US Postal Service Subpoenas Chesapeake Energy on Royalty Payments

Chesapeake Energy continues to see its legal battles compound over its royalty-payment practices.

Already facing lawsuits in several different states and having been subpoenaed by the U.S. Department of Justice, StateImpact Pennsylvania reports that another government outfit is taking a legal interest in the company's royalty payment strategies:

Chesapeake Energy has been subpoenaed by the U.S. Postal service, seeking information on its royalty practices, according to a regulatory filing. 

As StateImpact Pennsylvania has previously reported, the Oklahoma City-based driller faces a slew of disputes and complaints over how it pays royalties.

We've posted articles in the past that looked at some of the questionable practices that Chesapeake has employed to reduce the amount of royalties it pays out to landowners.  As a quick refresher, note how ProPublica reporter Abrahm Lustgarten shared some of the details in an article which we shared here on The Daily Digger in March of last year:

ProPublica pieced together the story of how Chesapeake shifted borrowing costs to landowners from documents filed with the U.S. Securities and Exchange Commission, interviews with landowners, people who worked for the company and employees at other oil and gas concerns.

The deals took advantage of a simple economic principle: Monopoly power.
Boiled down to basics, they worked like this: When energy companies lease land above the shale rock that contains natural gas, they typically agree to pay the owner the market price for any gas they find, minus certain expenses.

Federal rules limit the tolls that can be charged on inter-state pipelines to prevent gouging. But drilling companies like Chesapeake can levy any fees they want for moving gas through local pipelines, known in the industry as gathering lines, that link backwoods wells to the nation's interstate pipelines. Property owners have no alternative but to pay up. There's no other practical way to transport natural gas to market.
Chesapeake took full advantage of this. In a series of deals, it sold off the network of local pipelines it had built in Pennsylvania, Ohio, Louisiana, Texas and the Midwest to a newly formed company that had evolved out of Chesapeake itself, raising $4.76 billion in cash.

In exchange, Chesapeake promised the new company, Access Midstream, that it would send much of the gas it discovered for at least the next decade through those pipes. Chesapeake pledged to pay Access enough in fees to repay the $5 billion plus a 15 percent return on its pipelines.

That much profit was possible only if Access charged Chesapeake significantly more for its services. And that's exactly what appears to have happened: While the precise details of Access' pricing remains private, immediately after the transactions Access reported to the SEC that it collected more money to move each unit of gas, while Chesapeake reports that it also paid more to have that gas moved. Access said that gathering fees are its predominant source of income, and that Chesapeake accounts for 84 percent of the company's business.

What's more, SEC documents show, Chesapeake retained a stake in the gathering process. While Chesapeake collected fees from landowners like Drake to cover the costs of what it paid Access to move the gas, Access in turn paid Chesapeake for equipment it used to complete that process, circulating at least a portion of the money back to Chesapeake.

ProPublica repeatedly sought comment and explanations from both Chesapeake and Access Midstream over the course of several months. Both companies declined to make executives available to discuss the deals or to respond to written questions submitted by ProPublica. 

Days after the last of the deals closed, Drake and other landowners learned the expense of sending their gas through Access's pipelines would eat up nearly all of the money they had been previously earning from their wells. Some saw their monthly checks fall by as much as 94 percent.

An executive at a rival company who reviewed the deal at ProPublica's request said it looked like Chesapeake had found a way to make the landowners pay the principal and interest on what amounts to a multi-billion loan to the company from Access Midstream.

"They were trying to figure out any way to raise money and keep their company alive," said the executive, who declined to be named because it would jeopardize his dealings with Chesapeake. "I think they looked at it as an opportunity to effectively get disguised financing…that is going to be repaid at a premium.''

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