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Price Signals in Supply/Demand

In considering a price cap for oil and gas (windfall profits tax), a review of how price signals work in a market is highly instructive.

If you offer ten cents a month to workers to clean capital hill toilets, how many workers would sign up? If you offer these same workers $1 million a month to work on a study of Hawaiian beaches on location, how many workers would sign up? That is what price signals do to supply. A higher “incentive” (i.e. price) encourages supply.

This supply response is already underway in the energy markets. The number of drilling rigs in the United States searching for oil and gas has increased dramatically as the price, “incentive” increased. In fact, there are now problems with not enough rigs available on a timely basis as every oil and gas producer with money available wants to try and find more oil and gas to produce.

This shows up too in the projected earnings and capital reinvestment forecasts in studying the industry. The table below shows the estimated per share earnings, and re-invested capital expenditures for several of the oil companies. The estimates are all taken from “The Value Line Investment Survey,” Issue 3, September 16, 2005.

2005 Earnings 2005 Capital
Major Integrated Companies per Share Reinvested per Share

BP $6.25 $4.00
ChevronTexaco $5.95 $4.45
ConocoPhillips $8.30 $6.55
ExxonMobil $4.90 $2.05
Royal Dutch $6.60 $4.30

Re-investment of capital to fund the search for more oil and gas to provide consumers is estimated to take 67% of major integrated oil companies net income in 2005. Capital investment by independent producers (predominantly U.S. production) is even greater. Again from “The Value Line Investment Survey,” Issue 3, September 16, 2005 and Issue 12, August 19, 2005.

Anadarko Petroleum $8.00 $13.45
Apache Corp. $6.80 $ 9.45
Burlington Resources $5.50 $ 4.40
Chesapeake Energy $2.35 $ 6.60
Devon Energy $5.40 $ 7.35
EOG Resources $4.00 $ 6.65
Kerr McGee $9.70 $12.25
Marathon Oil $6.40 $ 7.10
Murphy Oil $4.15 $ 6.50
Occidental Petroleum $9.00 $ 5.20

The estimate for 2005 is that 129% of earnings will be re-invested for the continued search for more oil and natural gas. Re-investment in excess of net income shows that cash flow including depletion is sourcing more drilling activity. This belies the assertion that depletion is merely a tax preference item. In actuality, it helps fund greater production of oil and gas.

Since the increase in earnings is being reinvested and showing up as a higher number of drilling rigs searching for oil and gas, how is supply doing? Looking at U.S. natural gas production from the Department of Energy in conjunction with the increased rig count, this is what we find.

The obvious question is why we can’t get more natural gas production from the higher drilling, and thus increase supply, lowering price. It has to do with geologic maturity of the domestic natural gas basins, and new areas for exploration.
Think of it this way. You are into your fourth hour of filibuster and ask a staffer to get you some water which you very much need. A couple minutes later, she returns to tell you that the usual “onshore traditional basins” vending machine is very nearly sold out and there were several dozen other staffers milling around trying to get their coins in the machine, i.e. she couldn’t get you any water. You respond by suggesting trying another vending machine in a different location. A few minutes later, the staffer returns to inform you that while she believes the vending machine on the second floor “offshore Florida” has plenty of water, the elevators and stairs to the second floor have all been sealed off. Getting ever thirstier, you suggest the other side of the building on the same floor, perhaps that vending machine will have some bottled water. After a lengthy time, the staffer returns and tells you that yes, there is bottled water at the “Federal lands vending machine”, she even saw it, but she still has no bottled water for you. It seems someone has put a turnstile in the way that will cost more than the change originally budgeted for bottled water. In addition, there is an individual that won’t allow her to step up to the turn stile without a written 30-page essay of why she wants the water.

Finally, in exasperation and nearly hoarse needing some water during your filibuster, you hand your staffer significant additional change and suggest going to the vending machine in the basement “deep gas” or next door “outer continental shelf,” but please bring back some water.

Unfortunately, she returns to explain that while there was bottled water at either of those two vending machines and although they were more expensive, she did have the necessary change, but there was a new problem. It seems a gruff, masked figure stepped out of the shadows and took the change, telling the staffer that he had a better use for it than buying bottled water.

Congress must decide its proper role. One choice is a free market response to remove impediments to oil and gas supply so that the increased funds and increased drilling can in time bring new supplies of oil and gas and lower prices and lower inflation and assist economic growth. The other choice is to “mug the staffer” (windfall profit tax) so that there is no bottled water(oil and gas).

Help solve the problem or magnify the problem?? Your call!

Election Year

As we are in an election year with higher than historic fuel prices, there will be many “solutions” to high oil prices advanced by politicians, think tanks, and pundits. One of the all time favorites is conservation as a solution. Of course conservation is necessary, economically rational, and should be promoted as a part of the solution. It does not in itself offer a solution. Proponents always state that the U.S. is energy wasteful compared with Europe, and also report that we successfully improved our energy efficiency in the last oil shock of the late 1970’s. A thorough analysis though leaves questions on both these believed “truisms.”

1) Conservation through energy efficiency, with the example of Europe.

The American public will be criticized for our large homes, driving habits, and “wastefulness” -compared with Europe’s mass transit, and more ecology-friendly lifestyle.

However, there is much less here than meets the superficial eye. A comparison of U.S. oil consumption and oil consumption by the 25-member countries of the European Union (E.U.) are instructive. On the surface, 453 million residents of E.U. countries consume only 14.8 million bls/d of oil compared with 295 million Americans consuming 22 million bls/d of oil. We certainly do seem wasteful, but on a full comparison, what do we really find?

The E.U. Gross Domestic Product (GDP) according to the World Factbook is a virtual tie with the U.S. GDP, at $11.650 trillion for the E.U. and $11.750 trillion for the U.S. On a per capita basis though, the U.S. citizen enjoys $40,100 of GDP to only $26,900 for an E.U. resident. As energy consumption is fundamental to an economy, it is unlikely our populace would favor reducing oil consumption by throttling back the economy. A “beggar the poor” policy of reduced economic activity is both unworkable and unconscionable.

What about transportation though? A different story, as we all “know” of Europe’s trains, better vehicle mileage, and conservation-inducing gasoline taxes. Again, there is more to the comparison, such as the fact that even without including Alaska, the continental U.S. land mass is more than twice the land mass of all the 25 E.U. countries combined. According to the “World Factbook,” the U.S. even without Alaska is 8.15 million sq. kilometers while the total land mass of the E.U. countries is only 3.9 million sq. kilometers. Yes, the E.U. has better mass transit and better fuel mileage, but how expensive, inconvenient, or unwanted would a mass transit system stretched to the U.S. size be? Can a mass transit system that works in small countries even be “super-sized” to U.S. standards? London to Birmingham just isn’t meaningful to compare New York to Los Angeles. If a mass transit system raises questions, what about vehicle efficiency? Let us look at actual gasoline demand and other fuels and products, adjusting for economic and land mass differences.

If we break out oil demand into product categories, and per capita (adjust for population) we find the E.U. within 20% of U.S. demand through the middle distillates and fuel oil, but much lower per capita consumption in light distillates, and other products. Other products are generally lubes, tars, waxes, petrochemical feedstock, i.e. industrial usage, reflecting again our healthier economic position. Light distillates for gasoline though offer a conservation opportunity. Adjusting for consumption differences in gasoline, diesel, and space heating, with consideration given to economic growth, GDP per capita and the land mass difference, a number of ratios become surprisingly similar. Actual total oil consumption is 39.8% greater for the U.S., just as our energy growth coefficient (EGC) is also 38% greater and after adjusting for land mass and per capita GDP, the per capita oil consumption is 34.6% greater. So with those ratios lining up and matching with the economic differences, (I am assuming the U.S. doesn’t mind consuming more oil for higher growth and greater wealth) that leaves only transportation for improved oil conservation. In transportation then even after adjusting for the land mass difference there is evidence we are 30%-35% less efficient. As noted above, a U.S. super-sized mass transit may not be realistic, so I will focus on vehicle fuels. If we look at per capita adjusted gasoline demand, this would calculate to not quite 2 million bls/d of oil consumption to reduce from our roughly 9.5 million bls/d of light distillate consumption.

In conclusion, while on the surface it would appear to offer massive reduction, after a more thorough analysis, to meet E.U. “efficiency” standards without harming our economy, suggests only about 2 million bls/d of oil consumption can be reduced through mileage standards, and mass transit where applicable, roughly a 20% reduction in gasoline consumption. There still remain several questions.

2) Of course supporters of conservation will vehemently disagree with the assessment that our economy can’t become more efficient in production without damaging itself. They will point to the success of the response to the energy shocks of the 1970’s, where the U.S. energy growth coefficient (EGC) did decline meaningfully while we transitioned to a more service oriented economy.

Herein though is what former Fed Chairman Alan Greenspan would call a conundrum. While it is true that our economic growth has increased while our EGC fell, that is only part of the story. A question must be answered: Did we truly reduce our industrial & manufacturing energy consumption per unit of GDP, or merely out-source our heavy industry to lower cost developing nations? Did we really conserve oil, or just shift the energy cost to a different part of the globe where it could be offset by cheaper labor costs?

If we take the refined product history of U.S. consumption from 1965 through 2005, there are interesting comparisons. Between 1965 and 1980, light distillate demand grew 2.2% CAGR (Compound annual growth rate), but from 1980 to 2005 grew at only a 1.18% CAGR, a decline in growth rate of 46%, as would be expected. This is the period of muscle cars fading out as the popularity of Japanese vehicles with lower fuel use became popular.

However, the decline in growth rate of middle distillates on the same two period comparison was 52.75%, the decline in growth rate of other (industrial usage) declined by 67.4%, and fuel oil usage actually declined meaningfully in absolute terms. Clearly industrial oil consumption slowed more than gasoline consumption. While many will claim this is American ingenuity in energy saving technology, a review U.S. government data raises questions.

A comparison with the Federal Reserve Total Index of Industrial Production, seasonally adjusted shows a correlation with the decline in oil consumption. The U.S. industrial production index grew at a 3.65% CAGR between 1965 and 1980, but decelerated to only 2.48% CAGR between 1980 and 2005. I don’t believe anyone would argue that U.S. consumption of manufactured goods slowed dramatically while our population grew during that time frame. The U.S. simply obtained its goods from external rather than internal production. This is shown in records of the Foreign Trade Division of the U.S. Census Bureau.

In the 1960 through 1970 period, the U.S. actually ran a balance of trade surplus in goods, and not until 1984 did it cross $100 billion deficit balance of trade in goods. Since then the balance of trade deficit in goods has accelerated sharply to $1,473 Billion in 2005.

It is at least worthy of review, that the U.S. move to a service economy, our supposed aggressive improvement in energy efficiency, and our exploding balance of trade deficit are actually an interrelated result of merely off-shoring our manufacturing base. Of course, this merely shifts oil demand to a different part of the globe, not representing conservation but just movement to where cheaper labor could offset higher energy costs to mute the inflationary impact.

Indeed, a review of total oil consumption globally shows merely a transitional pause in the early 1980’s (as industry moved from the west to the developing countries and substituted labor for energy) and then resumed the upward growth in demand. This substitution of labor for energy was possible in the oil shocks of the 1970’s-1980’s as there was adequate availability of substitutable labor and spare capacity in oil production via withheld volumes from the market. The current situation, however, sees China and India rapidly industrializing, lessening the pool of available “labor at any price,” and increasing the cost structure of the energy substitute in the factors of production. More worrisome is the lack of spare capacity in oil production as we no longer have withheld volumes.

This time, we are in a true supply/demand balance situation, not artificially caused through withheld volumes. The world also is more uniformly developed and with less ability to substitute raw labor for energy.

Accordingly, faith in conservation as a solution is misguided. It is a necessary but insufficient part of the response to rising energy costs.

By Gregory J. Winneke, CFA, CMM

Windfall For The Dimwitted

12/4/2005 The Washington Post
By George F. Will

”A Locrian who proposed any new law stood forth in the assembly of the people with a cord round his neck, and if the law was rejected, the innovator was instantly strangled.”    — Edward Gibbon, ”The History of the Decline and Fall of the Roman Empire”

If Congress had the rule of the Locrians, a people in ancient Greece, it would have been fatal to Sen. Byron Dorgan, the North Dakota Democrat. He recently got 34 colleagues, none of them Republicans, to vote for his measure to punish oil companies for earning profits that, relative to revenue, were unimpressive.

Dorgan’s measure also would have inflicted collateral damage on everyone who buys petroleum products, and it would have injured millions of Americans — many of them currently inciting Congress to smite the oil companies — who do not know that they own oil stocks. Herewith an after-action analysis of a battle that has been fought before and will be again.

”None of us know much about what is happening with respect to pricing,” said Dorgan, disclaiming a competence rarely ascribed to senators. But, quickly recovering from uncharacteristic humility, Dorgan joined Senate colleagues in exhibitionistic indignation about the fact that the five largest oil companies, led by ExxonMobil’s $9.9 billion, had combined third-quarter profits of $32.8 billion.

ExxonMobil, which has more than $50 billion of past profits invested in energy development, made 9.8 cents per dollar of sales, much less than the 21.2 cents made by a company selling another fluid that lubricates American life — Coca-Cola. Nevertheless, another Midwestern populist, Sen. Charles Grassley, the increasingly eccentric Iowa Republican who chairs the Finance Committee, admonished the oil companies to contribute 10 percent of their third-quarter profits to augment existing federal subsidies that help some Americans pay their heating bills. Many of those Americans live in the chilly Northeast and vote for liberals who, in Congress, write this narrative: By blocking much drilling in Alaska and offshore, Congress does nothing to lower the price of oil. Then Congress spends taxpayer dollars to soften the impact of the price, thereby encouraging consumption that raises the price. Then Grassley asks oil executives to join the moral grandstanding by squandering their shareholders’ wealth — diverting it to protect oil consumers from some consequences of their representatives’ irrationality.

The Senate, having flirted with this loopy idea of oil companies tithing themselves, then contemplated a worse idea — Dorgan’s ”windfall profits” tax. A ”windfall profit” is a technical term denoting a profit made by someone else. Americans do not say there was anything windfall-like about this year’s $2.5 trillion increase in the value of their houses.

   This year the six largest oil companies will disperse 34 percent of their cash flow — $31 billion — in dividends to shareholders. But such flows can be shrunk by ”windfall profit” taxes. That is explained, with a clarity sufficient even for the dimmest 35 senators, in a study — ”The Economic Impact of a Windfall Profits Tax for Savers and Shareholders” — by Robert J. Shapiro, former undersecretary of commerce in the Clinton administration, and Nam D. Pham, an economist.

Although the real rationale for a windfall profits tax is to allow legislators to strike a histrionic pose, Dorgan’s tax, say Shapiro and Pham, would have produced gross revenue — depending on where the price of oil is in the range between $45 and $60 a barrel — of $18.5 billion to $104.9 billion over five years. But because the windfall profits tax payments would have reduced corporate income tax payments, the government’s net, say Shapiro and Pham, would have been only $8.6 billion to $48.7 billion.

They calculate that 41 percent of oil company stocks are owned by pension plans and individuals’ retirement accounts. Hence much of the tax’s burden would have fallen on current and future retirees, reducing both the market value of, and dividends paid by, those stocks. The cost to all the oil companies’ shareholders, in forgone stock appreciation and dividends, would have ranged — depending on oil prices and inflation — from $21.3 billion to $121.8 billion per year. Shapiro and Pham also conclude that the windfall profits tax would have discouraged domestic oil production and increased U.S. dependence on imports from the Persian Gulf. And from Venezuela, thereby funding the left-wing fascism of Hugo Chavez.

Because the average price of a gallon of gasoline has swiftly plunged from the post-Katrina high of $3.07 to $2.15 (compared with $185.60 for a gallon of Starbucks espresso), the recurring populist fever that always follows oil price spikes has broken. It will be back. Too bad the Locrians’ rule will not be.

News Archive

May 12, 2006


A Senate floor amendment to Engrossed HB 2984 by Rep. Shane Jett, R-Tecumseh, and Sen. Frank Shurden, D-Henryetta, was added unexpectedly and passed by the Senate on Wednesday, April 26. Petroleum industry lobbyists asked the bill’s House author to remove the bill from Monday’s floor agenda until a solution can be found. Rep. Jett agreed and the bill is supposed to be laid over to allow time for development of amendments.

The amendment limits entrance to farming, ranching or forestry land without permission. It also allows a landowner to deny permission to those who might have a legitimate need for entrance. Such a law could allow a particular landowner to deny access for the development of mineral rights. It is sponsored by the Oklahoma Farm Bureau.

Industry lobbyists will meet Monday (May 15) to look over language to remedy the bill. If your company has any suggestions, please get them to our office by Monday morning.

February 24, 2006


Thursday, February 23, was supposed to be the Senate deadline for reporting Senate bills from committee. However, due to the Monday closing of the legislature due to bad weather, that deadline was extended until Monday, February 27.

The House of Representatives’ deadline for reporting measure from the committee in the house of origin is Thursday, March 9.

Although the Senate deadline is not until the close of business on Monday, there are actions we can report to you about.


SB 1345 and SB 1688 by Sen. Don Barringon, D-Lawton, were removed from the agendas of their respective committee assignments by the senator. Both of these bills dealt with county commissioner control and the routing of truck traffic. The Mid-Continent Oil and Gas Association of Oklahoma has spoken with Sen. Barrington concerning the detrimental effects of such proposals on commerce and oil and gas investment. He agreed. Lobbyists for county government were critical of the senator’s decision.

There are efforts underway to modernize Oklahoma’s oversize and overweight vehicle permitting. Additional funds are likely to be made available this session to allow the Department of Transportation and Department of Public Safety to improve Oklahoma’s ability to quickly permit such vehicles. The Mid-Continent Oil and Gas Association of Oklahoma and members have met with state officials to help in this effort.


Never underestimate the importance of maintaining an energy industry presence at the state capitol. In addition to the Senate measures mentioned above, the following bills were also sidelined. If it were not for our efforts, some of these kinds of bills would pass every year.

SB 1376 Anderson – Creates a 21-member Task Force for the Study of the Taxation of Oil and Gas Production Property to conduct a comprehensive review of the taxation of property used in the production of oil and gas and make recommendations regarding which property and/or equipment should be subject to ad valorem taxation and which should be subject to the payment of gross production taxes in lieu of ad valorem taxation.

SB 1474 Bass – Requires oil and gas well operators, in addition to any other damages due a surface owner, to annually remit to any surface owner of the land upon which an oil or gas well is located an amount equal to one-half of the total amount of the surface owner’s ad valorem property taxes. The county assessor of the county in which the well is located would be required to furnish and verify the amount due by the operator to the surface owner. The amount would be paid by the operator and deductible from the royalty proceeds of each mineral interest owner in the well. Operators would be required to include such payment information on royalty checks.

SB 1575 Laughlin – Provides that, for any lease covering agricultural lands, oil or gas, other minerals, or mineral rights granted by the Commissioners of the Land Office, the lessee would be required to pay to the commissioners 92 percent of the lease payment and to pay to the county in which the land lies 8 percent of the lease payment in lieu of ad valorem taxes. The land commission would be prohibited from increasing the minimum bid amount or in any way increasing the lease payment to compensate for the payment in lieu of ad valorem taxes. If the lease agreement includes lands in more than one county, the lessee would be required to pay a prorated amount to each county, based on the percent of the leased land lying in the county. The county treasurer would apportion the money in the same manner ad valorem taxes are apportioned in the county.

SB 1608 Williamson – Provides that, if exemplary damages are awarded to a plaintiff against a corporation, its officers and directors would be personally liable for all civil damages and attorney fees.

Other bills that appear to remain in committee are:

SB 1660 Lerblance – Providing an ad valorem tax exemption for certain drilling rigs; limiting time period for exemption; defining terms; requiring Oklahoma Tax Commission to promulgate rules.

SB 1413 Branan – Expands information required to be included with interest owner payments to include the unit, name including the county and state in which it is located and the identification number assigned to it by the payor. The measure removes the exemption for providing information regarding the windfall profits tax. Payors also would be required to provide an address and telephone number at which additional information regarding the payment may be obtained and questions may be answered. Upon written request by the owner of a royalty interest submitted to its payor via certified mail, the payor would be required to provide in writing certain other information that has been specifically requested.

SB 1857 Coffee – An Act relating to civil procedure; authorizes courts to decline jurisdiction if a claim or action would be more properly heard in another forum. The measure specifies conditions under which courts are authorized to decline jurisdiction.


HB 2411 by Rep. Dennis Adkins, R-Tulsa and Sen. Jay Paul Gumm, D-Durant, passed the House of Representatives on Thursday, February 23, with an amendment helpful to industry. The bill extends the current exploration and drilling gross production tax incentives until July 1, 2009.

The amendment applies to Title 68, Section 223, paragraph C to make clear that a tax report must be “willfully” false with the “intent to evade tax” to allow the Tax Commission to begin a court proceeding for the collection of the tax without assessment.


The House Committee on Energy and Utility Regulation will meet on Tuesday, February 28, at 8:30 a.m. On the agenda is HB 2372 by Rep. Dennis Adkins, D-Tulsa. The bill is sponsored by the American Royalty Council and supported by the Mid-Continent Oil and Gas Association. It makes changes to Oklahoma’s “check stub” law providing additional information to royalty owners.

Also included on the agenda will be:

A committee substitute for HB 2432 by Rep. Adkins which amends the membership of the Oklahoma Energy Resources Board.

A committee substitute for HB 2691 by Adkins which amends Title 52 O.S. 2001, Section 317, to add “limited liability company” to the definition of “person” as applies to drilling plugging regulation.

A committee substitute for HB 2788 by Rep. John Smaligo, R-Owasso, which repeals 52 O.S. 2001, Section 476, which applies to invalidating of provisions of the Standard Gas Measurement Law.

A committee substitute for HB 2507 by Rep. Sue Tibbs, R-Tulsa, Oklahoma Storage Tank Regulation Act.


Legislative leaders in the House and Senate today announced a supplemental appropriations agreement that provides crucial funds for prisons, repairs for the state’s worst bridges and replenishes dollars spent fighting wildfires across Oklahoma.

Highlights of the agreement include:

• $100 million for the state’s worst bridges. About $93 million for the bridge fund would come from an infrastructure and economic development fund established last year. The remaining $7 million would come from current cash sources.

• $25 million of state funds set aside for county bridges. The $25 million will come from expected surplus money estimated to exceed the allowed size of the Rainy Day account. Those funds will become available at the end of the fiscal year. The funds will be administered by the Oklahoma Department of Transportation.

• A $24 million supplemental appropriation for the Department of Corrections, providing for a $2,800 raise for corrections officers and prison facility staff. The $24 million will also allow the department to hire an additional 75 corrections officers and 50 parole officers in the current fiscal year. Leaders have also agreed to annualize the supplemental to allow the addition of 150 corrections officers and 50 parole officers in FY 2007.

• $3.6 million for the Oklahoma Department of Agriculture to offset the costs of fighting wildfires since November 1.

• $4.6 million for OHLAP (Oklahoma Higher Learning Access Program) to offset the casino gaming revenue shortfall.

• The agreement also includes funds for the state Supreme Court ($3.8 million) to offset a Judicial Fund shortfall, as well as $456,000 for OSBI to provide support for a DNA evidence database.

The bipartisan accord also fulfills previous agreements made by the Speaker, Senate President Pro Tempore and the governor for winter heating bills assistance ($5.4 million) and funds to celebrate Oklahoma’s centennial ($17 million).

Industry Updates #1

January 2006
By Al Pickett
Special Correspondent


A meeting held in December in Oklahoma City reflects an attempt to change the sometimes contentious relationship between producers and royalty owners.

The American Royalty Council, which was formed last year, created a committee composed of at least 12 royalty owners and 12 producers. That committee held its first meeting December 2. Rob Abernathy, a member of the ARC Board of Directors, says more than 40 people attended that meeting, including royalty owners as well as representatives from major producers such as Devon Energy Corp., Chesapeake Energy Corp., Chevron, ExxonMobil, Kerr-McGee Corp. and Anadarko Petroleum.

“We hashed through a number of issues,” Abernathy reports. “We were in agreement on how to proceed on most of the more important issues affecting the oil industry. I think it was hugely productive.”

Royalty owners and producers sitting down to discuss issues of mutual interest anywhere other than in a courtroom or the legislative chambers at a state capitol seemingly hasn’t happened much in recent years.

“Its hard for me to believe that people haven’t done it a long time ago,” says Rick Chapman, ARC’s executive director in Norman, OK. “The Texas Oil & Gas Association has a Royalty Issues Committee. But that is just companies talking about royalty issues. We put the two groups together. Everyone I have talked to thought it was good. It was as successful as it could be.”

Ken Wonstolen, senior vice president and general counsel for the Colorado Oil & Gas Association, asserts that the National Association of Royalty Owners has been co-opted by trial lawyers. It has been changing for a number of years,” he says of the relationship between producers and royalty owners. “NARO was organized around the effort to get the Windfall Profit Tax repealed. But we have seen royalty owner/producer issues marked by litigation in recent years. Its a wide-spread phenomenon across the oil patch. Its much more adversarial these days.”

“There certainly have been problems,” agrees Bruce Stallsworth, senior vice president for government affairs for the Oklahoma Independent Petroleum Association. “Plaintiffs lawyers have been much more aggressive the past four or five years both in the courtroom and at the Oklahoma Capitol. There are gray areas in the law that are open for interpretation. We believe plaintiffs lawyers are using gray areas in the law to instigate litigation against producers. We would like to see the law clarified to slow the frivolous lawsuits.”

Common Goals

The ongoing litigation and seemingly increased adversarial relationship between NARO and producers prompted the formation of ARC in 2005. “There were a number of people who were active in NARO,” Abernathy recalls. “We felt royalty owners were natural allies of oil and gas producers. But we were concerned there was a drift by some NARO members against the industry. We felt that was bad for business and bad for royalty owners.

“We decided to approach the glass as half full. We decided to concentrate on common goals rather than the things that divided us. The petroleum industry needs some grass roots support.”

Stallsworth points out that another group, the Coalition of Oklahoma Surface and Mineral Owners (COSMO), also has emerged in that state in the past couple years.

“COSMO has created a created degree of tension between producers and royalty owners,” he says. “ARC has a much more positive agenda, focused on the idea that what is good for producers usually is good for royalty owners. That is a seemingly simple concept.”

Chapman has a unique perspective on the differences between NARO and ARC. He served as chairman of the NARO Board of Directors from 1993 to 96. After a four-year stint working for the Oklahoma Marginal Well Commission, he was hired as executive director of NARO, and held that position for five years until resigning in early 2005.

“My resignation was over a fundamental disagreement on the direction the board wanted to take the organization,” Chapman reveals. “Oil and gas producers pay royalties. It is fundamental that (royalty owners) have a relationship with oil and gas companies. The board that was in place when I left NARO didnt see it that way. I think you should be able to visit with an operator if there is a dispute. That is ARCs objective.”

Abernathy is an Oklahoma City attorney whose family has been involved in the oil business for four generations. He says he began buying oil leases eight years ago to supplement income from his fledgling law practice. He says his philosophy on his role as a royalty owner is simple.

“I am not going to kill the goose that lays the golden egg,” he avers. “I am not going to complain about the gold, either. My income comes from producers leasing mineral rights or drilling new wells and properly maintaining production. There are several million mineral owners in this country, and each mineral and royalty owner is a potential spokesman for the oil industry.”

Stallsworth says ARC has been a breath of fresh air for producers in Oklahoma. “The good news is the new royalty owners group provides a more balanced perspective on issues compared to (some others),” he praises. “Its message is more producer friendly, and it has a more regional perspective. We look forward to working with ARC in the coming years and wish it the best as it re-emerges as a force at the state Capitol.”

Chapman says he would like to expand ARCs producer/royalty owner committee even further. “I would like to add several state legislators,” he says, “to tell us their comfort level in crafting legislation. We could settle things before we come to the statehouse.”

ARC wants to keep producers and royalty owners talking, he adds. “At ARCs core is keeping companies and royalty owners at the table in a formal setting,” Chapman outlines. “There are always changes in the oil industry. We want to make sure we are asking the right questions, and that the people who pay royalties and those who receive money are comfortable and understand how the system works.

“There are two big days in a royalty owners life: when he signs a lease and when he gets paid for production,” Chapman muses. “Most people want to be paid their fair share. ARC wants to make sure all sides are paid fairly.”

Royalty Conflicts

However, royalty owners and producers dont always see eye-to-eye. The problem between the two groups often boils down to how royalties are calculated or what costs can be deducted from the sales price of the oil or natural gas, notes COGAs Wonstolen. That has been especially troublesome in Colorado.

“We have a horrible case law record,” Wonstolen rues. “Since Rogers v. Westerman Farms, we not only have to make gas marketable cost-free to royalty owners, but we also have to pay royalty owners on the cost. Then we can be second guessed whether we sold it at the real market place.”

Wonstolen says producers absorb that expense and pay royalty on well site treating costs as well as on transportation expenses in some cases. “It has been an incentive for lawyers to come to Colorado,” he reflects. “There is ongoing class action litigation. We have tried for three years to get it changed, and I havent seen anything improve. Some royalty owners want to have their cake and eat it, too.”

According to a NARO publication, that organization is pushing for national check-stub legislation. Abernathy says that is not necessarily a bad thing.

“We look at check-stub legislation as a very small part of the whole,” he says. “Anything to eliminate gray areas is a benefit. Our goal is to have simple, understandable rules. To eliminate litigation, you have to eliminate the causes for it. ARCs goal is to mutually solve our differences without going to legislatures or the courts.”

Stallsworth says OIPA testified at an Oklahoma Senate Energy Committee hearing last fall concerning check-stub concerns. The contentious part of that legislation is what information ought to be required on a royalty owners check.

During the Energy Committee hearing, he says, a spokesman for COSMO pushed for more information to be included on royalty check stubs. “The bottom line is that the law should be clear,” Stallsworth states.

Chapman says there also have been efforts to pass a new check-stub law in Kansas. A similar bill in Oklahoma was vetoed by the Governor. Chapman says he likes the Texas check-stub law.

“Check stubs are one of the components,” he says. “There are four times when a royalty owner deals with an oil and gas company: the deed at the courthouse, the lease, the division order, and the check. The information with the check is important to reconcile that you are being paid what you should be. The check stub is vital information, and there needs to be a model check stub. But it shouldnt be full of information that can be used to hang the producer.

“The Texas law gives ample information on check stubs,” he continues. “It determines volumes and values, and gives permission for the royalty owner to ask for anything he wants. It spells out the rules of engagement in disputes. One of the things we learned at our meeting in December is that companies said they have had minimal inquires. Most (royalty owners) accept what they get on the check detail.”

Surface Restrictions

Another issue that sometimes complicates the producer/royalty owner relationship is restrictions on surface usage and compensating surface owners.

While royalty owner/producer conflicts have seemingly been worse in Oklahoma than anywhere, according to Abernathy, a fight over surface issues is brewing in urban area-plays such as the Barnett Shale in and around Dallas-Fort Worth or the Denver Julesburg Basin along Colorados Front Range.

“That area north and east of Denver is a great example,” Abernathy remarks. “It is a hot play for oil and gas, but it also is a hot play for real estate speculation. In Texas, they are arguing over how many angels can dance on the head of a pin, but the real threats to the industry as a whole are in the Rocky Mountains. The real threat is surface use restrictions. If you cant access the land, nothing else matters.”

Wonstolen agrees, “Royalty owners who have unified estates want to get their royalty checks and get paid for the surface use, too,” he says. “Its the free lunch theory. I can pay X for a lease, but if I have to compensate surface owners for the loss of land value, then I cant pay X for the lease. When we bring up those issues, (royalty owners) shrug them off. I guess it is supposed to come out of producers hides.”