The Schemes for Underpayment of Royalties

by Steven C. Townsend on Jan. 31, 2016

Industry Specialties Oil & Gas 

Summary: How companies underpay royalties

The Schemes for Underpaymet of Royalties

Although the schemes are often different, here are a few of the common ways royalty owners are being cheated:

(1) selling gas to an “affiliate” which resells at higher prices, but paying royalty only on the lower-priced first sale to the affiliate, in direct violation of the lease and/or implied duties and regulations requiring payment of royalties based on the higher re-sale price by the affiliate;

(2) selling gas which is actually processed for removal of NGL by the producer or an affiliate as “unprocessed” gas on which no NGL royalties are paid;

(3) entering into NGL processing agreements with affiliated processors whereby the producer retains only a percentage of the NGL or its proceeds and the affiliated processor acquires the balance, and paying royalties only on the producer-retained percentage;

(4) undermeasuring, or allowing others to undermeasure, the actual quantities of NGL produced or removed from lands, and reporting and paying royalties only on the undermeasured quantities;

(5) undermeasuring, or allowing others to undermeasure, the quantities of gas produced from pooled or unitized lands, and paying gas royalties only on the undermeasured quantities;

(6) allocating a portion of the gross proceeds of the sale of gas as a “supply reservation charge” or other charges, and not paying royalties on such portion of the gross proceeds;

(7) placing gas in storage, or “selling” gas to an affiliate which placed it in storage during summer months when gas prices are low, and paying royalties on the basis of the low summer prices, instead of at the higher winter prices at which the gas is actually sold by the producer or affiliate after it is removed from storage;

(8) taking illegall unauthorized deductions for “marketing” fees, costs or expenses on gas and/or NGL;

(9) taking deductions from royalty payments for costs of processing, handling, treating, dehydrating, compressing, storing, parking, banking, wheeling and/or transporting gas and/or NGL which are unauthorized by law, lease terms and/or regulations;

(10) “commingling” other landowners gas to obtain “aggregation” premiums without paying royalties on the premiums;

(11) utilizing financing and tax devices such as “volumetric production payments” to mask the true gross proceeds of gas sales by producers and their affiliates, and thus underpaying gas and NGL royalties actually owed;

(12) using gas “swaps” or exchanges to underpay gas royalties;

(13) using the device of fictional pipeline “backhauling” to underpay gas royalties;

(14) failing to pay royalties as required by law on amounts paid as “buy-outs” and “buy-downs” of gas sales contracts;

(15) taking unlawful deductions for transportation and processing costs;

(16) taking deductions for non-deductible gathering costs improperly treated as allegedly deductible transportation costs;

(17) failing to pay royalties on refunds or downward adjustments by pipeline carriers;

(18) Failing to pay royalties on upward price adjustments and additional payments made by purchasers of gas and NGL after the initial payments in which royalties were paid; and

(19) paying royalties on the lower, instead of the higher, of (1) gross proceeds or (2) market value, as required by the leases addendum or law.

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