Reason offered for shrinking royalty checks
says Chesapeake has to pay high fees for transporting gas
An article published by the ProPublica news organization asserts that it has an explanation for the large decreases in the last couple of years in the size of royalty checks paid by Chesapeake Energy Corp. to landowners in Bradford County.
The article, which was written by Abrahm Lustgarten and published on March 13, 2014, was cited by the Bradford County commissioners when they called earlier this month for a federal probe of Chesapeake Energy Corp.
Around 2012, Chesapeake sold its gathering pipelines in Pennsylvania and other states to a company which is now called Access Midstream, raising $4.76 billion in cash, and, since then, large deductions from landowners' royalty checks have occurred because Chesapeake is on the hook to pay the unusually high costs of transporting gas through those lines, according to the article. Much of the high cost of transporting gas through Access-owned lines is being passed by Chesapeake onto landowners in the form of large deductions from their royalty checks, the article states.
"The ProPublica article asserts that the reason for the steep increases in postproduction costs charged through to Chesapeake's leaseholders is because Chesapeake, in an effort to raise cash to cover shortfalls, sold its local pipelines to a company spun off from Chesapeake, Access Midstream, and that the cost of transporting gas through those pipelines has increased dramatically beyond any reasonable approximation of actual market cost. If the allegations contained in the article are true, then there may be violations of state or federal law, including the Pennsylvania Guaranteed Minimum Royalty Act," the Bradford County commissioners wrote in a letter to U.S. Attorney Peter J. Smith, which is dated July 10, 2014.
"Due to the serious allegations raised in the article, and separately-received anecdotal complaints received from county residents, the Bradford County commissioners are formally requesting your office conduct an investigation into Chesapeake's alleged business practices as regards the calculation of royalties," the letter states.
Due to deductions for post-production costs, many Bradford County landowners are receiving royalties of 0 to 5 percent, which is far lower than the royalty rate that is written into their leases, Bradford County Commissioner Daryl Miller has said. Post-production costs are various expenses that are incurred after gas leaves the wellhead, such as compressing, dehydrating, and transporting the gas.
The ProPublica article says its findings are based on documents filed with the U.S. Securities and Exchange Commission, interviews with landowners, people who worked for Chesapeake, and employees at other oil and gas concerns.
The ProPublica article states that, in exchange for the $4.76 billion, "Chesapeake promised the new company, Access Midstream, that it would send much of the gas it discovered for at least the next decade through those pipes (that Chesapeake had sold to Access Midstream). Chesapeake pledged to pay Access enough in fees to repay the $5 billion plus a 15 percent return on its pipelines.
"That much profit was possible only if Access charged Chesapeake significantly more for its services. And that's exactly what appears to have happened: While the precise details of Access' pricing remains private, immediately after the transactions (between Chesapeake and Access Midstream), Access reported to the SEC that it collected more money to move each unit of gas, while Chesapeake reported that it also paid more to have that gas moved," according to the ProPublica article.
"In its securities filings, Chesapeake said that the deals brought the company (Chesapeake) $1.76 billion more than it had invested to build and maintain its pipelines and the companies that ran them, leaving the impression that the sales were an unqualified boon for Chesapeake," the ProPublica article states.
"But a look at an SEC filing by Access Midstream tells a different story: Chesapeake was going to have to give much of that money back," according to ProPublica. "On the same day as the last of the major sales (of Chesapeake gathering lines), Chesapeake signed long-term contracts pledging to pay Access a minimum fee for transporting its gas. In some cases, the fee held no matter what happened to the price of gas, or even how little of it flowed out of Chesapeake's wells.
"Chesapeake also promised to connect every new well it drilled to Access' lines for the next 15 years in Ohio's Utica Shale, a potentially lucrative emerging drilling field, and made similar agreements elsewhere," according to the ProPublica article.
"According to ProPublica projections based on figures disclosed by the companies in late 2013, Chesapeake's commitments would have it paying Access a whopping $800 million each year. Over 10 years, the contracts would generate nearly twice as much money as Access had paid Chesapeake for its businesses in the first place," the ProPublica article states.
Part of the ProPublica article focuses on Joe Drake, a Pennsylvania farmer who had leased his gas rights to Chesapeake and whose monthly royalty payments for the same amount of gas plummeted from $5,300 in July 2012 to $541 in February 2013.
"Days after the last of the deals (between Chesapeake and Access Midstream) closed, Drake and other landowners learned the expense of sending their gas through Access' pipelines would eat up nearly all of the money they had been previously earning from their wells. Some saw their monthly checks fall by as much as 94 percent," the ProPublica article states.
Citing the fact that Access Midstream is involved in litigation focused on the ProPublica article, Access declined to provide comment to The Daily Review on the specifics of the ProPublica article.
However, Chris Callahan, a spokesman for Access Midstream, stated: "The lawsuits are a direct attack on Access Midstream's integrity and we take that very seriously as it is a foundation of our core values. We believe the allegations are without merit and we will aggressively defend the cases. I cannot comment further on this matter due to the pending litigation."
Chesapeake Energy declined to provide comment to The Daily Review for this article.
The Bradford County commissioners all praised Lustgarten's ProPublica article.
"I think that ProPublica is an excellent source of investigative journalism," said Mark Smith, Bradford County commissioner. "I tend to think their article is spot-on."
The article is "very well done" and "very in-depth," said Miller.
"I called the editor (of ProPublica) and thanked him for the job that Abrahm did on that article," said Doug McLinko, Bradford County commissioner.
ProPublica is a New York City-based, non-profit, independent news organization which won the Pulitzer prize for national reporting in 2011.
James Loewenstein can be reached at (570) 265-1633; or email: email@example.com.