Insight: To cut natural gas costs, Chesapeake pumps up royalty deductions

Wed Aug 28, 2013 1:28am EDT
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By Ernest Scheyder

SAYRE, Pennsylvania (Reuters) - As the natural gas industry struggles to cope with depressed prices, Chesapeake Energy Corp (CHK.N: Quote) has begun shifting a much larger share of transportation and marketing costs to the owners of Pennsylvania land it leases.

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.   Continued...

A well operated by Chesapeake Energy Corp is seen extracting natural gas from the Marcellus shale formation in Sayre, Pennsylvania, August 12, 2013. REUTERS/Ernest Scheyder