By Adam Natwick, AVP Senior Trust Officer
When it comes to oil and gas royalties, it can be an exciting experience for you and your family when your royalty checks arrive in the mail or via ACH each and every month. However, this excitement can be greatly tempered when you come to realize that you could have made a lot more had it not been for those pesky deductions that are taken out of your check.
These deductions are going to be determined by two main factors: The amount of production by the wells in which you have ownership, and the negotiated royalty percentage that is included in your lease. To rephrase: More production means more royalties, and a higher percentage in your lease means more royalties. You can see how these two factors combined can greatly increase your profits but also the expenses (deductions) associated with this production.
Deductions and reason we have them can be boiled down to the following: making the product marketable. What does that mean? Well, crude oil and natural gas is produced in its raw form and is almost never in sufficient quality to be marketed for immediate use. That is where these deductions come into play as there are costs associated with getting this product from raw and unusable (no value) to marketable and useful (value).
If you look closely, your check statements will usually show some or all of the following main deductions:
- Transportation – a charge for transporting the product
- Gathering – a charge for pipeline gathering of a product
- Compression – a charge for compression of the gas to a sufficient pressure to enter pipeline
- Processing – a charge for expenses relating to further refinement
Can you avoid deductions?
If you have not yet signed a mineral lease, it’s highly suggested that you consult with an Oil and Gas leasing expert. If you have already signed a lease, make sure to pay attention to the terms of that lease and renegotiate whenever possible. Some leases call for cost-free or “free of cost in the pipeline” means that a valuation point is established for the crude oil wherever it was delivered into the pipeline, and that all costs incurred before that point were not deductible. This does not guarantee you zero deductions, but it has the potential decrease certain deductions greatly.
As recently as June 1, the North Dakota Supreme Court voted to adopt the interpretation that established this point of value at the point of entering the pipeline. Once final, this decision is expected to establish a precedent upon which production companies will calculate these deductions and almost certainly means royalty owners with the correct lease language can benefit, which is why it is so crucial to ensure that you have the proper team not only negotiation your Oil and Gas lease, but ensuring that the terms of the agreement are being followed exactly as they should.
If you have any questions or would like to know more about oil and gas deductions, please give us a call!