In a decision released yesterday, the United States District Court for the Northern District of Ohio concluded that Ohio would adopt the “at the well” rule regarding the deduction of post-production costs, the first time the issue has been squarely addressed under Ohio law. Lutz v. Chesapeake Appalachia, L.L.C., N.D.Ohio No. 4:09-cv-2256 (Oct. 25, 2017).

By way of background, the plaintiffs (landowners/lessors) had filed a class action complaint, alleging the defendant lessee underpaid gas royalties under the terms of their oil and gas leases by allocating to the plaintiffs their share of post-production costs when calculating royalties. Three lease forms were at issue, including one that contained “at the well” royalty language:

The royalties to be paid by Lessee are: . . . (b) on gas, . . . produced from said land and sold or used off the premises . . . the market value at the well of one eighth of the gas so sold or used, provided that on gas sold at the wells the royalty shall be one-eighth of the amount realized from such sale. . . .

The lessee argued that the “at the well” language meant that a lessee could deduct post-production costs from the downstream sales price of natural gas to work back to the price of the gas “at the well” when calculating royalties. The plaintiffs, conversely, urged the court to adopt the “marketable product rule,” which provides that post-production costs—for example, costs for compression, dehydration, processing, and transportation of gas—must be borne solely by the lessee.

In April 2015, the district court certified the question of whether Ohio follows the “at the well” or the “marketable product” rule to the Supreme Court of Ohio.  Although the Supreme Court of Ohio accepted the certified question, it ultimately declined to answer it, concluding that oil and gas leases are contracts and the “the rights and remedies of the parties are controlled by the specific language of their lease agreement[.]”

Afterwards, the lessee filed a motion for partial summary judgment as to the “at the well” lease form, which the district court granted in yesterday’s decision. In its ruling, the district court determined that Ohio would apply the “at the well” rule.  Concluding that the “at the well” language in the lease was clear and unambiguous, the district court found that it referred to the “location at which the gas is valued for purposes of calculating a lessor’s royalties”—i.e., at the well.  Conversely, applying the marketable product rule, as urged by the plaintiffs, “runs the risk of giving the lessor the benefit of a bargain not made.”

Read the full decision here.