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Permalink Reply by Bacon on January 14, 2015 at 3:10

Excellent question Mr. Graves!

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Permalink Reply by Henry on January 21, 2015 at 13:35

I sat in on the telecon tonight, 1/21/2015.  Here's what is new:

Aside from the cheating on gathering fees that we all know about, McDonald has found another "more  brash and brazen" cheat.  I'll try to explain it, but I doubt I'll get it right.  It has something to do with how CHK hedged their gas in futures trading.  You have to have physical gas behind whatever futures you trade -- you cannot trade naked futures.  And CHK apparently used all of the gas coming out of the ground (theirs plus ours) as collateral in their futures trading.  Apparently this is really wrong, and McDonald say the royalty owners should be compensated for the risk taken when CHK used our gas as their collateral.  

He estimated that the total amount of cheating comes to, at least, $2/Mcfe.

To date, they've filed almost 100 lawsuits, all in TX.  They file their first OK lawsuits tomorrow.  They have 1000 clients in LA and 1000 in PA.  Lawsuits are being grouped by drilling unit.  They are expecting 40,000 clients by the end of 2015.

Litigation is progressing well.  They have done over 10 depositions of current and former CHK employees, and have 25 more scheduled before the end of February.  They have tons of documents, emails, and letters that have been gathered in discovery.

Note to people in PA:  There are 2 class proceedings currently in PA.  The courts will soon eliminate one.  CHK has made an offer of $11M to settle the one called the "market enhancement clause lease."  This is a pathetic settlement.  McDonald encourages all people in PA to opt out of this suit and join him.

That's it.  Henry here....  I will add that I have a relative in this suit.  I noticed that the suit has been ammended to Include Total (the French oil company, and a partner of CHK) as a defendant.

I will try to listen in every few weeks and update you all with anything new.

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Permalink Reply by Pam on January 21, 2015 at 17:43

Thanks for your efforts and sharing with us, Henry!

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Permalink Reply by Jesse Joyner on January 22, 2015 at 4:25

Good job, Henry. Much appreciated. Interesting stuff.

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Permalink Reply by Henry on February 12, 2015 at 1:49

I listened in on the teleconference last night (2/11/2015).  Here are a few new things I learned...

The speaker was not Dan McDonald.  Instead, it was another attorney (I missed his name) from a different firm, who is helping on the case.  The attorney made the point that his firm was only helping.  No cases would be referred out to them or other firms.  All cases will have the McDonald Law Firm as the lead attorney.

He told a bit more of the story on Access and Total (the French oil giant).  He said that when Access bought out Chesapeake's gathering system, Access demanded a monthly minimum payment from CHK, regardless of how much gas went through the line.  Apparently Access drove a hard bargain, and this is what got CHK into trouble.  The minimum was so high, that CHK started losing money.  So when Total started looking at CHK's acreage, when they were going to buy into a JV, they told CHK that they were not going to pay these crazy high transportation fees.  They told CHK to pass that charges onto the royalty owner, and CHK agreed.  At that point, people's monthly checks plummeted.

I learned a bit more on the hedging issue.  Apparently, CHK hedged the gas that belonged to the royalty owners.  And apparently they were very successful at this -- when it came time to sell the royalty owners' gas, the hedged price that CHK received was much higher than the market value.  So CHK paid the royalty owners the market value and kept the difference as profit for themselves.  The McDonald Law Firm thinks that the royalty owners should have received the hedged price, and they are trying to recover that as part of this lawsuit.

Another fraudulent practice was discovered.  This was more limited.  There were people who had multiple wells in their unit.  CHK would shut one well in, and tell the owners all the wells were shut in.  However, they would continue to pump gas, from the non-shut-in wells and not pay the royalty owners.

The speaker cautioned mineral owners in both OK and PA that there are class action suits going on there now that are approaching a settlement.  He judged the proposed settlement amounts to be very, very low.  If you live in PA or OK, you will be receiving a notice that says you are part of the class, unless you choose to opt out.  If you don't actively opt out, you will be forced to take the settlement and cannot join the MacDonald effort.  He said that if you join the MacDonald effort, they will ensure that you get opted out. [Henry here.... I am just repeating what the speaker said.  Don't take this as any advice from me as to what you should do.]

The speaker ended by answering some questions that they often get at the town hall meetings...

1.  What happens if CHK goes bankrupt?  Answer:  You probably don't get paid.  You become one of their many creditors.  However, they don't think CHK is going bankrupt.  [Henry here.... Remember, MacDonald wants to get paid too.  They would not waste their efforts, if they thought CHK could not pay.]

2.If I sue CHK, can they counter sue me?  Answer:  Yes.   However, this has not happened to date.  It would be hard to see what CHK could actually sue you for, since you are a passive royalty owner.  Also, the PR would be bad for CHK.

3. Who decides whether to go to trial or accept a settlement?  Answer:  Each person makes his/her own choice.  If 99 people in a section want to settle and one wants to go to trial, then 99 will get a settlement and one will go on to trial.  

4.  Can CHK suspend my payments since I'm suing them?  Answer: Yes.Most gas leases allow this.  But it has not happened yet.

That's it.

Henry here....  Personally, I'm still confused/conflicted over the hedging issue.  Yes, I understand they made money by using the royalty owner's gas to hedge.  However, they did pay the royalty owner what was outlined under the terms of the lease.  If CHK had lost money by doing this, the royalty owner would be demanding payment of what was outlined in the lease, so I have trouble seeing why CHK owes the royalty owner more.  This seems to me to be a risk that CHK took -- it could have gone well, or poorly.  Maybe this is something for the Commodity Futures Trading Commission to look at -- is it legal?  I have no clue.

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Permalink Reply by tc on February 12, 2015 at 2:44

Thanks for the update Henry.

I agree with you on the hedging issue, while CHK may have run afoul of some SEC/CFTC/etc. regulations, I don't see how the mineral owners can win in a lawsuit, unless they can prove that CHK gave the mineral owners the lower hedge price when market prices were higher and then the lower market price when the hedge price was higher.

For #1, the biggest worry isn't that CHK goes bankrupt, but that they split the assets up such that an "independent" unit goes bankrupt, leaving the plaintiffs with little assets to go after, Caesars Entertainment is currently trying this move in bankruptcy court.

As to #3, that is a little tricky as some settlements require a certain acceptance rate for the company to accept the settlement.  If they have to spend legal cost on 1 settlement how much more is it to bundle all the cases together.  A company will do a cost benefit analyst to determine the best course of action. 

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Permalink Reply by Jesse Joyner on February 12, 2015 at 5:12

Good job, Henry. Thanks for investing your time in sharing this intel. Having been around the block at a lot of rodeos, I honestly think that the McDonald group are sharp lawyers with an edge when it comes to protecting landowner rights. As to the hedging, such a group of lawyers wouldn't waste their energy unless there was a crooked angle there. Seems to me it simply boils down to making money off produced petrol that CHK does not own. In other words, that commodity is actually owned by the royalty owner, which means that CHK is gathering an income from someone else's ownership. If my farming neighbor wanted to make money on the futures market for the corn grown on my land and not pay me to hedge my corn, that would be crooked since it's not his corn, seems to me. Anyway, from all that I've read to date, if I was harmed by CHK, I certainly would sign up with the McDonald law firm. Some money is better than no money in such situations, if you ask me. 

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Permalink Reply by DellP on February 12, 2015 at 5:59

May have been charging hedging fees as expenses. 

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Permalink Reply by Skip Peel - Mineral Consultant on February 12, 2015 at 6:11

Lessor is Not Entitled to Royalty on Hedging Profits

By Charles Sartain on May 21st, 2013 Posted in Lease Disputes  energyandthelaw.com

A Louisiana lessee does not owe its lessor royalties based on hedging profits, said a federal district court in Cimarex Energy Co. v. Chastant. Cimarex, the lessee, hedged its gas contracts and didn’t pay its lessor, Chastant, earnings from the hedge.

As the court described it, hedging involves buying and selling financial positions as a strategy to avoid the risk of a price fluctuation. The hedging party uses financial transaction derivatives to minimize the risk if/when the price of the commodity drops below a certain level. 

Cimarex Memorandum in Support of Motion for Summary Judgment is a good description of the hedging process and its value to oil and gas producers.

The question for the court was whether additional royalties must paid on amounts the lessee generated by a separate, purely financial, transaction from the sale of the oil and/or gas at the property.  The answer is “no”.

Chastant’s royalty clause provided for payment by Cimarex, on gas, of 1/8 of the market value at the mouth of the well and on oil, 1/8 of the price received f.o.b. the leased property.  In Louisiana, a royalty is the “landowner’s share of production, free of expenses of production.”

Chastant argued that since Cimarex calculated the hedge price in filings with the SEC, the hedge price constitutes “market value” under the lease. Chastant cited Frey v. Amoco Prodcution, a 1992 case where the Louisiana Supreme Court held that royalties were owed on a take-or-pay case settlement because the the take-or-pay payments were part of the “amount realized” under the terms of the lease. Therefore, said Chastant, any benefit derived by the lessee because of oil and gas production, even separate transactions, should be included in the calculation of the royalties due to the lessor. 

Cimarex argued that the lease royalty provisions are in keeping with well-established Louisiana principles in which “market price” is based on the market price at the well or field for the oil and/or gas. Therefore, the market price cannot be tied to some future financial transaction because of the oil and gas produced.

The court rejected Chastant’s arguments. To agree with Chastant would overturn decades of Louisiana oil and gas law by holding that standard lease language allows royalties to be based on something other than the price or value of the oil and/or gas. According to the court, such a holding would allow royalties to be based on monies earned by any transaction remotely connected to the oil or gas. Therefore, Cimarex did not owe royalties based on its hedging profits.

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Permalink Reply by Henry on February 12, 2015 at 8:28

I kind of have to agree with this, in principle.  When I consider the opposite outcome of hedging, i.e., that CHK could guess wrong, and lost on the hedges, I certainly would not want to accept a price lower than the market value in that case.  I'd tell them to eat the loss.  So it doesn't seem that I have a right to demand the profits, if I'm not ready to take the loss if they guess wrong.

On the other hand....  the only way CHK could put on those extra hedges was to use the royalty owners' gas.  So one might argue that CHK should compensate the royalty owners for the use of their gas to allow the hedging.  Who knows.  And how would you set a price on this.  Way beyond my knowledge.

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Permalink Reply by Skip Peel - Mineral Consultant on February 12, 2015 at 8:36

A lessor may choose to take their share of the gas or oil produced at the well head, incur no deductions for transportation, treatment or marketing  and market it themselves.  Few lessors would have that ability therefore the courts tend to consider that some deductions by the operator/lessee are justified for expenses incurred beyond the well head as those charges are not considered "free of the cost of production" which is part of the standard definition of a "royalty".

Any lawyer that talks about CHK, or any other operator for that matter, as cheating royalty interests because they hedge some portion of their production does not know mineral law or case histories..

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Permalink Reply by tc on February 12, 2015 at 9:29

Another possible way that CHK could be found guilty of owing mineral owners money on the hedges, is if they used the mineral owners production as collateral for the hedges.  A simplified stock version would be if I sold a cover call on 1,000 shares of ABC, but I only own 800 shares and used my neighbors 200 shares for the rest of my collateral.  The stock price went down so the shares were never called away and the neighbor never knew his shares were at risk and I collected the whole premium.  The important word in this scenario is collateral.

Now I don't know the law, nor do I know how CHK structured their hedges, but it won't surprise me to find out that they were a complicated financial transaction.  For most normal hedging activity, Skip is right that the mineral owners have no right to the financial gain or loss of hedges.

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