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Deductions: The Good, Bad and Ugly

by Shannon Reed, Heritage Mineral Management

Shannon ReedWith today’s low prices for oil and natural gas, clients want to be sure they are receiving all of the income they are entitled to. One way we play an important role in that is to keep up with the changes – including the standard language of the Oil and Gas Lease as it pertains to proceeds a mineral owner receives for the products sold off the leased premises.

Traditionally, an Oil and Gas Lease contains a “Gross Proceeds” clause in which the Lessee agreed to pay the Lessor for gas, of varying nature or kind, produced and sold or used off the leased premises (THE GOOD). However, we have seen a shift in the industry towards oil and gas companies seeking a “Net Proceeds” clause in which the Lessee agrees to pay Lessor for gas (including casinghead gas) and all other substances from the sale thereof, less a proportionate part of the production, severance and other excise taxes and the cost incurred by Lessee in processing, gathering, treating, compressing, dehydrating, transporting, and marketing, or otherwise making such gas or other substances ready for sale or use (THE BAD). These deductions are now one of the hottest topics in the oil patch.

As a result, one has two distinct different points of view when it comes to negotiating the deduction terms of an Oil and Gas Lease. GROSS PROCEEDS –VS– NET PROCEEDS. Heritage Mineral Management, as Agent for our clients, continues to negotiate leases with the “Gross Proceeds” clause. The opposing point of view of the oil and gas companies (Lessee) is that they should be able to share the cost to make the product marketable. In an effort to further solidify our clients’ position, Heritage will seek to add a “NO DEDUCTIONS CLAUSE” as a special provision to the lease. This provision emphasizes that royalties payable under this lease shall be made without deduction. An exception is often made per a court decision that allows the sharing of some costs if the result is more profitable (example: transportation charges to deliver gas to a different market that brings a price that outweighs the extra expense). Otherwise, Heritage goes great lengths to avoid deductions.

In recent years, many oil and gas companies have been investigated and class action lawsuits have been initiated as a result of these improper deductions. Many leases did not contain provisions authorizing deductions for the cost of converting gas to marketable condition (THE UGLY).

Our team proactively reviews monthly revenue to check for deductions that may or may not be taken against our mineral owners’ royalty income. As a result of this research, Heritage has been successful in obtaining refunds due to our clients for “deductions” that should not have been taken, including going as far as opting out of class action lawsuits and pursuing a more fair refund on our own. At Heritage Mineral Management, we provide expertise, teamwork, and extensive research to best serve client needs—and today’s deduction issues are an example of how we can help.