rahm
Lustgarten, PROPUBLICA
Posted: Tuesday, August 27, 2013, 11:00 PM
Don Feusner ran dairy cattle on his 370-acre slice of northern
Pennsylvania until he could no longer turn a profit by farming. Then, at
age 60, he sold all but a few Angus and aimed for a comfortable
retirement on money from drilling his land for natural gas instead.
It seemed promising. Two wells drilled on his lease hit as sweet a spot
as the Marcellus shale could offer – tens of millions of cubic feet of
natural gas gushed forth. Last December, he received a check for $8,506
for a month’s share of the gas.
Then one day in April, Feusner ripped open his royalty envelope to find
that while his wells were still producing the same amount of gas, the
gusher of cash had slowed. His eyes cascaded down the page to his
monthly balance at the bottom: $1,690.
Chesapeake Energy, the company that drilled his wells, was withholding
almost 90 percent of Feusner’s share of the income to cover unspecified
“gathering” expenses and it wasn’t explaining why.
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“They said you’re going to be a millionaire in a couple of years, but
none of that has happened,” Feusner said. “I guess we’re expected to
just take whatever they want to give us.”
Like every landowner who signs a lease agreement to allow a drilling
company to take resources off his land, Feusner is owed a cut of what is
produced, called a royalty.
In 1982, in a landmark effort to keep people from being fleeced by the
oil industry, the federal government passed a law establishing that
royalty payments to landowners would be no less than 12.5 percent of the
oil and gas sales from their leases.
From Pennsylvania to North Dakota, a powerful argument for allowing
extensive new drilling has been that royalty payments would enrich local
landowners, lifting the economies of heartland and rural America. The
boom was also supposed to fill the government’s coffers, since roughly
30 percent of the nation’s drilling takes place on federal land.
Over the last decade, an untold number of leases were signed, and
hundreds of thousands of wells have been sunk into new energy deposits
across the country.
But manipulation of costs and other data by oil companies is keeping
billions of dollars in royalties out of the hands of private and
government landholders, an investigation by ProPublica has found.
An analysis of lease agreements, government documents and thousands of
pages of court records shows that such underpayments are widespread.
Thousands of landowners like Feusner are receiving far less than they
expected based on the sales value of gas or oil produced on their
property. In some cases, they are being paid virtually nothing at all.
In many cases, lawyers and auditors who specialize in production
accounting tell ProPublica energy companies are using complex accounting
and business arrangements to skim profits off the sale of resources and
increase the expenses charged to landowners.
Deducting expenses is itself controversial and debated as unfair among
landowners, but it is allowable under many leases, some of which were
signed without landowners fully understanding their implications.
But some companies deduct expenses for transporting and processing
natural gas, even when leases contain clauses explicitly prohibiting
such deductions. In other cases, according to court files and documents
obtained by ProPublica, they withhold money without explanation for
other, unauthorized expenses, and without telling landowners that the
money is being withheld.
Significant amounts of fuel are never sold at all – companies use it
themselves to power equipment that processes gas, sometimes at
facilities far away from the land on which it was drilled. In Oklahoma,
Chesapeake deducted marketing fees from payments to a landowner – a
joint owner in the well – even though the fees went to its own
subsidiary, a pipeline company called Chesapeake Energy Marketing. The
landowner alleged the fees had been disguised in the form of lower sales
prices. A court ruled that the company was entitled to charge the fees.
Costs such as these are normally only documented in private transactions
between energy companies, and are almost never detailed to landowners.
“To find out how the calculation is done, you may well have to file a
lawsuit and get it through discovery,” said Owen Anderson, the Eugene
Kuntz Chair in Oil, Gas & Natural Resources at the University of
Oklahoma College of Law, and an expert on royalty disputes. “I’m not
aware of any state that requires that level of disclosure.”
To keep royalties low, companies sometimes set up subsidiaries or
limited partnerships to which they sell oil and gas at reduced prices,
only to recoup the full value of the resources when their subsidiaries
resell it. Royalty payments are usually based on the initial
transaction.
In other cases, companies have bartered for services off the books,
hiding the full value of resources from landowners. In a 2003 case in
Louisiana, for example, Kerr McGee, now owned by Anadarko Petroleum,
sold its oil for a fraction of its value – and paid royalties to the
government on the discounted amount – in a trade arrangement for
marketing services that were never accounted for on its cash flow
statements. The federal government sued, and won.
The government has an arsenal of tools to combat royalty underpayment.
The Department of Interior has rules governing what deductions are
allowable. It also employs an auditing agency that, while far from
perfect, has uncovered more than a dozen instances in which drillers
were “willful” in deceiving the government on royalty payments just
since 2011. A spokesman for the Department of Interior’s Office of
Natural Resources Revenue says that over the last three decades, the
government has recouped more than $4 billion in unpaid fees from such
cases.
There are few such protective mechanisms for private landowners, though,
who enter into agreements without regulatory oversight and must pay to
audit or challenge energy companies out of their own pockets.
ProPublica made several attempts to contact Chesapeake Energy for this
article. The company declined, via email, to answer any questions
regarding royalties, and then did not respond to detailed sets of
questions submitted afterward. The leading industry trade group, the
American Petroleum Institute, also declined to comment on landowners’
allegations of underpayments, saying that individual companies would
need to respond to specific claims.
Anderson acknowledged that many landowners enter into contracts without
understanding their implications and said it was up to them to do due
diligence before signing agreements with oil and gas companies.
“The duty of the corporation is to make money for shareholders,”
Anderson said. “Every penny that a corporation can save on royalties is a
penny of profit for shareholders, so why shouldn’t they try to save
every penny that they can on payments to royalty owners?”
* * *
Gas flows up through a well head on Feusner’s property, makes a couple
of turns and passes a meter that measures its volume. Then it flows into
larger pipes fed by multiple pipelines in a process the industry calls
“gathering.” Together, the mixed gases might get compressed or processed
to improve the gas quality for final sale, before feeding into a larger
network of pipelines that extends for hundreds of miles to an end
point, where the gas is sold and ultimately distributed to consumers.
Each section of pipeline is owned and managed by a different company.
These companies buy the gas from Chesapeake, but have no accountability
to Feusner. They operate under minimal regulatory oversight, and have
sales contracts with the well operator, in this case Chesapeake, with
terms that are private. Until Chesapeake sold its pipeline company last
winter, the pipelines were owned by its own subsidiaries.
As in many royalty disputes, it is not clear exactly which point of sale
is the one on which Feusner’s payments should be based – the last sale
onto the open market or earlier changes in custody. It’s equally unclear
whether the expenses being charged to Feusner are incurred before or
after that point of sale, or what processes, exactly, fall under the
term “gathering.” Definitions of that term vary, depending on who is
asked. In an email, a spokesperson for Chesapeake declined to say how
the company defines gathering.
Making matters more complicated, the rights to the gas itself are often
split into shares, sometimes among as many as a half-dozen companies,
and are frequently traded. Feusner originally signed a lease with a
small drilling company, which sold the rights to the lease to
Chesapeake. Chesapeake sold a share of its rights in the lease to a
Norwegian company, Statoil, which now owns about a one-third interest in
the gas produced from Feusner’s property.
Chesapeake and Statoil pay him royalties and account for expenses
separately. Statoil does not deduct any expenses in calculating
Feusner’s royalty payments, possibly because it has a different
interpretation of what’s allowed.
“Statoil’s policy is to carefully look at each individual lease, and to
take post-production deductions only where the lease and the law allow
for it,” a company spokesman wrote in an email. “We take our production
in kind from Chesapeake and we have no input into how they interpret the
leases.”
Once the gas is produced, a host of opaque transactions influence how
sales are accounted for and proceeds are allocated to everyone entitled
to a slice. The chain of custody and division of shares is so complex
that even the country’s best forensic accountants struggle to make sense
of energy companies’ books.
Feusner’s lease does not give him the right to review Chesapeake’s
contracts with its partners, or to verify the sales figures that the
company reports to him. Pennsylvania – though it recently passed a law
requiring that the total amount of deductions be listed on royalty
statements – has no laws dictating at what point a sale price needs to
be set, and what expenses are legitimate.
Concerns about royalties have begun to attract the attention of state
legislators, who held a hearing on the issue in June. Some have
acknowledged a need to clarify minimum royalty guarantees in the state,
but so far, that hasn’t happened.
“If you have a system that is not transparent from wellhead to burner
tip and you hide behind confidentiality, then you have something to
hide,” Jerry Simmons, executive director of the National Association of
Royalty Owners (NARO), the premier organization representing private
landowners in the U.S., told ProPublica in a 2009 interview. Simmons
said recently that his views had not changed, but declined to be
interviewed again. “The idea that regulatory agencies don’t know the
volume of gas being produced in this country is absurd.”
Because so many disputes come down to interpretations of contract
language, companies often look to courts for clarification. Not many
royalty cases have been argued in Pennsylvania so far, but in 2010, a
landmark decision, Kilmer v. Elexco Land Services, set out that the
state’s minimum royalty guarantee applied to revenues before expenses
were calculated, and that, when allowed by leases, energy companies were
free to charge back deductions against those royalties.
Since then, Pennsylvania landowners say, Chesapeake has been making
larger deductions from their checks. (The company did not respond to
questions about this.) In April, Feusner’s effective royalty rate on the
gas sold by Chesapeake was less than 1 percent.
Paul Sidorek is an accountant representing some 60 northeastern
Pennsylvania landowners who receive royalty income from drilling. He’s
also a landowner himself – in 2009, he leased 145 acres, and that lease
was eventually sold to Chesapeake. Well aware of the troubles
encountered by others, Sidorek negotiated a 20 percent royalty and made
sure his lease said explicitly that no expenses could be deducted from
the sale of the gas produced on his property.
Yet now, Sidorek says, Chesapeake is deducting as much as 30 percent
from his royalties, attributing it to “gathering” and “third party”
expenses, an amount that adds up to some $40,000 a year.
“Now that the royalties are flowing, some people just count it as a
blessing and say we don’t care what Chesapeake does, it’s money we
wouldn’t have had before,” Sidorek said. But he’s filed a lawsuit. “I
figure I could give my grandson a first-class education for what
Chesapeake is deducting that they are not entitled to, so I’m taking it
on.”
Landowners, lawyers, legislators and even some energy industry groups
say Chesapeake stands out for its confusing accounting and tendency to
deduct the most expenses from landowners’ royalty checks in
Pennsylvania.
“They’ve had a culture of doing cutthroat business,” said Jackie Root,
president of Pennsylvania’s chapter of the National Association of
Royalty Owners.
Chesapeake did not respond to questions on whether its approach differs
from that of other companies.
Root and others report good working relationships with other companies
operating wells in Pennsylvania, and say that deductions – if they occur
at all – are modest. Statoil, which has an interest in a number of
Chesapeake wells, does not deduct any expenses on its share of many of
the same leases. In an email from a spokesperson, the company said “We
always seek to deal with our lease holders in a fair manner.”
Several landowners said that not only do deductions vary between
companies using the same gas “gathering” network – sales prices do as
well.
On Sidorek’s royalty statements, for example, Chesapeake and Statoil
disclose substantially different sales prices for the same gas moved
through the same system.
“If Statoil can consistently sell the gas for $.25 more, and Chesapeake
claims it’s the premier producer in the country, then why the hell can’t
they get the same price Statoil does for the same gas on the same day?”
Sidorek wondered.
He thinks Chesapeake was giving a discount to a pipeline company it used
to own. Chesapeake did not respond to questions about the price
discrepancy.
Chesapeake may be the focus of landowner ire in Pennsylvania, but across
the country thousands of landowners have filed similar complaints
against many oil and gas producers.
In dozens of class actions reviewed by ProPublica, landowners have
alleged they cannot make sense of the expenses deducted from their
payments or that companies are hiding charges
Publicly traded oil and gas companies also have disclosed settlements
and judgments related to royalty disputes that, collectively, add up to
billions of dollars.
In 2003, a jury found that Exxon had defrauded the state of Alabama out
of royalty payments and ordered the company to pay nearly $103 million
in back royalties and interest, plus $11.8 billion in punitive damages.
(The punitive damages were reduced to $3.5 billion on appeal, and then
eliminated by the state supreme court in 2007.)
In 2007, a jury ordered a Chesapeake subsidiary to pay $404 million,
including $270 million in punitive damages, for cheating a class of
leaseholders in West Virginia. In 2010, Shell was hit with a $66 million
judgment, including $52 million in punitive fines, after a jury decided
the company had hidden a prolific well and then intentionally misled
landowners when they sought royalties. The judgment was upheld on
appeal.
Since the language of individual lease agreements vary widely, and some
date back nearly 100 years, many of the disagreements about deductions
boil down to differing interpretations of the language in the contract.
In Pennsylvania, however, courts have set few precedents for how leases
should be read and substantial hurdles stand in the way of landowners
interested in bringing cases.
Pennsylvania attorneys say many of their clients’ leases do not allow
landowners to audit gas companies to verify their accounting. Even
landowners allowed to conduct such audits could have to shell out tens
of thousands of dollars to do so.
When audits turn up discrepancies, attorneys say, many Pennsylvania
leases require landowners to submit to arbitration – another exhaustive
process that can cost tens of thousands of dollars. Arbitration clauses
can also make it more difficult for landowners to join class action
suits in which individuals can pool their resources and gain enough
leverage to take on the industry.
“They basically are daring you to sue them,” said Aaron Hovan, an
attorney in Tunkhannock, Pa., representing landowners who have royalty
concerns. “And you need to have a really good case to go through all of
that, and then you could definitely lose.”
All of these hurdles have to be cleared within Pennsylvania’s four-year
statute of limitations. Landowners who realize too late that they have
been underpaid for years – or who inherit a lease from an ailing parent
who never bothered to check their statements – are simply out of luck.
Even if a gas company were found liable for underpaying royalties in
Pennsylvania, it would have little to fear. It would owe only the amount
it should have paid in the first place; unlike Oklahoma and other
states, Pennsylvania law does not allow for any additional interest on
unpaid royalties and sets a very high bar for winning punitive
penalties.
“They just wait to see who challenges them, they keep what they keep,
they give up what they lose,” said Root, the NARO chapter president. “It
may just be part of their business decision to do it this way.”
Follow Abrahm Lustgarden on Twitter @AbrahmL
Read more at
http://www.philly.com/philly/business/Frackers_.html#3RqTyJFPgPzRelsY.99
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