Chesapeake Energy and Its Royalty Deduction Dilemma

In the last few years, property owners in similar circumstances to the Warren Plaintiffs began to take their claims to courts nationwide, citing significant deductions in royalties. In August 30, 2013, suit was filed against Chesapeake in the U.S. District Court for the Middle District of Pennsylvania (Demchak Partners Limited Partnership et al vs. Chesapeake Appalachia LLC, U.S. District Court for the Middle District of Pennsylvania, No. 3:13-cv-02289-MEM). Within hours of filing, Chesapeake's counsel submitted a proposed settlement order to the Court outlining a $7.5 million settlement with the Plaintiff class of property owners. The complaint alleged that Chesapeake’s calculation of royalty payments to property owners wrongfully “deducted costs for various “post-wellhead” activities, including costs for gathering, dehydration, compression, and otherwise placing the Gas onto the interstate pipeline system.” The Plaintiffs alleged that the cost deductions imposed on property owners were wrong in that “Under the express terms of the Pennsylvania Leases, Chesapeake is not permitted to deduct from Royalty payments to Plaintiffs and the Class Members the costs Chesapeake incurs to transform Plaintiffs’ and the Class Members’ Gas into marketable form.”

According to the settlement documents submitted to the Court, “To the extent Chesapeake and/or its Affiliates incur Post-Production Costs, Settlement Class Members will no longer bear one hundred percent (100%) of those Post-Production Costs on a pro rata basis but will, instead, bear only seventy-two and one-half percent (72.5%) of those Post-Production Costs on a pro rata basis actually incurred by Chesapeake and/or its Affiliates.” The settlement will bar Chesapeake from deducting certain percentages of fees from Plaintiffs’ royalty checks in the future. The wider implications of this settlement on Chesapeake’s future practices with regard to its royalty agreements under its leases are not known at this time. TheDemchak settlement will eliminate the imposition of post-production costs on Pennsylvania landowners doing leasing with Chesapeake. Additionally, the suit has spurred legislative action in the state to clarify the existing law on royalty payments in order to stop this practice. 

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Permalink Reply by FairMktValue on October 8, 2013 at 8:09pm

Something still don't smell right to me.  Why 72.5 %of post production cost laid on the landowners ????

Maybe I am looking at this wrong but the way I see it is.....

Say you have $100 in post production cost and Chesapeakes average royalty burden is 20%.

They are getting 80% of the gas and the landowners 20%.  They should bear $80 of the cost and $20 pro rated among the rest.

Seems simple to me - what am I missing here ??????

Permalink Reply by Keith Mauck (Site Publisher) on October 9, 2013 at 9:51am

nothing, I think you are hitting the right idea. it's a lowball figure

Permalink Reply by FairMktValue on October 9, 2013 at 10:18am

Let me ask maybe a dumb question.

Is it common for the O&G Co's to assign a higher percentage of post production cost than their royalty burden ?  In other words if it s anything other than my simple example above, give or take a few % points - IMHO its highway robbery!

I have not signed a lease yet but I have already made it very clear to the landman that it will be absolutely NO deductions. Of course he said no way, but then left the door open by saying well....  maybe if they want your parcel bad enough......

The more I read - I ain't movin an inch on that one !!!

Permalink Reply by bungalow_steve on October 9, 2013 at 5:02pm

No, 100% of the proportional (pro rata basis) cost is $20 for your example, so now it means 72.5% of the $20 is what they are allowed to deduct.

Permalink Reply by FairMktValue on October 9, 2013 at 6:16pm

Thank you Steve,

I guess I got lost in all the pro rata !!!   LOL

So CHK incurred a penalty of 27.5% for improper deductions.

Still not clear to me if this just applies to the leases in the claim or to all leases now and in the future.

Legal stuff -clear as mud to me!!!   LOL 

Permalink Reply by Keith Mauck (Site Publisher) on October 10, 2013 at 10:19am

Based on a conversation with an attorney it applies to all future chk production

Permalink Reply by Billy Park Whyde on October 9, 2013 at 3:58pm

  Can anyone answer this? I have seen numerous horror stories posted on GOMS  enhancement deductions.

 So for those that had these enhancement deductions what was the market price that was paid to you with your enhanced share? Rough example. 100bbl of NGLs raw price say $40 bbl enhanced cost of say $2bb would be $4000 minus $200 but what is the NGL worth enhanced $50/bbl? In other words enhacment should be earning you more not less.

Permalink Reply by Keith Mauck (Site Publisher) on October 10, 2013 at 10:22am

From

http://www.pagasleaseattorney.com/component/content/article/308.html

According to the terms of the proposed settlement:

The Settlement Class INCLUDES all individuals and entities who are Lessors to an oil and gas lease that:

1.) Covers a leasehold in Pennsylvania;

2.) Contains a Market Enhancement Clause or similar language;

AND

3.)  Is or has been owned, in whole or in part, by Chesapeake, according to the business records maintained by Chesapeake. 

(Please note that this language INCLUDES landowners that meet the above criteria, even if you have not yet received any royalty payments).

 

The Settlement Class EXCLUDES, in part:

Any person:

1.) Whose lease contains a Market Enhancement Clause, or similar language;

2.) To whom Chesapeake has made no Royalty payments as of the date of this Agreement;

AND

3.) Whose lease has been SOLD, TRANSFERRED, and/or ASSIGNED by Chesapeake in its entirety AS OF THE DATE OF THIS AGREEMENT.

 

Although this language can be confusing, it is critical to understand that if a landowner is leased to Chesapeake in whole or in part, they are INCLUDED in this proposed class action settlement even though they may not have received any royalty payments to date. Landowners must understand whether their lease falls into this proposed class action settlement. Landowners may contact my office at any time for a free confidential evaluation of their gas lease to determine whether they may be impacted by this proposed settlement.

Permalink Reply by Keith Palmer on October 10, 2013 at 12:37pm

Keith, can you explain in the included part - Contains a Market Enhancement Clause and farther down in the excluded part - Contains a Market Enhancement Clause? Thank's for running this site. 

Permalink Reply by Keith Mauck (Site Publisher) on October 10, 2013 at 5:45pm

Both of those are just qualifiers, or requirements, for exclusion or inclusion. So if you are a CHK mineral owner and you have a market enhancement clause you will be either included or excluded. Then you look to the other qualifiers to determine which category you fall into.

Permalink Reply by Keith Mauck (Site Publisher) on October 10, 2013 at 10:24am

OUTLINE OF PROPOSED CLASS ACTION SETTLMENT IN DEMCHAK v. CHESAPEAKE

With regard to the proposed class action settlement supported by Chesapeake, the broad terms of the proposed settlement agreement are as follows:

1. Collection of 55% Past Post-Production Deductions Before Attorney Fees

Chesapeake will refund landowners 55% of past deductions for post-production costs that Chesapeake has taken prior to September 1, 2013. If the requested attorney fees are approved, Landowners will receive 36.685% of past deductions taken prior to September 1, 2013; 

-

FOR EXAMPLE: If a landowner has $10,000.00 of total deductions taken prior to September 1, 2013, Chesapeake would pay the landowner a one-time payment of $3,668.50 after attorney fees. 

2. Chesapeake Deducts 72.5% of Post-Production Costs for the Lifetime of the Lease

After September 1, 2013, Chesapeake will continue to take deductions at the rate of 72.5% of all post-productions incurred compared to previously taking 100% deductions. Chesapeake will deduct 72.5% of all post-production costs FOR THE LIFETIME OF THE LANDOWNER'S OIL AND GAS LEASE. This means that after September 1, 2013, landowners will receive 27.5% of what had previously been deducted. However, this 27.5% figure will be reduced to 18.33% during the first 5 years if the requested attorney fees are approved.

FOR EXAMPLE: If there are $1,000.00 of post-production costs each month, the landowner will now receive $275.00 and Chesapeake will continue to deduct $725.00 from this payment. However, if attorney fees are approved as requested, the landower would receive $183.43 each month until September 1, 2018. After September 1, 2018, the landowner would receive $275.00 per month. (We maintain in our AAA filing that landowners are entitled to the entire 100% of all post-production costs deducted under the Market Enhancement Clause or similar provisions).

3. Attorney Fees Requested by Demchak Class Attorneys

The attorneys representing the Demchak Plaintiffs have requested court approval for the following attorney fees:

a. 1/3rd Attorney Fees on Lump Sum Past Deduction Payment:

33 1/3% or 1/3rd of the past recovery for 55% of all past deductions taken. It is estimated by the Demchal attorneys that the 55% of all past deductions taken that will be returned to all Pennsylvania landowners as a result of the proposed settlement is 7.5 million dollars. We believe that the 7.5 million dollar figure is a low estimate on the total deductions withheld as of September 1, 2013. However, if the figure is 7.5 million dollars, the Demchak attorneys would receive 2.5 million and the Pennsylvania landowners would receive a total of 5 million in past deductions taken. 

This means that after legal fees are deducted, approximately 36.685% of past deductions would be distributed to Pennsylvania landowners, if this settlement is confirmed.

b. Attorney Fees on Future Recovery

The Demchak class action attorneys are seeking court approval for 33 1/3 % or 1/3rd of all future payments to landowners under the terms of this settlement for the next 5 years. If the court approves this request, landowners will 18.33% of deductions that Chesapeake for the next five years, or until September 1, 2018. After 5 years, landowners will receive 27.5% of the deductions and Chesapeake will continue to deduct 72.5% of post-production costs.

Permalink Reply by FairMktValue on October 10, 2013 at 4:29pm

Keith,

I am still confused

 (We maintain in our AAA filing that landowners are entitled to the entire 100% of all post-production costs deducted under the Market Enhancement Clause or similar provisions).

Who is AAA and,  why can CHK still deduct $725 out of a thousand, and why the attorney fees don't come out of CHKs pocket?? Don't look like nobody won nothing here????

I gotta be still missing something.

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