The West Virginia Supreme Court of Appeals voted to allow oil and gas producers to deduct processing and transportation costs from the royalties of landowners in certain circumstances.

The decision may signal a change in the court's thinking. In a 2006 decision on more recent lease configurations, Tawney v. Columbia Natural Resources (a company now owned by Chesapeake Energy Corp.), the justices ruled that drillers had to pay the minimum royalty without deductions unless the lease said otherwise.

The old flat-rate leases had producers paying a fixed rate for gas from a lease and predate a 1982 law requiring a minimum 12.5% royalty to the leaseholder.

Producers often cannot value gas directly at the wellhead because it is not sold from the wellhead. Instead, gas producers calculate the wellhead value using the sale price downstream and subtracting the costs of processing and transportation that makes the gas ready for sale, netting a wellhead value. This "netback" accounting has been controversial throughout Appalachia, particularly in Pennsylvania, where some leaseholders have seen their royalty accounts set to a negative value after gas producers subtracted costs.

The West Virginia justices held in a decision released May 26 that drillers could deduct reasonable expenses to get gas from flat-rate leases ready for sale and that leaseholders could bear some of those costs. Whether those costs are reasonable or appropriate should be determined by trial courts, the justices said.

The justices acknowledged the fine distinction between the older flat-rate leases and more recent leases and called for lawmakers to fix the law's language.

"We find no inconsistent result where two distinct types of leases of completely differing character are involved, one type of which is the product of free and open negotiation and the other encumbered by operation of statute [flat-rate]," the court's decision said. "Nevertheless, this court recognizes the inherent tension between holders of leases subject to our interpretation of West Virginia Code § 22-6-8 and those freely-negotiated leases which remain subject to the holdings of Wellman and Tawney. We therefore implore the Legislature to resolve the tensions." (West Virginia Supreme Court of Appeals, Patrick D. Leggett v. EQT Production Co., No. 16-0136)