Pages

Thursday, August 11, 2011

For Investors Only: CHK To Deduct Expenses From Royalty Checks -- Folks Could See Barnett Shale Royalty Checks Decreased By As Much as 25%

Update


March 12, 2014: royalty owners being charged for transportation costs, post-production costs that exceed value of natural gas. Some say that defies logic. Not really.

August 21, 2011: I first posted the story below on August 11, 2011. Google "Chesapeake deducts 25% royalties" to see the number of posts about Chesapeake's decision.

Original Post


Link here.

This has to be one of the stranger stories I've read in a long time. CHK would hate to see royalty owners get two checks for same well, so CHK decides just to cut royalties by 25%.

Let's see, two options: a) send me two checks for a partial cut; or, b) send me one check with a full cut.

Hmmmm.

Here's the story, as I understand it:
1. Total, the French oil giant, recently paid $2.25 billion for a 25 percent interest in Chesapeake's Barnett Shale operations. 

2. There are costs associated with gathering, processing, and distributing (GPD) natural gas once it comes to the surface.  Chesapeake has historically not charged the royalty owners for the costs associated with GPD.

3. However, Total, the French company has routinely done that (gee, why does that not surprise me?).

4. So, a royalty owner in the Barnett, now has two companies to work with: CHK, which controls 75% and Total, which controls 25% of the natural gas that comes to the surface on their leases. 

5. CHK/Total could work out a deal where royalty owners would get two checks -- one from CHK which would not deduct costs associated with GPD, and one check from Total which would deduct those costs. Or CHK/Total could work out a deal where royalty owners would get a single check: one in which the entire amount would be subject to the GPD costs. 

6. CHK asked themselves: would their royalty owners like two checks for a bit less money, or one check for a lot less money.
Here is the first part of the story in case the link is broken:
About 20,000 royalty owners who have Barnett Shale natural gas leases with Chesapeake Energy will likely see their royalty checks slashed by roughly 25 percent after the company deducts expenses associated with post-production, such as gas gathering, compression and transportation.

The actual percentage and dollar amount decreases in royalty checks will vary monthly based on natural gas prices, post-production costs and output from wells.

Chesapeake is the No. 2 producer in the natural gas-rich Barnett Shale, which underlies more than 20 North Texas counties. 
This is the reason for the single check and 25% cut in royalties:
[A company spokesman] said the company's decision to begin assessing royalty owners for post-production costs was triggered by its agreement with Total, the French oil giant, which paid $2.25 billion for a 25 percent interest in Chesapeake's Barnett Shale operations.

Total was about to begin deducting post-production costs from royalty owners' checks based on its share of the Chesapeake wells' production, so Chesapeake also decided to begin assessing for the costs, Hood said.

Otherwise, payment to royalty owners would have required two separate checks, and "it didn't make any sense to have two different checks from two different companies," [the company spokesman] said. 
This sounds so incredible, I may have the story wrong, but that's how I read it.

If it's accurate, it falls under the category: I can't make this stuff up. 

I don't know how much it costs to find and produce natural gas, but it seems incredible that once brought to the surface, it costs 25% of its value to gather, process, and ship. What makes me think
that buyers of compressed natural gas are also charged for gathering, compressing and shipping?

This is like the potato farmer being charged for the costs associated with "compressing" the potatoes into French fries and for the shipping of the French fries to McDonald's. And, of course, the customer buying those French fries is still paying for the value-added processing from raw potatoes to finished products.

7 comments:

  1. The royalty clause In the lease would govern what costs are borne by each party to the lease agreement. If chk has historically borne gathering, processing and shipping costs of gas marketed under the lease then it would seem that a precedent has been established as to the lease intrepretation of royalty calculation. Selling the lease to another entity (the French company) does not alter the terms of the lease from the mineral owner standpoint.

    ReplyDelete
  2. "Our Barnett Shale production is concentrated in urban areas where the cost to develop the necessary infrastructure to gather and deliver the natural gas to intrastate pipelines significantly exceeds the cost of similar infrastructure in non-urban areas. As a result, our natural gas price realizations in the Barnett Shale are lower than those in our other operating areas."

    CHK 10=Q page 66

    Average nat gas prices - Barnett: $1.30
    Average of all nat gas prices, including Barnett: $3.25

    Last year: $2.74/$3.84

    For details on the Barnett gathering system see CHKM.

    http://www.chesapeakemidstream.com/Investors/Pages/Presentations.aspx

    Analyst Day and Monthly.

    The cost of building pipelines in a huge city is impressive.

    "Total CapEx spending was $109.7 million during the second quarter with 143 wells connected. The primary driver of capital spending continues to be the Barnett region. In the press release issued yesterday, we updated our outlook for CapEx spending for the 2011 full year to $440 million from $330 million previously, with $366 million of the new projection as growth capital. The increase in projected growth capital expenditures is primarily the result of adjustments to the timing of key organic projects. The scope of the Partnership's anticipated construction program remains unchanged."

    http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NDM3MjYyfENoaWxkSUQ9NDU3OTI0fFR5cGU9MQ==&t=1

    Back to the issue.

    Check out the ND Supreme Court case on post production costs. Is the price the price at the well or when it goes to a seller. Offhand, I thinks ND law matches what CHK will now do.

    So, why didn't they deduct before?
    Nice guys?
    Didn't think of it?
    Oil and NGL have high costs, gas less. It is more important now?
    Leases vary. Complications. PR?
    State law varies?
    Barnett prices got their attention?
    Total got their attention?

    ... ?

    http://www.chesapeakemidstream.com/SiteCollectionDocuments/pdf/August2011InvestorPresentation.pdf

    See page 15 - chart.

    Compare price and cost.

    CHK may be drilling only for the royalty owners - breaking even.

    The Barnett rock is wonderful, but urban drilling and production is hard and expensive.

    When is it HBP, drilling may wait for price.

    It might be like Bakken drilling if the price is $20/BO. The post production costs may exceed the profit.

    (CHKM contracts with CHK/Total for a 15% return on investment. Probably fair, more of less.)

    IIRC, the 2008 top of the bubble market for Barnett leases was $25-35,000/acre. Ouch.

    anon 1

    ReplyDelete
  3. This is where companies need to think "right," not "legal."

    A customer-friendly company would have sent a letter to those receiving royalties, explaining the situation, and asking folks to select option A, two checks for slightly less money, or option B, one check for a lot less money.

    Computers can easily make the computations. This is not rocket science.

    ReplyDelete
  4. The company said it simply had to do with one check vs two checks. They said nothing about losing money in urban areas.

    If it's about losing money on production, it's interesting that "we" didn't know this until Total got involved. Maybe the NY Times story had some validity.

    ReplyDelete
  5. Well, the costs of gathering, compressing and shipping the gas from the well head to the point of sale are real. The question is at what point in the pro ess is the royalty paid and what if any post processing costs are borne by the mineral owner on his royalty share of production. The lease (which is a contract) and the state law governing contracts (tx) apply. The magnitude of the cost does not matter unless the lease addresses this topic. The fact (if true) that chk in the past paid royalties at the wellhead with no processing costs and at some benchmark price does matter. Based on the facts as presented total and/or chk would seem to be on less than firm foundation for changing their royalty proceedure without agreement from the mineral owner(s). The only negotiating leverage I see is for total/chk to tell the mineral owner they will shut in or abandon the wells as non economic unless the mineral owner agrees to this new formula.

    ReplyDelete
  6. I agree with all the above and appreciate folks taking time to comment.

    What surprised me was the answer CHK gave: they thought folks would rather get one check than two checks, so they decided to follow Total's lead and start charging for GCT (gathering, compression, and transportation).

    That seemed disingenuous. I can't imagine folks being upset with getting two checks if it meant less of a hit to their wallet.

    Natural gas royalties can't be all that big to begin with (compared with oil) and then to have one's checks cut by 25% "out of the blue" seems noteworthy.

    ReplyDelete
  7. Note: the following was sent to me anonymously. I edited it slightly for publication. The "facts" were not changed. -- BAO

    25%? Try 90%!

    When the wellhead price on my CHK reconciliation statement, as given by CHK itself is $2.50, the "customer price," i.e., the price on the check is 25 cents!!!

    YES, 25 cents. The rest are deductions.

    What's more. I bought the royalty interest 2 months before the announcement. I have a strong suspicion that whoever sold me the interest has been tipped off that CHK is doing an audit.

    ReplyDelete

Note: Only a member of this blog may post a comment.