Oil and Gas Lawyer Blog
Chesapeake is spending a lot of money on lawyers.
Dan McDonald, a Fort Worth attorney, has filed some 250 cases against Chesapeake contending that it is underpaying its royalty owners. Companies affiliated with former House of Representatives Speaker Tom Craddick have now been added to McDonald’s client list. So many cases have been filed against it in Texas that Chesapeake asked the cases to be granted multidistrict litigation status, so that one judge could control pretrial discovery and motions and settings. Two judges have been appointed for that purpose, one for McDonald’s cases and another for cases brought by other attorneys. Chesapeake is settling cases as fast as it can.
Most of the claims against Chesapeake arise from its structure for selling gas. Chesapeake sells its gas at the wellhead to its wholly owned subsidiary Chesapeake Energy Marketing. Chesapeake Energy Marketing arranges for the gathering of the gas and delivery to central sales points, and pays Chesapeake for the gas based on a weighted average price of all sales at those central gathering points, less costs of compression, gathering, treating and transportation, and less a “marketing fee” charged by Chesapeake Energy Marketing. The costs incurred between the wellhead and the point of delivery to the purchaser were formerly incurred by another Chesapeake affiliate, Access Midstream. Chesapeake spun off its gathering systems into a separate company a few years ago, and as part of that deal it guaranteed a minimum rate of return on those gathering systems to the new spin-off company, thereby receiving a premium price in the market for the new company’s shares. Chesapeake pays royalties based on the new price it receives from Chesapeake Energy Marketing, after deduction of post-production costs and marketing fees. McDonald says that these “costs” are “sham sales” and “fraudulent transactions.”
McDonald’s first ten cases against Chesapeake are set for trial early next year. McDonald’s cases are mainly for wells in the Barnett Shale, where Chesapeake has sold a share in its wells to Total, the French energy company. Total is also named as a defendant, and it markets its share of gas in a manner similar to Chesapeake.
Chesapeake recently reported a $4 billion loss and has eliminated its dividend. It recently sued its founder and former CEO Aubrey McClendon for allegedly stealing trade secrets when he was fired by the company.
Chesapeake recently lost an important case in the Texas Supreme Court, Chesapeake v. Hyder, and the opinion in that case has other companies concerned about their ability to deduct post-production costs from royalties. Chesapeake recently filed a motion for rehearing in that case, and amicus briefs urging the court to reconsider its opinion have been filed by Texas Oil & Gas Association, BP, Devon, EOG, Exco, Shell, XTO and others. With low gas prices, the ability to force royalty owners to share in post-production costs can mean the difference between profit and loss for some companies.