Royalty Rip-off

Around the country, landowners are suing Chesapeake and other drillers for massive deductions from royalty checks.
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Posted April 16, 2014 by PETER GORMAN in News

Chesapeake founder and former CEO Aubrey K. McClendon, dubbed “America’s Most Reckless Billionaire” by Forbes magazine in 2012, was famous for mixing personal business with company business. He bought or built mansions in Oklahoma City, in Minnesota, in Vail, Colo., and on “billionaires’ row” in Bermuda. He kept a leased fleet of jets at his disposal in Oklahoma City, where he built a 111-acre corporate campus that includes a 72,000-square-foot gymnasium for employees, four restaurants, and a theater. It all cost hundreds of millions of dollars at a time when the glut of natural gas had dropped the price below the cost of actually getting it out of the ground. He was forced out of the company in 2013.

Those expenditures, plus Chesa-peake’s continual expansion, from the Barnett Shale to the Marcellus to Ohio, Oklahoma, and elsewhere, stretched the company too thin, even for the second largest producer of natural gas in the country. By the end of 2012, Chesapeake was nearly broke, and its stock value was tumbling.

Townsend said he “hates to pick on Chesapeake, but they’re the first, the most aggressive, and the one that keeps getting caught. And it’s nearly impossible to find out what they’re calling production or enhancement items because they don’t have to make that public here in Pennsylvania. If Chesapeake pays a county $60,000 for the drilling tax to drill a well, is that being charged to the landowner? They say they’re not doing that, but who knows because we don’t get to audit them.”

Simmons: “Educate yourself before you sign.” Courtesy Jerry Simmons

Simmons: “Educate yourself before you sign.” Courtesy Jerry Simmons

Not far behind Chesapeake is Range Resources, which was sued back in 2008 by landowners who wanted their leases cancelled because royalty payments had dipped below the 12.5 percent threshold. The class action suit, which included 25,000 landowners, was withdrawn after the decision in the Kilmer suit, then re-filed with a new angle, claiming that the landowners were being charged for marketing and gas management fees, as well as not being paid royalties for other salable hydrocarbons that were separated out of the natural gas — including propane, benzene, and oil. Range settled and finally paid $22 million — but after deductions for legal fees, the average landowner in the suit got less than $800. As part of the settlement, Range has continued to drill and pump gas from the properties involved.

Carol French, a landowner who spent months getting out from under her gas lease even though it had expired without any wells being drilled, is an outspoken critic of the way gas companies do business in her state.

“In Pennsylvania there are no laws on the byproducts of natural gas — propane, oil, and so forth — giving landowners a share in those royalties,” she said. “So while the landowners don’t get any share of those hydrocarbons, you can bet that they’re still paying for their separation out of the natural gas and to make those products ready for sale.”

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The Chesapeake model does not stop with deducting post-production and enhancement charges. Their corporate structure is predicated on the idea of the company taking money at each step along the way — money that otherwise would go to landowners.

“The way Chesapeake set up their company allows it to make a lot of money from royalty owners just in the way they do their accounting,” McFarland said. “They set up a system that has affiliate companies and subsidiary companies doing the drilling, the fracking, separation of the gas, the gathering of the gas, the compression, and even the marketing.”

That structure means that, when one affiliate levies a fee on another affiliate, the fee is charged back to the landowner, and those fees find their way to Chesapeake coffers. When the fees and deductions are inflated, the company’s profits go even higher. Chesapeake pays royalties to landowners based on the value of the gas as sold to its affiliate. Since those prices are always lower than market price, McFarland said, so are the checks to royalty owners. On the other side, the subsidiaries that do the drilling and separating charge higher than normal rates to Chesapeake — and those costs are again passed on to landowners.

A striking example of the practice involves the gathering lines that bring the gas from the wellhead to a compressor station. Chesapeake’s subsidiary pipeline company, Chesapeake Midstream Operating, was sold in July 2012 to another affiliated company, Access Midstream Partners. In that sale, covering its gathering lines nationwide, Chesapeake received $4.76 billion.

According to a report last month from the online investigative news site ProPublica, in Pennsylvania, Access Midstream almost immediately began charging Chesapeake 85 cents to move 1,000 cubic feet of gas, while the same amount of gas moved by another company in the same lines cost only 9 cents. That markup came right out of royalty payments.

“That was an outrageously high fee,” said NARO’s Root. “But that’s how Chesapeake does it. I’ve got cases where Chesapeake is claiming to have gotten $3.56 per mcf [thousand cubic feet] at the point of sale and then taking out more than three-quarters of that in deductions — like pipeline fees — before figuring royalties.”

Within a relatively small area, there might be four different companies operating under several different types of leases, Root said. So a landowner with one type of lease might be losing most of his or her royalties to Chesapeake’s post-production or enhancement fees, while a neighbor who leased to a different company might have no deductions.

Townsend said the problem is so bad in Pennsylvania that sometimes the gas companies “take money out of royalty checks for several months’ previous post- production or enhancement costs, leaving royalty owners essentially owing the gas companies for the right to take their gas.”

Worse, he said, is that even when royalty owners decide to band together in a lawsuit, the statute of limitations on suing over royalties is four years. “So if someone realizes they’re being cheated and have been cheated for 10 years, well, even if they bring a suit and win it, the gas company only has to reimburse them for the most recent four years of cheating.”

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Pennsylvanians are also discovering an entirely new issue, one that has little to do with royalties but a lot to do with gas companies and their leases: Drilling companies are taking loans out against their properties.

McFarland said that oil and gas companies have taken out lines of credit against the value of the mineral rights on properties they have under long-term lease. “Oil and gas companies do that all the time to give themselves enough cash to drill, but here in Texas, the lien only attaches to the oil or gas company’s mineral interests — it doesn’t affect the surface owner at all,” he said.

Garry Miller, of Ohioville in south-west Pennsylvania, went to his credit union in October 2013 to take a loan out on his 12-acre property. “I filed for a mortgage, and not long afterward I got a call to come into the credit union to take a look at something,” he said.

When he went in, he was told that a title search had discovered a lien on his property. “I couldn’t believe it. I looked, and sure enough, there was a lien on my house for $500,000. Then they told me to take a second look: It turned out it wasn’t for a half a million dollars, it was for half a billion dollars. Can you imagine? I had a $500 million lien on my house!”

Miller called Chesapeake and asked why there was a lien against his property. Chesapeake explained that it wasn’t a lien on his property, it was a lien on the mineral rights under his land and surrounding properties.

“The thing was that the company making the money available to Chesapeake needed a physical address, and they happened to use mine. Which meant no refinanced mortgage.”

Miller, who is retired and living on about $1,500 a month, wanted to refinance the note on his land to lower payments and leave him enough money to buy a truck. But he said that no one has been willing to give him a loan, at least at a rate he can afford, while that lien is there.

“When the gas people first came and offered me nearly $2,500 an acre — a total of $30,000 — in bonus money, that was fantastic. But now, with everything I’ve heard and with this lien … well, since they haven’t started drilling yet, I hope they never do. I hope the lease expires because I’m sick of this, and I don’t want anything to do with Chesapeake or any other gas company.”

He’s not alone. Carol French and Carolyn Knapp went to the Bradford County courthouse when they first got wind of mortgages being taken out on property without the owners knowing it and found 31 properties in the county with such liens against them.

“We had landowners here getting bills for equipment that was leased by Chesapeake and that they didn’t pay for,” said French. “Like when their own [affiliated] drilling company, NOMAC, was drilling, the farmer who had that well was named as a prudent partner in the drilling. And in our state, being named a prudent partner means you’re held responsible if the other partner, the company, doesn’t pay up. One landowner here was saddled with a $1.2 million bill for a compressor station that Chesapeake had built but didn’t pay for.”

French said that Chesapeake cleaned up a lot of the liens but not all of them.

The problem was even bigger than French knew. As early as August 2011, according to numerous news reports, Chesapeake had mortgaged the mineral rights on more than a thousand properties in Bradford County, preventing some of those owners from getting loans on their property.

Diane Ward, a former secretary-treasurer of Standing Stone Township in Bradford County, explained the problem in a public meeting in 2011 with Bradford County commissioners. The meeting was taped by several local news organizations. “The mortgage is technically on the mineral rights, but it has to be filed on the property,” Ward was quoted as telling the commissioners. “In the courthouse there is no separation between the mineral rights on the one hand and the land and buildings on the other. So unless you’ve separated your property, it’s all one deed.”

Which is why Miller finds himself saddled with a $500 million lien on a $275,000 property. “Chesapeake says there’s no problem, but I still can’t get my loan, and I still don’t have my truck,” he said.

“You don’t have to like the way some of these companies do business,” said NARO’s Simmons, “but it’s the way business is done in this country. It isn’t always nice.”

Patrick Creighton, of the pro-drilling Marcellus Shale Coalition, wrote in an e-mail that “Our member companies … are committed to being responsible corporation citizens” and that “post-production costs are part of any lease.”

In what is perhaps an understatement, he added, “We have long taken the position that all mineral owners should consult legal counsel prior to entering a lease agreement … .”

Simmons said that anyone entering into business, and particularly anyone entering into the business of leasing mineral rights to an oil or gas company, should be wary.

“Whether we like it or not, these companies often planned on taking post-production costs out of your royalties, and they structure their leases in a way that allows them to do that. So if you signed a lease allowing that, well, then it’s your fault,” he said. “You’ve got to take responsibility for that. … So educate yourselves before you sign.”

Simmons isn’t talking to the people who’ve already signed. He said NARO is focused on trying to educate people who have not yet signed on the dotted line. “There are a lot more leases going to be signed in this country in the coming years,” he said. “People can do it right and protect themselves and their property and future royalties, or they can make a stupid decision and kick themselves for years.”


6 Comments


  1.  

    Excellent article explaining the many devious ways that Chesapeake and other gas companies milk more money out of landowners and give them less royalties over time to enhance their pockets. Buyer beware of the Gas Industry and their endless ways to take advantage of and abuse landowners and residents…




  2.  
    Bubba

    They ain’t called Cheat-sapeake for nothing. Interesting that former Fort Worth mayor Mike “the Gasfather” Moncrief and his estate hasn’t needed to sue like other large leaseholders such as the Basses and even Chesapeake’s close partner the City of Fort Worth? Hmmm.




  3.  
    Don Young

    The best way to deal with these shisters is to never sign a lease. We left $15.K on the table to preserve our dignity. That decision looks better every day.




  4.  
    Terry

    Very well written article and very informative. I’m a Landman and deal with these very issues everyday and I still learned a lot.




  5.  
    Tim Ruggiero

    Leases written by the operators are always going to favor the operator, and cover all the contingencies. But leases are always written in a way that’s vague at best, and certainly in legalese, a language few understand and up for interpretation. The people who go door to door, some are pretty slick salesmen. Their job is to get you to sign the lease by having you believe vast riches are yours to be had, just sign here. They might even calculate the percentages and dollars of how much you could get. Just like those famous sweepstakes- “You could be a millionaire!” Yes, you COULD, but very likely, will not. The fine print in those leases are just like in the sweepstakes: The odds of becoming a millionaire: 1 in a 100 million. One signed lease in our favor per household.




  6.  
    Kit

    Really good article….it should be circulated in every newspaper and by every tv media outlet in states where gas drilling is rampant. I have always opined that the drilling industry is overly opportunistic and needs more oversight. In Texas, we have the Railroad Commission, but they appear to be more a supporter than regulator.





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