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EQT Suing West Virginia Over Flat-Rate Leases, Royalties

EQT Corp. has filed a lawsuit in federal court arguing that West Virginia’s flat-rate lease statute is unconstitutional. Legislators last month passed a bill prohibiting post-production expenses from being deducted from flat-rate royalties.

The company operates more than 5,000 wells in the state and has 1,700 flat-rate leases that were signed decades ago. Flat-rate leases are often paid monthly, quarterly -- or in EQT’s case -- annually. They are not tied to the volume of oil and gas produced or marketed. While the flat-rate leases are uncommon, EQT said in its complaint that it likely holds the largest number of them in the state.

The flat-rate statute was enacted in 1982, requiring operators to pay lessors a 12.5% royalty on the sale of natural gas “at the wellhead,” or when it is extracted from the ground. The wellhead price is typically calculated as the interstate pipeline index price less the post-production expenses incurred to get the product to market, such as gathering, compression and transportation.

Senate Bill (SB) 360  passed the legislature by wide margins and was signed into law by Republican Gov. Jim Justice last month. It amends the 1982 law and applies only to flat-rate leases. Lawmakers removed the “wellhead” language and replaced it with “the first point-of-sale” as the royalty valuation point.

“The designation of the point-of-sale as the valuation point is significant,” wrote attorney Robert Burnett, of Pittsburgh-based law firm Houston Harbaugh, in a blog post after the bill passed. “Most, if not all, post-production costs are typically incurred between the wellhead and the downstream point-of-sale. When a royalty is calculated and valued at the point-of-sale, there are no intervening costs which must be netted out to arrive at a fictional wellhead value.”

EQT argues that the law, and the legislation that would find it paying more to landowners, both violate the contract and due process clauses of the U.S. Constitution. “The flat-rate statute thus substantially impairs EQT’s vested drilling rights under its flat-rate leases and imposes unconstitutional conditions on EQT’s exercise of its property rights under those contracts,” says the company’s lawsuit, which was filed last week in the U.S. District Court for the Northern District of West Virginia.

EQT has named West Virginia Department of Environmental Protection Secretary Austin Caperton as the defendant because it is his responsibility to enforce flat-rate statute.

Industry representatives told NGI’s Shale Daily after SB 360 passed that they expected EQT, which was already challenging the statute in a state court before the legislation was drafted, to file a lawsuit against it.

The bill was sponsored by Republican state Sen. Charles Clements to reverse a controversial West Virginia Supreme Court ruling last year that favored EQT Corp. and would have allowed it to continue deducting post-production expenses from flat-rate royalties.

Most of EQT’s flat-rate leases provide for a $100-300 annual payment to the lessor for each producing natural gas well, in addition to enough free gas for a lessor’s house, according to the company. Many of the leases are perpetual, meaning that they remain in effect as long as oil and gas is produced. The leases also provide an additional one-eighth royalty for any oil produced.

Instead of negotiating amendments to their leases, EQT claims in its lawsuit that landowners have effectively lobbied the state legislature on two occasions now with the passage of the 1982 law and SB 360, which is set to take effect May 31.

“The legislature has thus twice substantially impaired EQT’s contract rights by retroactively awarding the lessors more compensation than they bargained for in the leases, based on some ill-defined notion of ‘fairness’ in the distribution of the ‘natural wealth of the state’ as between private parties: originally by enacting the flat-rate statute and more recently by gifting the lessors an even greater share of the fruits of EQT’s decades of investment,” the company’s lawsuit says, in reference to some of SB 360’s language and its work in the state over the years.

The bill met little resistance from the industry on its way to passing. It was supported by groups such as the West Virginia Royalty Owners Association (WVROA) and the West Virginia Farm Bureau.

In an interview late last month, WVROA President Tom Huber said there are more flat-rate leases in the state than some might think, adding that he has one for his property. Many of them, Huber said, were executed for sizeable plots of land, ranging from 200 to 500 acres or more, at a time when farms were much larger, in counties that have today also become hotbeds of Marcellus Shale development.

“There’s one estimate that around a quarter of the acreage in Wetzel County is held by flat-rate leases,” he said. “That’s a lot of acreage we’re talking about.”

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