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Royalty Owners Haul Exxon Subsidiary XTO to Court Over Royalties

5 min read

Batesville attorney Blair Arnold noticed something curious in the royalty statements he received regularly from two different companies producing natural gas from the Fayetteville Shale: David H. Arrington Oil & Gas Inc. of Midland, Texas, was selling gas at higher prices than XTO Energy Inc. of Fort Worth, Texas.

XTO, a subsidiary of Exxon Mobil Corp., is the second-largest gas producer in Arkansas, having produced 165.5 million MCF (thousand cubic feet) in the state in 2013. Arrington was No. 13 last year, producing only 1.3 million MCF. (See Natural Gas in Fayetteville Shale Takes Arkansas from Zero to Billions in 10 Years.)

“I mean every month for three or four years, [Arrington’s price] was substantially more than what XTO was getting, and XTO ought to have a much more sophisticated, much better marketing capability than this itty-bitty company,” Arnold said.

He said some months there would be a 50 percent differential.

“And it occurred to me that this could not be an accident,” Arnold said. “And that’s what started us looking.”

He thinks he figured it out. In May, Arnold filed a federal lawsuit alleging that XTO wasn’t getting the highest price possible for natural gas because it was selling the product to its own subsidiary, Cross Timbers Energy Services Inc., at below-market prices.

Plaintiffs in the case include Mobley Lumber Co. LP and Greg Smith, both of Independence County. The plaintiffs want their lawsuit to be certified as a class action and are seeking more than $5 million in damages.

Gas production companies like XTO and Arrington pay a percentage — at least 12.5 percent — of the price received for gas back to the mineral rights owners in the form of royalties. A lower market price means lower royalties.

The Moberly and Smith complaint is one of at least three pending cases that allege XTO underpaid royalties. But the specific question of whether XTO may have sold gas to its subsidiary at below market rate has also piqued the interest of the Arkansas Oil & Gas Commission.

On July 21, the commission reaffirmed language in a lease form that says an affiliate cannot buy gas at the lowest price within a township. The company is required to raise the price to match the next-lowest price purchaser, according to the order.

The commission also ordered an investigation to determine whether XTO followed that rule in its sales to Cross Timbers. But that investigation is on hold because XTO appealed the order last month to Pulaski County Circuit Court. As of Wednesday, the commis-sion hadn’t filed an answer in the case.

Other Complaints

XTO was already facing another lawsuit that seeks class-action status for property owners who said they were underpaid for royalties. A named plaintiff in the case, Claude D. Wallace of Cleburne County, complained that XTO improperly took deductions from royalty payments for post-production expenses. The plaintiffs filed the lawsuit in October in U.S. District Court and are suing for several counts including fraud and breach of contract.

Last week, XTO asked the federal judges to put Mobley’s case and Wallace’s case on hold while the appeal in the Oil & Gas Commission’s case makes its way through the state system. Rulings haven’t been made on those requests.

XTO also is facing allegations of underpaying royalties in a lawsuit filed by the investment arm of commercial real estate developer Joe Whisenhunt. Whisenhunt Investments and Whisenhunt family members also named Exxon Mobil and other firms as defendants in the suit, which seeks more than $6 million in allegedly underpaid royalties.

In court filings, XTO has denied the allegations in Wallace’s and Whis-enhunt’s lawsuits and has asked that the complaint filed by Mobley Lumber and Smith be dismissed. XTO’s attorney, Robert Honea of Fort Smith, declined to comment on the pending cases.

Disputes over gas royalty payments are not unique to XTO. Chesapeake Energy Corp. of Oklahoma City faces similar lawsuits in other states over allegations of royalty underpayments. Chesapeake sold its interests in the Fayetteville Shale to BHP Billiton in 2011 but still operates more than 100 wells in the conventional Arkoma Basin in western Arkansas.

Chesapeake’s most recent quarterly report filed with the Securities & Exchange Commission said the pending lawsuits involve allegations of “among other things, that we used below-market prices, made improper deductions, used improper measurement techniques and/or entered into arrangements with affiliates that resulted in underpayment of royalties in connection with the production and sale of natural gas.”

Chesapeake said it has settled or won a number of cases. In August 2013, Chesapeake agreed to pay $7.5 million to settle a federal class-action lawsuit in Pennsylvania alleging that it improperly charged royalty owners post-production fees.

Cross Timbers

Arnold, the Batesville attorney, wrote in the Moberly complaint that XTO’s gas buyer, Cross Timbers Energy Services, was not much of a company.

“Cross Timbers has no office space and no employees other than a President,” the lawsuit said. “Contracts are written in the name of XTO or Cross Timbers almost interchangeably, and because Cross Timbers has no employees, XTO handles all of the transactions.”

As a result of the below-market sales prices, the plaintiffs and other landowners who have contracts with XTO “have received and continue to receive reduced royalty payments while the company increases its revenues,” the lawsuit said.

The plaintiffs are suing on several counts, including breach of contract.

Whisenhunt Case

Whisenhunt is fighting his battle against XTO alone.

In the lawsuit he filed last year, Whisenhunt said that his business entities entered into an agreement in 2005 for the development of natural gas wells on his 4,000-acre cattle ranch at Bee Branch in Van Buren County. He first leased the right to Petrohawk Energy Corp. of Houston.

Whisenhunt said he was supposed to receive a 40 percent royalty on production from each well with no deductions other than severance taxes.

In October 2010, Petrohawk sold its Arkansas interests to XTO. Beginning in 2011, according to the lawsuit, XTO began paying Whisenhunt less than what was required by the terms of the leases.

Whisenhunt accused XTO of “fraudulently evading the terms of the leases by creating a sham or bogus price upon which” Whisenhunt’s royalties were calculated.

The other plaintiffs include Whisenhunt’s daughter, Kari L. Whisenhunt, and her husband, Douglas S. Robertson. The couple bought property in their own names or through HMR LLC, the lawsuit said.

The plaintiffs are seeking the money they said they are owed plus other unspecified damages.

David Blair of Batesville, Whisenhunt’s attorney, said the lawsuit is still in the discovery phase.

The case is set for jury trial next June in U.S. District Court in Little Rock.

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