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The Attorney General of Texas
December 31, 1982
MARK WHITE
Attorney General
Mr. Bob Armstrong Opinion No. MW-550
Supreme Court Buildmg
Comr4issioner
P. 0. Box 12546
Austin.TX. 76711.2548
General Land Office Re: Interpretation of royalty
5121475.2501 1700 North Congress provisions of state leases or
Telex 9101674-1367 Stephen F. Austin Building lands dedicated to the Permanent
Telecopier 51214754266 Austin, Texas 78701 School Funds and Permanent
University Fund
1607 Main St., Suite 1400
Dallas, TX. 752014709 Dear Mr. Armstrong:
214/742-6944
You have requested an opinion from this office regarding the
calculation of royalties due for gas produced from state leases where
4624 Alberta Ave.. Suile 160
El Paso. TX. 799052793
the state’s lessee sells the gas pursuant to a contract which provide:
9151533-3464 that the purchaser reimburse the lessee for any severance tax paid ir
regard to the production of that gas.
:220 Dallas Ave., Suite 202
The current General Land Office lease form, “Revised Lease Fore
HOUS,O”, TX. 77002-6966
71316500666
9-81 ,‘I provides:
The Lessee agrees to pay... (B) Non-Processed gas:
606 Broadway. Suite 312 As a royalty on gas.. . part of the gross
Lubbock, TX. 79401-3479
production or the market value thereof. at the
6061747-52?6
option of the Lessor, such value to be based on
the highest market price paid or offered for gas
4.109 N. Tenth. Suite B of comparable quality in the general area where
McAllen. TX. 785c1.1665 produced and when run. or the price paid or
5 I21362~4547
offered to the producer, whichever is the
greater....
200 Main Plaza, Suite 400
San Antonio. TX. 762052797 The instant question arises only where the state has elected to takl
5121225-4191 its royalty in cash rather than in kind. Although question
concerning the effect of federal price controls have been raised ant
An Equal Ooportunityl will be addressed, this opinion will initially address the issues 01
Affirmative Action Employer the assumption that prices are not governmentally established.
A hypothetical may help explicate the analysis of these. issues
Assume that “A” leases permanent school fund lands productive of ga
at a one-fifth royalty. In the relevant month “A” produces on,
thousand mcf of gas. “A” has a contract with “B” for the sale of al
gas produced at the price of $5.00 per mcf plus any severance tax pai,
by “A” as a result of such production.
p. 2000
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Mr. Bob Armstrong - Page 2
-I
(MW-550)
A brief discussion of the Texas severance tax on gas is necessary
prior to pursuing that hypothetical further. Section 201.051 of the
Tax Code provides: “There is imposed a tax on each producer of gas.”
Section 201.052 further provides:
(a) The tax imposed by this chapter
is at the rate of 7.5 percent of the
market value of gas produced and saved
in this state by the producer.
Sections 201.101 and 201.102 respectively provide:
The market value of gas is its value at the
mouth of the well from which it is produced.
If gas is sold for cash only, the tax shall be
computed on the producer’s gross cash receipts.
Payments from the purchaser of gas to a producer
for the purpose of reimbursing the producer for
taxes due under this chapter are not part of the
gross cash receipts.
Section 201.001(5) defines producer to include royalty owner.
The state, however, has been held to be exempt from severance tax
liability even though as a royalty owner it falls within the statutory
definition of producer. Group Number 1 Oil Corporation v. Sheppard,
89 S.W.2d 1021 (Tex. Civ. App. - Austin 1935. writ ref’d). Under
section 201.051, the tax collection obligation is imposed on the gas
producer.
Returning to the above hypothetical. further assume that there
has been no increase in severance tax since the execution of the
contract between “A” and “B”. Cf. Attorney General Opinion H-176
(1973). Thus, we see the followingpayments made:
Price:
Total Production 1000 mcf
Times Base Price x$5 mcf
Total Base Price $5000
Total Base Price $5000
Times X Necessary to Yield $5/mcf Net of x.081
Severance Tax
Equals Severance Tax Due on Entire Production $ 405
Times Non-Exempt Producer’s Share of Production x.80
Equals Total Severance Tax Paid and Reimbursed S 324.00
Plus Total Base Price $5000.00
Equals Gross Price $5324.00
p. 2001
Mr. Bob Armstrong - Page 3 (NW-550)
State’s Royalty:
GLO Method:
Gross Price $5324.00
Times Royalty Percentage x.20
Equals Minimum Amount of Royalty $1064.80
Producer’s Method:
Total Production 1000 mcf
Times Royalty Share x.20
Equals State’s Share of Production 200 mcf
Times Base Price x$5 mcf
Equals Minimum Amount of Royalty $1000
tinder either method of royalty calculation both the gross price and
the severance tax amount remain the same.
Under the assumed facts, where the price is a negotiated one.
“the gross price paid or offered to the producer” is $5.324.00 for one
thousand mcf of gas. Thus, the state’s royalty of twenty percent of
the market value of the gross production is a minimum of $1.064.80,
not $1.000.00. The royalty due may be higher than that if comparable
sales dictate that result but it cannot be less.
Certain producers, in advocating the second royalty calculation
method noted above, have contended that it is inequitable to reach the
foregoing conclusion because to do so results in the state receiving
more for its portion of total production than the producer receives.
Under the approach advocated by those producers, both the state and
the producer would be compensated at a rate of $5.00 per mcf net of
severance tax. This result strikes those producers as the only just
result. The result, however, is that the state receives a lower
royalty than the producer who is liable for severance tax. Severance
tax liability is a cost of doing business to which the state is not
subject. Adopting a formula to protect producers from that expense is
no more justified than adopting one which takes into account, for
example, federal income tax liability.
The argument made by those producers seems premised on the
misapprehension that the severance tax is paid on particular units of
gas, like an ad valorem tax. It is not. It is a tax on the privilege
of engaging in the business of producing gas in Texas which is
computed on the basis of the amount of gas produced.
The conclusion advocated by those producers does not, in any
event, follow from the analysis which they make. If the state’s
fractional part of production, that is. the percentage of production
reflected in the state’s royalty share. is. as those producers
advocate it should be. segregated from the total production in
measuring the royalties due to the state the result is a higher
royalty than that resulting from the calculation advocated by the
p. 2002
Mr. Bob Armstrong - Page 4 (Mw-550)
General Land Off ice. The result of that analysis is that there are.
in effect. two sales of gas: one sale of 200 mcf of gas at $5.00 per
mcf reflecting the state’s share, and one sale of 800 mcf of gas at
$5.405 per mcf, reflecting the producer’ s share. Since the producer’s
share is a directly comparable sale under free market conditions, the
characterization of the transaction between “A” and “B” in that manner
results in the state receiving 200 mcf times $5.405 per mcf or
$1,081.00 rather than the $1,064.80 resulting from the General Land
Office’s method of calculation. That result, however. is artificial
since the transaction is, in fact, only one sale of gas. The
purchaser has agreed to pay and the producer baa agreed to accept
$5.324.00 for 1000 mcf of gas, not $1.000.00 for 200 mcf and $4.324.00
for 800 mcf.
Thus, absent price controls, the state’s royalty is to be
calculated on the basis of the entire consideration paid to the
state’s lessee for the production from the state lease including
severance tax reimbursement. Whether the existence of the Natural Gas
Policy Act of 1978 (hereinafter NGPA). 15 U.S.C. section 3301 et seq.,
alters this result as to production covered by its terms will be
discussed. next.
The NGPA sets ceiling prices on initial sales of natural gas.
Title 15, section 3320 of the United States Code provides:
(a) a price for the first sale of natural gas
shall not be considered to exceed the maximum
lawful price.. . if such first sale price exceeds
the maximum lawful price to the extent necessary
to recover -- (1) State Severance taxes
attributable to the production of such natural gas
borne by the seller....
Thus, one who has natural gas which has not previously been sold can
sell that gas for the applicable ceiling price plus any applicable
severance taxes for which that individual is liable. The fact that
section 201.001 of the Tax Code defines producer to include royalty
owner and that the state, although nominally a producer where it owns
royalty interests, is exempt from severance tax liability does not
make the state a seller within the meaning of the NGPA and. therefore,
subject to the price limitations.
If we amend the foregoing hypothetical so that the gas produced
by “A” is subject to the NGPA’s price ceiling and the base contract
price of $5.00 per mcf of gas is the ceiling price, we have the same
economic result between “A” and “8”. The royalty calculation issue.
however, requires additional analysis due to the supreme court’s
holding in Exxon v. Middleton. 613 S.W.2d 240 (Tex. 1981). that the
stat”8 of g=s under federal price control is relevant to the
determination of market value for royalty calculation purposes.
p. 2003
Mr. Bob Armstrong - Page 5 (NW-550)
As noted above, the transaction between “A” and “B” can be
characterized as, in effect, two sales: one of the state’s 200 mcf of
gas, as to which no severance tax is due for the $5.00 ceiling price;
and one of “A’s” 800 mcf of gas, as to vhich severance tax is due for
the $5.00 ceiling price plus $.405 per mcf as severance tax
reimbursement. If this characterization is legitimate’ then the
state’s gas sold for $5.00 per mcf and the sale of ‘A’s” gas for
$5.405 per mcf is not a comparable sale under the Middleton analysis.
From “B’ a” perspective, however’ the transaction appears different.
‘B’ purchases 1000 mcf of gas for $5’324.00, or for $5.324 per mcf.
As noted above, the severance tax is an occupation tax not an ad
valorem tax. The use in our hypothetical of 80% of the total
production as a basis of calculating the severance tax due from “A”
does not imply that there are two sales of gas. That calculation
merely reflects an allocation of the tax liability resulting from that
production activity. The tax liability is necessary because the
severance tax statute defines producer to include royalty owner. The
NGPA does not purport to limit the amount of royalty which may be paid
for gas produced.
The state owns a royalty interest. A royalty owner’s right to
receive payment of the money due upon production is a contractual
right to a money judgment. Shell Oil Company v. State, 442 S.W.2d 457
(Tex. Civ. App. - Houston [14th Dist.] 1969, writ ref’d n.r.e.). The
result in that case is not inconsistent with the taxability of the
royalty interest as an interest in real property under the ad valorem
tax statutes.
We note that a federal district court in Oklahoma has construed
section 3320 of the United States Code differently. See Hoover and
Bracken Energies, Inc. v. United States Department ofthe Interior,
No. 81-461-T (W.D. Okla., filed Nov. 18, 1981). However, this ruling
is not binding upon us, it is on appeal, and appears to be
inconsistent with Mobil Oil Corporation v. Federal Power Commission,
463 F.2d 256 (D.C. Cir. 1972).
In summary, there is only one sale of 1000 mcf of gas and the
state is entitled, as its royalty, to a minimum of 20% of the
consideration paid by “8” and received by “A” in that sale. “A” is
making, just as in the free market situation, one sale of gas for
$5.00 per mcf plus any severance taxes due.
The foregoing result is to be distinguished from the result under
the NGPA, 15 U.S.C. section 3316(b), Intrastate Rollover Contracts.
Part (2)(A) of that subsection provides:
In the case of any first sale under any
[intrastate] roll-over contract of natural gas...
which constitutes a State government’s... natural
w* production, or royalty share or other
p. 2004
Mr. Bob Armstrong - Page 6 (MW-550)
interests... in natural gas production... the
maximum lawful price... shall be the maximum
lawful price... under section 3312.
This constitutes an exception to a general rule under section
3316(b) which provides for a maximum price of $1.00 (adjusted for
inflation) or the old contract price, whichever is higher, for
intrastate rollover contract gas. This price will generally be less
than that allowed for the natural gas constituting the state's royalty
share. The effect of section 3316(b) of the NGPA is to create tvo
categories of gas, that is. to work the kind of segregation of the
hypothetical 100 mcf of gas which certain producers have advocated.
The fact that the terms of the NGPA do not alter the state law
regarding the obligations among the parties is irrelevant. By its
very terms, section 3316 segregates, for the purpose of determining
price, the gas attributable to the state's royalty interest from the
remainder of the gas produced.
SUMMARY
The state's royalty on gas is calculated on the
basis of the market value of the gas produced, but
is in no event less than "the price paid or
offered to the producer." There is no basis in
law for the treatment of the sale as, in effect,
two sales at different prices' one of that
percentage of the gas equal to the state's royalty
percentage and one of the remainder of the gas
produced. The state is entitled to' at minimum,
its royalty percentage of the total consideration
including any severance tax reimbursement received
by the lessee/producer without regard to how that
total is calculated.
MARK WHITE
Attorney General of Texas
JOHN W. FAINTER, JR.
First Assistant Attorney General
RICHARD E. GRAY III
Executive Assistant Attorney General
Prepared by Carl Glaze
Assistant Attorney General
p. 2005
Mr. Bob Armstrong - Page 7 olw-550)
APPROVED:
OPINION COKMITTEE
Susan L. Garrison, Chairman
Jon Bible
Rick Gilpin
Carl Glaze
Patricia Hinojosa
Jim Moellinger
p. 2006
Untitled Texas Attorney General Opinion
Combined Opinion