As most mineral owners know, contracts between owners and mineral companies are often complicated, covering a wide array of factors to be negotiated and agreed upon. Everything from the quality of the minerals to the length of time that the mineral company has rights to develop the land is open for negotiation. It’s all too easy for those unfamiliar with legal terms, contract law, and oil valuation methods to become overwhelmed by the information and miss crucial details, especially when professional legal assistance is not utilized. One of the areas most commonly overlooked by mineral owners, yet discussed by industry and regulators, is the potential for deductions from royalties for transportation costs.

Before discussing transportation deductions, a brief explanation of the two methods of mineral valuation will help clarify when these deductions can be considered. Oil and gas can be sold at one of two places: at the wellhead or at market. In either of these locations, the company that extracted the minerals is selling them to a third party, then takes that amount and pays the mineral owner a royalty from the sale. Each of these options includes different factors to consider, with the first being the price at which the minerals will be bought and sold. Selling the minerals at market will generally earn the mineral company, and thereby the mineral owner, a larger amount, although the difference between the two can often be small.

The other substantial difference comes from incurring transportation costs. As one might expect, selling minerals at the wellhead does not require transportation of the minerals, but considers the value of the minerals where they are extracted. Conversely, selling minerals at market requires transportation of the minerals to a pipeline terminal or processing facility, which results in transportation costs. The difference in valuation can often outweigh the increased cost, incentivizing the mineral company to sell minerals at market more often than not. At this point, a problem occurs.