When negotiating a lease with an oil and gas company, it is important to seek to include a clause stating that no deductions from royalty payments will be permitted for costs. Landowners who leased their property to Chesapeake Energy for natural gas drilling have recently been reminded of the importance of a “no deductions” clause.
In August 2011, Chesapeake Energy sent notices to royalty owners saying that the company would begin subtracting “post-production costs” from the prices for natural gas used to calculate royalty payments. Chesapeake claimed that it had always been permitted to deduct such costs, but had foregone the deductions in the past. In the notices, Chesapeake said that landowners with lease clauses prohibiting such deductions would not see a change.
Today, Chesapeake is involved in multiple lawsuits in different states over alleged underpayment of royalties. One class action lawsuit has been filed by Johnson County, Texas landowners. The royalty owners claim that Chesapeake deducted costs even though their leases prohibited such deductions. On the other hand, a neighborhood association in Arlington, Texas was successful in convincing Chesapeake to reinstate higher royalty payments based on the “no deductions” clause in their lease.
Chesapeake Energy took the action at a time when natural gas prices were dropping precipitously. The price of natural gas dropped below $2 per 1,000 cubic feet (mcf) in 2012. The fall in prices meant that the post-production costs for processing and transporting natural gas, which can sometimes amount to $1 per mcf or even more, constituted a large percentage of what the landowner believed they should receive.