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Bob Skarphol showing a group of mineral royalty owners the breakdown of a royalty statement during an organizational meeting in October 2018.

Some North Dakota mineral owners report they have seen as much as two-thirds of the oil and gas royalties they expect to receive in a given month disappear as Bakken producers take deductions to move the products down the processing chain, and they’re asking for lawmakers to help stop the practice.

The oil industry is pushing back, saying that such change might cause oil development to dry up and would discourage companies from investing in pipelines and other infrastructure needed to accommodate gas produced alongside oil in the Bakken.

The issue is complex and garnered numerous questions Monday from legislators on the Senate Finance and Taxation Committee when they heard from supporters and opponents of Senate Bill 2217, whose lead sponsor is Rep. Brad Bekkedahl, R-Williston.

The Williston Basin Royalty Owners Association, led by former Rep. Bob Skarphol, R-Tioga, is backing a bill to address the deductions, which are sometimes taken from royalties to help pay for post-production costs. The expenses have to do with transporting oil or gathering gas from wells, compressing it and moving it to a processing plant where its various components are separated out into more marketable products.

Skarphol said royalty owners familiar with deductions “will express their disdain” whenever the topic comes up.

“Disdain is a polite way to say it,” he said. “Many royalty owners find the royalties statement so complex they do not even make the effort to decipher what is happening. They simply deposit the check and stick the statement in a drawer. Some royalty owners are afraid if they complain, their wells could be shut down and their royalties would end.”

Deductions for post-production costs are not applied consistently across the Bakken — some oil and gas companies take them at a variety of rates, and others don’t. Whether a mineral owner sees deductions also depends on the specific language of the lease he or she signed with the company developing the minerals.

The bill would prohibit the deductions unless a lease explicitly allows for the practice. It also would give mineral owners the right to audit the records of the oil and gas company paying them royalties and require the business to comply. Violators could be punished with a Class B misdemeanor and a $10,000 penalty.

Several oil industry executives testified against the bill Monday, as did the North Dakota Petroleum Council.

“The transportation and processing of gas enhances the value of the gas, and it has a higher value at the tailgate of a plant than at the mouth of a well,” said Todd Kranda, a lobbyist for the Petroleum Council.

Oil and gas companies, working interest owners and mineral owners “share proportionally in the enhanced value of the oil or gas from the downstream sale,” he said.

Deductions help determine the value of the gas at the well when it’s first produced, he said.

Natural gas is extracted wherever companies drill for oil in North Dakota, but it’s far less profitable than oil. It’s not uncommon for a company to produce more gas than it can accommodate through pipelines and processing plants, in which case it’s wastefully flared off at well sites.

Regulators have cracked down on flaring over the years, requiring companies to capture increasingly greater percentages of their gas.

Partially in response to that, oil producer Hess has spent $2.9 billion in North Dakota since 2015 on oil and gas gathering pipelines, compression, processing and storage facilities, Vice President Barry Biggs said.

“Infrastructure investments are critical,” Biggs said, adding that the bill “would undermine these goals by discouraging producers and midstream companies from making additional infrastructure investments.”

He said that when mineral owners share in the costs associated with gathering, transporting and processing gas, “it allows Hess to recover some of the extensive investment that it has made to transport oil and gas in and out of North Dakota.”

Skarphol shared a different view with lawmakers.

“The profitability of the oil and gas industry is not the responsibility of the royalty owner,” he said. “If the operator is experiencing a loss, that loss should fall on the company and the stockholders of that company, not the royalty owner.”

Skarphol said he has devoted “countless hours” to poring over royalty statements and studying the issue after his wife noticed significant deductions taken from her royalties on wells near Tioga several years ago. The royalty owners association he formed has 200 members, many of whom share frustrations about deductions.

He added that North Dakota loses out on substantial tax revenue it could collect from royalty owners if the deductions were not allowed.

Sen. Jim Roers, R-Fargo, asked Skarphol why royalty owners want the Legislature to address the issue when they could try to deal with the matter through the courts.

“Who’s going to be able to afford to file a suit against the battery of attorneys that are employed by these companies?” Skarphol responded.

The committee did not immediately vote on the bill.

The debate over post-production costs has surfaced a number of times in recent years in North Dakota. Lawmakers contemplated studying the issue following the 2019 legislative session, but that review never materialized. Regulators in recent years also approved new rules aimed at providing more transparency to mineral owners, though Skarphol indicated Monday that mineral owners still have many questions.

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