Many Pennsylvania landowners are receiving royalties relating to natural gas leases. That revenue stream may be subject to tax implications. Likewise, an estate that owns natural gas rights must determine the Pennsylvania inheritance tax implications of the rights and any related natural gas lease. The Marcellus shale exploration boom brought with it many questions pertaining to valuation of natural gas interests for estate purposes. Recognizing these questions, the Pennsylvania Department of Revenue issued Inheritance Tax Bulletin 2012-01on July 10, 2012. That Bulletin was entitled, “Taxation and Valuation of Mineral Rights and Natural Gas Interests for Pennsylvania Inheritance Tax.” The Bulletin addresses taxable value of mineral and natural gas rights and states:
Under provisions of the Inheritance and Estate Tax Act of 1991, (72 P.S. §§ 9102, 9121),
the Secretary of the Department of Revenue (“Department”) announces that the
Department has clarified existing Department policy concerning the taxation of mineral
rights and natural gas interests for Pennsylvania inheritance tax purposes. All mineral and
natural gas rights shall be reported on Inheritance Tax Schedule E (REV-1508) as Cash,
Bank Deposits & Misc. Personal Property. The Department clarifies its policy as follows:
(1) The taxable value of mineral rights shall be determined using the same
methodology used to value any real property or tangible personal property
interest. Taxable value is most clearly established by determining the actual
monetary worth of the interest determined by either a bona fide sale or, if
the transfer is for no or nominal consideration, computed value (based on the
common-level ratio applied to the assessed value of the mineral right). In the
event that there is no sale and no computed value, then the taxable value is
the interest’s actual monetary worth.
(2) The taxable value of natural gas rights shall be determined using the
same methodology used to value any real property or tangible personal
property interest. Taxable value is most clearly established by determining
the actual monetary worth of the interest determined by a bona fide sale. If
there is no bona fide sale, natural gas rights can be determined from a
credible appraisal. A computed value using assessed value cannot be
accomplished because natural gas rights do not have assessed values.
Therefore, absent a bona fide sale, an appraisal or other credible
evidence to the contrary, value shall be determined as follows:
(i) For leased and producing properties, an estate shall value
natural gas rights at an amount equal to any amounts received
that were attributable to actual production of the natural gas
interests at issue during the twelve months prior to the
decedent’s date of death, multiplied by two.
(ii) For leased, non-producing properties (including
unconventional natural gas wells as that term is defined by 58
Pa.C.S. § 2301), interests shall be reported at a value of zero
unless, at the time of death, the properties were part of a
contractual arrangement whereby the properties generated
fixed future payments, in which case the natural gas rights shall
be calculated by reducing the fixed future payments to present value as of the decedent’s date of death using established
Internal Revenue Service actuarial tables as found in IRS
Publication 1457 Actuarial Values Table B, Section 3 Annuity,
Income, and Remainder Interests For a Term Certain.
(iii) For non-leased, non-producing properties, interests shall
be reported at a value of zero.
Therefore, the Department of Revenue has allowed that an estate can calculate taxable value of gas rights by obtaining an appraisal. Undertaking this appraisal can be costly and time consuming to the estate. Apparently recognizing this, the Department has also provided for a capitalization model allowing for a multiplier where the estate holds leased, producing acreage. Absent leased/producing acreage, and/or a fixed future payment arrangement an estate can likely report a value of “zero” on the Pennsylvania inheritance tax return relating to natural gas rights.
If you are an executor or administrator of a Pennsylvania estate that owns gas and/or mineral rights, or if you are an heir or beneficiary of such an estate, you may wish to seek legal representation to ensure proper calculation of Pennsylvania inheritance tax liability. If you would like to discuss the Tax Bulletin in detail, or if you have questions as to how the Bulletin may impact an estate in which you have an interest, please feel free to contact this law firm for a consultation.
In representing landowners in oil and gas lease negotiations and transactions throughout Southwestern Pennsylvania, we are mindful of how changes in state law can affect our clients’ interests. House Bill 1950 was recently passed and signed into law by Governor Corbett in February of 2012. This legislation is formally known as The Act Amending Title 59 of the Pennsylvania Consolidated Statutes (Act 13 of 2012). Therefore, Act 13 serves to update the Pennsylvania Oil and Gas Act. Much of Act 13 applies only to natural gas operations involving hydraulic fracturing (“fracking”) or multilateral well boring technology. It is fair to say then that the Act in many ways specifically addresses “unconventional” Marcellus (and Utica) deep well drilling which has become a significant commercial endeavor over the course of the last several years in the region. This article will summarize how “Act 13” may impact landowners.
I. Environmental Regulation by Local Municipalities
In the recent past many municipalities have attempted to regulate and/or ban unconventional natural gas exploration by passing local ordinances. Some landowners favored such measures while others opposed them in that the ordinances could result in chilling effect on leasing activity. Regardless of how a landowner reacted to local ordinances impacting natural gas exploration in a given municipality, Act 13 clarified that environmental regulation of the oil and gas industry is the responsibility of the Commonwealth of Pennsylvania, and not local municipalities. That clarification, effective April 14, 2012, reinforced the gas industry’s ability to operate and/or explore for gas in Pennsylvania. Specifically, the Act prohibits local environmental regulation of oil and gas operations. Additionally, the Act sets restrictions and requirements on local zoning so as to allow for reasonable gas exploration and development. These provisions were intended to provide a greater degree of uniformity throughout the Commonwealth. Act 13 was intended to clarify the future of natural gas exploration in the region, however several municipalities have already challenged the Act by initiating lawsuits.
II. Additional Environmental Regulations
When we negotiate a lease on behalf of a landowner we are aware that the laws of the Commonwealth of Pennsylvania offer some degree of protection to the landowner (a well-negotiated lease provides additional protections). Act 13 changed and added to the environmental regulatory scheme associated with natural gas exploration. Some of the major changes are summarized as follows:
- Notice to landowners during permitting phase: Under the old regulatory scheme, certain landowners within 1000 feet of the proposed well bore were to be provided notice of a well permit application. Under Act 13 that distance has been expanded to 3000 feet. Once receiving notice a landowner may elect to object to the application with the Department of Environmental Protection.
- Water management: Even prior to Act 13 gas operators were required to submit water management plans with the drilling permit application. Act 13 imposes additional obligations in this regard relating to water withdrawals. Under Act 13 gas operator’s management plans must demonstrate, among other things, that there will not be diminished water supply to other users; that there will not be a negative effect on the quality of the water supply as a whole; and that the gas operator has an acceptable plan to capture and/or reuse fracking fluids.
- Well location: The placement of a well is of particular concern to landowners and Act 13 imposes new restrictions which gas operators must observe. Under the old statutory framework wells had to be set back at least 200 feet from buildings, structures and water wells. Act 13 has expanded that setback to 500 feet. The Act has also addressed increased setbacks in relation to reservoirs, streams, wetlands, springs, and other bodies of water. Further, Act 13 prohibits drilling in floodplains in certain instances.
- Damage to water supply: Under Act 13 there is a rebuttable presumption that a gas operator is responsible for pollution or diminution of a water supply if the pollution occurs within 12 months of completion of drilling or alteration of the well within 2500 feet of the affected water supply. This increases both the timeframe and distance of the former statutory provision which only prescribed a time frame of 6 months and a distance of 1000 feet.
- Containment practices: The new act imposes requirements that well sites be constructed so as to prevent spills either onto the ground or to locations surrounding the well site.
- Disclosure of chemical use: Many landowners and commentators have expressed concern that the fracking material was of an unknown chemical make up. Act 13 imposes chemical disclosure obligations and formation of a chemical disclosure registry. Specifically, service providers, vendors and gas operators must submit a record listing chemical additives to the fracking fluid with percent by volume information.
III. Drilling Impact Fee
Many landowners have expressed concern that increased gas exploration in the Commonwealth is causing strain on the local infrastructure and on the resources of the regulatory agencies without generating enough additional tax revenue to offset the burden. Act 13 established a drilling impact fee whereby individual counties can pass ordinances setting forth an impact fee. The drilling impact fee is to be calculated as a function of the average price of natural gas with a sliding scale which decreases over time. Act 13 specifies the specific amounts from the impact fee to be divided among regulatory governmental entities. Unlike the majority of the provisions of Act 13 which went into effect on April 14, 2012, the drilling impact fee became effective immediately upon the signing of the legislation in February of 2012.
Please note that this article was not intended to be a comprehensive analysis of Act 13 and is intended to provide a brief overview of the provisions of the new law which most impact landowners. If you would like to discuss the Act in detail, or if you have questions as to how the Act may impact your land and/or existing lease, please feel free to contact this law firm for a consultation.
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In representing landowners in oil and gas lease negotiations throughout southwestern Pennsylvania, it is apparent that there has been significant slowing in gas leasing and exploration activity in many areas of the region. In one recent instance, a gas operator even withdrew offers relating to proposed oil and gas leases for several clients of ours on the eve of the lease signings. The explanation provided by the landman regarding this particular instance was that the gas operator had become concerned about the steady downward trend in the price of natural gas and this prompted a complete shut down in their leasing activity in the area.
The low price of natural gas does not fully explain the reason why gas leasing activity has slowed in certain areas. During the same week that the lease offers were withdrawn in the example described above, this law firm was representing other landowners in negotiations with the same gas operator in different areas of southwestern Pennsylvania where the leasing activity remained very active and the offers very competitive. Our clients that have had offers recently pulled were initially frustrated and confused. They wondered why there are still a lot of areas in the Marcellus Shale and Utica Shale where gas operators are leasing acreage at a fast and furious pace if the reason for the slowdown in leasing activity in their territory is due to the decline of natural gas prices. What most people are surprised to learn is that not all natural gas drilled in the Marcellus Shale and Utica Shale has the same value.
A better explanation of why leasing activity has slowed in certain areas is that the gas industry is prioritizing their efforts in territories where the natural gas is more value. There are two types of natural gas that are being produced in the Marcellus Shale, wet gas and dry gas. Dry gas consists of little more than methane, and when brought to the surface dry gas has very little of the condensable heavier hydrocarbon compounds such as propane and butane. One benefit of dry gas is that it is typically ready for market at the wellhead, needing little or no additional treatment because it does not contain other liquid compounds which would need to be separated. The problem with dry gas these days is that methane prices have significantly declined and in the current market dry gas is not as lucrative as wet gas.
Wet gas contains the mix of hydrocarbons that contain a considerable amount of condensable or liquid compounds, such as propane and butane. These gas compounds need to be separated before the gas can be sold at market. Although there are costs incurred with separating these compounds, the propane and butane provides added value to the gas processing companies as these gas compounds can be sold separately. Because of the added value found in wet gas, gas operators are making a strategic effort to focus their drilling activities in areas which contain wet gas.
A common question that clients of ours have these days is how do they know if the natural gas in their area is wet or dry? In an interview with Mike Bradwell of the Observer-Reporter, Matt Pitzarella, a spokeman for Range Resources, explained in general terms that the “wet gas” region of the Marcellus Shale in south western Pennsylvania is located west of Interstate 79 and north of Interstate 70. Bradwell, Mike. “Range keeps focus on region”. Observer-Reporter January 31, 2012. There also appears to be significant wet gas producing areas in western Pennsylvania related to the Utica Shale as well.
So, what does a landowner do if they own gas rights in an area with dry gas? Probably the best and most simple advice that we can give our clients is to be patient. Although the leasing activity in certain areas has slowed down significantly in recent months, most gas operators have advised us that they expect the leasing activity to resume within months. Secondly, it is helpful to remain in contact with the gas operators and leasing agents who were at one time actively leasing in an area but have suspended leasing activities. We have many clients who we currently represent that are in this situation. Our goal is to make an effort to remain in contact with the leasing agents on a regular basis to ensure that when the gas operator gives the green light to resume its leasing activity our clients are at the top of their list. Finally, once a landowner receives a lease offer they should strongly consider seeking the advice of legal counsel who can explain the provisions and legal significance of an oil and gas lease as well as negotiate important revisions to the gas lease on behalf of the lessor.