(Corrects 13th paragraph, deleting reference to U.S. three-yeargas supply needs and inserting instead U.S. gas consumption in2012)
By Ernest Scheyder
SAYRE, Pa., Aug 28 (Reuters) - As the natural gas industrystruggles to cope with depressed prices, Chesapeake Energy Corp has begun shifting a much larger share of transportationand marketing costs to the owners of Pennsylvania land itleases.
The largest natural gas operator in Pennsylvania's Marcellusshale formation, Chesapeake started this year to take muchheavier deductions from royalty checks it sends landowners tohelp 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 thecompany, are permitted under most Pennsylvania drilling leases.Such deductions are made in other states, mainly Texas, whereenergy companies have had a harder time passing on the costs. Anambiguous Pennsylvania law has allowed Chesapeake and others inthe industry to push the practice further there, analysts,politicians and attorneys said in interviews.
For years, landowners said, most of the industry has chargedsmall percentages of their royalties, typically 5 to 10 percent,a step generally accepted with little push-back. Some companiesdeducted nothing to cover costs.
Starting in January, however, Chesapeake began to deduct 60percent or more from Pennsylvania royalty checks, according to areview of contracts and more than a dozen interviews.
The deductions, allowed under Pennsylvania's 1979 GuaranteedMinimum Royalty Act, have helped the company cut costs and boostshareholder returns. But inevitably they are upsetting somelandowners 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, aretired accountant who along with his wife, Diana, owns 17 acresnestled 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 checkfrom Chesapeake deducted, up from 24 percent for December 2012.For May, the most-recent monthly payout he's received, hisroyalty check came to $122.08, with $274.70 deducted.
The first page of Van Curen's five-page lease agreementincludes a clause guaranteeing a royalty of 12.5 percent on allrevenue collected from his well, but with "adjustments onproduction," allowing taxes and other costs to be deducted. It'sthat small clause that has empowered Chesapeake to ramp updeductions and chip away at that 12.5 percent, attorneys said.Van Curen acknowledged he barely read that clause when aChesapeake agent came knocking on his door in 2009.
Chesapeake declined several requests to comment for thisarticle. In the past year the energy company has aggressivelymoved to cut costs and sell underperforming or non-core assetsto offset low natural gas prices, which have held backprofit.
The low gas prices are a direct result of the development ofAmerican shale reserves thanks to hydraulic fracturing, aprocess known as fracking. The rush to frack in the past fouryears has boosted domestic natural gas supplies, sharplydepressing prices and pressuring Chesapeake and its peers.
Doug Lawler, who became Chesapeake's CEO in June afterco-founder Aubrey McClendon was forced out following agovernance crisis and liquidity crunch, emphasized the company'sefforts to cut costs on a conference call with investors earlierthis month. Chesapeake's shares are up nearly 60 percent sinceJanuary.
Still, the company warned its costs to transport natural gasin Pennsylvania are rising. Pennsylvania's Marcellus shaleregion holds roughly a quarter of Chesapeake's 10.93 trillioncubic feet of proven natural gas reserves. The U.S. consumed25.5 trillion cubic feet of natural gas in 2012.
It is not clear how much money Chesapeake has saved byshifting more cost to landowners. Energy companies closely guardspecific data on wells, and Wall Street analysts say it isnearly impossible to extrapolate how much the new practice hasboosted Chesapeake's bottom line, thanks to constantly changingproduction volumes and natural gas prices across the company'sthousands of Pennsylvania wells.
LEADING THE CHARGE
Chesapeake's new strategy has stirred criticism among thelocals.
"I proudly support energy development across our state,"Doug McLinko, a Bradford County commissioner, said during aninterview at the RiverStone Inn, a popular watering hole forenergy industry workers in Towanda, Pennsylvania.
"But these higher deductions are affecting working familiesand senior citizens."
The fear in Bradford County, a mountainous region on thestate's northern border that produces more natural gas than anyother Pennsylvania county, is these deductions may get evensteeper as energy rivals catch on to the practice.
Talisman Energy Inc, the fourth-largest natural gasproducer in the Marcellus, said it is deciding now whether todeduct costs from royalty checks.
"Any decision will be made in a thoughtful manner, takinginto account considerations of our landowners," Talismanspokeswoman Phoebe Buckland said.
Royal Dutch Shell PLC, the third-largest producerin the Marcellus, said it takes deductions "on a lease-by-lease"basis and has done so for years at roughly 70 percent of itsPennsylvania wells. Earlier this year, though, Shell begandeducting costs from the remaining 30 percent of itsPennsylvania leases, which it acquired as part of its 2010buyout of East Resources.
"It is already a part of their lease agreement," Shellspokeswoman Kimberly Windon said of the legacy East landowners.
Statoil ASA, which holds a 33 percent interest inmany of Chesapeake's Pennsylvania wells, does not deduct anycosts.
Southwestern Energy Co and Cabot Oil & Gas Corp already deduct low percentages from royalty payouts toleaseholders, typically no more than 20 percent. The twocompanies declined to comment when asked if they planned toincrease deductions.
WHAT IS A 'ROYALTY'?
In 2008, several Pennsylvania landowners sued SouthwesternEnergy trying to get their leases invalidated, arguing that thecompany had no right to deduct any fees under the 1979 law. Twoyears later the state Supreme Court ruled that energy companiescould deduct the fees since the law did not precisely definewhat a royalty actually is.
The court asked the state legislature to update the law,something it has yet to do.
In the absence of any update, Chesapeake sent letters to itsleaseholders in early 2012 saying they would begin deductingcosts from royalty checks, and in some cases send retroactivebills for costs dating back to the 2010 ruling.
Some members of the state House of Representatives plan tointroduce legislation next month that would update the 1979 lawand guarantee landowners a minimum of 12.5 percent royaltypayment, regardless of costs.
"Are we as a government not responsible for fair play?" saidRepresentative Tina Pickett, a Republican.
Pickett is responding to constituents like Janet Geiger andher husband, Dick, who own 10 acres leased to Chesapeake. Thecouple acknowledged they did not read their lease in full beforesigning it and now realize it allows costs to be deducted.
They have attended several Chesapeake community relationsevents at local libraries with company staff, but said theyalways came away frustrated their questions about deductionsweren't answered to their satisfaction. Last month the couplereceived a check from Chesapeake for $45.28, after more than$450 was deducted.
"They take out, oh my God, line after line of deductions,"said Janet Geiger, a retired nurse. "I never expected to getrich, but hell we don't get enough in royalties to pay the taxeson our property." (Reporting by Ernest Scheyder; Editing by Edward Tobin and TimDobbyn)
