Oil/Gas/Arkansas "Marketable Product - Minority Rule" Parameters
My father, brother and I share ownership of mineral intersts in Cleburne County, Arkansas. My brother and father have signed leases, but I have not. The AOGC integrated my interests four years ago which included specific provisions for bonus and royalty. I just recently found out that the well has been producing continuously for over 4 years now, and none of us have received a penny. My father was only recently offered a lease with XTO eneergy, the current operator, when it was discovered that he was left out of the original title/heirship process by the former operators/petitioners.
I have recently composed a formal demand letter to XTO Energy, holding them responsible, as the sole operator, for all sums currently owed to me - including 12% per annum accrued interest - per the AOGC integration order and Arkansas Title Codes 15-74-601 through 15-74-604.
Upon looking more closely at my father's lease, not only did XTO backdate the effective date of the lease to two months prior to the integration order, but I read a provision in it that allowed XTO to deduct "all costs incurred by Lessee in delivering, processing, or compressing" all gas produced.
Now, Upon researching legal precedent for "lawful deductions", the case most often, and recently, cited was Hanna Oil& Gas Co. v. Taylor,759 S.W.2d563 (Ark. 1988). This Supreme Court ruling established that while Arkansas has yet to explicitly state that the Lessee is required to bear all costs incurred in obtaining a "marketable product", it did rule that the compression costs, which were in question, are not deductible.
The 2011 Annual AAPL Meeting in Boston also established the following:
“Marketable Product” Rule
Colorado, Oklahoma, Arkansas, Kansas.
Lessee bears all of the costs associated with production
and transforming into a marketable product.
Only after gas has reached “marketable condition” can
post-production costs be deducted.
View that leases are silent as to allocation of post-
production costs and “at the well” is ambiguous
When lease refers to “gross proceeds” or “proceeds” at the well, sharing of post-production costs is not permitted.
Once gas reaches a “marketable
condition,” additional costs to improve or
transport the product may be shared.
Burden on lessee to demonstrate “marketable
Now, after scouring every Arkansas law, regulation, and statute I could find, it seems that the defining of allowable deductions is assumed to be dictated by the framework set aside in each individual two-party lease. And, after studying both the petition that One-Tec put to the commission, as well as the resulting order, there is no provision whatsoever as to royalty deductions of any kind.
So, my question to you would be: In my case, where no provisions concerning royalty deductions have been provided for, can ANY deduction, other than taxes, be defined as unlawful based on a "lack of clarity"? And, if additional deductions are taken, is that an issue that can be argued before the AOGC, or is that something that would have to be taken up with private litigation?
The "marketable product rule" you mentioned is great in theory, but in actuality has not been clearly enunciated or exemplified (i.e. defined..as in: What is "marketable condition" exactly?) by Arkansas (or Oklahoma, where I live) thus it is hard to apply expect on a case-by-case (i.e. someone decides to sue and get a ruling) basis.
Dana, the unfortunate truth is that in in the past, and to a lesser extent today, some companies will simply deduct post-production costs from EVERY lease, notwithstanding the fact that many lessors refuse to allow them in their leases. It's just more cost-effective for companies in some cases to risk being sued than it would be to rework their entire pay decks to satisfy the various payment requirements found in the many leases they are paying on. They feel most mineral owners are simply unlikely to sue them over a "few bucks" a month in deductions made, and that assumes the mineral owner is even aware of them.
That certainly doesn't mean you shouldn't try to have a good lease. A good lease will help you in the event you decide to enforce it in court, or in the event you end up being part of a class-action suit relating to post-production costs being deducted contrary to lease terms (and there have been plenty of such cases.)
Oil and gas accounting really IS a nightmare at many companies, and so I can understand (to a point) why some of them in the past chose to basically ignore no-deductions and other "non-standard" clauses in a lease in order to simplify their pay decks. However, with today's technology the fact that lease payment terms can vary greatly is no excuse for ignoring their terms; not to mention that it's dishonest. As I mentioned though, most royalty owners won't bother suing over a "few bucks" a month and so some companies continue the practice; knowing that.
To answer your question though, if the lease is silent, then the lessee will be able to legally deduct anything it wants to as long as it's allowed for in the lease, or not specifically disallowed, as long as the deductions are not contrary to state law. As for deductions pursuant to a forced-integration, I would think they the lessee would be allowed to deduct post-production costs needed to make a marketable product (whatever that is) if the order is silent in that regard.
The lessee's goal is to value your production as it comes out of the ground, and to that end will attempt to deduct your share of the costs related to ANYTHING they do to it between that time and when it is sold (even if to an affiliate.) The goal of any no-deductions clause added to a lease by a lessor is to get the lessee to value the gas (for royalty purposes) further "downstream" than the wellhead (i.e. after it's been compressed, dehydrated, separated etc. and is thus more valuable than where it came out of the ground.)
Private litigation (using an attorney EXPERIENCED in OIL AND GAS litigation) would be your best avenue in the event you felt deductions are being taken illegally or contrary to lease terms. The attorney would be well aware of any AOGC rulings, as well as any pertinent state laws affecting your royalty, and thus could advise on both. You could also contact the AOGC though of course, and explain to them your problem. They might be able to give you some guidance as well, and it would be free.
Hope this helps you out.
Frederick M. "Mick" Scott CMM RPL
The Mineral Hub