwise. The bill also declares that the
producer does not pay royalty on gas not sold, while permitting
deduction of post-production costs incurred by the producer.
This is a new article; therefore, underscoring and
strike-throughs have been omitted.