How Oil, Gas Drillers Avoid Paying Royalties
[imgbelt img=gas_pipes.jpg]Thousands of property owners who lease land to energy companies are receiving lower-than-expected royalty payments – or virtually no payments at all. An investigation reveals that in many cases, oil and gas companies manipulate the numbers to reduce what they owe.
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.
“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 through 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.
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 cents 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, Pennsylvania, 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.”
ProPublica is an independent, non-profit news organization that produces investigative journalism in the public interest.