New bill aims to protect landowners' gas royalty checks from drillers

Since the natural gas extraction boom hit Pennsylvania, some landowners who lease their properties to gas companies for drilling purposes have become the target of bare minimum payments by those very gas companies legally bound to pay them royalty checks for that privilege. 

State lawmakers have heard numerous examples of drilling companies drawing gas from leased properties, only to pay the landowners next to nothing after deducting their share of the costs of piping and processing the gas for market. 

In an effort to increase fairness and transparency for landowners who receive natural gas royalties, state Rep. Jason Ortitay (R-Washington) recently proposed legislation that would define what post-production costs are and what is considered to be an acceptable deduction. 

In addition, the legislation would allow landowners to receive a written summary of any deductions taken and create an audit provision allowing landowners to review the records to confirm the authenticity of those deductions. 

House Bill 1708 would also guarantee all sales take place as an arm's-length transaction to ensure that appropriate business practices don’t jeopardize royalty owners, as well as prohibit the issuance of negative balance royalty checks. 

“My office has received numerous calls regarding concerns with gas royalty payments,” said Ortitay. “While my proposal – or any legislation - cannot change existing leases, if approved, it would put in place important protections to make sure landowners receive the royalties to which they are entitled.”

This isn’t the first attempt by the General Assembly to help landowners receive their fair share of gas royalties. Rep. Garth Everett has reintroduced legislation, House Bill 557, for the third time to clarify the Guaranteed Minimum Royalty Act (Act 60 of 19179) to ensure that landowners are paid the state minimum royalty payment of 12.5 percent or one-eighth. 
Natural gas producers commonly deduct a leaseholder’s share of expenses involved in getting gas to market, such as compression, dehydration, transmission and other costs incurred between the wellhead and a final market point of sale. 

“When these expenses are deducted, final royalty payments often are below the statutory one-eighth and sometimes result in no royalty payment at all,” said Everett in a co-sponsorship memo earlier this year. “We believe it’s obvious that this was not the intent of the General Assembly in 1979.” 

In 2010, the Pennsylvania Supreme Court determined in the case of Kilmer v. Elexco Land Services Inc., that the current statute did not address the deduction of post-production costs and stated that the “General Assembly is the branch of government best suited to weigh the public policies underlying the determination of the proper point of royalty valuation.” 

“When PA landowners signed leases for a percentage of the value of the gas produced from their property, they were assured by the gas companies that they would receive no less than the statutory one-eighth – not something significantly less than that because of deductions,” said Everett. 

Ortitay, however, doesn’t support Everett’s bill, saying that it is in violation of contract law and only helps landowners and their future contracts with oil and gas companies, not current, lease-holding landowners. 

“[Landowners] want to be paid the royalty price, the sale price at the end. That’s something that we can certainly have a discussion about but when you read that whole contract, what you have to take into consideration is that you’re interrupting the entire economic model that the company has laid out as the landowner,” said Ortitay. “Some people negotiated post-production costs for a lower royalty percentage, some say they want a higher rate at 17 or 18 percent, which is higher than the 12.5. There were a lot of different components that went into negotiating a lease. To come back and change that, you’re changing the whole model and I think that’s where you get into the issue of constitutionality and whether it’s fair or not.” 

“I don’t think it will help any current lease holder because this would only be for future contracts. You can’t go back and change a contract that was already signed into law,” he added. "So I’m trying to provide help to people right now that doesn’t violate the constitution and actually gives them what they want.” 

Ortitay believes the four provisions of his bill – no negative royalty checks, no gas transaction outside of the arm’s-length transaction of market value, an audit provision and defining the post production cost in statute – are fairer provisions for landowners and are constitutionally sound. 

“I think putting these four provisions into statute, it gives people immediate peace of mind and allows them to say, ‘I can go look at your books anytime I want and figure out if you’re violating my lease,’” said Ortitay. “I want people to be able to sleep well at night and not feel like they are being taken advantage of because I want them to get the money they deserve.”

But the National Association of Royalty Owners (NARO) doesn’t agree and states that Ortitay’s bill actually stands to take many of the rights of landowners away, which Everett’s HB 557 stands to protect. 

“It’s being billed as being transparent, but it serves to actually just take it all away,” said Jackie Root of NARO. “They talk about the 12.5 percent but then they want to price it at well head, which actually allows all the deductions to be taken. It delineates all the deductions and says they can take them and even says they can’t reduce the royalty to below zero. Another way to say that is you can reduce the royalty to zero but not below. The point of a royalty is not to reach zero.” 

Root strongly denies Ortitay’s claims that HB 557 is unconstitutional, stating that NARO just wants to see royalty landowners receive what is rightfully theirs. 

“We have several attorneys that have weighed in on this that say it is absolutely constitutional. We believe this is just an industry roadblock,” said Root. “We want our fair share. We don’t want more, we’re not asking that we receive more than our contracts allow for, but [oil and gas companies] need to be held to what they have promised. It doesn’t give them the license to steal from the people who own the resource to begin with, and that’s really what’s happening with some cases.” 

House Bill 1708 currently stands before the House Environmental Resources and Energy Committee with no scheduled timeframe as to when it will be brought up for a vote. Everett’s House Bill 557 is currently the subject of a potential discharge resolution, which could force the issue to the House floor, but has not otherwise received action this session.

Alanna Koll is the Pittsburgh bureau chief of The PLS Reporter, an online news site dedicated to covering Pennsylvania government.