Audit Process

BACKGROUND

In 1979, Pennsylvania enacted the Guaranteed Minimum Royalty Act (“GMRA”), 58 P.S. § 33. The GMRA provides that an oil and gas lease must pay the lessor “at least one-eighth royalty of all oil, natural gas or gas of other designations removed or recovered from the subject real property.”

Post-production have been defined by the Supreme Court of Pennsylvania in Kimler v. Elexo Land Services, as “(i) all losses of produced volumes (whether by use as fuel, line loss, flaring, venting or otherwise) and (ii) all costs actually incurred by Lessee from and after the well head to the point of sale, including, without limitation, all gathering, dehydration, compression, treatment, processing, marketing and transportation costs incurred with the sale of such production.”

The most important point made in Kilmer is that the responsibility lies with the MINERAL OWNER.  Simply stated, if you suspect that a gas company is charging higher post-production costs than are actually being paid,  you are entitled to seek a court-ordered accounting of those post-production costs.  In other jurisdictions, including Texas, if the mineral owner does not timely question their royalty payments they will forever lose their right to recover those underpayments.

Given this ruling, it is apparent that there will be numerous disputes regarding the appropriate determination of post-production costs and royalties for gas wells.

 

ROYALTY AUDIT PROCESS

 

AUDIT NOTIFICATION LETTER

ShaleAdvice will inform the entity being audited (auditee), by virtue of an Audit Notification Letter, of a pending audit. The Audit Notification Letter describes the scope of the audit and requests certain information and materials.

REQUEST FOR DOCUMENTS

After the Audit Notification Letter, ShaleAdvice will request certain documents or records (see Records Requirements above) be made available by a specified due date. This request provides the following specific audit information to the auditee:

• The individual leases being audited,

• The time period covered by the audit, and

• The particular types of documents/records being requested for:

1) Each lease in the audit,

2) The time period for which the various documents are needed for each lease.

• Other additional information, documents, and/or records may be included in this Request or may be requested at a later date during the audit.

AUDIT OPENING CONFERENCE AND FIELDWORK

ShaleAdvice will then contact the auditee to schedule an Opening Conference at the auditee’s office. Auditee representatives at the Opening Conference should include senior management and other key personnel responsible for the oil and gas production, sales, reporting, and payment of royalties.

Inclusion of management for production operations and the marketing of production on leased lands could also be beneficial. The audit fieldwork usually begins with the Opening Conference and a portion may be done at the auditee’s office. Fieldwork consists of interviews with key personnel as well as gathering audit documentation and analyzing and evaluating that information.

AUDIT CLOSING CONFERENCE AND PRELIMINARY AUDIT REPORT

Upon the audit’s completion, ShaleAdvice will schedule a Closing Conference to present the auditee with a Preliminary Audit Report and discuss the findings. If it is determined additional royalties are due, the Preliminary Audit Report will include schedules that specify the amount of Royalty Due and the reasons for such determination. The auditee then has thirty (30) days to contest any of the issues in the report with an audit response and additional documentation. ShaleAdvice will consider the audit response and revise the Preliminary Audit Report as necessary. The auditee will then have fourteen (30) days to respond.

FINAL AUDIT REPORT AND AUDIT BILLING NOTICE

Once the issue(s) in the Preliminary Audit Report has been resolved or determined to be disagreed, a Final Audit Report and Audit Billing Notice (ABN) will be issued. The ABN will specify the additional royalty due, along with any applicable penalty and interest, and the reasons for the determination. The lessee may pay the additional royalty due to stop the accrual of penalty and interest.

LITIGATION

Should the Auditee disagree with Final Audit Report, then ShaleAdvice will proceed with legal action pursuant to remedies of the lease and the Fee Agreement between ShaleAdvice and the mineral owner.