Ohio Supreme Court Oil and Gas Royalty Calculation Decision Respects Ohioans’ Freedom of Contract

Today the Ohio Supreme Court determined that Ohio will not adopt a blanket or standard rule for determining whether post-production costs may be deducted prior to royalty calculation.  The Court made this determination in Lutz v. Chesapeake Appalachia, Case No. 2015-0545, by declining to answer a certified question from the federal court in the Northern District of Ohio.  This means the specific language used in oil and gas leases—interpreted in accordance with the traditional rules of contract construction—will control how royalties payments are calculated on a case-by-case basis.

Historically, oil and gas producers were allowed to calculate royalty payments using a “workback” or “netback” method.  This method, often referred to as the “at the well” rule, takes into consideration expenses associated with transporting, gathering, processing, treating, and marketing the extracted minerals.  Relatively recently, certain states—such as Kansas and Oklahoma—have moved away from this time-honored royalty calculation method and are only willing to allow producers to account for transportation costs from royalty payments.  Other states—including Colorado and West Virginia—have taken a more drastic approach by prohibiting the producers from even accounting for transportation costs in determining the proper royalty payments for mineral interest owners.  Following Lutz, this remains an open issue in Ohio to be decided by the language of the lease and the intent of the parties.