Arlington approves gas royalty settlement with Chesapeake
http://www.star-telegram.com/2014/08/19/6054582/arlington-approves-...
ARLINGTON — Chesapeake Energy will pay the city of Arlington $700,000 to settle a lawsuit accusing the company of using a complicated scheme devised to reduce royalty checks for gas pumped from under parks, airports and other pieces of public property.
The Arlington City Council voted 8-0 Tuesday to approve a deal reached with the Oklahoma City-based company and Total E&P USA, a French energy company that owns 25 percent of Chesapeake’s Barnett Shale holdings.
Mayor Robert Cluck, who recently had surgery, was not present.
The city sued in August, saying that Chesapeake, which holds leases on about 1,900 acres of public property, based its royalty payments on gas prices that were well below the actual sales price and improperly deducted certain post-production costs.
Under the agreement, Chesapeake will no longer subtract post-production costs and the city’s royalty will be calculated based on the highest price received by Chesapeake when the gas is sold or the price established by a formula.
Initially, attorneys representing the city stated that they reasonably expected damages to exceed $1 million. But in the end, the city and Chesapeake decided to settle out of court for a lower price.
“I think it is a fair settlement,” said City Attorney Jay Doegey. “It clarifies the methodology that Chesapeake will use in the future to pay the city its royalties.”
In settling, Chesapeake denied doing anything improper. As a matter of fact, in court documents, Chesapeake, the second-largest producer in the Barnett Shale, and Total said that Texas law allows certain post-production costs to be deducted from royalty payments. Two recent federal appeals court decisions back that assertion.
“We are pleased to have reached a mutually acceptable agreement with the city of Arlington and look forward to continuing our partnership,” said Gordon Pennoyer, a spokesman for Chesapeake.
The settlement, which covers 25 leases of varying size, resolves most of the substantive issues between the city and Chesapeake and Total, although some issues still need to be ironed out.
Chesapeake still faces a number of other lawsuits filed by large property owners, other public entities and a number of individuals whose lease covers not much more than their home.
The deal with Arlington doesn’t mean that other lawsuits will be settled. For example, no outreach has been made to the city of Fort Worth or the Fort Worth school district.
The Arlington school district, which joined the city’s lawsuit in November with similar claims of royalty miscalculation, also continues to negotiate with Chesapeake on its claims.
‘Engaged in a scheme’
Arlington’s lawsuit made claims that are repeated in other litigation against Chesapeake — that the company underpays royalties by basing them on proceeds from sales to affiliates or other “sham transactions” and after production costs had been taken out.
Arlington said its lease agreements “prohibit or significantly limit deductions” such as transportation and production costs and taxes, and “provide for cost-free royalties.”
But even after raising concerns about underpayments and improper cost deductions. the city said, Chesapeake continued to “engage in a scheme of affiliated transactions aimed at hiding or embedding impermissible cost deductions and suppressing the royalties it pays to the city.”
It also said the charges deducted from the royalty payments were “excessive and unreasonable in instances where only limited deductions are authorized.” The lawsuit also stated that the deductions were not apparent from information provided to the city.
But Chesapeake has argued that the procedures it uses to drill, market and sell the gas are acceptable and done within the letter of the law and the leases. They also said royalties in the Arlington case, and others, are to be based on the price of the gas at the wellhead.
But after that sale takes place, an affiliate, Chesapeake Energy Marketing, transports the gas through a gathering system downstream through pipelines to the next buyer to maximize the price, records show.
What Chesapeake Energy Marketing eventually pays is what is known as the “weighted average sales price” that it gets from an unaffiliated third-party less the actual post-production costs incurred in moving the gas.
Since 2006, Chesapeake has paid Arlington more than $12 million in royalties, Pennoyer said.
While some argue that their leases prohibit any post-production costs from being deducted, the 5th U.S. Circuit Court of Appeals in two cases stemming from disputes over royalties in Tarrant and Johnson counties said it is allowed. The court also stressed that each lease is different.
Other settlements
Arlington’s deal mirrors one that Chesapeake reached with Dallas/Fort Worth Airport in 2012 for $5 million. That deal also established a formula for royalty payments.
Chesapeake also quietly settled with the Tarrant Regional Water District earlier this year when it agreed to pay the district $1.8 million for royalties on 100 leases from January 2008 through October 2011. After conducting an audit, the water district challenged the deduction of post-production costs.
The district recently approved another forensic audit to double-check payments from Chesapeake.
“It is a pattern to improperly pay the landowners,” said Jim Lane, a water board member, who described what Chesapeake does as a “numbers game.”
“We assumed the oil and gas company would follow their own rules, and it is a shame that a company as big as Chesapeake is not,” he said.
Chesapeake has been in a period of retrenchment. The company, struggling to reduce a large debt load after the collapse of natural gas prices, recently sold its 20-story glass-and-steel office tower on the edge of downtown Fort Worth to a Houston-based real estate firm.
At one time, Chesapeake had about 400 employees working from the top half of the building. But in recent years, the company has scaled back and sold numerous Barnett Shale properties.
This report contains material from the Star-Telegram archives.
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Replies to This Discussion
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Permalink Reply by Henry on
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The sad part (from my perspective) is that while these large entities can sue CHK and get a settlement that protects them going forward, the little guy still has no recourse. CHK will continue to underpay all of them.
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Permalink Reply by Steverino86 on
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You absolutely have to have deep pockets to go after them, and patience. It looks as though they settled this one quicker than most.
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Permalink Reply by tc on
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CHK also overcharges its JV partners. This is from Goodrich's latest earning conference call and while CHK is not specifically mentioned, almost all of Goodrich's non-operated wells are part of the JV they have with CHK..
Our non-operated gas price for the second quarter came in at $2.54 per Mcf. The non-operated gas price is net of transportation and marketing fees. Our operated gas price for the second quarter was $5.04.
$2.8 million charge for gathering and marketing costs on our non-operated Haynesville wells. We are currently disputing this charge with the operator of the wells.
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Permalink Reply by jim weyland on
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if i were a non-operating working interest owner in a well or project, i sure wouldn't let the operator sell my production per/under the joa. i'd take my share in kind and market it my self.
i'd also insure that the joa allowed non-ops opting to tik to retain the right to split connect as to takeaway.
in the example of chk versus gdp realized prices, one could make back the approximate $2.50 delta in realized product pricing pretty easily, imo.
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Permalink Reply by Skip Peel - Mineral Consultant on -
Good thoughts, jim. If the JOA allows for WIs to independently market their share of production. I say "if" because I suspect that CHK has sold a lot of their midstream systems to buyers in conveyances that guarantee volumes and profits for the duration of the contract. I'm unsure if the WIs can circumvent those asset sales agreements. If that was possible I think plenty of WIs who are quite capable of handling their share of production would have taken that route before now. You might want to look into that. It's above my pay grade.
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skip,
unless otherwise permitted a wio, operator or otherwise, can only dedicate his share of production to any sort of marketing/midstream agreement.
i've seen many a joa. and if enough production is involved, its pretty standard for a party to not sell joa but to tik. i'm a bit fuzzy on split takeaway rights in the form aapl joa, but i think it's in there.
and, if i had a dollar for every split takeaway situation i've seen, i'd have, well....a bunch of dollars.
in my experience it's not uncommon to split connect onshore, offshore it is uncommon.
the only thing i can imagine is that if a party wanted badly enough to buy into someones project, they might have been required to give up tik and split connect rights as part of the deal.
when 'the great deal makers in the sky' ignore the recommendations of their marketing personnel, they shouldn't later be surprised at $2.50 deltas.
and, in a tangential note, as one of grandfathers told me when i was a little boy: 'jim, if you lie down with dogs don't be surprised to get up with fleas'.
jim
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The interesting thing is that Goodrich's JV with Chesapeake dates back to 2008 and this is the first time I have heard that they have an issue with prices & fees. Maybe this gauging wasn't was not just an Aubrey thing, but a corporate culture. Was Chesapeake a "dog" in 2008?
It also shows the importance of an ironclad CYA lease/JOA, because you never know what may happen in the years/decades to come.
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Permalink Reply by Henry on
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tc,
Here's the problem. An "ironclad CYA" lease does not protect most people from CHK. Don't you think that the Dallas Airport, the Bass Brother, and all those others had great legal advice that wrote a lease that was ironclad? It appears that CHK chooses to ignore the ironclad language and forces you to sue in order to have them abide by the lease. Probably 99% of those who lease with CHK don't have enough acreage to make a law suit worth the cost. CHK knows this. That is why they settle all these cases (as Skip noted) -- then no case law is made, and they can continue to skim off money from 99% of their royalty owners. The only way to protect yourself from CHK (IMHO) is to NEVER enter into any agreement with them.
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The problem with "never" is that CHK can buy any lease or company it wants to, so you can't stop CHK from being your business partner unless you want to sell your lease/rights.
I agree, ironclad leases & laws can't stop people/companies from breaking them, what they do is give you a legal avenue to pursue. I understand that many people don't have the money to sue, but this is what can happen to small business, i.e. landowners, when they do business with large companies.
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Permalink Reply by w.r. frank on
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Would you accept my friend request so I can send you a message. Thanks.
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Permalink Reply by TL DS1 on
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CHK paid fair market on my well for 2 years. Then in Feb '12 they began the illegal withholdings. They do not care what your lease says. Luckily, EXCO bought my section from CHK and is already drilling several wells. BTW when EXCO took over they paid fair market.
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Permalink Reply by John L on
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We have seen our deductions from CHK rise from an average of $1.00/Mcf from 2008 thru 2013 to over $1.60/Mcf since Jan 2014. This is probably what has got Goodrich's attention and it has ours! I guess they are going to keep increasing deductions until someone puts them up against a wall.
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