By Ernest Scheyder
SAYRE, Pa. Aug 28 As the natural gas industry
struggles to cope with depressed prices, Chesapeake Energy Corp
has begun shifting a much larger share of transportation
and marketing costs to the owners of Pennsylvania land it
The largest natural gas operator in Pennsylvania's Marcellus
shale formation, Chesapeake started this year to take much
heavier deductions from royalty checks it sends landowners to
help pay to gather, compress, market and transport natural gas,
in most cases cutting compensation by more than half.
The deductions, set entirely at the discretion of the
company, are permitted under most Pennsylvania drilling leases.
Such deductions are made in other states, mainly Texas, where
energy companies have had a harder time passing on the costs. An
ambiguous Pennsylvania law has allowed Chesapeake and others in
the industry to push the practice further there, analysts,
politicians and attorneys said in interviews.
For years, landowners said, most of the industry has charged
small percentages of their royalties, typically 5 to 10 percent,
a step generally accepted with little push-back. Some companies
deducted nothing to cover costs.
Starting in January, however, Chesapeake began to deduct 60
percent or more from Pennsylvania royalty checks, according to a
review of contracts and more than a dozen interviews.
The deductions, allowed under Pennsylvania's 1979 Guaranteed
Minimum Royalty Act, have helped the company cut costs and boost
shareholder returns. But inevitably they are upsetting some
landowners who overlooked the fine print in their contracts.
"When they take such a large chunk, then you kind of go,
'It's not worth it to have them drill'," said Terry Van Curen, a
retired accountant who along with his wife, Diana, owns 17 acres
nestled on the side of a misty mountain in Litchfield Township,
Pennsylvania. "Why are we paying to have them be on our land?"
Van Curen saw 85 percent of his January 2013 royalty check
from Chesapeake deducted, up from 24 percent for December 2012.
For May, the most-recent monthly payout he's received, his
royalty check came to $122.08, with $274.70 deducted.
The first page of Van Curen's five-page lease agreement
includes a clause guaranteeing a royalty of 12.5 percent on all
revenue collected from his well, but with "adjustments on
production," allowing taxes and other costs to be deducted. It's
that small clause that has empowered Chesapeake to ramp up
deductions and chip away at that 12.5 percent, attorneys said.
Van Curen acknowledged he barely read that clause when a
Chesapeake agent came knocking on his door in 2009.
Chesapeake declined several requests to comment for this
article. In the past year the energy company has aggressively
moved to cut costs and sell underperforming or non-core assets
to offset low natural gas prices, which have held back
The low gas prices are a direct result of the development of
American shale reserves thanks to hydraulic fracturing, a
process known as fracking. The rush to frack in the past four
years has boosted domestic natural gas supplies, sharply
depressing prices and pressuring Chesapeake and its peers.
Doug Lawler, who became Chesapeake's CEO in June after
co-founder Aubrey McClendon was forced out following a
governance crisis and liquidity crunch, emphasized the company's
efforts to cut costs on a conference call with investors earlier
this month. Chesapeake's shares are up nearly 60 percent since
Still, the company warned its costs to transport natural gas
in Pennsylvania are rising. Pennsylvania's Marcellus shale
region holds roughly a quarter of Chesapeake's 10.93 trillion
cubic feet of proven natural gas reserves, enough to supply U.S.
needs for nearly three years.
It is not clear how much money Chesapeake has saved by
shifting more cost to landowners. Energy companies closely guard
specific data on wells, and Wall Street analysts say it is
nearly impossible to extrapolate how much the new practice has
boosted Chesapeake's bottom line, thanks to constantly changing
production volumes and natural gas prices across the company's
thousands of Pennsylvania wells.
LEADING THE CHARGE
Chesapeake's new strategy has stirred criticism among the
"I proudly support energy development across our state,"
Doug McLinko, a Bradford County commissioner, said during an
interview at the RiverStone Inn, a popular watering hole for
energy industry workers in Towanda, Pennsylvania.
"But these higher deductions are affecting working families
and senior citizens."
The fear in Bradford County, a mountainous region on the
state's northern border that produces more natural gas than any
other Pennsylvania county, is these deductions may get even
steeper as energy rivals catch on to the practice.
Talisman Energy Inc, the fourth-largest natural gas
producer in the Marcellus, said it is deciding now whether to
deduct costs from royalty checks.
"Any decision will be made in a thoughtful manner, taking
into account considerations of our landowners," Talisman
spokeswoman Phoebe Buckland said.
Royal Dutch Shell PLC, the third-largest producer
in the Marcellus, said it takes deductions "on a lease-by-lease"
basis and has done so for years at roughly 70 percent of its
Pennsylvania wells. Earlier this year, though, Shell began
deducting costs from the remaining 30 percent of its
Pennsylvania leases, which it acquired as part of its 2010
buyout of East Resources.
"It is already a part of their lease agreement," Shell
spokeswoman Kimberly Windon said of the legacy East landowners.
Statoil ASA, which holds a 33 percent interest in
many of Chesapeake's Pennsylvania wells, does not deduct any
Southwestern Energy Co and Cabot Oil & Gas Corp
already deduct low percentages from royalty payouts to
leaseholders, typically no more than 20 percent. The two
companies declined to comment when asked if they planned to
WHAT IS A 'ROYALTY'?
In 2008, several Pennsylvania landowners sued Southwestern
Energy trying to get their leases invalidated, arguing that the
company had no right to deduct any fees under the 1979 law. Two
years later the state Supreme Court ruled that energy companies
could deduct the fees since the law did not precisely define
what a royalty actually is.
The court asked the state legislature to update the law,
something it has yet to do.
In the absence of any update, Chesapeake sent letters to its
leaseholders in early 2012 saying they would begin deducting
costs from royalty checks, and in some cases send retroactive
bills for costs dating back to the 2010 ruling.
Some members of the state House of Representatives plan to
introduce legislation next month that would update the 1979 law
and guarantee landowners a minimum of 12.5 percent royalty
payment, regardless of costs.
"Are we as a government not responsible for fair play?" said
Representative Tina Pickett, a Republican.
Pickett is responding to constituents like Janet Geiger and
her husband, Dick, who own 10 acres leased to Chesapeake. The
couple acknowledged they did not read their lease in full before
signing it and now realize it allows costs to be deducted.
They have attended several Chesapeake community relations
events at local libraries with company staff, but said they
always came away frustrated their questions about deductions
weren't answered to their satisfaction. Last month the couple
received a check from Chesapeake for $45.28, after more than
$450 was deducted.
"They take out, oh my God, line after line of deductions,"
said Janet Geiger, a retired nurse. "I never expected to get
rich, but hell we don't get enough in royalties to pay the taxes
on our property."