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What is a "no deductions" clause, and do I need it in my oil & gas lease

At a minimum, a no-deductions clause is supposed to prevent your lessee from deducting the costs they incur in transforming your share of the raw natural gas they bring to the surface into marketable condition.

What is Marketable Oil & Gas?

“Marketable” can be defined as “sufficiently free from impurities that it will be taken by a purchaser.” This is a vague definition at best however, as there are many types of purchasers, each of whom can have different standards for marketability. Unfortunately, most jurisdictions, with the possible exceptions of Wyoming and Colorado, have failed to enunciate a standard for marketability and thus would have to look at the specifics of each case to determine whether this gas or that gas had been placed in “marketable” condition prior to sale in the event a lessee was challenged by their royalty owner.

Don Be Too Restrictive In A No Deductions Clause

That said, a no-deductions clause is still a good clause to have in your lease, though in my opinion you don’t want to make it too restrictive by disallowing deductions for improving already marketable gas or transporting it to a purchaser in another town who is offering a better deal (even after deductions.) If enough lessors (mineral owners) insist on a strict "NO-deductions" clause in their lease, it may discourage the lessee from working hard to find the best market they can, since a strict no-deductions clause will require them to pay not only for making the gas marketable at the well, but also will require them to pay for transporting your share of the gas to a potentially better market downstream (away) from the well.

In such cases they may just decide to sell to a "wellhead" purchaser rather than paying your share of the costs needed to get it to a better buyer downstream. The wellhead purchaser will offer your lessee (and thus you) less than the buyer downstream is paying since it will cost the wellhead purchaser money to transport the gas to that purchaser. I therefore usually allow deductions if (and only if) doing so results in me getting a higher price (even after deductions) than I would have received if my lessee sold to a wellhead purchaser.

I feel this "allowance" benefits both myself and my lessee as it means we both are sharing in the costs of obtaining a better market that results in a better net price (price after deductions) than could be had by selling to someone closer to or at the wellhead. It seems fair to me to offer to help pay to move my share of the gas to a better market location if one is available. "Moving" the gas might mean buying space on a wellhead purchaser's line (while not actually selling to them) and transporting it using that line to another purchaser's pipeline further "down the road" who is offering a better net price.

Gas Marketing Is Complicated

Confused yet? Well, I agree it certainly can be confusing! Gas marketing is complicated because there are so many variables, including some that are beyond the scope of this article such as how royalty is calculated on heavier gasses (ethane, butane etc.) that are removed (by processing) from the wellhead gas stream. There is lots of room for mischief by oil companies, especially vertically-integrated companies who may sell to their affiliated purchasers or processors and base your royalty payment on that sale, rather than the sale from their affiliate to a true arms-length purchaser.

Because we, as royalty owners, aren’t usually privy to the gas sales contracts used and thus can’t always verify whether we are being paid correctly, I usually add language relating to affiliate sales in my no-deductions clauses.

On a positive note, I’ve also had very good experiences with some companies. These companies are as transparent as they can be with me and their often overworked staffs at least make an attempt to explain to me exactly how my royalty is calculated. With these companies I feel less of a need to insert a lot of strict clauses into my leases.

 

Frederick M. "Mick" Scott CMM, RPL

Manager at THE MINERAL HUB

www.mineralhub.com

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Comment by Frederick M. "Mick" Scott on July 1, 2013 at 11:18am

Buddy; thanks for you comment. To be clear though, I didn't say I wanted to assist them in making the gas marketable (which I agree is their job.) I said that I would be willing to share in the costs of transporting already marketable gas to a better market, where we would both be paid more, even after the costs incurred in getting it there. While the company may decide to move the gas to a better market anyway, I don't feel it's fair to ask them to move MY gas as well as theirs to the better market and give me the benefit without charging me my share of the costs. In fact, some smaller companies may indeed decide to pass up better marketing opportunities if the lessor is not willing to proportionately share the costs, especially if that lessor happened to own all the minerals in their unit.

Comment by Buddy Cotten on May 27, 2013 at 11:20pm

Just to clarify my understanding.

If I had a 20% royalty and had 100% of the minerals in the well, then to assist the operator in making the gas marketable and increase its value, you recommend paying 20% of the costs out of your share of production?

What I want to know is this.  The operator is going to pay all the costs anyway.  What is the incremental cost to bring your share of royalty gas to market?  A few dollars of diesel to run the equipment?  The gas line is the same, the compressor is the same.  And the landowner has no tax advantage on the equipment, depreciation and deduction and the whole ball of wax.  

Thanks in advance.

Buddy Cotten

Mineral Manager

Comment by T L Shields on May 22, 2013 at 10:46am

Mick's "right on" - trust him.

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