The best of EcoWatch, right in your inbox. Sign up for our email newsletter!
How the Fracking Industry Avoids Paying Royalties to Landowners
Don Feusner ran dairy cattle on his 370-acre slice of northern Pennsylvania until he could no longer turn a profit by farming. Then, at age 60, he sold all but a few Angus and aimed for a comfortable retirement on money from drilling his land for natural gas instead.
It seemed promising. Two wells drilled on his lease hit as sweet a spot as the Marcellus shale could offer—tens of millions of cubic feet of natural gas gushed forth. Last December, he received a check for $8,506 for a month’s share of the gas.
Then one day in April, Feusner ripped open his royalty envelope to find that while his wells were still producing the same amount of gas, the gusher of cash had slowed. His eyes cascaded down the page to his monthly balance at the bottom: $1,690.
Chesapeake Energy, the company that drilled his wells, was withholding almost 90 percent of Feusner’s share of the income to cover unspecified “gathering” expenses and it wasn’t explaining why.
“They said you’re going to be a millionaire in a couple of years, but none of that has happened,” Feusner said. “I guess we’re expected to just take whatever they want to give us.”
Like every landowner who signs a lease agreement to allow a drilling company to take resources off his land, Feusner is owed a cut of what is produced, called a royalty.
In 1982, in a landmark effort to keep people from being fleeced by the oil industry, the federal government passed a law establishing that royalty payments to landowners would be no less than 12.5 percent of the oil and gas sales from their leases.
From Pennsylvania to North Dakota, a powerful argument for allowing extensive new drilling has been that royalty payments would enrich local landowners, lifting the economies of heartland and rural America. The boom was also supposed to fill the government’s coffers, since roughly 30 percent of the nation’s drilling takes place on federal land.
Over the last decade, an untold number of leases were signed, and hundreds of thousands of wells have been sunk into new energy deposits across the country.
But manipulation of costs and other data by oil companies is keeping billions of dollars in royalties out of the hands of private and government landholders, an investigation by ProPublica has found.
An analysis of lease agreements, government documents and thousands of pages of court records shows that such underpayments are widespread. Thousands of landowners like Feusner are receiving far less than they expected based on the sales value of gas or oil produced on their property. In some cases, they are being paid virtually nothing at all.
In many cases, lawyers and auditors who specialize in production accounting tell ProPublica energy companies are using complex accounting and business arrangements to skim profits off the sale of resources and increase the expenses charged to landowners.
Deducting expenses is itself controversial and debated as unfair among landowners, but it is allowable under many leases, some of which were signed without landowners fully understanding their implications.
But some companies deduct expenses for transporting and processing natural gas, even when leases contain clauses explicitly prohibiting such deductions. In other cases, according to court files and documents obtained by ProPublica, they withhold money without explanation for other, unauthorized expenses and without telling landowners that the money is being withheld.
Significant amounts of fuel are never sold at all—companies use it themselves to power equipment that processes gas, sometimes at facilities far away from the land on which it was drilled. In Oklahoma, Chesapeake deducted marketing fees from payments to a landowner—a joint owner in the well—even though the fees went to its own subsidiary, a pipeline company called Chesapeake Energy Marketing. The landowner alleged the fees had been disguised in the form of lower sales prices. A court ruled that the company was entitled to charge the fees.
Costs such as these are normally only documented in private transactions between energy companies, and are almost never detailed to landowners.
“To find out how the calculation is done, you may well have to file a lawsuit and get it through discovery,” said Owen Anderson, the Eugene Kuntz Chair in Oil, Gas & Natural Resources at the University of Oklahoma College of Law, and an expert on royalty disputes. “I’m not aware of any state that requires that level of disclosure.”
To keep royalties low, companies sometimes set up subsidiaries or limited partnerships to which they sell oil and gas at reduced prices, only to recoup the full value of the resources when their subsidiaries resell it. Royalty payments are usually based on the initial transaction.
In other cases, companies have bartered for services off the books, hiding the full value of resources from landowners. In a 2003 case in Louisiana, for example, Kerr McGee, now owned by Anadarko Petroleum, sold its oil for a fraction of its value—and paid royalties to the government on the discounted amount—in a trade arrangement for marketing services that were never accounted for on its cash flow statements. The federal government sued, and won.
The government has an arsenal of tools to combat royalty underpayment. The Department of Interior has rules governing what deductions are allowable. It also employs an auditing agency that, while far from perfect, has uncovered more than a dozen instances in which drillers were “willful” in deceiving the government on royalty payments just since 2011. A spokesman for the Department of Interior’s Office of Natural Resources Revenue says that over the last three decades, the government has recouped more than $4 billion in unpaid fees from such cases.
There are few such protective mechanisms for private landowners, though, who enter into agreements without regulatory oversight and must pay to audit or challenge energy companies out of their own pockets.
ProPublica made several attempts to contact Chesapeake Energy for this article. The company declined, via email, to answer any questions regarding royalties, and then did not respond to detailed sets of questions submitted afterward. The leading industry trade group, the American Petroleum Institute, also declined to comment on landowners’ allegations of underpayments, saying that individual companies would need to respond to specific claims.
Anderson acknowledged that many landowners enter into contracts without understanding their implications and said it was up to them to do due diligence before signing agreements with oil and gas companies.
“The duty of the corporation is to make money for shareholders,” Anderson said. “Every penny that a corporation can save on royalties is a penny of profit for shareholders, so why shouldn’t they try to save every penny that they can on payments to royalty owners?”
Gas flows up through a well head on Feusner’s property, makes a couple of turns and passes a meter that measures its volume. Then it flows into larger pipes fed by multiple pipelines in a process the industry calls “gathering.” Together, the mixed gases might get compressed or processed to improve the gas quality for final sale, before feeding into a larger network of pipelines that extends for hundreds of miles to an end point, where the gas is sold and ultimately distributed to consumers.
Each section of pipeline is owned and managed by a different company. These companies buy the gas from Chesapeake, but have no accountability to Feusner. They operate under minimal regulatory oversight, and have sales contracts with the well operator, in this case Chesapeake, with terms that are private. Until Chesapeake sold its pipeline company last winter, the pipelines were owned by its own subsidiaries.
As in many royalty disputes, it is not clear exactly which point of sale is the one on which Feusner’s payments should be based—the last sale onto the open market or earlier changes in custody. It’s equally unclear whether the expenses being charged to Feusner are incurred before or after that point of sale, or what processes, exactly, fall under the term “gathering.” Definitions of that term vary, depending on who is asked. In an email, a spokesperson for Chesapeake declined to say how the company defines gathering.
Making matters more complicated, the rights to the gas itself are often split into shares, sometimes among as many as a half-dozen companies, and are frequently traded. Feusner originally signed a lease with a small drilling company, which sold the rights to the lease to Chesapeake. Chesapeake sold a share of its rights in the lease to a Norwegian company, Statoil, which now owns about a one-third interest in the gas produced from Feusner’s property.
Chesapeake and Statoil pay him royalties and account for expenses separately. Statoil does not deduct any expenses in calculating Feusner’s royalty payments, possibly because it has a different interpretation of what’s allowed.
“Statoil’s policy is to carefully look at each individual lease, and to take post-production deductions only where the lease and the law allow for it,” a company spokesman wrote in an email. “We take our production in kind from Chesapeake and we have no input into how they interpret the leases.”
Once the gas is produced, a host of opaque transactions influence how sales are accounted for and proceeds are allocated to everyone entitled to a slice. The chain of custody and division of shares is so complex that even the country’s best forensic accountants struggle to make sense of energy companies’ books.
Feusner’s lease does not give him the right to review Chesapeake’s contracts with its partners, or to verify the sales figures that the company reports to him. Pennsylvania—though it recently passed a law requiring that the total amount of deductions be listed on royalty statements—has no laws dictating at what point a sale price needs to be set, and what expenses are legitimate.
Concerns about royalties have begun to attract the attention of state legislators, who held a hearing on the issue in June. Some have acknowledged a need to clarify minimum royalty guarantees in the state, but so far, that hasn’t happened.
“If you have a system that is not transparent from wellhead to burner tip and you hide behind confidentiality, then you have something to hide,” Jerry Simmons, executive director of the National Association of Royalty Owners (NARO), the premier organization representing private landowners in the U.S., told ProPublica in a 2009 interview. Simmons said recently that his views had not changed, but declined to be interviewed again. “The idea that regulatory agencies don’t know the volume of gas being produced in this country is absurd.”
Because so many disputes come down to interpretations of contract language, companies often look to courts for clarification. Not many royalty cases have been argued in Pennsylvania so far, but in 2010, a landmark decision, Kilmer v. Elexco Land Services, set out that the state’s minimum royalty guarantee applied to revenues before expenses were calculated, and that, when allowed by leases, energy companies were free to charge back deductions against those royalties.
Since then, Pennsylvania landowners say, Chesapeake has been making larger deductions from their checks. (The company did not respond to questions about this.) In April, Feusner’s effective royalty rate on the gas sold by Chesapeake was less than 1 percent.
Paul Sidorek is an accountant representing some 60 northeastern Pennsylvania landowners who receive royalty income from drilling. He’s also a landowner himself—in 2009, he leased 145 acres, and that lease was eventually sold to Chesapeake. Well aware of the troubles encountered by others, Sidorek negotiated a 20 percent royalty and made sure his lease said explicitly that no expenses could be deducted from the sale of the gas produced on his property.
Yet now, Sidorek says, Chesapeake is deducting as much as 30 percent from his royalties, attributing it to “gathering” and “third party” expenses, an amount that adds up to some $40,000 a year.
“Now that the royalties are flowing, some people just count it as a blessing and say we don’t care what Chesapeake does, it’s money we wouldn’t have had before,” Sidorek said. But he’s filed a lawsuit. “I figure I could give my grandson a first-class education for what Chesapeake is deducting that they are not entitled to, so I’m taking it on.”
Landowners, lawyers, legislators and even some energy industry groups say Chesapeake stands out for its confusing accounting and tendency to deduct the most expenses from landowners’ royalty checks in Pennsylvania.
“They’ve had a culture of doing cutthroat business,” said Jackie Root, president of Pennsylvania’s chapter of the National Association of Royalty Owners.
Chesapeake did not respond to questions on whether its approach differs from that of other companies.
Root and others report good working relationships with other companies operating wells in Pennsylvania, and say that deductions—if they occur at all—are modest. Statoil, which has an interest in a number of Chesapeake wells, does not deduct any expenses on its share of many of the same leases. In an email from a spokesperson, the company said “We always seek to deal with our lease holders in a fair manner.”
Several landowners said that not only do deductions vary between companies using the same gas “gathering” network—sales prices do as well.
On Sidorek’s royalty statements, for example, Chesapeake and Statoil disclose substantially different sales prices for the same gas moved through the same system.
“If Statoil can consistently sell the gas for $.25 more, and Chesapeake claims it’s the premier producer in the country, then why the hell can’t they get the same price Statoil does for the same gas on the same day?” Sidorek wondered.
He thinks Chesapeake was giving a discount to a pipeline company it used to own. Chesapeake did not respond to questions about the price discrepancy.
Chesapeake may be the focus of landowner ire in Pennsylvania, but across the country thousands of landowners have filed similar complaints against many oil and gas producers.
In dozens of class actions reviewed by ProPublica, landowners have alleged they cannot make sense of the expenses deducted from their payments or that companies are hiding charges
Publicly traded oil and gas companies also have disclosed settlements and judgments related to royalty disputes that, collectively, add up to billions of dollars.
In 2003, a jury found that Exxon had defrauded the state of Alabama out of royalty payments and ordered the company to pay nearly $103 million in back royalties and interest, plus $11.8 billion in punitive damages. (The punitive damages were reduced to $3.5 billion on appeal, and then eliminated by the state supreme court in 2007.)
In 2007, a jury ordered a Chesapeake subsidiary to pay $404 million, including $270 million in punitive damages, for cheating a class of leaseholders in West Virginia. In 2010, Shell was hit with a $66 million judgment, including $52 million in punitive fines, after a jury decided the company had hidden a prolific well and then intentionally misled landowners when they sought royalties. The judgment was upheld on appeal.
Since the language of individual lease agreements vary widely, and some date back nearly 100 years, many of the disagreements about deductions boil down to differing interpretations of the language in the contract.
In Pennsylvania, however, courts have set few precedents for how leases should be read and substantial hurdles stand in the way of landowners interested in bringing cases.
Pennsylvania attorneys say many of their clients’ leases do not allow landowners to audit gas companies to verify their accounting. Even landowners allowed to conduct such audits could have to shell out tens of thousands of dollars to do so.
When audits turn up discrepancies, attorneys say, many Pennsylvania leases require landowners to submit to arbitration—another exhaustive process that can cost tens of thousands of dollars. Arbitration clauses can also make it more difficult for landowners to join class action suits in which individuals can pool their resources and gain enough leverage to take on the industry.
“They basically are daring you to sue them,” said Aaron Hovan, an attorney in Tunkhannock, PA, representing landowners who have royalty concerns. “And you need to have a really good case to go through all of that, and then you could definitely lose.”
All of these hurdles have to be cleared within Pennsylvania’s four-year statute of limitations. Landowners who realize too late that they have been underpaid for years—or who inherit a lease from an ailing parent who never bothered to check their statements—are simply out of luck.
Even if a gas company were found liable for underpaying royalties in Pennsylvania, it would have little to fear. It would owe only the amount it should have paid in the first place; unlike Oklahoma and other states, Pennsylvania law does not allow for any additional interest on unpaid royalties and sets a very high bar for winning punitive penalties.
“They just wait to see who challenges them, they keep what they keep, they give up what they lose,” said Root, the NARO chapter president. “It may just be part of their business decision to do it this way.”
Visit EcoWatch’s FRACKING page for more related news on this topic.
EcoWatch Daily Newsletter
By Randi Spivak
Slashing two national monuments in Utah may have received the most attention, but Trump's Interior Department and U.S. Forest Service have been quietly, systematically ceding control of America's public lands to fossil fuel, mining, timber and livestock interests since the day he took office.
A new report by Greenpeace International pinpointed the world's worst sources of sulfur dioxide pollution, an irritant gas that harms human health. India has seized the top spot from Russia and China, contributing nearly 15 percent of global sulfur dioxide emissions.
By Sue Branford and Thais Borges
Ola Elvestrun, Norway's environment minister, announced Thursday that it is freezing its contributions to the Amazon Fund, and will no longer be transferring €300 million ($33.2 million) to Brazil. In a press release, the Norwegian embassy in Brazil stated:
Given the present circumstances, Norway does not have either the legal or the technical basis for making its annual contribution to the Amazon Fund.
Brazilian President Jair Bolsonaro reacted with sarcasm to Norway's decision, which had been widely expected. After an official event, he commented: "Isn't Norway the country that kills whales at the North Pole? Doesn't it also produce oil? It has no basis for telling us what to do. It should give the money to Angela Merkel [the German Chancellor] to reforest Germany."
According to its website, the Amazon Fund is a "REDD+ mechanism created to raise donations for non-reimbursable investments in efforts to prevent, monitor and combat deforestation, as well as to promote the preservation and sustainable use in the Brazilian Amazon." The bulk of funding comes from Norway and Germany.
The annual transfer of funds from developed world donors to the Amazon Fund depends on a report from the Fund's technical committee. This committee meets after the National Institute of Space Research, which gathers official Amazon deforestation data, publishes its annual report with the definitive figures for deforestation in the previous year.
But this year the Amazon Fund's technical committee, along with its steering committee, COFA, were abolished by the Bolsonaro government on 11 April as part of a sweeping move to dissolve some 600 bodies, most of which had NGO involvement. The Bolsonaro government views NGO work in Brazil as a conspiracy to undermine Brazil's sovereignty.
The Brazilian government then demanded far-reaching changes in the way the fund is managed, as documented in a previous article. As a result, the Amazon Fund's technical committee has been unable to meet; Norway says it therefore cannot continue making donations without a favorable report from the committee.
Archer Daniels Midland soy silos in Mato Grosso along the BR-163 highway, where Amazon rainforest has largely been replaced by soy destined for the EU, UK, China and other international markets.
An Uncertain Future
The Amazon Fund was announced during the 2007 United Nations Climate Change Conference in Bali, during a period when environmentalists were alarmed at the rocketing rate of deforestation in the Brazilian Amazon. It was created as a way of encouraging Brazil to continue bringing down the rate of forest conversion to pastures and croplands.
Government agencies, such as IBAMA, Brazil's environmental agency, and NGOs shared Amazon Fund donations. IBAMA used the money primarily to enforce deforestation laws, while the NGOs oversaw projects to support sustainable communities and livelihoods in the Amazon.
There has been some controversy as to whether the Fund has actually achieved its goals: in the three years before the deal, the rate of deforestation fell dramatically but, after money from the Fund started pouring into the Amazon, the rate remained fairly stationary until 2014, when it began to rise once again. But, in general, the international donors have been pleased with the Fund's performance, and until the Bolsonaro government came to office, the program was expected to continue indefinitely.
Norway has been the main donor (94 percent) to the Amazon Fund, followed by Germany (5 percent), and Brazil's state-owned oil company, Petrobrás (1 percent). Over the past 11 years, the Norwegians have made, by far, the biggest contribution: R$3.2 billion ($855 million) out of the total of R$3.4 billion ($903 million).
Up till now the Fund has approved 103 projects, with the dispersal of R$1.8 billion ($478 million). These projects will not be affected by Norway's funding freeze because the donors have already provided the funding and the Brazilian Development Bank is contractually obliged to disburse the money until the end of the projects. But there are another 54 projects, currently being analyzed, whose future is far less secure.
One of the projects left stranded by the dissolution of the Fund's committees is Projeto Frutificar, which should be a three-year project, with a budget of R$29 million ($7.3 million), for the production of açai and cacao by 1,000 small-scale farmers in the states of Amapá and Pará. The project was drawn up by the Brazilian NGO IPAM (Institute of Environmental research in Amazonia).
Paulo Moutinho, an IPAM researcher, told Globo newspaper: "Our program was ready to go when the [Brazilian] government asked for changes in the Fund. It's now stuck in the BNDES. Without funding from Norway, we don't know what will happen to it."
Norway is not the only European nation to be reconsidering the way it funds environmental projects in Brazil. Germany has many environmental projects in the Latin American country, apart from its small contribution to the Amazon Fund, and is deeply concerned about the way the rate of deforestation has been soaring this year.
The German environment ministry told Mongabay that its minister, Svenja Schulze, had decided to put financial support for forest and biodiversity projects in Brazil on hold, with €35 million ($39 million) for various projects now frozen.
The ministry explained why: "The Brazilian government's policy in the Amazon raises doubts whether a consistent reduction in deforestation rates is still being pursued. Only when clarity is restored, can project collaboration be continued."
Bauxite mines in Paragominas, Brazil. The Bolsonaro administration is urging new laws that would allow large-scale mining within Brazil's indigenous reserves.
Hydro / Halvor Molland / Flickr
Alternative Amazon Funding
Although there will certainly be disruption in the short-term as a result of the paralysis in the Amazon Fund, the governors of Brazil's Amazon states, which rely on international funding for their environmental projects, are already scrambling to create alternative channels.
In a press release issued yesterday Helder Barbalho, the governor of Pará, the state with the highest number of projects financed by the Fund, said that he will do all he can to maintain and increase his state partnership with Norway.
Barbalho had announced earlier that his state would be receiving €12.5 million ($11.1 million) to run deforestation monitoring centers in five regions of Pará. Barbalho said: "The state governments' monitoring systems are recording a high level of deforestation in Pará, as in the other Amazon states. The money will be made available to those who want to help [the Pará government reduce deforestation] without this being seen as international intervention."
Amazonas state has funding partnerships with Germany and is negotiating deals with France. "I am talking with countries, mainly European, that are interested in investing in projects in the Amazon," said Amazonas governor Wilson Miranda Lima. "It is important to look at Amazônia, not only from the point of view of conservation, but also — and this is even more important — from the point of view of its citizens. It's impossible to preserve Amazônia if its inhabitants are poor."
Signing of the EU-Mercusor Latin American trading agreement earlier this year. The pact still needs to be ratified.
Council of Hemispheric Affairs
Looming International Difficulties
The Bolsonaro government's perceived reluctance to take effective measures to curb deforestation may in the longer-term lead to a far more serious problem than the paralysis of the Amazon Fund.
In June, the European Union and Mercosur, the South American trade bloc, reached an agreement to create the largest trading bloc in the world. If all goes ahead as planned, the pact would account for a quarter of the world's economy, involving 780 million people, and remove import tariffs on 90 percent of the goods traded between the two blocs. The Brazilian government has predicted that the deal will lead to an increase of almost $100 billion in Brazilian exports, particularly agricultural products, by 2035.
But the huge surge this year in Amazon deforestation is leading some European countries to think twice about ratifying the deal. In an interview with Mongabay, the German environment ministry made it very clear that Germany is very worried about events in the Amazon: "We are deeply concerned given the pace of destruction in Brazil … The Amazon Forest is vital for the atmospheric circulation and considered as one of the tipping points of the climate system."
The ministry stated that, for the trade deal to go ahead, Brazil must carry out its commitment under the Paris Climate agreement to reduce its greenhouse gas emissions by 43 percent below the 2005 level by 2030. The German environment ministry said: If the trade deal is to go ahead, "It is necessary that Brazil is effectively implementing its climate change objectives adopted under the [Paris] Agreement. It is precisely this commitment that is expressly confirmed in the text of the EU-Mercosur Free Trade Agreement."
Blairo Maggi, Brazil agriculture minister under the Temer administration, and a major shareholder in Amaggi, the largest Brazilian-owned commodities trading company, has said very little in public since Bolsonaro came to power; he's been "in a voluntary retreat," as he puts it. But Maggi is so concerned about the damage Bolsonaro's off the cuff remarks and policies are doing to international relationships he decided to speak out earlier this week.
Former Brazil Agriculture Minister Blairo Maggi, who has broken a self-imposed silence to criticize the Bolsonaro government, saying that its rhetoric and policies could threaten Brazil's international commodities trade.
Senado Federal / Visualhunt / CC BY
Maggi, a ruralista who strongly supports agribusiness, told the newspaper, Valor Econômico, that, even if the European Union doesn't get to the point of tearing up a deal that has taken 20 years to negotiate, there could be long delays. "These environmental confusions could create a situation in which the EU says that Brazil isn't sticking to the rules." Maggi speculated. "France doesn't want the deal and perhaps it is taking advantage of the situation to tear it up. Or the deal could take much longer to ratify — three, five years."
Such a delay could have severe repercussions for Brazil's struggling economy which relies heavily on its commodities trade with the EU. Analysists say that Bolsonaro's fears over such an outcome could be one reason for his recently announced October meeting with Chinese President Xi Jinping, another key trading partner.
Maggi is worried about another, even more alarming, potential consequence of Bolsonaro's failure to stem illegal deforestation — Brazil could be hit by a boycott by its foreign customers. "I don't buy this idea that the world needs Brazil … We are only a player and, worse still, replaceable." Maggi warns, "As an exporter, I'm telling you: things are getting very difficult. Brazil has been saying for years that it is possible to produce and preserve, but with this [Bolsonaro administration] rhetoric, we are going back to square one … We could find markets closed to us."
- Brazil's New President Could Spell Catastrophe for the Amazon ... ›
- Amazon Deforestation Increase Prompts Germany to Cut $39.5M in ... ›
Hawaii's Kilauea volcano could be gearing up for an eruption after a pond of water was discovered inside its summit crater for the first time in recorded history, according to the AP.
Gina Lopez, a former Philippine environment secretary, philanthropist and eco-warrior, died on Aug. 19 from brain cancer. She was 65.
Thousands of union members at a multibillion dollar petrochemical plant outside of Pittsburgh were given a choice last week: Stand and wait for a speech by Donald Trump or take the day off without pay.
By Simon Mui
States across the country are stepping up to make clean cars cheaper and easier to find. Colorado's Air Quality Control Commission (AQCC) voted Friday to adopt a Zero Emission Vehicle (ZEV) program that will increase the availability of electric vehicles in the state, improve air quality and increase transportation affordability.