Based on a very conservative estimate, landowners in Bradford County lost a total of $10 million during the second half of 2012 due to post-production costs being deducted from their royalty checks, Bradford County Commissioner Daryl Miller testified at a hearing held Thursday by a Senate committee.

Miller was one of several officials from Bradford County who testified at the hearing, which was held by the Pennsylvania Senate Environmental Resources and Energy Committee on issues related to royalties on natural gas that is extracted from the Marcellus Shale. Sen. Gene Yaw is the chairman of the committee.

Yaw said excessive post-production cost deductions and issues related to royalty stub transparency have significantly impacted many leaseholders throughout his Senate district, which he said prompted him to convene the hearing.

"Many leaseholders are seeing costs being deducted from royalty checks for what is being described as the costs of getting gas to market," Yaw said. "In some cases, these costs have caused royalty payments to be as low as 1.47 percent, well below the 12 1/2 percent guaranteed minimum. This hearing provided an open, honest dialogue that will hopefully answer questions and address concerns brought forward by many of our constituents."

Senator Yaw was joined at the hearing by Senators John Yudichak (D-14), Minority Committee Chairman, Lisa Baker (R-20), Kim Ward (R-39), Elder Vogel (R-47), Scott Hutchinson (R-21), as well as Representatives Garth Everett (R-84), Matthew Baker (R-68), Tina Pickett (R-110) and Sandra Major (R-111).

The committee heard testimony at the hearing from the Pennsylvania Farm Bureau (PFB), National Association of Royalty Owners (NARO), the Marcellus Shale Coalition, Bradford County commissioners and attorney Chris Jones of Griffin, Dawsey, DePaola and Jones, PC.

Yaw said that much of the debate, in regards to post production costs, is whether the legislature needs to amend the Guaranteed Minimum Royalty Act (GMRA).

The Act, passed by the legislature in 1979, provides that a lease to remove natural gas "shall not be valid if such lease does not guarantee the lessor at least one-eighth royalty" of all natural gas removed from the property. The term "royalty" is not specifically defined within the provision.

"While the Pennsylvania Constitution and the United States Constitution prohibit a legislature from changing the terms of an existing contract (lease), we can look prospectively to address this issue," Yaw said. "We all have the same goal - to ensure that our leaseholders are treated fairly."

"Effectively having your royalty payments cut by these kind of percentages severely affects royalty owners," said David Sikes, CMM, NARO National President. "There are some companies, however, that appear to not care what the lease says and continue to make unauthorized deductions and refuse to substantiate why those deduction are being made. In this instance a clear breach of contract has occurred."

Commissioner Miller said in his prepared testimony that his $10 million estimate is based on the fact that the Department of Environmental Protection reported that in the last six months of 2012, 286 billion cubic feet of natural gas was produced in Bradford County.

"If you take that DEP gas production figure and (you figure that natural gas is) selling for $2.50 per thousand cubic feet, and assume only one-third of landowners in the county are affected, and their royalty checks are being reduced by 33 percent because of post production costs, you come up with a number of about $10 million," Miller stated. "That is $10 million of royalty money that is not circulating in our (county's) economy."

"Bradford County has over 35,000 separate parcels of land," Miller said. "The overwhelming majority of them are ten acres or less. These people are small landowners who are working families and senior citizens trying to make ends meet. They are looking at this as a little bit of extra income. They simply want to be treated fairly."

The deductions are being taken out of royalty checks for various post-production costs, such as transporting the gas to market, and compressing and dehydrating the gas, Miller said.

In prepared testimony, Bradford County Commissioner Doug McLinko said:

"Our constituents have shown us evidence of extraordinary post production cost in Bradford County, with deductions of 40 and 50 percent all the way up to as much as 90 percent from our landowners' royalty checks. Since the Kilmer case (the 2010 Pennsylvania Supreme Court decision on the Kilmer vs. Elexco Land Services case) that pulled the safety net our from under the landowner, we have seen (royalty) checks come with zero payment. We have seen retroactive charges being billed to land owners for tens of thousands of dollars where the property owners actually have a bill sent to them and they go without any royalty payments until it is paid in full. It has been three years since the Kilmer case, and the state legislature has done nothing."

"When you look at this incredible practice of gouging property owners, there is no excuse for this," McLinko said.

Towanda attorney Chris Jones testified that the problem of large post-production costs is affecting farmers, who had entered into gas leases before the Marcellus gas boom hit the area.

"When the Marcellus Shale gas boom hit our area, there were many landowners (in Bradford County) whose property was already tied up with an oil and gas lease," Jones stated in his prepared testimony. "Unfortunately, many of these individuals were primarily rural farmers. As you are aware, many of our Pennsylvania farmers have been hurting for many years financially, and these individuals were not able to benefit from the new increase in the price for oil and gas leases. Some of these older leases paid $5 per acre whereas there were some newer leases that have paid $6,500 per acre. These landowners (farmers) were also faced with having leases that provided the lowest royalty payment, being 12 1/2 percent.

"In 2010 and 2011, I began seeing clients that were receiving gas royalties," Jones continued.

"Some leases specifically stated that the royalties would be paid after post-productions were deducted," Jones said. "However, there were many older leases that were signed that did not specifically state that there would be post-production costs deducted. Not only did these leases fail to state that post-production costs would be deducted, but many of the individuals were specifically advised, at the time that they entered into the lease, that there would not be any deduction.

"In 2009 to 2011, as these properties were producing natural gas, the royalties were generally being paid by gas companies without deducting any costs," Jones stated. "Then in 2012, everything changed. In January of 2012, my clients began receiving letters from Chesapeake Energy advising that they would begin taking post-production costs from their royalties and that they would take them retroactively to the time when royalty payments began. Chesapeake did this unilaterally. In fact, I still have some clients who have yet to receive a royalty check from Chesapeake.

"From leases that I have reviewed from January of 2012 to the present, most gas companies have been deducting post-production costs," Jones said. "It should be pointed out that this not consistent of all gas companies. For example, I have yet to see an example where Statoil has deducted post-production costs from royalties."

Yaw said standardized pay stubs provide for a more open and transparent means for leaseholders to review them, as seen in other natural gas producing states.

Joel Rotz, Senior Director of State Government Affairs for the PFB, voiced support for pending legislation that would clarify royalty pay stubs. "The information that would be required to be included on royalty stubs by enactment of this legislation is clearly not asking for any proprietary information from gas well operators and frankly is common sense detail that those receiving royalties should have in understanding and determining that the payment received is proper compensation as provided for in the lease agreement with the corresponding gas well company."

James Loewenstein can be reached at (570) 265-1633; or email: jloewenstein@thedailyreview.com.