The meaning of Pennsylvania’s minimum 12.5% oil & gas royalty

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For those of you not familiar with the ins and outs of the oil and gas industry, I want to give you a brief opening. When you buy your house and property, you are purchasing the surface use or surface estate (the literal ground that you can see on the surface). In addition, you will most likely own the subsurface estate as well – and anything worth anything underground – like oil and gas. You don’t have to do anything extra because buying your house also gets you your subsurface rights and any goodies that come from underground, UNLESS, someone in the past already reserved it. When you use a title company before closing on your house, they will research your land “title” back to see if there are any issues with it that they need to report.

Because you most likely own your subsurface estate, an oil and gas company must lease it from you in order to extract anything. In Pennsylvania, the legislature believes that the landowner is entitled to 12.5% of the royalties from the oil and gas that it produces from your land. But what happens if your lease contains language that other costs will be taken out of that royalty percentage for things such as transportation and compression, sometimes referred to as “post-production costs,” (any cost that arises to get it out from under your land into usable oil and gas)? Generally, landowners have an attorney look over the lease language, which may not even help in some or most cases where attorneys are unfamiliar with the oil and gas industry and precedent. Other times, an attorney negotiating holds no more weight than if you, yourself, were negotiating.

Enter present day – most of the area around me currently is leased and has been producing natural gas, but what if those costs leave you with less than 12.5%? Pennsylvania is still new to the oil and gas game, unlike say, Texas or Oklahoma. This very topic has been and still is being debated about. Just today, Supervisors in Wilmot Township, Bradford County, Pennsylvania, plan to pass a resolution asking the state’s legislature to address this issue.

The current Guaranteed Minimum Royalty Act reads:

Section 1.3. Royalty guaranteed.
A lease or other such agreement conveying the right to remove or recover oil, natural gas or gas of any other designation from the lessor to the lessee shall not be valid if the lease does not guarantee the lessor at least one-eighth royalty of all oil, natural gas or gas of other designations removed or recovered from the subject real property.”

To my knowledge, nothing has been discussed at the state level or in PA’s Supreme Court regarding the post-production costs, that come out of the royalty percentage. Some could say that the Act is ambiguous because it simply states “shall not be valid if the lease does not guarantee the lessor at least one-eighth royalty…” and so, it’s not addressing the “post-production costs” coming out of that one-eighth royalty percentage, after the fact. While others could argue, that “Post-production costs” not discussed in the Act are instead addressed in the terms of the lease itself, so regular, contract law principles apply. If regular contract principles apply, then the landowner signed, agreeing to those terms. Or even if they agreed, are the terms so unconscionable that the court should rule in landowner’s favor, regardless? This most likely won’t apply to oil and gas since unconscionability is used in sale of goods. Real estate/real property law principles may apply where buyer’s severance of the oil and gas will materially harm the real estate and the law generally considers oil, gas, and minerals as being in that category. Whether this is a sale of goods, a sale of services, or something else materially harming real estate has been discussed more in other states but not Pennsylvania…yet.

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