West Virginia’s natural gas industry keeps pushing to whittle away payments to residents

For decades, Arnold and Mary Richards collected monthly royalty checks – most recently from $1,000 to $1,500 – for the natural gas sucked up from beneath their West Virginia farm by small, old wells.

So in 2016, when EQT Corp. drilled six new gas wells, the Ritchie County couple expected to see their royalty payments skyrocket. The much-larger wells would collect far more natural gas from the Marcellus Shale formation, which is fueling the boom in the state’s gas industry.

The Richards’ checks did grow considerably. But the couple also saw something they didn’t expect: EQT was cutting the size of those new checks.

EQT began deducting for what it said was the cost of transporting the gas, for processing the gas and even for state taxes. All told, since November 2016, the Richardses calculated they were missing about $235,000 in royalties.

The Richardses had looked closely at their lease agreements. The agreements stated that EQT would give them 12.5 percent of the revenue generated from the wells. They didn’t say anything about allowing deductions. So the Richardses went to court, filing a federal suit against the company in February 2017.

“I only want the royalty that is due us, according to our lease,” Mary Richards told a jury in Clarksburg this September.

Arnold and Mary Richards are the latest among thousands of West Virginians who have watched the state’s natural gas producers whittle away at royalties promised to them, according to a review of court records by the Charleston Gazette-Mail and ProPublica.

Sometimes, the companies deduct a variety of “post-production” costs from gas proceeds, as appears to have happened in the Richards’ case. Other times, they’ve avoided paying full royalties by creating shell companies that, at least on paper, buy the gas at reduced prices. These practices have gone on for decades.

While the state Legislature and courts have both tried to ensure that residents are getting their fair share, gas companies have simply shifted their tactics.

In 1982, the Legislature banned leases that limited payments to just a few hundred dollars a year. The bill declared an end to the “continued exploitation of the natural resources of this state in exchange for such wholly inadequate compensation.”

Twenty years later, residents filed a series of suits alleging they were still being shortchanged. The lawsuits prompted a series of settlements and a $400 million verdict in 2007.

Yet residents say these practices haven’t ended. A class-action lawsuit, filed in 2013 on behalf of more than 10,000 individuals and companies that own gas, is set to go to trial in two weeks. It alleges that EQT – the state’s second-largest producer – continues to take improper deductions from royalties.

“It’s still going on, and they’re finding ways to disguise it,” said Scott Windom, a Harrisville lawyer who represented the Richardses and who often represents gas owners in fights with producers.

EQT, as well as other gas companies and industry trade groups, maintain that they’ve done nothing wrong, and that royalty payments are fair and based on lease language or state law.

Deduction of post-production costs from gas royalty payments is a method that has “long been used in West Virginia and other states,” lawyers for EQT argue in the ongoing class-action case. They made similar arguments in the Richards’ case.

West Virginia’s natural gas industry has flourished, with production roughly tripling in the past five years. State leaders portray the industry as the heart of a strong future economy, perhaps to replace the declining coal business.

But there are growing indications that natural gas is taking West Virginia down the same path as coal, including a long and continuing battle over how the profits are divvied up among residents and out-of-state companies that are extracting natural resources from the land. And EQT is now suing to gut the 1982 royalty law that was meant to give gas owners a larger piece of the industry pie.

Joshua Fershee, a West Virginia University energy law professor, said the number of royalty disputes has increased as the industry has grown, and they are likely to continue as gas production keeps expanding.

“These issues will keep playing out,” Fershee said.

For Arnold Richards, the reason to fight is clear: “It’s not because I don’t have enough money to live on. I do,” he testified. “I really worked hard all these years to get it, not pass it on to a corporation.”

After deliberating for just a few hours, the jury ordered EQT to repay the Richardses the $192,000 in post-production costs that had been deducted from their royalty payments. U.S. District Judge Irene Keeley had already ordered the company to pay them nearly $43,000 in taxes that had been deducted, for a total of $235,000.

An EQT spokeswoman declined to comment on the verdict in the Richards’ case, on whether the company plans to appeal or on the class-action case that’s headed for trial.

Back in the day

Sixty-seven years ago, Arnold and Mary Richards got married. They were both about 18 years old. A few years later, in 1954, they bought their farm, on Rock Camp Run outside Harrisville.

As part of the deal, the Richardses acquired the rights to about half of the natural gas under the farm. In those days, gas wasn’t in high demand. There were wells on the Richards’ land, but they were small and only drilled vertically.

The ownership of land and mineral rights in West Virginia is complex and confusing, even for many who live in the state.

Someone may own the surface land, while someone else owns the coal, oil or gas underneath. Sometimes, as in the Richards’ situation, people own both the surface and the gas below. Much of the natural gas in West Virginia is produced under lease agreements, in which an owner or owners of the gas lease it to a production company. Many leases are decades, or sometimes more than a century, old. In the early 1900s, natural gas leases that paid $100 to $300 a year were considered reasonable, maybe even generous. Back then, most drillers were after oil, and natural gas was mostly an undesirable byproduct.

As the market for gas increased, in manufacturing, home heating and electricity, the industry has grown. Newer leases pay a share of the revenue generated, so gas owners make more money as production increases. Leasing practices also have changed so that many leases have set terms, often five years, rather than being open-ended.

With the industry growing, West Virginians who owned their natural gas pushed successfully in 1982 to ensure they would get a bigger cut of the profits. Lawmakers passed a bill outlawing those flat-fee leases that paid just a few hundred dollars a year. The bill declared that such arrangements had been “unfair, oppressive” and “an unjust hardship on the owners of the oil and gas.”

The new law only applied to situations in which both the gas lease was an old flat-fee arrangement and the well was new, drilled after the 1982 law took effect. In order to get a state permit for such wells, gas companies would have to pay the gas owners at least 12.5 percent of the revenue collected from the gas. (Since the Richardses already received that, the new law did nothing for them.)

For more than 40 years, Arnold Richards drove an hour each way daily from Ritchie County to DuPont’s plant near Parkersburg, where he worked as a millwright. The couple also worked their farm, and when they had the chance and had some money saved up, they bought more of the gas reserves under the farm.

Then, in 2014, the Richardses seemed to get good news. EQT bought the gas leases to their land. By then, companies were using advanced hydraulic fracturing and horizontal drilling to capture larger and larger amounts of gas. EQT wanted to do that at the Richards’ farm.

To do so, the company wanted to change the lease, to allow it to “pool” the gas reserves, drilling into the Richards’ gas from an adjacent piece of property. The couple went along with it, agreeing to a new “pooling clause” in their lease, but not to any other changes. The new wells were drilled in 2016.

But when the first check arrived, Arnold Richards noticed that EQT had taken out production costs. He called the company to ask what was going on.

The company has paid the Richardses $935,000 in royalty payments, but it would have been more than a million dollars without the deductions. The company “didn’t give us any satisfaction,” Mary Richards said later in court.

So the couple went to see Rod and Scott Windom, a father-son legal team in nearby Harrisville, the county seat. The Windoms filed a lawsuit for the couple in February 2017.

“An awful lot of charges that we didn’t know about”

The Richards’ lawsuit wasn’t the first against EQT or other producers over royalties, and it wouldn’t be the last.

Perhaps the most significant challenge to West Virginia natural gas leasing practices came about a decade ago when a teacher couldn’t decipher the accounting statements on the stubs the gas company sent him.

Garrison Tawney grew up in Roane County and went to Marshall University, in Huntington. Around 1940, he came back home to teach school and tend the family farm near Looneyville. He retired from the school system in 1976, but kept working his hay and cattle.

Tawney’s wife, Freda Vineyard Tawney, owned natural gas reserves she had inherited from her family. In 1989, the Tawneys leased those gas reserves to Columbia Natural Resources. Their new leases paid them 12.5 percent of the sales.

But to Garrison Tawney, the numbers never seemed to add up. Eventually, he turned to a local lawyer. Tawney and his lawyer started investigating and eventually sued when they discovered Columbia was taking various deductions from the gas revenue before it calculated royalties.

Company lawyers tried to explain away the move. They pointed to Federal Energy Regulatory Commission orders aimed at deregulating the pipeline industry. Previously, gas had been sold by the producer at the physical “wellhead” to the pipeline company. Under the new FERC-ordered system, it was routinely sold at a remote point of sale following processing and transportation.

“The only logical way to calculate royalties,” lawyers for the West Virginia Oil and Natural Gas Association argued in a brief supporting Columbia Gas in the Tawney case, “is to permit gas lessees to deduct the lessor’s proportionate share of post-production expenses from the total price received at the point of sale.”

Companies like Columbia Gas started deducting the costs of processing and shipping gas to pipelines before they calculated the royalties for people like the Tawneys. They just didn’t tell them they were doing it. Accounting statements to gas owners continued to list “Your Share Prod. Charges” as “0.00.”

Tawney died at age 90, about two years before the three-week trial in Roane County Circuit Court in January 2007, but he had told his story under oath in a deposition, part of which was read to the jury.

“Well, the only thing I know, that I was thinking that we was getting one-eighth of the production [12.5 percent] without any modification or deductions,” Tawney testified. “But I didn’t know that they was going to do what they did, which was take out an awful lot of charges that we didn’t know about.”

By then, the lawsuit was a class-action on behalf of 10,000 gas owners, and jurors came back with a $400 million verdict for Tawney and the other gas owners. Most of the money – about $271 million – was to punish the companies involved. Sharing the liability were NiSource, which had, at one point, owned Columbia Gas, and Chesapeake Energy, which later bought Columbia.

The verdict set off a firestorm of protest from the gas industry.

In a Charleston Gazette story, Chesapeake Energy spokesman Scott Rotruck compared it to “getting clobbered with a big, roundhouse punch in the first round.” Rotruck told the Charleston Daily Mail that the punitive damage award was “almost like capital punishment for a parking violation.”

Chesapeake and NiSource tried to appeal the verdict, especially the punitive damages portion. The state Supreme Court turned them down in May 2008.

Chesapeake’s colorful CEO, Aubrey McClendon – known for collecting wine, antique maps and vintage motor boats – wasn’t happy, and he let West Virginia officials know it. Within a week of the Supreme Court’s refusal to hear its appeal, Chesapeake dropped plans to build a new regional corporate headquarters in Charleston, expected to cost $30 million to $40 million. The company had already purchased land and broken ground for the office building. (McClendon died in May 2016, in a one-car crash, a day after being indicted on federal charges that he rigged bids for oil and gas leases.)

In October 2008, Chesapeake and NiSource dropped an appeal to the U.S. Supreme Court and settled the case for $380 million.

In the three years after the Tawney verdict, at least three other class-action cases against gas producers in West Virginia were settled for a total of more than $80 million on behalf of some 35,000 gas owners.

That included about a $30 million settlement by Equitable – as EQT was then known – with about 10,000 class members who had gas leases with the company.

Despite the predicted doom from industry leaders, natural gas activity in West Virginia skyrocketed in the decade after the Tawney case. Today, Southwestern Energy, which, in 2014, bought Chesapeake’s West Virginia operations, is the third-largest producer in the state.

“They have arrogantly disrespected the law in West Virginia”

After years of litigation, some residents – and even landowners and their lawyers with years of experience in gas issues – contend they still aren’t sure what’s being deducted from their royalty checks.

In January 2014, U.S. District Judge Joseph R. Goodwin told EQT that its leases with W.W. McDonald Land Co. did not allow it to deduct expenses like “meals and entertainment,” “uniforms,” “meter operation and repair” and “personal property taxes” from the payments it made to the company, which had sued EQT.

The judge noted that the leases in question allowed deductions only for “compressing, desulphurization and/or transporting gas” from the well to the point of sale. Generally, the judge observed, deductions are allowed only if they are spelled out in the lease and are “actually incurred” and “reasonable.”

“I find that meals and entertainment, uniforms, meter operations and repair, and personal property taxes are not costs of compression, desulphurization, or transportation,” the judge wrote.

The McDonald Land case was notable in another way. It alleged that, after legal challenges to the practice of deducting post-production costs from royalty payments, EQT reorganized its operations in an effort to keep pocketing those deductions for itself.

Between 2000 and 2005, EQT produced gas owned by W.W. McDonald and transported it to an interstate pipeline, where it was marketed to third parties. EQT paid the costs of transporting and marketing the gas, and passed on some of those costs to W.W. McDonald.

Then, in January 2005, EQT reorganized. It formed separate entities, including EQT Gathering Inc. and EQT Energy. A different EQT arm, EQT Production, was the one that had the McDonald leases and was producing its gas.

In 2005, EQT Production starting selling the gas to its own sister company, EQT Energy. EQT Energy, after contracting with yet another spinoff to collect and transport the gas, would then sell it to a third party at a higher price than the company originally paid.

EQT Production argued in court that once it started that arrangement, it was no longer improperly deducting transportation costs when it paid McDonald Land’s royalties.

Lawyers for McDonald Land, though, responded that the result of the complex setup was “exactly the same”: EQT could keep paying less in royalties.

Goodwin concluded that EQT’s new system – the company calls it a “work-back methodology” – wasn’t allowed in West Virginia.

“The defendants cannot calculate royalties based on a sale between subsidiaries at the wellhead when the defendants later sell the gas in an open market at a higher price,” Goodwin wrote in a 36-page ruling in November 2013. “Otherwise, gas producers could always reduce royalties by spinning off portions of their business and making nominal sales at the wellhead.”

EQT and McDonald Land reached a confidential settlement in August 2015, but, by then, a new class-action lawsuit had been filed against EQT, alleging the company hadn’t ended the practice. That case, in U.S. District Court in Wheeling, involves roughly 8,000 leases and 10,000 class members, court records show.

“They have arrogantly disrespected the law in West Virginia,” wrote lawyers for the gas owners currently suing EQT. “They are intelligent, smart and knowledgeable in this industry. … Instead of preparing to comply with the law, they set about and prepared to dodge it and find and invent arguments to disobey the law.”

EQT lawyers argue the company’s royalty payment methods “are not a sham,” and they urged that the class-action case be thrown out.

While a final decision has not been issued in the case, U.S. District Judge John Preston Bailey has already ruled that, as a matter of law, various EQT subsidiaries are the parent company’s “alter ego” and can’t be used to help reduce royalty payments to gas owners. The lead named plaintiff is the Kay Co., a small landowning firm named for its founder, James Kay, a well-known coal executive who was president of Royal Coal and Coke Co. The trial is slated to start on Nov. 27.

Other royalty suits against EQT, and against other gas producers like Antero, are pending in West Virginia courts. (The lead lawyer for gas owners in the class-action case, and in several other such cases, is Charleston attorney Marvin Masters, who is among a group of local investors who bought the Charleston Gazette-Mail this year.)

“Outdated statutory language”

Despite the flurry of settlements it triggered, the Tawney case didn’t end the practice of companies taking post-production deductions from royalty checks. EQT continued taking such deductions from some of its leases, arguing that the 1982 law meant to benefit landowners actually allowed the company to pay them less.

That position got them sued again, by Patrick and Katherine Leggett, owners of natural gas reserves in Doddridge County.

In that case, the state Supreme Court ruled in November 2016 that the company couldn’t take such deductions. But then, a new justice, Beth Walker, took office and voted to rehear the case. In a decision made controversial by investments Walker’s husband had had in the natural gas industry, the court, in May 2017, reversed itself and decided in EQT’s favor. What that meant was that, for flat-fee leases and wells drilled after 1982, post-production expenses could be deducted from the royalty payments.

But the Supreme Court also urged lawmakers to consider the impacts of the ruling, with one justice urging the Legislature to rewrite “outdated statutory language” to address “significant changes” in the gas industry.

When lawmakers came to Charleston for their annual legislative session in January 2018, they heeded the court’s call, taking up a bill to overturn the second ruling in the Leggetts’ case and banning post-production deductions for gas owners with leases since 1982.

“If this decision is allowed to stand, it will shift millions if not billions of dollars out of West Virginians’ pockets – West Virginia farmers’ and mineral owners’ pockets – into the hands of out-of-state corporations,” Farm Bureau lobbyist Dwayne O’Dell told one committee. “We want those folks to be able to stay in business and develop the oil and gas here, but at the same time, we want our people well cared for.”

No one from the gas industry spoke up publicly during two committee hearings, so the measure moved quickly, passing the Senate unanimously and the House by a vote of 96-2.

Gov. Jim Justice signed the bill and it took effect on May 31. EQT is now suing the state in federal court, challenging this year’s legislation and the entire 1982 royalties law.

The Richards Trial

The bill didn’t stop gas companies from taking deductions from the royalty payments made to people like Arnold and Mary Richards, whose leases already required a 12.5 percent payment.

That brought them four months later to the federal building in Clarksburg in mid-September for a trial – the first time either of them had been in federal court, except for once years ago when Mary was a juror in a federal case.

During the trial, EQT lawyer David Hendrickson explained that EQT Production sold the Richards’ gas to a sister company. The sister company paid them the price of the gas, minus transportation costs, and that final price was what ETQ Production based the couple’s royalties on. Hendrickson said that’s not the same as EQT Production taking deductions.

“We’re paying the fair market value of what we received for the gas,” Hendrickson said.

Both Arnold and Mary Richards testified, briefly, telling jurors the story of their farm, their gas leases and how they were shocked to suddenly have EQT taking deductions from their royalty checks.

The Richardses are in their 80s now. They have adult children, grandchildren and some great-grandchildren. By the time the case reached trial, it was purely a contracts case. They weren’t seeking some huge, multimillion-dollar punitive damage award. They just wanted the royalties they thought were coming to them.

“We want our children to have the fruit from our labor, rather than give it to someone that doesn’t, I don’t want to say doesn’t deserve it, because they did a fine job getting it produced, but I have nothing against them, other than the fact that I just want what’s due our family,” Arnold Richards told the jury. “That’s about all the reason I’m here.”

Before the verdict in the Richards’ favor, Scott Windom told jurors in his closing argument that Hendrickson was asking them to take his word that the payments are fair, and not to look too closely at EQT’s new system.

“EQT reminds me a little bit of the great magnificent Oz in the movie, ‘The Wizard of Oz,’” Windom said. “He’s pulling the levers and making the smoke and the noise and the lights behind the curtain and Dorothy and Toto look behind there and he says, ‘Oh, don’t pay attention to what you see, only pay attention to what I’m telling you.’”