Land Board seeks to clarify natural gas royalty deduction letter

Attorney General Wayne Stenehjem, right, discusses the state's obligation in unpaid gas royalties at a meeting of the Board of University and School Lands on Thursday in the state Capitol in Bismarck. On the left is state Land Commissioner Jodi Smith.

Following an outcry by the oil and gas industry, officials offered clarity Thursday on a recent letter the state issued seeking payments for improper deductions taken from natural gas royalties, and they loosened the time frame for when companies must comply.

Royalty payers need to show a “good faith” effort to work with the state toward complying within 90 days to avoid penalties and owe minimal interest, the Board of University and School Lands determined. Some companies previously were under the impression that they had to pay back the deductions within 90 days, a task that could prove difficult for ones that have operated wells for decades and have to track down old paperwork, according to oil industry representatives.

“Good faith means that you don’t wait until the last day,” said Secretary of State Al Jaeger, a member of the Land Board. “What we’re trying to say is come on in. Initiate the conversation.”

Gov. Doug Burgum requested that Land Board members reconsider the letter they directed the Department of Trust Lands to issue earlier this month to companies that have developed state-owned minerals. Burgum, who chairs the five-member board, said Thursday that he was concerned the letter could prompt more natural gas flaring if it makes oil and gas companies less inclined to operate in North Dakota.

“We have to make sure that we do not take any actions that disincent people to make investments in our state,” he said.

Attorney General Wayne Stenehjem said he did not feel the board needed to reconsider the letter, but he was open to clarifying some of the issues raised by the oil and gas industry.

“There is the question about how far back to go, and I think that is a fair question,” he said.

The North Dakota Petroleum Council, in a letter sent to the state earlier this week, asked that the officials establish May 1, 2017, as the point in time from which to recalculate deductions. That date coincides with a 2017 memo all royalty payers received from the state offering guidance for calculating royalties.

Some companies had been improperly taking out deductions to cover “post-production costs,” which refers to the expense of gathering and removing impurities from the gas to get it ready for sale further down the processing chain.

The petroleum council, a trade group representing the state’s oil and gas industry, said that requiring companies to make payments accounting for production as far back as 40 years ago from older wells is “simply impractical and unattainable” because “companies have come and gone, many no longer exist, ownership interests have been sold over and over, wells have since been plugged and abandoned, and records simply no longer exist.”

Stenehjem said he would like to know when the department first notified companies that they were improperly taking deductions.

Land Commissioner Jodi Smith said that the answer varies depending on the company. She agreed to track down that information for the board.

The royalty money paid to the state goes into trusts that benefit public education in North Dakota. The Department of Trust Lands estimates it’s owed tens of millions of dollars from 40 companies that improperly took deductions.

“We have a duty to the school children of North Dakota, but at the same time, we don’t want to stifle development in the state of North Dakota,” Stenehjem said.

The effort to collect the deductions follows a North Dakota Supreme Court ruling last summer that sided with the state in a lawsuit filed by Newfield Exploration. The court ruled that calculating royalties based on an amount reduced to account for post-production costs “is contrary to the leases” involved in the Newfield case.

The case has since returned to a lower court for further interpretation.

Stenehjem offered several suggestions for how to handle payments in the meantime. The state could hold the money in a special account until the litigation ends or it could negotiate settlements with companies, he said.

“There is a value to not suing and not having uncertainty,” he said. “I certainly hope that this is not something that we are litigating five, six, seven years from now.”

Treasurer Kelly Schmidt indicated she wants to stand by the letter the state sent out.

“What about those that have been in compliance and have paid us on time and have done the responsibility that we have asked them to do? Are we going to reimburse them?” she said. “There are more questions than there are answers and, quite frankly, I thought we had made a decision when we sent out that letter.”

Schmidt said the fallout from the confusion surrounding the letters has led “to name-calling and to some very horrible, horrific communication that has come from a lot of people.”

“To be compared to Nazi Germany and communist Russia is a little bit over the top for me,” she said.

State Superintendent Kirsten Baesler suggested the state hold a public forum to “hear the comments and the perspectives and the experiences and the circumstances” of those with a stake in the issue. Several other officials at the meeting shot down that idea, however, citing confidentiality concerns about discussing companies’ specific situations in public.

Smith said that for some royalty payers, it will “be a very quick process” to come into compliance. She anticipates one company will send its payment to the department within the next 10 days and another by the end of March. At least 25 royalty payers have contacted the department to inquire about the money they owe.

Smith, at Burgum’s request, said she would provide the Land Board with information about what royalty guidance the department has provided to companies in the past.

The Land Board did not vote on any of the royalty-related issues it discussed Thursday. The meeting was held in a larger room at the Capitol than its usual location to accommodate dozens of people who attended as audience members, including oil company representatives and state and school officials.

When the meeting ended, Ron Ness, president of the petroleum council, said the clarification on the time frame for complying “helps a lot.”

“I’m sitting with operators here in the room today and they don’t have a lot more clarity, but the ability to go in and talk to (the department) and understand that the matrix is a starting point is very important,” he said, referring to a flowchart the department issued alongside the letter that spells out increasing penalties and interest the longer it takes companies to comply.

Ness said he believes that “the crux of the issue” is how long ago the state notified each company about the improper deductions. He added that he will encourage petroleum council members to communicate that information with the department and to start working together within 90 days.

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