Landowners seek to turn off wells when royalty checks disappear

STATE COLLEGE, Pa. — At the annual meeting of Pennsylvania’s natural gas royalty owners association last month, attorney Robert Burnett told frustrated landowners that when the royalty checks stop coming, it is time to take a hard line.

Examples abound of drilling companies drawing gas from leased properties and then paying the mineral owners next to nothing after deducting their share of the costs of piping and processing the gas for market.

At times the gas prices are so low and the post-production costs are so high that the drilling companies stop sending checks at all. Instead, upon request, they provide their landowner partners with statements that reveal a negative balance — meaning the costs of moving and marketing the gas that month were more than the money made selling it.

“So you know there’s thousands of people out there in this situation,” said Jackie Root, president of the Pennsylvania chapter of the National Association of Royalty Owners. “It is not something here and there. There are people that have accrued those negatives into tens, hundreds of thousands, and over a million dollars.”

By Mr. Burnett’s assessment, cuts that deep trigger the end of leases, which generally expire when gas stops being produced in paying quantities. The attorney at Downtown law firm Houston Harbaugh has started telling gas companies that if they continue to send his clients statements showing a negative royalty, they should file documents to surrender the lease in 30 days.

“I think I’ve gotten the drillers’ attention,” he said.

As lawmakers continue to postpone dealing with steep royalty deductions and as a state Attorney General’s lawsuit to recover post-production costs from a handful of companies slowly advances in the courts, landowners are fed up with companies pulling gas from their properties if they can’t make any money keeping the wells flowing.

Last fall, township supervisors in Wilmot, Bradford County, passed a resolution demanding natural gas companies shut off wells paying landowners “nothing or nearly nothing” in royalties or accruing a negative balance because of “exorbitantly high post-production costs.”

But getting a company to shut off a money-losing well is not as simple as making a demand.

A lot depends on the precise language of individual leases. Pennsylvania courts, for example, are not going to imply that a lease must produce gas in paying quantities if the text of the contract doesn’t explicitly require it, said Kevin Douglass, an attorney with Downtown-based Babst Calland, who represents natural gas clients.

A 2012 state Supreme Court decision clarified that “in paying quantities” generally means a well produces a profit, however small, over the costs to operate it. If the well isn’t making a profit, it is still up to the landowner to prove that the gas company is operating in bad faith and that there isn’t a legitimate business reason to continue producing gas from the well for some period of time at a loss, Mr. Douglass said.

“Generally speaking, the bar is high for the lease to be invalidated once it starts producing,” he said.

If it were as simple for landowners to terminate leases as proving that they didn’t receive royalties for a couple months, “You would think there would be a lot of cases out there where landowners are challenging their leases on that basis,” Mr. Douglass said. “So far, I have not seen that.”

The ownership structure of wells can also complicate Mr. Burnett’s strategy. If multiple companies have a joint stake in a well — as is commonly the case — as long as one company is still paying royalties, a landowner is going to have a harder time arguing the lease isn’t profitable, Mr. Burnett admitted.

Still, he said, his argument is gaining traction when he advances it to resolve disputes.

“A lot of operators and their counsel will disagree with me, but I’m right on this,” he said at the royalty owners meeting. 

In the meantime, landowners who have called for wells to be shut off are not having much luck.

Russ Forba, one of six siblings who own a 335-acre farm in Wyoming County, was assured by representatives of Chesapeake Energy Corp. that the Oklahoma-based oil and gas company would shut off production from wells if post-production costs ever exceeded revenue from gas sales. But when costs eclipsed sales, the wells kept flowing.

During nine months in 2015 and 2016, when Chesapeake sold more than 2 billion cubic feet of gas from beneath the farm, the family received nothing from Chesapeake and technically owed the company $112,000 for post-production costs, according to Mr. Forba’s tally.

Two billion cubic feet of gas is enough to heat about 30,000 homes for a year.

“The wells under our farm are rapidly being depleted and we again ask that you terminate production of all wells that are in our units,” Mr. Forba wrote to Chesapeake in October 2015, during a spell when the family went eight straight months without receiving a royalty check.

In response, a Chesapeake representative wrote that because another company operates the wells and didn’t want to curtail production, Chesapeake didn’t have the authority to shut it down. The company representative promised, in writing, that the company zeroes out any negative balance each month and will not take it out of the family’s future royalties.

A Chesapeake spokeswoman confirmed that it is the company’s practice not to use post-production costs that created a negative balance for landowners in past months to offset future royalties.

Mr. Forba, a retired environmental engineer who lives in Montana, has a hard time believing it.

He keeps assiduous notes to make sure that when the company deducts past expenses from current checks, it isn’t applying costs from months the family was paid nothing.

In all, $1.7 million in post-production costs were deducted from the family’s royalty stake during the three years between January 2014 and January 2017.

Their lease allows for deductions, but these are exploitative, he said.

“Our fear is not only the fact that we don’t get anything,” he said. It is that the companies might try to collect the debt. “At that point, we’re paying them to take gas out of the ground.”

Laura Legere:

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