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Market Enhancement Clause, a.k.a. Post-Production Costs

In law school we're taught quite a few things about contracts that I think everyone should be taught in high school.

One of those things is that the heading of a contract, or the heading of a clause in a contract, does not control what the contract or the clause actually says.  For example, I've seen plenty of documents that say they're wills, but when you read through them, they actually set up trusts.  While the will still has to go through probate, it's going to create a trust in the end.

Most oil and gas companies will give a name to their document that roughly describes what it actually is.  A lease is usually just a lease, a modification is usually just a modification, etc.

But when it comes to the clauses in a lease, it's a different story.  The heading will always tell you the main point to that clause.  But the devil is in the details.

For example, for decades there has been a clause in every lease that gave the producer the right to deduct post-production costs from the royalty.  For those who might not know, post-production costs are what it costs the producer to do things to the gas, such as transport through a pipeline, dehydrate, compress, clean up, and separate the different types of gasses for marketing, to name a few.

Here in West Virginia a couple years ago there was a big, high profile case (Tawney v. Columbia Natural Resources) about royalties and post-production costs that went to the West Virginia Supreme Court.  The Court sided with the royalty owners and said that post-production costs could not be passed on to the royalty owner unless they were specifically spelled out in the lease.  It got a lot of press because it was a $404 million dollar settlement (which was negotiated down to $380 million.)

Everybody heard about the Tawney case.  Royalty owners got wise and started asking for no post-production costs or deductions.  Oil and gas companies didn't like that.

No More Post Production Costs Clause

So instead of putting a Post-production Costs clause in their leases, they put in a Market Enhancement clause.  Their landmen could point to their lease and say, "we don't include a post-production costs clause."

While it was true, it was also a blatant lie.

The Market Enhancement Clause Is Born

The Market Enhancement clause was nothing more than the old Post-production Cost language, changed around a bit, with an emphasis on how the costs being deducted actually increased the value of the gas.  If you parsed the old language and the new language, there was almost no difference.

When someone called the landmen on it, the landmen would respond, "those costs actually increase the amount of royalty you get because they increase the value of the gas."

While that statement is (possibly) true, you have to remember that everything the producer does increases the value of the gas.  Building a pad, drilling the well, flaring the well, even the title work increase the value of the gas because if none of those things happen, the gas will have literally no value.  That's the argument that the landmen are making, and it's just wrong.  You will get more royalty when no post-production costs are deducted from it.  A post by John McFarland from Oil and Gas Lawyer Blog does an excellent job of explaining how.

The takeaway here is that you really need to read everything that's in a lease.  You can't skim the headings and know for sure what you're signing.

And always get no post-production costs.

 

Kyle Nuttall is a former landman and practicing lawyer in the State of West Virginia.  You can view his web site at www.nuttalllegal.com.

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Comment by Lisa Kirts on October 1, 2013 at 12:36pm

We have a "Market enhancement" clause in our lease..... can we just scratch that?  I don't like the thought of having to pay for their job when my interests are low....  

 

Comment by Kyle Nuttall on May 22, 2013 at 12:46pm

The nice thing about West Virginia is that there's no forced pooling.  They tried to get a bill for it through the legislature last session, and were unsuccessful.  Where are your minerals located, T L Shields?

Comment by T L Shields on May 22, 2013 at 10:38am

Great remarks and dead on.  As an old geologist I saw the transition in the 1980s to PPE... "Market enhancement" is a mealy mouth way of doing it. I write EXPLICIT language saying I am not responsible for it, won't pay it, and they can force pool me first before I sign it.

Comment by Kyle Nuttall on May 21, 2013 at 3:00pm

There is also a good discussion going on about post-production costs on another part of the forum.  It was started by r w kennedy, and you can find it here.

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