How Low Can It Go? Questions From Those Who Can't Believe the Commodity Prices on Their Royalty Statement

Recently a GHS member asked a few pointed questions that demonstrate the frustration felt by anyone who has labored through deciphering their royalty statement only to discover they're being paid far less for their gas than the prices reported on TV. 

Whole books can (and have) been written on the issues surrounding the payment and reporting of royalties, and this post is not intended to be as comprehensive. Rather, I hope this post will address some common and reasonable concerns shared by many, without going too far into depth. 

1. Who Determines how much an operator Sells your gas for? 

Most gas is sold by the operator to a third-party gathering/pipeline/midstream company at the wellhead or close by. In this scenario, the operator and the purchaser will negotiate the price which should theoretically be the "market price," which is roughly defined as "the amount for which property should change hands between a willing buyer and a willing seller in an arms-length transaction." Things get hairy when the sale is not arms-length. See next answer.

2. How can an operator sell your gas for $1.06 when it says the average is is selling for $3.25? And this is just an example, but I'm sure you get the point?

First, the spot price of natural gas at Henry Hub is likely higher than what is actually paid to royalty owners anywhere. The economics of this are rather complex, but basically it boils down the fact that the purchasers in any given locale have only so much capacity, and thus they will buy gas from the "lowest bidders," which effectively lowers the wellhead price. 

Second, a royalty statement reporting the sale of gas at $1.06 per mcf likely came from an operator who reports the net price, rather than reporting the gross price received and then deducting itemized exenses. In effect, both methods involve deducting expenses for marketing, compression, etc, but the net price approach is less transparent about what deductions are made and for what. I have heard horror stories of royalties in the Barnett Shale being paid on $0.15 per mcf this past year. The only operator I am personally aware of that reports net price is Chesapeake. Put mildly, I find this method of reporting to be inadequate at best.

Third, there is the possibility of accounting shenanigans, deceit, or honest mistakes by the operator. I believe most problems falling in this category are due to honest mistakes, but suspicion of foul-play is always lurking when the operator sells gas to a related party, as was the case with Chesapeake until recently.  

3. And are there any organizations that oversee this matter and can stop this madness?

Governmental - not really. The LA Office of Conservation does NOT monitor or regulate private royalty issues because they will not interfere with individual freedom of contract. If there are serious allegations of criminal fraud, the state Attorney General may get involved, but I have never heard of this actually happening and the standard for criminal fraud is hard to meet - federal anti-trust law would be even less helpful. The ideal solution would be for the legislature to mandate certain royalty reporting requirements, but the very powerful industry lobby combined with the confusing nature of the issue makes this a challenge.

Non-Profit/Watchdog The National Association of Royalty Owners and their Louisiana chapter advocate for the rights of royalty owners, but they are most helpful in providing education and prevention at the contract negotiation phase. NARO appears to me to be less potent in aggressively pursuing litigation or lobbying efforts, but I may be wrong.

Private/For-Profit - There are companies you can pay to monitor your royalty payments to ensure their accuracy, and will address any discrepancies with the operator on your behalf. This is usually a consulting service, and should not involve them owning any of your mineral rights. In the Haynesville, ShaleTrak is by far the most effective and reputable consulting service that I am familiar with, but there may be others that are good as well.

 

4. People keep saying go to a lawyer ask a lawyer, but apparently all give conflicting information. And it doesn't matter what the topic or issue is. It has come to my attention that you can't trust anyone when it comes to your money. Even someone at the conservation office said don't trust anyone, and that's a real shame.

With time, patience, lots of education, familiarity with Louisiana's Department of Natural Resources, and constant monitoring of your royalty, your own efforts can go a long way. However, most people don't have enough royalty at stake to make a full-time job out of monitoring it, which is why third-party management companies can add value in some cases. You should trust yourself above all, but be willing to seek good advice when you're in over your head.

5. Should I take this and many other issues to Federal court?

Litigation is expensive, messy, expensive, time-consuming, and expensive. Oh, and it's expensive. Litigation should always be a last resort. I am told by numerous parties that most royalty issues are the product of genuine mistakes (or perhaps incompetence) by operators. If you've exhausted all other remedies, consider whether the cost of pursuing the suit would be more than the potential recovery (hint: it usually will be unless at least 6 figures sums hang in the balance). 

On a more technical note, most plaintiffs prefer to bring suit in state court, as state courts are theoretically more favorable to citizens who elect the judges (federal judges are appointed for life) and are less expensive than federal courts. Conversely, the defendants will often do everything they can to get a suit moved to federal court. As for the "many other issues," some kinds of claim will have to be brought in state court, where other have to be brought in federal court. The attorneys for both parties will spend months or years arguing over which courthouse to try the case in before anyone starts to even think about a trial.

MAIN TAKEAWAY

Prevention is the best medicine. Issues with royalty payment and reporting are one of the many points of lease negotiation often overlooked by eager mineral owners. In this respect, a qualified attorney will be much cheaper in the negotiation phase than in litigation, and can save the mineral owner substantial sums. Even small mineral owners should consider hiring an attorney to negotiate a lease as long as the legal fees are less than the total bonus.

In nearly all cases, legal advice from a qualified attorney is usually a good idea, and this post doesn't qualify, so please consider asking other members of the site for referrals if necessary.

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Tags: Gas, Prices, Royalty, Statement

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Comment by Andrew on January 19, 2013 at 1:25pm

Steve,

I have actually been personally overpaid by an operator in the past. I didn't realize that this happened until about 18 months later when I had "adjustments" made to my royalty one month and had to follow up with them for an explanation why.

Comment by Skip Peel - Independent Landman on January 17, 2013 at 3:30pm

Good blog post, Andrew.  I have one added point of emphasis: Not every attorney, or firm. is experienced in the area of mineral law.  The practice of mineral law is a specialty requiring many years to become proficient. I am constantly astounded by the complexity of the Code and the evolving nature of case law.  I know zero attorneys who are personal injury lawyers and experienced oil, gas and mineral lawyers.  There may be a few but most O&G attorneys have additional areas of practices such as business or contract law.  If an attorney or firm doesn't list mineral law as one of their specialties on their website I would not consider hiring them.  Experienced O&G attorneys or firms sometimes have potential conflicts of interest and will turn down work where they perceive that to be a problem.  IMO it's always acceptable for the client to ask.  Experienced O&G attorneys are not cheap but they will quote hourly rates and provide an estimate of the hours required to complete a project.  The hours required to review  a lease or even to negotiate one on behalf of a client are few when compared to those required to litigate after the fact. 

Comment by John Brewster on January 17, 2013 at 10:51am

A royalty owner can, and should, request a break down of the deductions from the price, especially when the price seems low.  The owner may not be qualified to know whether those deductions were legal under the terms of the lease, but at least you then have some information to take to a lawyer so that he can examine your lease and provide advice based on the law of the state where the propety is located.

Comment by Steve on January 17, 2013 at 8:32am

Thanks for your apt advice - which summarized is never ever trust an oil company. There have historically been countless "mistakes " made in royalty payment accounting, since it is so difficult to follow and the Regulators generally could care less whether you got screwed. (perhaps CHK is the only operator that doesn't want to confuse the royalty owner so it nets them out 1st?) But, I can't help but observe that for some unexplained reason, the royalty owner rarely gets paid too much -  the accounting errors seem to always be in favor of the operator. Hummmmm? The biggest mistake consistently made is trusting the operator to be fair to the royalty owner. NEVER accept the 1st lease a landman hands you is your best defense.

Comment by reathia alexander on January 15, 2013 at 1:10pm

Is anyone out there in the process of leasing their land at this time and finding it a long process to get leasing papers.

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