Replies to This Discussion

Permalink Reply by John L on November 7, 2013 at 3:41

Skip, We were held by production under an older lease and CHK came in and purchased the deep rights from the operator.  We do have a rider that states we will pay reasonable marketing and transportation as long as the transactions are at arms length but will not pay for compression.

I compared the last few months gas prices with the NYMEX prices and month to month spread was lower but the difference between the NYMEX and our price is averaging $1.22 and has risen slightly over the past few months.  Is this reasonable?  From looking at the responses, it looks like it can be very complicated to determine unless there is some type of standard that the costs can be compared to like Nixon stated. I also feel that there should be more transparency of the costs so the royalty owner can review them and dispute errors.  Of course this would only work if the operator was required to acknowledge the dispute and diligently try to resolve it rather than just stop communicating with the royalty owner.  We received a copy of revenue reconciliation from a CHK representative  a couple of years ago that clearly showed we were being charged for compression and high marketing fees by CEMI.  When we disputed this the rep. simply stopped communicating with us. All other inquiries over high deductions have been ignored.

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Permalink Reply by Skip Peel - Mineral Consultant on November 7, 2013 at 4:00

John, don't feel lonesome.  You're in the same boat with other lessors with some version of a No Cost, or in your case a limited cost, Royalty clause.  Although the NYMEX monthly settlement price is a better price comparison than spot prices it does not take into account the hub where the gas is sold nor what additional costs are incurred before your gas reaches that hub.  Even if we knew the specifics there would likely remain a significant price difference between CHK's price paid to you and the price paid by other operators producing gas in the same field to their lessors.  We have a number of members who have royalty income from CHK and from some other operator in the same field who semi-regularly post the price differential.  There have been instances of CHK paying one price and a Working Interest in the very same well paying something different.  There is no good answer to this very complex question.  There is little doubt that what CHK is doing is a departure from industry norms but it will take a court to rule on the legality and impose a criteria for legitimate deductions. 

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Permalink Reply by Dion Warr, CPL on November 7, 2013 at 4:31

Henry:

It would appear that you have signed with an operator that has chosen to interpret these various provisions in a way that you and your attorney intended, rather than choosing to conflate the possible incongruities into a justification to apply charges against the products stream post-"mouth of the well".

It is also possible that your counsel has constructed an "iron-clad" lease rider. Given the conduct of some of the players, some of which seem bent upon collecting deducts as a matter of course irrespective of the contents of the lease provisions, I would assume that both of these suppositions are at work.

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Permalink Reply by Andrew on November 11, 2013 at 13:10

Henry,

You are correct about "market value at the well." There is essentially no market at the wellhead. The market is typically elsewhere in the field, and that gas has to be dehydrated and compressed (at minimum) before being transported to the purchaser. The market value at the well is equal to the price paid at that point, less whatever costs where incurred to get the gas from the wellhead to his pipeline (this is called the "reconstruction approach").

So technically, a lease calling for royalty as a fraction of the market value at the well, but "free of all costs" is a contradiction in terms. Nevertheless, this is how most leases are written, and therein lies the problem some people have with all the costs being deducted from their "cost-free" royalty. A true cost-free lease royalty would be based on the market value at the point of sale. However, that method has a host of problems itself, and the "market value at the well" royalty is so extremely common in our area that both lessors and lessees are more comfortable with just modifying it with cost-free provisions.

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Permalink Reply by Joe Aldridge on November 12, 2013 at 1:11

Andrew,

Would it be better to state in the lease that the sale price of any gas will be the NYMEX price or greater at the point of sale? If sold at the point of entry into the pipeline then this would include any deducts for costs for treatment and compression. So I guess that it would be fob the pipeline.

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Permalink Reply by Andrew on November 12, 2013 at 13:50

If you wanted to go that route, you'd want to use Henry Hub instead of NYMEX. The price paid by the pipeline at the entry point would be the "full price" without deductions, as the operator is presumably the one who bears the costs to get the gas into the pipeline. You could add a provision that costs deducted from gross sales proceeds by the purchaser itself have to be added back in to your royalty by the lessee, if you go with that approach.

In either the spot-price approach or the "point of sale" approach, you'll need a heck of a bargaining position to get a lessee to agree to it. Especially for the mega independents with thousands off royalty owners, it will take a lot for them to even be willing to deal with the special accounting attention that such a lease royalty would require, not to mention give away their right to share post-production costs in general.

Permalink Reply by Joe Aldridge on November 12, 2013 at 23:00

I've been looking at the NYMEX and the Henry Hub price and the NYMEX seems to run higher overall. So why HH over the NYMEX? Also, if the lease stated that the price would be corrected weekly or even monthly, say the Monday or Friday of each week or the first or last trading day of the month, rather than daily do you think an operator would be more likely to accept that definition of gas pricing for royalty purposes? 

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