Articles Posted in Post-Production Costs

Three amicus briefs have been filed in support of the Hyders, opposing Chesapeake’s motion for rehearing of the Texas Supreme Court’s decision in Chesapeake v. Hyder.

An amicus brief was filed by the City of Fort Worth and others who have filed suits against Chesapeake and Total to recover additional royalties on production in the Barnett Shale area:  City of Fort Worth Amicus Brief

An amicus brief was filed by a group of royalty owners represented by Dan McDonald, a Fort Worth attorney who has filed 430 separate suits against Chesapeake, representing more than 20,900 royalty owners in Johnson and Tarrant Counties: Barnett Shale Royalty Owners Amicus Brief

The Texas Supreme Court asked the Hyders to respond to Chesapeake’s motion for rehearing in Chesapeake v. Hyder, after the court’s recent 5-4 decision in favor of the Hyders. Several amicus briefs (“friend of the court” briefs by entities not parties to the case) were filed in support of Chesapeake’s motion for rehearing. Exploration companies are clearly unhappy with language in Chief Justice Hecht’s majority opinion and asking the court to modify its language. The amicus briefs made the San Antonio Business Journal’s “Eagle Ford Shale Insight” feature.

I’ve written about this case before, and our firm filed an amicus brief in the case before the court issued its opinions, on behalf of Texas Land & Mineral Owners’ Association and the National Association of Royalty Owners-Texas.

So far, on rehearing, the following parties have joined in amicus briefs criticizing the court’s majority opinion:

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.”

The Texas Supreme Court has ruled 5 to 4 that Chesapeake cannot deduct post-production costs from the Hyder family’s gas royalties.

The case in the Supreme Court actually addresses only the Hyders’ overriding royalty. As part of the Hyders’ oil and gas lease, the Hyders agreed that Chesapeake could use their land to drill horizontal wells producing from their neighbors’ land — the surface location on the Hyders’ land, but all of the productive lateral of the well under the neighbor’s property. In exchange, Chesapeake agreed to pay the Hyders a 5% royalty on production from such wells. Because the Hyders have no mineral interest in the lands from which these wells produce, the parties referred to this royalty as an overriding royalty.

The Hyders’ lease contains very specific provisions prohibiting Chesapeake from deducting post-production costs from the Hyders’ royalty on production from their lands. But the lease provision granting the overriding royalty on production from wells bottomed under their neighbors’ property is not so clear. Although Chesapeake originally fought to deduct post-production costs from both the royalties and the overriding royalties, the trial court and court of appeals ruled for the Hyders on all claims, and Chesapeake elected to appeal to the Texas Supreme Court only on the issue of deductibility of post-production costs from the Hyders’ overriding royalty.

Last November, the Texas General Land Office lost its appeal in Commissioner v. SandRidge Energy, Inc., in the El Paso Court of Appeals. For the first time, a court has ruled that a lessee can deduct post-production costs under the Texas General Land Office’s Relinquishment Act lease form, citing Heritage Resources v. NationsBank, 939 S.W.2d 118 (Tex. 1996).

The case actually involves several oil and gas leases owned by SandRidge in Pecos County, some covering lands owned by private parties, some covering Relinquishment Act lands. (The State owns the minerals under Relinquishment Act land; the surface owner is agent for the state in granting oil and gas leases, for which the surface owner receives ½ of bonuses and royalties. The lease must be approved by the GLO and be on the approved GLO lease form.) The most interesting part of the case is the court’s interpretation of the GLO’s Relinquishment Act lease form. There are somewhere between 6.4 million and 7.4 million acres of Relinquishment Act lands in Texas, principally in West Texas, in and around the Permian Basin.

SandRidge’s wells on the leases in dispute produce mostly carbon dioxide, mixed with some natural gas. Originally, SandRidge paid the GLO royalties on its sales of natural gas and carbon dioxide. More recently, SandRidge made an agreement with Oxy USA; SandRidge built a plant, the Century Plant, to extract the CO2 from SandRidge’s gas. Oxy owns and operates the plant and gets the CO2 extracted; SandRidge gets the natural gas. Oxy doesn’t charge SandRidge for separating the gas from the CO2. Oxy uses the CO2 in secondary recovery projects. The plant reportedly cost a billion dollars.

As I have written, Chesapeake has asked the Texas Supreme Court to reverse the San Antonio Court of Appeals’ decision in Chesapeake v. Hyder. The court of appeals ruled that Chesapeake could not deduct post-production costs from the Hyders’ royalty.

The Texas Land & Mineral Owners’ Association and the National Association of Royalty Owners – Texas have filed an amicus brief in Hyder supporting the Hyders’ case. The brief can be viewed here. Final Amicus_Brief_Chesapeake_v__Hyder.pdf It was authored by my firm and by Raul Gonzalez, who was a member of the Texas Supreme Court when the court decided Heritage v. NationsBank, the case relied on by Chesapeake as authority for its deduction of post-production costs.

Last month I wrote about two cases recently decided by the U.S. Court of Appeals for the 5th Circuit in which Chesapeake defeated royalty owners’ efforts to prevent it from reducing their royalties by deducting post-production costs. One of those cases is Potts v. Chesapeake. The plaintiffs in that case have asked the Court of Appeals to reconsider its appeal “en banc,” meaning that it has asked the other judges on the court to grant its petition for rehearing and reconsider the decision of the three-judge panel who decided the case. Plaintiffs’ Petition for Rehearing may be viewed here:  Potts Petition for Rehearing En Banc.pdf

Yesterday, our firm filed a friend-of-the-court brief in the Potts case, on behalf of the Texas Land and Mineral Owners Association and the National Association of Royalty Owners – Texas, asking the Court to grant the plaintiff’s motion for rehearing and either consider the case en banc or refer the question to the Texas Supreme Court for its consideration. A copy of our brief may be viewed here:  Potts v. CHK Amicus Brief.pdf

Meanwhile, in Pennsylvania, suit has been filed against Chesapeake claiming that its conduct in selling gas to its affiliate company at prices well below market, and then selling its affiliate company for a substantial profit, constituted fraud on its royalty owners in violation of the Racketeer Influenced and Corrupt Organizations Act, known as RICO.  That petition can be viewed here:  Suessenbach v. Chesapeake.pdf