Posted on Sun, May. 11, 2008

Gas royalty checks trickling in

By David Wethe and Jim Fuquay

Star-Telegram staff writer

After traveling the world for much of his life, John Beaman is now happy to be touring Texas, thanks to the Barnett Shale.

But the Johnson County resident, who spent 21 years in the military, is still a little perplexed about why it took so long to get the flow of natural gas royalties streaming into his bank account.

His first check didn't appear until almost a year after drilling began.

"They always told me, 'Well, we're behind,'" said Beaman, who signed his lease with Devon Energy, which later traded it to EOG Resources. "Well, hey, if you don't have enough staff to get these business commitments taken care of, maybe you need to hire somebody. But they're not going to do it."

It's a gripe that's starting to pop up more and more as the Barnett Shale begins to write a new chapter. As landmen continue to hand out bonus checks and lease mineral rights from property owners in the urban core of Tarrant County, the early wave of lease signers are starting to move onto the next phase -- royalties.

Early Barnett Shale signers are starting to see just what those mysterious royalty checks look like. It's one of the biggest unknowns property owners face when they first sign their lease.

"You can only do kind of a best-guess analysis of what you've seen happen in some other wells," said John Terrell, vice president of commercial development at Dallas/Fort Worth Airport, which projected first-year royalty payments of anywhere from $30 million to $70 million from Chesapeake Energy. "At the time we were making our projections, there had been almost no wells drilled immediately around D/FW. So, this was all speculative."

As of March, the airport's monthly check hit $1.8 million, which, after three consecutive months of growth, was unchanged from the previous month because of a need for more pipelines.

The amount of royalties is one issue. When the payments start is another.

The process

Property owners are learning that they might be just a tad unrealistic in their expectations about how fast they'll get paid. It can easily take more than a year for a well to begin producing gas.

"Based on the phone calls we receive, people think it should be immediately," said Cheryl Thompson, land supervisor for Devon's Fort Worth Basin operations. "Well, first we need to get a pipeline, and a market to sell to, and the paperwork to confirm ownership."

Royalty owners should remember that when it comes to getting a well on production, she said, the company, which is already out millions in drilling and development costs, has plenty of incentive to get it done as fast as it can.

But some things have to happen before the gas flows out of a well and money flows into the hands of a property owner. And that takes time.

The Barnett Shale is home to an increasingly large and complex web of hundreds of miles of interconnecting pipelines. These include gathering lines that serve individual wells or leases; larger trunk lines that collect the output of numerous gathering lines; and big transmission lines that carry gas to East Texas hubs that tie into the huge interstate pipelines leading to major markets like Chicago or the Northeast.

Before a well's first cubic foot of gas can be sold -- and any royalty check can be cut -- the well must be connected to a pipeline, and sometimes that means waiting for a line to arrive.

Or, as Chesapeake Energy spokesman Justin Bond put it: "If there's no pipeline, that meter doesn't tick and the royalty doesn't pay."

How fast a well is tied into the pipeline network depends on "where you are in relation to existing infrastructure," said Mike Latchem, director of corporate development for Crosstex Energy Services, which says its 700 miles of pipeline is the most in the Barnett Shale. "Many times the gathering system is there to receive the gas. But if you're drilling where there's not much infrastructure, there will be timing delays."

Not only that, but the growth in natural gas production in Johnson and Tarrant counties has been much stronger than most in the industry expected. That means it has sometimes outrun what is called takeaway -- the capacity to move gas out of the field and on to users.

"Looking back," said Roy Patton, an Energy Transfer Partners senior vice president, "we probably could have built twice as much" capacity as the Dallas-based pipeline operator installed just a few years ago. Energy Transfer currently moves about 2 billion cubic feet of natural gas a day out of Barnett Shale wells and toward sales markets.

For example, Energy Transfer announced plans in 2005 for a 42-inch pipeline from Cleburne to Carthage, south of Longview near the Louisiana border. The price tag was $450 million.

The pipeline opened in April 2007. Energy Transfer is already adding its Southern Shale line, a 30-mile, 36-inch pipeline originating near Interstate 35 and Risinger Road in south Fort Worth and tying into the big 42-inch line in Cleburne. The new line will carry an additional 700 million cubic feet of gas a day out of the Barnett Shale when it opens in October.

And when the gas flows, so do the royalty checks.

How much? Last year, the Barnett Shale produced 1,165 billion cubic feet of natural gas. Assuming an average sales price of $7 per 1,000 cubic feet and an average royalty rate of 20 percent, royalty owners split just more than $1.6 billion in royalty payments last year.

Under state law, a producer has four months to get property owners their first royalty check after production begins. But the clock doesn't start ticking until the end of the first month of production. After that, drillers have as much as 90 days after the end of the month to deliver the next royalty check.

Debbie Kelly, assistant controller the Devon division that includes the Barnett Shale, said her company typically issues royalty checks 45 days after the end of the month of production. Companywide, she said, Devon issues 30,000 royalty checks a month, plus an additional 50,000 that are made only once a year because they are for small amounts.

The traveler

As those and other royalty checks find their way to landowners, the plans for their use vary.

"I knew nothing about the gas business," Beaman said. "I wasn't familiar with the leasing process. Being naive, I guess I got taken a little bit, but the way I look at it, this is money that I sit here and don't do anything for. It shows up the 15th of the month. So, I really, really can't complain."

In fact, Beaman used his money to buy a 28-foot travel trailer. And the regular checks he gets are used to fill up the gas tank as he and his wife motor across the Lone Star State.

Drilling under Beaman's 1-acre property began around February or March of last year, he said. He received his first royalty check of $4,580 about three months ago. It was a lump-sum payment that included royalties from the sale of gas from June 2007 through February. It covered natural gas from three wells.

Since then, he's received two other monthly checks, for $406 and $906.

The amounts vary based on how many wells are drilled on the unit in which his property is pooled. Drillers organize their leases into units, typically of hundreds of acres, and royalty owners are compensated based on the production of wells in their unit.

It all averages out to a little more than what Beaman was hoping for -- about $100 a month per well.

"If it paid my electric bill for a month, I was going to be happy," he said. "But, when I look at the amount of revenue that they get from a single well in a single month, I'm going, 'Whoa, this ain't much.' But am I happy with it? Yeah."

The way Beaman figures it, the steady flow of cash from drilling will help make up for the "nuisance factor" associated with drilling, including torn-up highways and mud strewn about from some of the drilling subcontractors.

"So, in the long run," he said, "if they never showed up, I wouldn't have cared either."

The boater

Francis Leong used his natural-gas money to buy a second home overlooking Richland Chambers Lake and a 19.5-foot boat he uses to fish and pull skiers.

So naturally, the former mayor of Haslet looks at his royalty payments with a twinkle in his eye.

"This came in as a blessing," he said. "It really helps because I'm retired."

He admits he probably wouldn't have bought "anything as expensive" without the help of the natural gas money, which he estimates is now coming in at "several hundred dollars a month" for his 5 acres.

Before he retired as mayor three years ago, Leong led Haslet residents into a mineral-rights lease with Four Sevens Oil Co. that was one of the first leases negotiated jointly for a group of landowners. That was around 2003. Before that, most leases were negotiated individually with property owners.

Leong helped organize property owners with a total of about 400 acres, ranging from several acres down to a quarter-acre. Along the way, he tried to manage expectations.

"I explained to the people, 'You're not going to get rich on this quarter of an acre, but at least you're going to get something,'" he said.

The party planner

Joe Epps has already decided what he's going to do with his royalty checks. With his 60th wedding anniversary approaching, he's either going to have a really big bash, he says, or a more sedate one.

The Woodhaven resident, who helped lead mineral-rights lease negotiations for the east Fort Worth neighborhood, was pretty disappointed when his first check arrived in December. It was just $26.14. And that was for several months.

But the first two wells drilling under Woodhaven by Chesapeake Energy were mostly under Woodhaven Country Club, which had its own lease. Hundreds of Woodhaven homeowners shared just 12 percent of the royalties from those wells, Epps said.

Then Chesapeake drilled five wells that will pay the homeowners 50 percent of the royalties. Epps' share for his quarter-acre lot came to $148 in April.

Big numbers

Other property owners raking in royalties from the Barnett Shale have their eyes set on bigger fare.

D/FW Airport, which pulled in its first royalty check last November, is looking at a number of different ways to invest its new-found money, including the development of a retail center at the south end of the airport along Texas 183.

The airport has pulled in almost $5.6 million in royalties since November.

Chesapeake, which is drilling at the airport, is working on expanding its pipeline network there, and revenues should start growing again within a couple months, Terrell said.

The city of Fort Worth is also increasing its royalty revenue.

So far, it's pulled in a total of $11.7 million in royalties since drilling began in August 2005, said Jean Petr, who is managing the city's natural gas-leasing program. But with 24 producing wells, Fort Worth is just getting warmed up. Over the life of all the wells, city officials are hoping for about $1 billion in bonus and royalty revenue.

"That's just an estimate," Petr said. The city has leased out almost 6,000 acres, but Petr said that number will at least double and could possibly triple by the time the entire city is finished.

Overall, the revenue is better than expected, she said.

"It's been a surprise for us," she said. "We've been pleasantly pleased with the results that have come in."

Step by step

Here is a simplified list of major steps that must happen before a landowner can receive a royalty check. This process can take a year or more.

1. Mineral-rights owner signs lease.

2. Producer accumulates enough adjoining leases to receive drilling permit from Texas Railroad Commission.

3. Producer receives municipal drilling permit (if required).

4. Well drilled.

5. Well fractured and completed.

6. Wellhead connected to gathering system or trunk line.

7. Gathering system or trunk line connected to sufficient compression and processing capacity to reach transmission line.

8. Producer sells gas.

9. Mineral-rights owner receives division order documenting proper acreage and mineral-rights ownership.

10. Producer makes initial royalty payment no later than four months after the end of the first month of production.

11. Producer thereafter sends monthly royalty checks no later than three months after production, unless checks are small, in which case they may be mailed less frequently.

Estimating royalties

Royalty payments depend on several factors, mostly related to a royalty owner's lease terms, acreage and value of the natural gas produced. Here's a look at the payments that the owner of a typical Tarrant County urban lot might expect. Out of the estimated royalty payment, the royalty owner will see deductions for state severance taxes and ad valorem (property) taxes.

Assumptions

Lot size: 9,600 square feet (0.22 acres)

Sales price: $10 per 1,000 cubic feet

Acres per well: 65

First month production rate: 2 million cubic feet/day*

Royalties

First year: $4,304 ($359/month)

Second year: $2,382 ($199/month)

Third year: $1,649 ($137/month)

Fourth year: $1,415 ($118/month)

Fifth year: $1,187 ($107/month)

Total after 30 years: $25,985

*Gas wells decline from initial production rapidly, falling on average 56 percent after one year, 27 percent the second, 18 percent the third, 10 percent the fourth and 8 percent thereafter.

Source: Powell Barnett Shale Newsletter

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