Are February 2021 Production Royalty Payments Leaving you Out in the Cold?

May 15, 2021

On March 8, 2021, the Pennsylvania Attorney General announced a settlement of the lawsuit filed against Chesapeake Energy Corporation that challenged several of Chesapeake’s business practices. One of the announced points of settlement was that Chesapeake must stop offering leases that contain “market enhancement” clauses or “ready for sale or use” clauses to Pennsylvania landowners.

“Market enhancement” royalty clauses have many forms but generally prohibit post-production cost deductions from royalties unless those costs were incurred by the gas company to “enhance” the value of already marketable gas to attain better pricing. In theory, this seems reasonable to royalty owners. If the gas company will incur additional charges to get a better price for the gas, then it seems fair for the royalty owner to share in those costs because it will result in more money for the royalty owner. But, this is not always how drillers have used “market enhancement” royalty clauses. All too often, “market enhancement” provisions in leases are not even a speedbump in the way of drillers deducting all post-production costs.

Given Chesapeake’s diminished position in Pennsylvania, its bankruptcy, and the overall state of the leasing market, it is unclear what effect this settlement between Chesapeake and the Pennsylvania Attorney General will have in the future. But, it should make royalty owners aware that the presence of a “market enhancement” royalty clause in a lease is not a guarantee that it will be followed.

Just weeks before the Pennsylvania Attorney General announced this settlement, record cold descended on Texas and other states in the central plains. The power grid failed and left millions without heat and other essentials. Gas prices skyrocketed in that region for several days. We suggested that the sky-high natural gas prices in Texas could be a marker for royalty owners to determine if their driller was actually working to enhance the value of gas in a previous article that can be found here.

Now is the time to take stock of any evidence of value enhancement. Royalty payments generally lag 1-2 months behind the month of production and sales. That means that royalty owners should have received royalties for February 2021 production. Do those royalty statements reflect the substantial pricing premiums that were available during that month? Do the royalty statements show how the driller did anything to enhance the value of gas? Are the types of deductions any different than past royalty statements?

Royalty owners should carefully review their leases and royalty statements to see if drillers are following any “market enhancement” royalty clauses and consult with experienced oil and gas counsel for further clarification.

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