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Farm Bureau officials help unravel the maze of oil, wells, royalties, taxes

By Carol McIntire

Farm Bureau officials help unravel the maze of oil, wells, royalties, taxes
Attorney Chris White (left) and Dale Arnold, director, Energy, Utility and Local Government Policy at Ohio Farm Bureau Federation, take questions from the crowd that filled the sanctuary of the Scio United Methodist Church Monday to learn about oil and gas issues.

Is buying an oil and gas well located on my property a good idea?

What is the difference between a net lease and gross lease?

How do I know if the oil producer who has a lease for my property is paying me the correct amount?

What if I don’t receive royalties?

Is mandatory pooling by oil and gas producers permitted in the state of Ohio?

What is the severance tax and who pays it?

These questions and many more were answered by Dale Arnold, director, Energy, Utility and Local Government Policy at Ohio Farm Bureau Federation, and Attorney Chris White with the White Law Office, Co. of Millersburg during an informational session March 17 in the Scio United Methodist Church.

The meeting, originally scheduled to be held in the church social hall, was moved to the church sanctuary when organizers ran out of chairs for the large crowd that attended.

Arnold addressed the issue of domestic well purchases, pointing out the positives and negatives.

“I have seen domestic well purchases that were good and others that were bad,” Arnold said. “Knowledge is power. Know what you are getting into before you make the purchase.”

He noted in most cases that tract of land is more than five acres and includes the release of any oil and gas lease associated with the well and property.

“The sale is filed with the county recorders office and becomes a part of the property deed…forever,” he noted. “The well will become an exempt domestic well only if the well is sold to the landowner, the products produced are used only on the property and no pipelines from the well are installed off the property. If pipelines are installed that go off the property, it becomes a utility,” he added.

Arnold reviewed regulatory compliance, decommissioning of wells, liability requirements, information posting, maintenance and operation requirements as well as plugging and restoration of wells.

“To decommission a well costs approximately $25,000 and right now it is very difficult to obtain liability insurance for an exempt domestic well so anyone considering the purchase of a well on their property should first make sure they are willing to accept the responsibility,” Arnold said.
Over 6,000 domestic well purchases have been completed in the last couple years. The Ohio Department of Natural Resources Division of Oil and Gas must approve all sales.

Miller, who said he is a landowner’s advocate attorney, explained net vs. gross leases and royalty share using a chart.

“I get many questions from clients asking me, ‘how much should I be getting?’ when they begin receiving royalty checks,” White said. “The royalty process is very convoluted. You have gross leases, net leases, market enhancement clauses, audit clauses; it all depends on the individual lease.”

Using the chart, White used the example of a 12.5 percent net lease. “I you have one of these older leases, you, the landowner are bearing the costs of production such as maintenance, hauling, disposal of brine; all costs associated with producing the product,” he said. “You get 12.5 percent of what is left after the costs are paid. “If you have a 12.5 percent gross lease, you get 12.5 percent off the top and the producer is responsible for the production costs. In short, regardless of the percentage of royalties your lease provides you, if you have a net lease, you pay the production costs. If you have a gross lease, the producer pays the production costs.”
Some leases now have what is known as a market enhancement clause. White said this clause allows oil companies to “reach around behind a gross lease and take royalties.”

“The devil is in the details when it comes to these clauses,” he said.
He also explained audit clauses by saying those who have this included in their lease agreement have the right to check what is going on with the oil and gas producer.

“This clause allows you to check their books, to audit them, see what is going on and keep them honest,” he explained. “Anyone who has an audit clause and did not do an audit on the company would be bad stewardship,” he said.

He suggested neighbors who are in the same drilling unit should take turns auditing the company. “You need to do it at least three or four months in a row to obtain a baseline,” he said. “You may not need to do it month after month for an entire year.”

Costs are associated with audits and White said he did not have estimates of the cost of an audit, but referred anyone interested in the process to the Ohio Farm Bureau for a list of accounting firms with experience in the field.

On the subject of royalties and what happens if an oil company does not pay them, White spoke about a case that is going to be argued before the Ohio Supreme Court on that subject.

“The question is: is a lease an interest in property or is it a license,” he said. “Even those arguing the case have no idea how it turn out, but it does have implications that could create big change,” he noted. “Ohio law treats a license very differently from an interest in property.”

While also addressed the question: When should I receive royalties?

“Know the terms of the lease,” he said. Know the practice of the producer. If you accept the payment schedule of the producer, but it is not what is in your lease, it is known as ratification by acceptance, which simply means you accept the way they are paying you.”

Most leases today call for a royalty check to be issued 120-180 days after production begins and monthly thereafter, according to White.

When it comes to lease holders who have an old well and are no longer receiving a royalty check, White suggested they check Ohio Revised Code section 1509.062 A1 as it relates to minimum productions.

“If a well produces a minimum of 15 barrels of oil or 100 MCF of gas for two consecutive years, it should be plugged or classified as inactive,” he noted. He said this could release the leaseholder and allow them to sign a new and better lease.

“If there are no royalties and no production, there is no lease,” he said, but unfortunately, most people have to be willing to fight in court to get this,” he noted.

White outlined Ohio House Bill 400, which would specify what information should be included on each royalty check stub issued in Ohio. “This would be a big help to lease holders, but unfortunately, the bill may be dead in the water, because big oil companies don’t want to release this information; they consider it proprietary.”

White and Arnold both tackled the issue of mandatory pooling, noting it is allowed in the state of Ohio and has been used in the last three years. The oil and gas company must seek approval from ODNR. Arnold said in the last three cases, seven cases have been scheduled for a hearing before the ODNR review board, but were settled before they got there.

Arnold presented an update on the proposed severance tax, HB 375.

“Columbus is finally starting learn and listen to a number of concerns from eastern Ohio,” said Arnold. “In the latest proposal, they are making sure ODNR has funds to manage the oil and gas industry and plan to place a percentage of the funds in a fund until 2015. That leaves a big piece of money in the middle and the question is: how do we divide that up? Seems the devil is in the details when it comes to that part.”

In response to who will pay the severance tax: the landowner or the production company, Arnold simply stated: “If you have a net lease, you will pay the severance tax; if you have a gross lease, the producer will pay the tax.”

The meeting was hosted by the Farm Bureau Public Policy chairmen from Carroll, Harrison, Jefferson and Tuscarawas counties.  

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