In re Protests of River Rock Energy, Co.

• Decision Date: 31 October 2018
• Docket Number: 2017-581-PR,2017-578-PR,2017-570-PR,2017-566-PR,2017-575-PR,2017-571-PR,2017-574-PR,2017-567-PR,2017-572-PR,2017-568-PR,2017-579-PR,2017-577-PR,2017-582 PR,2017-580-PR,2017-747-PR,2017-573-PR,2017-576-PR,2017-569-PR
• Parties: IN THE MATTERS OF THE PROTESTS OF RIVER ROCK ENERGY, CO. FOR THE YEAR 2016 IN LABETTE COUNTY, KANSAS IN THE MATTERS OF THE PROTESTS OF RIVER ROCK ENERGY, CO. FOR THE YEAR 2016 IN NEOSHO COUNTY, KANSAS IN THE MATTERS OF THE PROTESTS OF RIVER ROCK ENERGY, CO. FOR THE YEAR 2016 IN WILSON COUNTY, KANSAS Nos. 2017-748 PR, 2017-768-PR
• Court: Tax Court of Kansas

IN THE MATTERS OF THE PROTESTS OF RIVER ROCK ENERGY, CO. FOR THE YEAR 2016 IN LABETTE COUNTY, KANSAS IN THE MATTERS OF THE PROTESTS OF RIVER ROCK ENERGY, CO. FOR THE YEAR 2016 IN NEOSHO COUNTY, KANSAS IN THE MATTERS OF THE PROTESTS OF RIVER ROCK ENERGY, CO. FOR THE YEAR 2016 IN WILSON COUNTY, KANSAS Nos. 2017-748 PR, 2017-768-PR

Nos. 2017-566-PR, 2017-567-PR, 2017-568-PR, 2017-569-PR, 2017-570-PR, 2017-571-PR, 2017-572-PR, 2017-573-PR, 2017-574-PR, 2017-575-PR, 2017-576-PR, 2017-577-PR, 2017-578-PR, 2017-579-PR, 2017-580-PR, 2017-581-PR

Nos. 2017-582 PR, 2017-747-PR

Tax Court of Kansas

October 31, 2018

FULL AND COMPLETE OPINION

RONALD C. MASON, CHAIR

Now the above-captioned matters come on for consideration and decision by the Board of Tax Appeals of the State of Kansas.

TaxpayerRiver Rock Energy Company("River Rock" or "Taxpayer") appears by and through its counsel of record, Keith A. Brock of Anderson & Byrd, LLP.Labette Neosho, and Wilson Counties (the "Counties") appear by and through their counsel of record, C. Michael Lennen and Trevor C. Wohlford of Morris, Laing, Evans, Brock, &amp Kennedy, Chartered.The State of Kansas, Division of Property Valuation("PVD"), Intervener herein, appears by and through its counsel of record, Amelia Kovar-Donohue.

After considering all of the evidence and arguments presented, the Board finds and concludes as follows:

I.Jurisdiction

The Board has jurisdiction of the subject matter and the parties as payment under protest applications have been properly and timely filed with the Board pursuant to K.S.A. 2017 Supp 79-2005.

On July 16, 2018, these matters were fully submitted to the Board upon final receipt of the parties respective Findings of Fact and Conclusions of Law, Briefs in support thereof, Responses, and Replies filed pursuant to the Parties' Order Accepting Written Direct and Rebuttal Testimony in Lieu of Oral Examination.On July 30, 2018, the Board issued its Summary Decision, and, on August 2, 2018, the Taxpayer requested that the Board issue a Full and Complete Opinion.

II.Subject Property/Issues Presented

These 2016 tax year protest applications, consolidated by agreement of the parties, involve a multi-jurisdictional dispute over the valuations determined and assigned severally to 203 gas wells, pipeline assets, and related equipment (the "subject property") located in Labette, Neosho, and Wilson Counties.The parties submit their respective causes to the Board on pre-filed written direct and rebuttal testimony, as well as exhibits, which the parties stipulated to their admissibility.The Board hereby accepts and admits into the agency record all pre-filed testimony and exhibits submitted by the parties.The parties indicated the disputed issues herein are as follows:

1) Whether the alternative minimum lease value methodology that was utilized by the Counties to appraise the Taxpayer's gas wells ignores certain expenses, thereby overstating the asset value, and thus violates Kansas law; and

2)Whether the Kansas Oil and Gas Appraisal Guide's table used to assign certain assumed equipment value to the subject wells should be deviated from on the basis of actual market conditions and values (or lack thereof) experienced by River Rock.

III.Findings of Fact

A.

River Rock acquired the subject property, along with 1, 947 other gas wells, leases, pipeline assets, and related equipment in the course of a jointly administered Chapter 11 bankruptcy case filed in the United States Bankruptcy Court, Western District of Oklahoma.In re PostRock Energy Corporation, et al., Bankr. W. D. Okla.., Case No. 16-11230-SAH.After the bankruptcy case was commenced on April 1, 2016, the bankruptcy trustee moved to liquidate the Debtors' assets thru a bankruptcy sale conducted under the credit-bid and debt-assignment procedures.River Rock, a subsidiary of Cardinal Energy Company("Cardinal") was formed in 2016 as part of a collaborate arrangement with a national bank group to assist the banks in making a credit bid to acquire Debtors' assets.

In the bankruptcy court's order approving the bidding procedures, entered May 20, 2016, the court determined that "[a] sale of the assets on an expedited basis without traditional marketing efforts [was] necessary."Taxpayer reviewed Debtors financial statements and determined Debtors' integrated portfolio of wells and related assets was collectively running a negative cash flow.Taxpayer worked with Debtors' lender to determine an estimated value for those assets.

The total cash consideration included in Taxpayer's credit bid for all of the mortgage and un-mortgage assets transferred by the trustee at the Bankruptcy Sale was $3, 100, 000.Taxpayer allocated 92% of that bid ($2, 861, 411) to the assets it acquired located in Kansas and exactly 60% of that amount ($1, 716, 847) to the 2, 150 Kansas well properties.

After the Bankruptcy Sale closed on June 1, 2016, Taxpayer began investigating why the Counties assigned a total appraised value of $13, 522, 670 and determined that most of the wells subject to these appeals were assigned a minimum lease value ("MLV") in accordance with the State of Kansas, Division of Property Valuation("PVD")Kansas Oil and Gas Appraisal Guide(the "Guide").

Following unsuccessful County-level appeals, the Taxpayer filed payment under protest applications with the Board for all of the 2, 150 Kansas well properties.Ultimately, the Taxpayer perfected 205 protest appeals ers and subsequently settled the appeals for two of these properties.As such, the subject property consists of the 203 well properties that remain for adjudication.

B.

Lynn Kent, PVD Oil and Gas Personal Property Section Manager, appeared as a witness for Intervener PVD and testified regarding the Guide methodology for valuation of Kansas oil and gas properties.Kent has 16 years of experience in the development of the Guide.Kent teaches courses about the Kansas oil and gas valuation scheme, oversees the continued development and promulgation of the Guide, and facilitates Guide meeting and conferences.Kent, further, reviews suggestions and supporting documents, gathers data, performs research and analysis, and makes preliminary comments and recommendations to the Director of Property Valuation for modifications or changes in the Guide.Kent also assists the Director of Property Valuation in determining the annual crude oil price and gas market adjustment factors for valuation purposes.

The Guide has been developed over many years beginning in the 1960's.Pursuant to K.S.A. 75-5105a, PVD has been authorized to devise or prescribe guides for the valuation of personal property.The Guide provides a mass appraisal methodology for valuing a universe of oil and gas properties developed by the PVD director, with consultation from Kansas County Appraisers and representative of the oil and gas industry including company officials, tax consultants, attorneys, accountants, geologists, petroleum engineers and software programmers.

The Guide's mass appraisal methodology is designed to value a large number of similar type properties in a uniform and consistent manner in an effort to achieve fair market value for ad valorem tax purposes.Standard guidelines and models using common data are used to value a universe of properties as of a given date.The goal is to provide a common valuation method that achieves a reasonable estimate of the fair market value for the most oil and gas properties.In accordance to Kansas statute, the Guide also allows for consideration of other factors and other valuation methods, if necessary, to achieve fair market value, for an individual piece of property.

The Guide's mass appraisal method is an income approach which determines the income by multiplying the prior year's production by the prior year's net weighted average price.The net weighted average price is multiplied by a market adjustment factor, as determined by PVD, to adjust the prior year's net weighted average price per lease to the current year's estimated market conditions.The net weighted average price is net of gathering, transportation, and conditioning expenses.These expenses are taken out of the price rather than as a lease expense allowance to affect all interests included in the entire lease value.This results in a gross income value, which is then multiplied by a present worth factor, that is determined from the lease's decline rate, to estimate the gross reserve value.The estimated gross reserve value is the present value of the entire lease inclusive of all interests.The entire lease value is then split to separately value the royalty, the overriding royalty, and the combined working interest.The working interest portion of the lease is then allowed to subtract certain operating costs by one of three methods.

There are three methods in which the Guide deducts operating costs from the working interest portion of the lease.Each expense methodology provides expenses allowances to account for operational costs.Kent testified there are different expense allowances based on different lease characteristics (location, field, well type, depth, production, and decline) is reasonable in the mass appraisal methodology and further takes these property characteristics of the lease into account.

The first method is applying expense allowances from the appropriate Guide table.Guide table allowed expenses are direct, re-occurring expenses for specific depths discounted over a seven year period for Table C.The expenses listed in Table C ("Table C expenses")(as well as the Guide's equipment values discussed below) reflect averages and therefore, may not compare directly to actual operating expenses experienced at individual wells.Table C...