Dirty Rotten Royalty Misdeeds

My dad always said that there were more horses' asses in the world than horses.  This article from Bloomberg reveals that the oil and gas industry is the Kentucky Derby without the horses.  In a response to falling gas prices, oil and gas companies have been re-interpreting royalty contracts and have stated deducting certain costs, including transporting, marketing and processing.  This means that royalty owners receive less income. Owners of an oil and gas royalty interest receive a fixed percentage of the oil and gas revenue produced from a particular lease, and in many cases the royalties are paid from gross revenue before the deduction of expenses.  The drop in the price of natural gas has lead to gas operators to look for ways minimize the impact, and one of the ways is to re-visit their royalty contacts: 

Deducting costs for processing, transporting and marketing gas before royalties are calculated can reduce the amount producers owe by 25 percent to 50 percent. About one in five landowners in Texas have signed contracts specifying that producers pay them based on a price before those costs are deducted, said Tom Hazlewood, an appraiser of royalty leases whose business reviews hundreds of properties annually for tax purposes.

For the same gas from the same well under the same contract terms, Thornton, the Texas accountant, says she has been paid about 25 percent more for her gas by Plains Exploration & Production Co. (PXP), which in 2008 bought a 20 percent stake in Chesapeake’s acreage in the Louisiana Haynesville shale formation.

The two companies pay her in separate checks, and she said she discovered the cost deductions when Plains paid her back for expenses it had been subtracting since 2010. Chesapeake has not refunded any costs, she said. Hance Myers, a Plains spokesman, declined to comment.

In August 2011, when gas prices had fallen 14 percent from the year earlier and were sliding toward a 10-year intraday low of $1.902 in April, Chesapeake notified royalty owners in North Texas that it would begin deducting costs from royalties.

The decision came after Chesapeake partnered with Total SA (FP) in 2010 in a $2.25 billion deal that gave the French oil company a 25 percent stake in Chesapeake’s wells in the region. Chesapeake reviewed lease terms after Total said it wanted to deduct costs, Henry Hood, Chesapeake’s general counsel, told the Fort Worth Star-Telegram newspaper in an Aug. 10, 2011 story.

On Jan. 24, Chesapeake notified landowners in Pennsylvania of its intent to deduct costs, citing a March 2010 state supreme court ruling that confirmed deductions were allowed.

The oil and gas industry is full of conflicts of interest and intra-company dealings.  I would suspect that in many cases the expenses the oil and gas company are charging royalty owners are paid to an affiliate company.  Contracts are designed to protect people, and it's wrong for big oil and gas companies to renege on their contractual obligations just because prices dropped.   Chesapeake is not the only company re-interpreting its contracts, but but it appears like the poster child for what's wrong in the oil and gas industry.