Why Bother Checking My Royalties?
Robert J. Brown
Certified Financial PlannerTM
Stone House Investment Management, LLC
Why Bother Checking My Royalties?
As more and more of our residents fall into the category of “royalty owners”, we are beginning to see a trend.
Upon opening the first check, you face sticker shock! Even though you estimated different amounts AND you knew that the first check is often a buildup of several months; once it’s in your hands, the moment is a bit alarming. You glance through the whole statement but it’s all a blur compared to that amount on the final check.
After several of these months go by, you begin to feel more emboldened and knowledgeable about these payments. Now some of the things that your friends and neighbors talked about, like decimal interest and gross vs. net, are starting to make sense.
In many cases, the total amounts begin to wane. Your curiosity turns to skepticism as you sort through the details of the pay stubs in hopes of trying to find out for yourself if things are “adding up”. After your eyes turn bloodshot and you’ve pulled enough of your hair out, you throw your hands up and officially declare it unsolvable!
As time goes by, you wrestle with the internal dilemma that plagues so many royalty owners:
Happy – “I don’t want to seem greedy. I’m thankful for what I’m getting. This is more than I ever thought I’d see.”
Unhappy – “What if I’m NOT getting paid correctly? How can I even determine that? These statements are seemingly impossible to read. If mistakes were found, what would I even do about it?”
Keep It Simple… PLEASE!
Let’s discuss a few simple terms as defined according to Wikipedia.org:
A lease is a contractual arrangement calling for the lessee (user) to pay the lessor (owner) for use of an asset.
A partnership is an arrangement where parties agree to cooperate to advance their mutual interests.
The gas leases that the majority of landowners have signed have formed partnerships between themselves, as owners of the asset and the gas companies as the producers/developers of the asset. In the simplest of terms, that’s pretty much it.
Yet, as this begins to play out, we’re sometimes seeing a substantial communication breakdown between the two parties which can lead to the royalty owner feeling frustrated and less trusting. Does it need to be so complicated? The root of the problem stems from a lack of understanding by most royalty owners on the topic combined with broad assumptions by the gas companies that simply by putting numbers on a check stub, we (the royalty owners) should be able to figure it all out.
In defense of the gas companies, they’ve been very proactive of late in posting tutorials on their websites and inserts of how-to-read-your-royalty-check in their mailings. In cases where you have just ONE company producing the gas and that same ONE company paying your royalties, that type of learning material is helpful. What happens though when your checks begin coming from more than one company? Simply put… it gets complicated.
Look At It From This Angle
Joint Ventures (more than one company) can create complexity based on accountability. Let’s say you lease your 100 acres to a farmer who decides to plant corn and give you 15% of the profits. He comes at the end of the season, harvests the corn and leaves. 3 months later, he sends you a check with a statement. The statement is a bit confusing but you eventually make sense of the calculations. What doesn’t make sense to you is the total amount of corn he took from your property. You thought it would be much more than that. You are confused?
A few weeks later you hear from a few of your neighbors that the farmer who leased from you is working closely with some other farmers (whom you’ve never heard of) and it looks like they’ve formed some sort of Joint Venture to work your field and others around you. You feel a bit odd that you weren’t told this directly and certainly still feel in the dark about the details.
A month after that initial check, you are surprised to get a check from 2 different farmers, paying you for the corn that was taken by the farmer you knew. Each of these farmers use different calculations that look similar but a lot of the details and terms they use are different. You try to add them to what the original farmer sent last month but it doesn’t really add up. Now what?
What often happens at this point is that you start to make assumptions. The mind is a powerful tool and it begins to reach for all kinds of conclusions. In this hypothetical, the farmer and anyone else affiliated with him seem to be out for themselves. When you call any of them they seem to give you answers but not exactly what you’re looking for… or what you wanted to hear. You wanted to hear them tell you that it got confusing but we’ll make it less confusing and pay you more. Instead you got some vague answers. Why? Maybe that’s because you asked them vague questions?
In the case of royalties, you can’t expect real thorough explanations when you call up and say “I feel like you took more gas than what I got paid for” or “My gas check seems lower than it should be”. If I’m on the other side of that phone call, my response might be, “Uh… well it’s all on your statements”.
Does the squeaky wheel always get attention? Not if you’re making noise just for the sake of making noise. Unless you provide the specific details that evidence your concern, then it sounds like you’re just saying “I wish I had more”.
Are Mistakes Being Made?
Yes. In our experience with our client base, we’ve identified a fair number of issues; some have been corrected while others remain in question. Often these fall into two categories.
Industry Side – Frequently, during normal reconciliation done by the gas company, “adjustments” will need to be made to previous months’ payments often related to a change in unitization, incorrect calculation assumptions, realized gas price, etc… Joint Venture agreements are a factor in how payments flow to the royalty owners and inconsistencies in how these are paid and reported sometimes contribute to errors to your bottom line.
As basic as the math is, we’ve still seen simple mistakes made with things like the Decimal Interest being off, acreage included in the unit not being the same as what’s on the lease, and other clerical type mistakes. By and large, the gas companies seem very willing to examine and correct these when brought to their attention.
Royalty Owner Side – Occasionally, things are happening behind the scenes of ownership that the gas companies are not privy to or may have misunderstood. The probability of these types of errors increases with each degree of complexity; family LLCs, joint ownership, transferred interest, etc…
For example, a family owns substantial acreage broken up into multiple parcels. Several years ago, during the planning process, even though some of these parcels were owned by various combinations of family members, it was mutually decided to transfer the royalties associated with each of them into the new Family LLC.
For more than a year now, money has been flowing into the LLC as the majority of these parcels are included within three side-by-side units. The issue that has now come to light is that royalties on one sizable parcel are not being paid to the LLC. Instead, those monies are going directly to one daughter. Why was this not noticed much earlier?
When everything was being transferred a few years back, it was mutually decided that this daughter would maintain her roughly 10 acre lot that was nearby since it was never considered to be part of the “family farm”. She and her husband remained owners of both the surface and sub-surface. However, the larger parcel which she had ownership in DID have its royalty rights transferred into the LLC. (or so everyone thought)
Eventually, the daughter and her husband began receiving royalties from the XYZ Unit and were pleased with the amounts. What they did not realize was that their checks were based on not just their 10 acres… but also the much larger parcel that was supposed to be going to the LLC. None of this was apparent to them because the check statements were confusing to them and they got lost in the details.
Quite a mess! Now this couple is faced with finding a way to make the Family LLC whole. In addition to the money, this took place over two calendar years, which means the couple paid tax on the extra money they received and now need to pay back. Yikes!
We are only one financial planning firm in NEPA but our office alone has seen errors like this take place. Fortunately, we’ve built quite a sophisticated system to help identify irregularities in royalties but due to the complexity of such matters, we currently only offer it to our clients who also have us managing other investments for them. We view their land as another asset that, especially at this time, needs to be monitored.
Recently, we had the pleasure of meeting with our local State Senator and two State Representatives on this topic and were very pleased to see how attentive they were to these details and aware of how many people were affected by these complex statements. At their request, we submitted a proposal to enhance the transparency of royalty reporting to benefit the land owner and gas company. It is our hope that with their help and the cooperation of the gas industry, some standardization will be in our future so royalties become easier to decipher. Someday Mom and Dad should be able to sit at their kitchen table and sort out their own details; confident that they are receiving a fair share of the partnership they signed up for years ago.
Robert J. Brown, CFP®
Stone House Investment