2010Public Service

Part 6: The $24 million question

Where are the royalties?
Daniel Gilbert
December 11, 2009

In one 80-acre square in Buchanan County, a gas company sucked up 1.6 billion cubic feet of coalbed methane gas in 2½ years – enough to satisfy the heating and cooking needs of about 18,000 homes for a year.

Denny Sutherland visits one of the natural gas wells on his property near Birchleaf, Va. (David Crigger/Bristol Herald Courier)

Some of the gas in that unit – dubbed W-8 by state regulators – is the property of owners who are not getting paid for it, including Buchanan County, which owns 14 acres. The producer, CNX Gas Co., should have been making royalty payments into a state-run escrow fund for those owners.

For 2½ years, it didn’t.

In March 2008, CNX discovered it never filed the necessary paperwork with the state Division of Gas and Oil to escrow royalties. Two months later, the company deposited more than $861,000 into the escrow sub-account for W-8, making it the largest account in the $24 million fund.

The W-8 case points to a significant regulatory gap, one in which the state agency overseeing the escrow fund didn’t notice nearly a million dollars missing from an operator for years.

The company caught its own error. But W-8, it turns out, is not an isolated case.

The Bristol Herald Courier compared monthly gas production in units like W-8 that should generate payments into escrow with actual payments into escrow from January 2008 through June 2009.
The analysis revealed that about one-third of the 750-plus active sub-accounts in escrow received no deposits for the months when the corresponding wells produced gas. Of those, nearly 100 sub-accounts received no deposits for all 18 months.

The Division of Gas and Oil has offered a series of evolving explanations in response to the Herald Courier’s analysis. Initially, the DGO posited on Nov. 6 that the discrepancies were the result of changes in the status of a well, such as when a coalbed methane well is swallowed up into a larger unit and owners begin receiving royalties in a separate escrow account. Or, the DGO suggested, gas companies were waiting to pay royalties until they reached a $1 threshold.

When presented with specific examples of escrow sub-accounts with very low balances – from 12 cents to $2.30 – despite high production from corresponding wells, the DGO responded that they were reasonable given the small amount of acreage subject to escrow. That explanation, however, ignored the fact that in several of the cases, no royalties were escrowed because the necessary paperwork has never been filed.

When presented with specific examples of missing paperwork, the DGO’s parent agency, the Department of Mines, Minerals and Energy, issued a statement Nov. 16 that it “has been aware of the discrepancies between reported production and deposits to the escrow account” and “has taken a number of steps to fix the problems. Your questions have been addressed to DMME in the middle of this work.”

The statement also acknowledged that DMME has been aware of a “backlog” of incomplete board files since “early 2009,” and declared that the agency has assigned additional staff to clear it, as well as review individual account information. These incomplete files raise questions about how much money is missing from the escrow fund, as well as the DGO’s ability, at current staffing levels, to ensure that gas companies comply with the governing law and regulations.

There are also uncertain implications for sub-accounts in escrow that should be receiving royalty payments but are not, landing awkwardly at the intersection of the Virginia Gas and Oil Act and the Uniform Disposition of Unclaimed Property Act. In all, 190 sub-accounts in escrow received no royalty payments for the entire 18-month period, which makes their combined contents of $3.8 million look like unclaimed property, ripe for the Virginia Department of Treasury to seize.

Queried about how the DGO determines when funds in escrow are unclaimed property, its director, David Asbury, responded that royalties in an escrow sub-account would be considered abandoned “once active production payments stop and there is no evidence of activity for one year.” The DGO has no records of surrendering any funds to the state treasury.

In fact, the Treasury’s Unclaimed Property Division only recently became aware of the escrow fund, and division officials met with their DMME counterparts in October, a Treasury official said.

“We really haven’t made a determination. We’re still in discussions,” Vicki Bridgeman, the Unclaimed Property Division’s director, said in late November.

Any money seized from escrow would go into a state fund that provides low-interest loans to localities that build public schools and could be claimed, in theory, at any time by owners.

Missing for years

What happens when a gas corporation authorized by the state to produce someone else’s gas fails to file the proper paperwork?

A 90-year-old woman whose family did not want her named is owed thousands of dollars but doesn’t get paid for four years.

The heirs of Ercil Cook check his balance in escrow and think they are entitled to 12 cents.
And it’s impossible to know what happened to the mineral interests of Ducinia Stacy, of Grundy, Va.

Instead, the royalties that should go into the pockets of owners, or into escrow, stay parked in limbo within corporate accounts of gas operators.

Denny Sutherland knew he should be getting paid. He signed a lease, and he could read the gas meter on well V-505254 – a very hot well that drained as much as 26.5 million cubic feet a month – approximately enough to heat 10 households for about 30 years.

Four years passed, V-505254 drained half a billion cubic feet of gas, and Sutherland never received a check. Whenever he spoke with an agent of the gas operator, Equitable Production Co., he got a different answer.

Sutherland, a 63-year-old builder and ex-Marine who lives near Haysi, Va., wasn’t thinking of himself; he had very little acreage in the gas unit. But a 90-year-old relative of his in Bristol had a substantial interest.

“I knew if she didn’t get it pretty soon, she never would,” Sutherland said in an interview.

In July, Sutherland and a cousin visiting from New Mexico decided to get to the bottom of the issue.

Lois Wark, who retired as an assistant managing editor at The Philadelphia Inquirer, trekked to the Division of Gas and Oil in Lebanon, Va., to inquire about the royalties. There, Diane Davis, one of two DGO employees who monitor Virginia Gas and Oil Board’s records, discovered that Equitable had never filed a supplemental order – the crucial document that shows which owners in a gas unit have leased, and which should receive royalties in escrow.

Within the month, Denny Sutherland received a check for $4,900; his 90-year-old relative received $23,000. The royalty statements each received do not indicate whether the royalties earned interest, according to copies reviewed by the Herald Courier.

The system did not self-correct in the case of V-505254. It took someone who was expecting a payment to discover the error and push for answers. In the case of someone whose royalties are escrowed, no one is waiting for a check.

The board files

The Division of Gas and Oil keeps a file for gas units in which the Virginia Gas and Oil Board has forced landowners to lease their mineral rights to a private energy company, a practice known as forced pooling. The files correspond to individual sub-accounts in escrow, and they contain the details that reveal which owners have royalties in escrow.

Anyone can examine the files, as long as they do so where a DGO staff member can see them.

In recent months, on the advice of its attorney, the DGO has zealously guarded its files, requiring anyone who wants to look at them to do so “where we can oversee the process,” a spokesman explained.

“It’s not a mistrust of anyone in particular,” said Mike Abbott, public relations manager for the Department of Mines, Minerals and Energy. “We’re the sole keeper of those files. These are the original copies of records, and we may not have duplicates.”

Abbott said he knew of no cases when documents had been taken or compromised. Actually, at least two files are missing.

The files for units Z-12 and V-12, both for wells in the Vansant area of Buchanan County, could not be located three months after the Herald Courier requested access to them. Neither unit received any deposits in escrow from January 2008 to June 2009; combined, their balances total almost $690,000.

Davis, programs administrator at the DGO, said the files were not lost, but that she would recreate them by going to local courthouses and copying the orders that have been recorded there.

Occasionally, a board file contains a forlorn objection from a force-pooled owner, like the letter Ducinia Stacy wrote on July 6, 2004.

“I do not think the Gas Company should be allowed to just take people’s property (the gas rights) when they do not own them and the property owner does not want them to have them,” she wrote. “I don’t think this is right and I object for all the good it does me.”

It isn’t clear what happened to Stacy and other force-pooled owners in unit I-39 because the gas operator, CNX, has not submitted a supplemental order.

Gas operators are required to file this paperwork within two months of the board’s order giving a company the right to produce gas belonging to force-pooled owners. Without a supplemental order, the escrow account for a unit cannot receive any royalties, and many contain only the initial “rental” payment of $5 an acre for force-pooled owners.

“I’m unaware of any case where our system hasn’t caught up with [paying royalties] as it did in the W-8 instance,” said Cathy St. Clair, a CNX spokeswoman. “We’re convinced we’re paying royalty monies that are required on wells we drill into that state account, or into an internal suspense account awaiting transfer” to the escrow fund, she said.

In reviewing 12 board files for gas units with high percentages of owners who did not agree to lease, the Herald Courier identified six units operated by CNX that lacked supplemental orders. The combined balance of those units is less than $250, even though the wells have been producing for at least four years.

St. Clair would not comment when presented with the unit names and identification numbers that lacked supplemental orders.

Two of these units show only one unknown owner, Ercil Cook, who has 1/100th of an acre in one tract, and 7/100ths of an acre in another. Over the six years that wells in these units have produced gas, Cook’s interest would entitle him or his heirs to about $938, according to average monthly prices on the Columbia Gas Transmission, an interstate pipeline on which CNX moves gas.

The combined sub-accounts for Cook’s interest show 12 cents.

Open questions

The Herald Courier’s analysis found 11 gas units in Dickenson County in which an unknown owner, the now-defunct Yellow Poplar Lumber Co., has rights to 100 percent of the gas underground. The wells on those units have produced 700 million cubic feet of gas since 2006, meaning substantial royalties should have been deposited into escrow.

Yet the sub-accounts in escrow received no deposits for a year and a half, and contained only the standard rental payment of $5 per acre.

When presented with this information, Kevin West, managing director of external affairs for EQT, Equitable’s corporate parent, acknowledged that his company had failed to make required monthly payments into escrow, and pledged to deposit the correct amounts with interest.

With regard to the Yellow Poplar units, he said, “There are some situations which I can’t explain, you know, somebody made a mistake in the manner of making the instruction on things getting paid. Yellow Poplar could well have been one of those situations.”

The DGO already was aware of the Yellow Poplar discrepancies before fielding the Herald Courier’s questions, Director David Asbury responded.

“Staff expects the [. . .] subject issues to be resolved before year’s end,” he wrote.

In fact, the DGO was alerted to the Yellow Poplar issue more than a year ago. Catherine Jewell, a Bristol, Va., resident who has been a relentless critic of the Virginia Gas and Oil Board, e-mailed the DGO in November 2008, noting the low balances in several Yellow Poplar units.
She received no reply.

On Sept. 25, a Tazewell, Va., attorney named T. Shea Cook wrote a letter to Butch Lambert, chairman of the Virginia Gas and Oil Board, and copied several Southwest Virginia legislators. Cook attached an affidavit from Jewell, stating she had audited 24 gas units in which Yellow Poplar owned gas interests and estimating that the accounts were missing close to $750,000.

“Your board has been charged with guarding these accounts and protecting the interests of the gas owners whose gas was essentially seized by the board,” Cook wrote. “These accounts need to be audited, and not just a checkbook audit.”