Rich and Strange Aeons

Posted by by Jacob Orledge, North Dakota Monitor

https://www.propublica.org/article/north-dakota-oil-mineral-rights-comparison

by Jacob Orledge, North Dakota Monitor

This article was produced for ProPublica’s Local Reporting Network in partnership with the North Dakota Monitor. Sign up for Dispatches to get our stories in your inbox every week.

Millions of Americans own the rights to oil and gas underground. When they’re approached by an energy company to lease out those rights, they’re offered a cut of the revenue, called a royalty.

“Royalties saved our place,” said James Horob, a farmer in northwest North Dakota, who used oil royalties to rescue his family’s farm from bankruptcy in 2008 and replace equipment that had been auctioned off. “We’re lucky to have what we got.”

However, the royalty income that mineral owners like Horob get can depend in part on the state where they live. In North Dakota, estimates show that in recent years companies have been deducting hundreds of millions of dollars annually to help cover the costs incurred once oil and gas leave the ground on their way to being sold. North Dakota officials have not stepped in to help royalty owners, even though the state, in its own leases, has explicitly prohibited oil and gas companies from taking deductions from government royalty payments since 1979, as the North Dakota Monitor and ProPublica reported this month.

“It’s tough to think that there isn’t some better solution out there than what we currently have,” said Aaron Weber, a Watford City-based attorney who represents mineral owners in North Dakota.

In contrast to North Dakota, at least seven oil-and-gas-producing states have taken either legislative or judicial action to restrict the costs that can be deducted from royalty owners’ checks. Here are the key ways North Dakota differs from these other states when it comes to protecting the interests of royalty owners:

North Dakota Gov. Kelly Armstrong has called the oil and gas industry the “No. 1 driver of our economy” in the state. The industry contributed $32 billion in oil and gas taxes to state and local governments between 2008 and 2024, according to the Western Dakota Energy Association, which advocates for energy-producing communities. That same study found that more than 50% of all local tax collections are tied to oil and gas.

Oil and gas companies owed the state’s private mineral owners, like Horob, an estimated $4.6 billion in 2023 before deductions, according to North Dakota State University research.

Deductions from that royalty income — which can vary greatly by company and mineral owner — are deeply contentious in the state: Companies say they’re withholding transportation and other expenses that should be shared with royalty owners; the owners say those “postproduction deductions,” as they are generally known, shouldn’t be permitted in most circumstances.

The energy industry says the postproduction deductions, which began surging about a decade ago, reflect changes in the oil business. Oil, discovered in the state in 1951, used to be sold primarily at the well site. Now, oil and gas are often sold farther away, and companies incur costs to process and transport the minerals. The companies say this enables them to fetch a better price, benefiting the royalty owner as well. The industry also attributes an increase in deductions to regulations added in 2014 to reduce natural gas flaring, requiring companies to make new investments.

Owen Anderson previously worked for North Dakota’s regulatory agencies and helped draft language to prohibit companies from taking deductions from royalty payments owed to the state. Anderson, a law professor who studies the energy industry, called the issue “a big, big deal.”

Armstrong declined to comment.

Around the country: State supreme courts in Colorado, Oklahoma, Kansas and West Virginia have determined oil and gas companies are responsible for the costs that make the commodities “marketable.” That means there are limits on the expenses that companies can pass on to royalty owners after the minerals leave the ground. Those expenses may include removing impurities, gathering the products in central locations, and transporting the oil and gas to where it will be sold.

Still, the costs that companies can deduct from royalties vary by state, depending on how states define when a product is marketable.

West Virginia provides royalty owners the most protection from deductions, the result of state Supreme Court of Appeals decisions in 2001 and 2006. In those cases, the court found that companies cannot pass on costs to the owners unless a lease explicitly allows it. This matters because many leases across the country were written before shifts in the industry led to more extensive deductions, so most early leases don’t explicitly mention them.

“The default is, you cannot take deductions unless they’re specifically agreed to,” said Tom Huber, the leader of West Virginia’s royalty owner association. The 2006 court decision “basically says if there’s ambiguous language, you go on the side of the royalty owner because the company constructed the lease,” he said.

That decision also determined that deductions cannot be taken unless leases specify which costs can be shared and lay out how the deductions will be calculated. Rulings in 2024 and 2025 confirmed the court’s stance.

Courts in Colorado, Kansas and Oklahoma also have placed limits on what costs can be deducted from royalty payments. Those courts have determined that companies must make the oil and gas “marketable” before costs can be deducted from royalties. Each state uses different criteria to determine at what point in the process the commodities become marketable.

Courts in other oil-and-gas-producing states have taken a legal approach that is more friendly to the industry. Texas, Louisiana, Mississippi and others have determined that companies can deduct costs incurred between the minerals’ extraction and when they are sold unless there is lease language to the contrary.

That is also true in Pennsylvania. But in 2015, the state’s attorney general cracked down on a company, Chesapeake Energy, alleged to be taking artificially excessive deductions. The attorney general’s lawsuit, prompted by complaints from landowners, was resolved with a $5.3 million settlement for royalty owners and an option to receive royalties moving forward without deductions. The company did not admit wrongdoing in the settlement.

In North Dakota: As is the case in Texas, Louisiana and some other states, the North Dakota Supreme Court has sided with companies. In 2009 and 2021, the court ruled that royalties, in most cases, should be based on the value of the oil and gas when the minerals are extracted from the ground. Costs incurred between when the minerals are extracted and when they are sold can be shared proportionately between the oil company and the royalty owner, the court found. Companies can deduct these costs unless a lease clearly specifies otherwise.

I hope that the people in North Dakota wake up and realize how much money should be in their pockets instead of industry’s pockets.

Josh Swanson, a Fargo-based oil and gas attorney who is involved in multiple pending lawsuits contesting deductions, said he’s concerned companies will impose even more “excessive” deductions unless courts place limits on what the companies can do.

“Operators are going to continue to be very aggressive in the amounts they’re taking for postproduction costs until a court tells them they’ve overstepped and gone over the line,” he said.

In responses to questions from the North Dakota Monitor and ProPublica, officials from three energy companies that operate in North Dakota said they follow the language in the leases when determining what costs they can deduct from royalty payments. Older leases often don’t mention deductions, however.

Around the country: Some state legislatures have passed laws that limit postproduction deductions. Laws in Wyoming and Nevada, passed in 1989 and 1991, respectively, prohibit companies from taking deductions for specific expenses incurred soon after extraction, such as gathering the commodities from well sites to get them to central hubs.

In Michigan, a law passed in 1999 allows companies to deduct from royalty income only two types of expenses — transportation and some gas treatment costs — unless a lease explicitly allows for other reasons.

The West Virginia Legislature, meanwhile, has helped royalty owners with what it called “oppressive” leases. Many West Virginia mineral owners receive royalties from “flat rate” leases signed as long as a century ago that provide owners a few hundred dollars a year instead of a percentage of the revenue. Calling those leases “unjust,” West Virginia lawmakers passed a measure in 1982 that guarantees owners at least 12.5% of the revenue, effectively overriding the original leases. A 2018 amendment requires that postproduction deductions not be taken from this royalty.

West Virginia’s law ensuring a minimum royalty for those leases is enforced by state regulators, who will grant new drilling permits only if the company files an affidavit promising to adhere to the law.

Huber said his state’s legislative and judicial branches have historically tried to protect landowner and royalty owner rights while encouraging the growing natural gas industry.

“It sounds like North Dakota doesn’t have that, and that’s a shame,” Huber said. “I hope that the people in North Dakota wake up and realize how much money should be in their pockets instead of industry’s pockets.”

In North Dakota: Legislators and state officials have argued that disputes should be settled in the courts. They rejected a measure in 2021 that would have prevented companies from taking deductions unless explicitly allowed in a lease, and another bill in 2023 that would have required oil companies to provide mineral owners with more information about how royalties are calculated.

State Sen. Dale Patten, a Republican from Watford City, said the Legislature is ill suited to address concerns related to private contracts and royalty owners should seek relief from the courts. Legal action would be prohibitively expensive for most families, however.

“We’re getting into really complicated issues. And actually in my mind the proper venue to solve that would be in the courts,” said Patten, who has served as chair of the Senate Energy and Natural Resources Committee. “And you deal with it on a company-by-company basis.”

Public officials have argued that royalty owners should have negotiated language into their leases to prohibit deductions. But leases in many cases were signed decades ago, before this was an issue, and don’t mention who should pay for postproduction costs. The leases don’t expire unless production stops. And in new lease negotiations, mineral owners are at a disadvantage against companies unless they own a large percentage of the mineral rights in the area.

“It’s really difficult for a private landowner to negotiate a no-deductions lease in North Dakota,” Anderson said.

Ron Ness, president of the North Dakota Petroleum Council, which represents the oil industry, warned that regulating or limiting the expenses that companies pass on to owners would discourage oil and gas investment in the state and drive business away.

“It’s one of the most foolish things the state of North Dakota could ever do, is to try and essentially financially punish operators from getting a better price for their commodities by not allowing postproduction costs on some of those things,” Ness said in an interview.

But Weber, the attorney who represents mineral owners, said it’s time for the Legislature to get involved and address the concerns.

“Given that the court has already selected what it is going to do,” he said, “the only way to fix it is to get it to the Legislature.”

https://www.propublica.org/article/north-dakota-oil-mineral-rights-comparison