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West Virginia High Court Reverses Royalties Ruling, Allows Post-Production Deductions

The West Virginia Supreme Court has sided with EQT Production Co. in a dispute over natural gas royalty payments, ruling that producers can deduct post-production costs in calculating the price at the wellhead.

In an opinion handed down Friday, the state's high court ruled 4-1 in favor of EQT's position that the only way to arrive at the wellhead price required to calculate royalty payments under state law is to deduct post-production expenses from the sales price.

"We do not believe that permitting lessors to benefit from royalties based upon an enhanced, downstream price without commensurately sharing in the expense to create the enhanced value effectuates the 'adequate' and 'just' compensation sought by the statute," Chief Justice Allen Loughry wrote in the majority opinion. "Nowhere within the stated purpose did the legislature utilize language which enabled the 'maximum benefit to landowners' construction adopted by the previous majority."

Friday's opinion reverses a previous decision by the court that sided against the industry and prohibited the deduction of post-production costs. Earlier this year, the justices ruled 3-2 to withdraw the earlier opinion and rehear the case.

Justice Brent Benjamin who wrote the previous opinion has since left the court. Justice Elizabeth Walker, who replaced him, joined the majority in agreeing to rehear the case. Walker was elected in November.

EQT filed a petition for rehearing in December, arguing that the high court misinterpreted state royalties laws, misapplied a previous state Supreme Court ruling on a similar case and exceeded the lower court's question.

In explaining the court’s decision to reverse its previous ruling, Loughry pointed to a similar case that came before the Pennsylvania Supreme Court. "While the language" of West Virginia's royalty statute "differs from that of the Pennsylvania statute, the import is the same: both were intended to guarantee a fair, minimum royalty to lessors calculated at the wellhead. The petitioners fail to persuade us that this purpose is undermined in any fashion through the pro-rata deduction or allocation of costs incurred to enhance the value of the oil or gas."

The plaintiffs in the case are a farm owner and other royalty interest owners that brought the challenge against EQT. The farm owner claimed that EQT had been wrongly deducting expenses for years.

In a concurring opinion, Justice Margaret Workman wrote that the EQT case raises policy issues that the state legislature may need to resolve.

Workman brought up previous cases in which royalty owners alleged that affiliate transactions or other means were used to improperly manipulate the sales price to the benefit of the producers. "The petitioners' allegations...are, unfortunately, not without precedent," she wrote.

Workman said the opinion "may elicit criticism for placing what may be characterized as an unfair burden on a landowner-lessor to" determine whether a producer is underpaying on royalties. "Regrettably, that is the unavoidable consequence of the court's decision. To alleviate such a burden other states have enacted legislation designed to compel the lessee to affirmatively provide information and be accountable to those with whom such costs will be shared."

The case "underscores...the necessity of the Legislature to address these policy-laden issues and declare, by statute, the will of the state's citizenry in this regard."

The issue of post-production deductions has been controversial in other onshore basins in recent years. The Pennsylvania attorney general's office filed a lawsuit in 2015 against Chesapeake Energy Corp. alleging deceptive business practices related to the deductions. And late last year, the Ohio Supreme Court ruled that landowners challenging post-production costs must have their cases heard by trial courts on an individual basis.

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