The city of Arlington appears to have reached a proposed settlement of a lawsuit it filed against Chesapeake Energy that accused the gas-drilling giant of improperly calculating royalties for natural gas being pumped from under 1,900 acres of public land.
The Arlington City Council is scheduled to approve the proposed settlement with Oklahoma City-based Chesapeake and Total E&P USA, a French energy company that bought 25 percent of Chesapeake’s holdings in 2010, at its meeting today.
The settlement will resolve most of the substantive differences between the city, Chesapeake and Total, although there some procedural issues still need to be ironed out, said Shayne Moses, the attorney representing the city in its negotiations with Chesapeake.
The city accused Chesapeake of improperly deducting post-production costs from the city’s royalty payments. The city also accused the company of failing to reasonably market the gases and obtain the best possible price by selling it to subsidiaries or affiliates in violation of the leases.
Moses would not specify the amount of the financial settlement with the city, saying only that it is “real money.” His original court pleading said the amount was expected to exceed $1 million.
City Attorney Jay Doegey said that the settlement took several weeks to hammer out because of its complexity, but that the deal being reached with Chesapeake is closer to the spirit of the leases the council signed starting in 2006 and be no post-production costs will be charged.
“I think it is within the parameters the City Council set for us,” Doegey said.
Chesapeake spokesman Gordon Pennoyer said the company did not want to comment.
Attempts to reach an official in Total’s Houston headquarters for comment were unsuccessful.
Arlington and a number of other public entities have challenged how Chesapeake is calculating its royalty payments to landowners. Fort Worth and the Fort Worth school district have similar lawsuits pending, as does the Arlington school district.
While Chesapeake has not tried to settle its cases with Fort Worth and the Fort Worth school district, the attorney representing both said the Arlington deals could be a sign of things to come.
“I haven’t studied [Arlington’s] leases or their claims but I’m not surprised that Chesapeake recognized the risks of continuing to disregard its commitments to bear post-production expenses,” said Ralph Duggins, the attorney representing Fort Worth.
Chain of affiliates
When Arlington sued Chesapeake last August, it contended that its lease agreements “prohibit or significantly limit deductions” such as transportation and production costs and taxes, and “provide for cost-free royalties.”
But after an audit, the city found that Chesapeake appeared to be basing its royalty payments on proceeds from sales to affiliates after production costs had been taken out. The lawsuit also said the deductions were not apparent from information provided to the city.
Even after raising concerns about underpayments and improper cost deductions. the city said, Chesapeake continued to “engage in a scheme of affiliated transactions aimed at hiding or embedding impermissible cost deductions and suppressing the royalties it pays to the city.”
Chesapeake, which is the second-largest producer in the Barnett Shale, and Total denied Arlington’s claims in court documents, saying Texas law allows certain post-production costs to be deducted. They also said the royalty is to be based on the price of the gas at the wellhead.
In other court cases where Chesapeake is being sued, it has shown that it does rely on a chain of affiliates to drill, market, sell and calculate the royalties on gas production. But Chesapeake has said the gas price it eventually uses to calculate royalties is what is paid by an unaffiliated third party less the post-production costs of moving the gas to that higher-priced point of sale.
Moses and Doegey said that the proposed settlement does not allow for post-production costs of any kind and that the city’s royalty will be calculated based on the higher of the prices received by Chesapeake or the price established by what Moses described as an objective formula.
Besides the proposed overall settlement, the council is scheduled to vote on amendments to clean up seven leases with Chesapeake totaling about 540 acres.
The Arlington school district joined the city’s lawsuit in November. If the council approves the settlement today, its litigation will continue. Moses said the district is still trying to reach a settlement with Chesapeake.
In 2012, Moses negotiated a similar settlement between Chesapeake and Dallas/Fort Worth Airport for $5 million. The deal also established a formula for royalty payments.
“I’m happy whenever a case is settled on an amicable basis,” Moses said. “I try to get business resolutions that make sense.”