MORGANTOWN — Pittsburgh-based natural gas producer EQT wants to have a new West Virginia law protecting royalty payments declared unconstitutional. It filed a lawsuit to accomplish that goal in the U.S. District Court for the Northern District of West Virginia in mid-April.
The law takes effect May 31. It comes as a result of SB 360, passed March 3, a week before the end of the 2018 legislative session. Sole sponsor Sen. Charles Clements, R-Wetzel, called attention to the suit during a legislative wrap-up forum held Wednesday in Morgantown.
“It created such a rumble in the gas industry that there’s a federal lawsuit now trying to overturn it,” he said.
SB 360 passed the Senate unanimously and passed the House 96-2 just three days later. The bill prohibits deduction of post-production costs for gas extracted from wells subject to old flat-rate leases that were converted to one-eighth royalty leases under a 1982 law.
EQT contends that the law violates the U.S. Constitution, which says no state shall make any law impairing the obligation of contracts. The original law – code 22-6-8 – and its revision under SB 360 both impair contracts.
Case background
SB 360 emerged in response to a May 2017 state Supreme Court opinion in a case called Leggett. The court was answering a question from a federal court regarding the meaning of “at the wellhead” and reversed its own prior opinion following the election of Beth Walker to the court.
The court recognized the stated intent of 22-6-8 regarding flat-rate royalty payments in a new era when royalties were based on volume: “That continued exploitation of the natural resources of this state in exchange for such wholly inadequate compensation is unfair, oppressive, works an unjust hardship on the owners of the oil and gas in place, and unreasonably deprives the economy of the State of West Virginia of the just benefit of the natural wealth of this state.”
However, the court said, the nature of transportation and sale of the gas had evolved since 1982; “at the wellhead” no longer meant where gas comes from the ground, but where it is sold after being processed and having value added.
The court said, “We do not believe that permitting lessors [mineral owners] 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 statue.”
But part of the criticism of EQT has been that it effectively sells the processed gas to itself through a series of subsidiaries, thereby artificially deflating the royalty due to the mineral owner.
So SB 360 calls for a royalty based on “the gross proceeds, free from any deductions for post-production expenses, received at the first point of sale to an unaffiliated third-party purchaser in an arm’s length transaction.”
EQT’s challenge
The Supreme Court noted that in 1982, the Legislature avoided trampling on contract rights by applying 22-8-6 (EQT calls it the Flat-Rate Statute) only to new permits. Producers would have to sign an affidavit pledging to pay a one-eighth royalty on all new wells drilled on land subject to flat-rate leases.
In its suit, EQT says it operates 13,600 wells in the Appalachian Basin, about 5,000 of them in West Virginia; of those 5,000, 1,700 are subject to flat-rate leases, the largest number of such leases among all Wes Virginia producers. Most of them provide for a $100 to $300 annual royalty plus free gas for the landowner, regardless of volume produced.
The landowners agreed to those terms knowing extraction technology would evolve, EQT argues. In turn, the company takes on all the risk and expense of developing that technology. The Flat-Rate Statute emerged in 1982 because mineral owners grew discontent with leases stuck at the start of the century.
“The Legislature has thus twice substantially impaired EQT’s contract rights by retroactively awarding the lessors more compensation than they bargained for,” EQT argues, creating a windfall for a small, special group of mineral owners.
EQT includes threats in its complaint, saying the law inhibits development and expansion in West Virginia. For 2018, it has only 28 wells planned here, but 122 for Pennsylvania. The law has “increased costs and forced EQT to look elsewhere for development opportunities. … EQT would likely apply or a greater number [of permits] in the absence of the Flat-Rate Statue and SB 360.”
EQT is asking the court to order that the Flat-Rate Statue and SB 360 violate the U.S. Constitution’s Contract Clause and award damages, fees and interest.
Judge Irene Keeley has set a planning meeting for June 5 (five days after SB 360 takes effect) and a scheduling conference for July 3.
Stakeholder response
While Clements sponsored SB 360, Senate Energy chair Randy Smith, R-Tucker, championed it.
The reason EQT wants, it, Smith said: “They make millions of dollars off of that the way it is now, taking money from the mineral owners.” EQT hopes that the reconstituted court, with Walker, will lean its way.
Smith said EQT stands alone among the state’s gas producers on this issue. “Other gas companies bargain in good faith; EQT refuses to bargain in good faith.”
EQT wants West Virginia to modernize its gas laws, Smith said, unless the old laws help it. “EQT can’t pick and choose which laws we modernize.”
At committee meetings, lobbyists supporting SB 360 presented examples of negative royalty checks, where dedications exceeded royalties.
“Mineral owner should not have to pay the company for extracting those minerals,” Smith said. “It’s a drop in the bucket to them. They’re being greedy and they’re not wanting to be good stewards in West Virginia. We’re just trying to do what’s fair.”
Tom Huber, president of the West Virginia Royalty Owners Association, lobbied for SB 360 and commented in an email exchange.
“EQT’s lawsuit is just another example in a long line of exploitative actions in the state of West Virginia,” he said. “We believe the court will recognize that the Flat-Rate Statute is perfectly within the constitutional authority of the state to require certain conditions in order to receive a permit and that EQT is simply challenging this law that is over 30 years old because they want to continue selling gas to themselves at a below market price, depriving both the state its fair share in severance taxes and royalty owners their fair share of royalty.
He continued, “West Virginia and its people deserve to benefit from our natural gas resources, not simply be a colony for EQT to exploit. To be clear, should EQT prevail, tens of thousands of West Virginia royalty owners will receive a flat-rate royalty on production volumes that will bring in billions of dollars.
“The Legislature in a nearly unanimous and bipartisan vote saw fit to update and re-enact the flat rate statute because they did not want our resources taken away for nothing,” Huber said. “Let’s hope the court follows the Legislature in declaring EQT’s ridiculous claims invalid.”
The Independent Oil and Gas Association-West Virginia took no position on SB 360 during the session and declined comment on the suit. Anne Blankenship, executive director of the West Virginia Oil and Natural Gas Association was in meetings and could not be reached.
The DEP typically does not comment on litigation but did not acknowledge a request for comment in this case.
