ODNR Drops “Market Enhancement” Clauses From its Forced Pooling Orders
Posted August 12, 2021
In follow-up to its July 20, 2021 press release regarding unfair “market enhancement” clauses included in the forced pooling orders issued by the Ohio Department of Natural Resources (ODNR), Gateway Royalty applauds the ODNR for eliminating the “market enhancement” clauses from recently issued forced pooling orders.
Chris Oldham, president of Gateway Royalty, LLC, commented, “This is great news for unleased mineral owners. Operators can no longer use a ‘market enhancement’ clause to convert what’s supposed to be a ‘gross proceeds’ royalty to a ‘net proceeds’ royalty.”
“Market enhancement” clauses began to appear in oil and gas leases several years ago when mineral owners, disturbed by widespread publicity about out-sized cost deductions from royalties, began to insist on being paid a “gross proceeds” royalty. In response, operators began to write leases providing for royalties on the “gross proceeds” and spelling out all the costs they said would not be deducted from the royalties (including the costs of “gathering, storing, separating, treating, dehydrating, compressing, processing, transporting, and marketing”). “Then comes the kicker,” Oldham says. “The lease goes on to say that costs can be deducted if they ‘enhance the value of already marketable oil and gas.’ Operators then say that oil and gas is marketable at the well. This allows them to deduct all costs incurred between the well and the point of sale, including the costs the lease just listed as being not deductible.”
“The ‘market enhancement’ clauses are highly misleading,” Oldham says. “They make you think no costs will be deducted when all of them will be.”
For many years, ODNR forced pooling orders provided unleased mineral owners, who are forced pooled into drilling units, a monthly royalty payment of 1/8th (12.5%) of the “gross proceeds” of the sale of the oil and gas. However, between February 13, 2018 and July 26, 2021, all 154 forced pooling orders issued by the ODNR added a “market enhancement” clause to the definition of “gross proceeds.”
Gateway Royalty issued a press release on July 20, 2021 (https://gatewayroyaltyllc.com/news/) after learning that the ODNR had been including “market enhancement” clauses in its unitization orders since February 13, 2018. It’s still a mystery as to “how and why” the ODNR came to add the “market enhancement” clauses. Gateway Royalty has filed a public records request seeking answers from the ODNR. A copy of Gateway Royalty’s request is available at https://gatewayroyaltyllc.com/odnr-request/.
Since July 26, 2021, there have been a total of 4 forced pooling unitization orders by the Chief, none of which have the “market enhancement” clause. The ODNR has dropped the “market enhancement” clause from these recent unitization orders.
While Gateway Royalty welcomes that the ODNR has dropped “market enhancement” clauses from its unitization orders, Gateway believes the orders need further improvement to ensure that the forced pooled mineral owner receives fair and equitable compensation on their royalty. The royalty percentage for the forced pooled mineral owner should the average percentage of all leases in the unit, not the 1/8th (12.5%) royalty presently found in ODNR’s orders. As Gateway noted in its previous press releases, 1/8th (12.5%) royalties are a thing of the past. Royalties today are typically in the range of 16-20%. It’s only fair that the forced pooled mineral owner receives a royalty percentage on par with his or her neighbors.
It is Gateway’s position that it’s not enough for the ODNR orders to provide for a royalty on the “gross proceeds.” Operators can convert the “gross proceeds” royalty called for in the order to a “net proceeds” royalty using several clever mechanisms. One is to sell the oil and gas to a marketing affiliate at the well. The affiliate resells the oil and gas to an unaffiliated buyer and pays the operator a “wellhead price,” calculated as the gross price paid to the affiliate less all costs incurred by the affiliate between the well and the point of sale. This allows the operator to say that it “deducts no costs” and that it pays the royalty on the “gross wellhead price paid by the affiliate.” That price is actually a net price, however, because it is less all post-production costs incurred in the first arms-length sale to an unaffiliated buyer.
To prevent operators from converting the “gross proceeds” royalty in ODNR unitization orders to a “net proceeds” royalty using these types of mechanisms, Gateway recommends that the ODNR unitization orders should provide forced pooled mineral owners with the following royalty:
A percentage, calculated as the average royalty percentage in all leases in the unit, of the gross proceeds paid by the first unaffiliated buyer in an arms-length transaction with no deduction of any costs, including, but not limited to, the costs of gathering, compressing, processing, dehydrating, separating, transporting and marketing.
The problems with ODNR unitization orders makes it all the more important that H.B. No. 152, now before the Ohio House Energy and Natural Resources Committee, be drafted in ways that provide the forced pooled mineral owner with fair compensation. The current version of the bill eliminates the unleased mineral owner’s option to be paid a royalty of 1/8th of the “gross proceeds,” leaving the unleased mineral owner with no choice but to become a working interest owner in one of two ways (by consent with a payment unaffordable to most mineral owners or by non-consent under terms that will yield little, if any, return).
The royalty option should be put back in the bill, and it should be increased from 1/8th (12.5%) to the average royalty percentage in the unit. Also, the royalty language in the bill should be the same “bullet-proof” royalty language that needs to be included in the ODNR unitization orders.
In addition, Oldham says that H.B. No. 152 should provide the unleased mineral owner with a one-time bonus equal to the average bonus paid on leased acreage within the forced pooled unit that is currently not held by production, compared to no bonus at all, as found in the current version of the bill.
Finally, H.B. No. 152 should require that the operator must have at least 85% of the acres in the proposed unit under lease before submitting an application for mandatory pooling, whereas the current bill has a 65% acreage threshold. The ODNR website states that 90% is the “preferred” acreage threshold and that operators have frequently met that mark.
Oldham commented, “An 85% threshold will require the operator to negotiate with more landowners and will create a more accurate market value for calculating the royalty percentage and the amount of the bonus.”
Gateway Royalty (www.gatewayroyaltyllc.com), founded in 2012, is a mineral and royalty acquisition company based in Carrollton, Ohio. Gateway owns minerals and royalties in the Utica in the following counties located in southeastern Ohio: Belmont, Carroll, Columbiana, Guernsey, Harrison, Jefferson, Monroe and Noble.