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 Keith Mauck (Site Publisher) on October 11, 2013 at 1:45am

AAA = American Arbitration Association (Arbitration Body that hears arbitration disputes like the one at issue)

CHK can deduct $725 as that has been what is agreed to by the Plaintiffs and CHK in the proposed settlement filed in Demchak.  This is the figure they agreed to. 

The parties agreed under the proposed settlement that the Plaintiffs’ legal fees would come from the proposed settlement award to the plaintiffs. 

Whether someone won or not is up to the landowners to decide, I have my thoughts :).  A great question arises as to what other companies who are not taking any deductions at all under the Market Enhancement Clause will do if this settlement is approved.  There are many companies who do not currently take any deductions under the Market Enhancement Clause and if this settlement is approved they may rethink their position.

Permalink Reply by FairMktValue on October 11, 2013 at 1:57am

Ok, I am starting to get it now, little slow, but gettin there. LOL

I was under the impression that this was strictly a "no deductions" clause.

The "market enhancement clause" interpretation is really the issue in this one.

Your "great question" is indeed a "great question" !

Permalink Reply by Dott on October 12, 2013 at 2:35pm

Keith,

Now we all know that any "Market Enhancement Clause"is not a good thing, although it may be too late for a lot of us. I am not leased with Chesapeake but I wonder if my market enhancement clause is NOT THAT BAD.  The language reads "17.5% of the gross proceeds received by Lessee for the sale of oil, gas and related products produced and sold from the leased premises and accruing to Lessor under this Lease, such royalty to be calculated without deduction, directly or indirectly, for the cost of producing, gathering, storing, separating, treating, dehydrating, compressing, processing, transporting and marketing the oil, gas and other products produced from the Leasehold; provided, however, any such costs which result in enhancing the value of the marketable oil, gas or other products to receive a better price may be deducted from Lessor's share of production so long as such costs are based on Lessee's actual cost of such enhancements, and further provided that in no event shall Lessor receive a price that is less than, or more than, the price received by Lessee. Lessor's royalty shall bear its proportionate share of applicable production, severance and other similar taxes attributable to Lessor's royalty interest."  I thought perhaps the section that reads that I cannot receive a price that is less than the price they receive saves me a bit, although I know it also means that they can still deduct from my royalties.  What are your thoughts?  Thank you in advance

Permalink Reply by Frank Walker on October 13, 2013 at 2:08am

Dott

Seems to me that's saying you receive your percentage based on the same gross price as the Lessee.  But, of course sadly, the market enhancement deductions are deducted from that gross price.  That's how they arrive at your net royalty.

Finally rest assured some gas companies, given opportunity, will interpret any lease ambiguities to favor themselves.  

Permalink Reply by Jim Litwinowicz on October 10, 2013 at 11:25am

Seems crazy that the gas rights owner should pay for 72.5% of the post production costs when they only get  12.5% to 20% in royalty.  So a company can spend whatever it wants in post-production costs and they only have to pay 27.5% of the costs?  The rights owner has no say it what costs are incurred. No say in how to control costs. No say in what processes are worth the expense. No say in any of post production activities.

What motive is there for the gas companies  to keep the costs down? What is to prevent them from running up costs on unnecessary items like new trucks for everyone or lavish offices or helicopters for big shots?

The landowner is not a business partner and should not be bearing the majority of costs incurred. If they force me to do so, I want a say in all post-production activity. And I should have a vote proportional to the percentage of my burden. If I am paying for 72.5% of the costs, I should have majority say it what costs are incurred.

The right and legal thing would to be for the landowner to pay the same rate as his royalty calculation. If the royalty is 12.5% then he/she should pay 12.5% of the costs.

Permalink Reply by Billy Park Whyde on October 10, 2013 at 5:31pm

My question is who owns the processing? Standard Oil Company created a monopoly in Oil trasportation and pricing could it be the same ploy by a different color?

Permalink Reply by Frank Walker on October 10, 2013 at 8:30pm

Jim read earlier in the thread where this was explained.  Landowner pays 72.5% of the PRO RATA cost, not the total cost.  Still not fair or reasonable, of course, but not as bad as you are thinking.

Permalink Reply by FairMktValue on October 10, 2013 at 10:16pm

Frank,

That certainly is the way it should be -" PRO RATA cost".

But the examples cited in Keiths post make it seem otherwise. The examples do not mention "pro rata" at all. Perhaps pro-rata is assumed in the examples - but it still has me scratching my head. Something just ain't right.

Permalink Reply by Frank Walker on October 12, 2013 at 12:59am

Well, you have me rather at sword's point there, old fellow.  What you wrote here is correct but . . . . . . how to say this gently . . . . . . we have to consider the possibility that Keith's post might be ever so slightly misleading.  There are other posters earlier on who, I believe, have this right.  That's why I pointed Jim back there.

Permalink Reply by FairMktValue on October 12, 2013 at 1:59am

Frank, 

I certainly did mean to point a sword at ya !   lol

I think I am trying to say the same thing as you are.

But thinkin ain't one of my strong points!   lol

Permalink Reply by FairMktValue on October 12, 2013 at 8:07am

please insert not after did

(and they give ya 15 min to edit)  

Permalink Reply by FairMktValue on October 10, 2013 at 10:22pm

Jim, excellent point.....

"What motive is there for the gas companies  to keep the costs down? What is to prevent them from running up costs on unnecessary items like new trucks for everyone or lavish offices or helicopters for big shots?"

EXACTLY !

I have argued this point with the landman. His response "Oh, we would not do stuff like that ".

Ya right !  lol

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