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COVID compounds Pennsylvania's fracking industry problems

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John Stavovy had become accustomed to getting monthly checks of $7,000 to $8,000 from the energy company that began pumping shale gas from his 285-acre farm in Washington County, Pennsylvania, at the peak of the Marcellus Shale boom. But as the price of natural gas fell to its lowest point in two decades, his checks have dropped to under $2,000. 

"We use the money to pay for expenses. There's five of us siblings so we split a little bit of it, but most of it goes to keeping up the farm," he said. "We're down probably 75% from where we were a year ago. It's down to about the time we're going to make our school tax, and that'll be it," he said.

After the 2008 financial crisis, a major influx of hydraulic fracturing, or fracking, boosted Pennsylvania's economy. Today the state produces more dry natural gas than any state except Texas, according to the Energy Information Administration (EIA). But overproduction, a warmer than usual winter and the pandemic have driven its New York Mercantile Exchange (NYMEX) Henry Hub price down over 30% since November.

Unlike the price of oil, which dropped by two-thirds from February to April, natural gas prices began declining last year because rapid production in states like Pennsylvania was outpacing demand and storage ability, says Corey Young, director of the Center for Energy Policy and Management at Washington and Jefferson College.

"If the industry were a patient, we could say that it has a number of pre-existing conditions, and that's made the prognosis in the wake of COVID-19 way more complicated than it might come across at first blush," he said. "While the pandemic hasn't hit it quite as hard as many other industries, it certainly hasn't helped either."

The Pennsylvania Independent Fiscal Office (IFO) estimated earlier this year that gas companies paid nearly $220 million in royalties to landowners in 2017, an increase from $120 million in 2016, the last year that the price of gas per million British thermal units (MMBTU) fell below $2. 

"You can see how volatile the amounts are year-to-year, and that's largely attributable to prices," said Jesse Bushman, a revenue analyst who worked on the IFO's 2017 royalty estimate. "There may be some other factors at play like the actual lease terms, but any significant change is largely going to be attributable to price changes."

Stavovy, whose family bought the land he now leases 100 years ago, said his royalty payments just keep falling. 

"In October, November, December, it went down from $10,000 to maybe $5,000," Stavovy said. "Then when COVID hit, it went down into the $2,000s and below. And it just keeps going down."

Landowners who lease the gas rights to their land typically receive monthly royalty payments from the producers pumping on their land based on the price of gas and how much their land produces. As wells age, they generally produce less gas. But with the dropping prices, even landowners with new productive wells have seen their royalties decline. 

"When gas is not being sold at price points we were used to three or four years ago, people's royalty statements reflect that," said Robert Burnett, a Pittsburgh lawyer who exclusively represents landowners in oil and gas disputes. "And that has a secondary effect that when the commodity prices fall: what stays the same in your royalty statement are the deductions of post-production costs." Those are largely fixed costs — "the cost of dehydrating, treeing processing, transporting the gas," Burnett explained.

"Those parts of the royalty statement didn't change, and that's the double whammy that landowners are experiencing," he said.

Although the price of gas went up modestly in the month of July, royalty payments are usually made based on the prior two or three months of gas production. Many landowners are taking an additional hit to their revenue because their contracts allow gas companies to deduct post-production costs.

William Black, a retired vocational agriculture teacher who leases 127 acres of land in Washington County to two gas producers, said his royalty checks have fallen by 80% over the past year. The post production deductions remained the same. 

"On the last check that we got, two-thirds went to the post production costs. We got one third," Black said. "Theoretically if they continue to take out two-thirds of the value of the gas as post production costs, and the production of the gas wells go down far enough and the price stays down low enough, we will end up owing them money on the gas that they took from us."

New drilling is also waning. Pennsylvania's rotary rig count, which measures new drilling, has fallen to 20 from 37 at this time last year and 25 in January, according to the oil field service company Baker Hughes. David Spigelmyer, the president of the Marcellus Shale Coalition, said that's due in part to increased efficiencies from new technology, like drilling two miles horizontally from a well, but that the lower prices impacted companies, too. 

"In February of 2008, when this play began, gas was selling at $13.71 MMBTU, and you think about a royalty check based on $13 gas versus $1 or $2 gas," Spigelmyer said. "The landowners, the mineral owners and the companies themselves have all been hurt. There's no doubt about it."

Natural gas production nationwide dropped about 7% from March to May, but in Pennsylvania it's fallen by less than half of that. Pennsylvania's lower rate of decline is in part a function of a major slowdown of drilling in the West for oil, which yields gas as a byproduct, said Jeremy Weber, director of the Shale Gas Governance Center at the University of Pittsburgh.

"It helps [Pennsylvania gas producers] that oil producers were hit hard by the pandemic," Weber said.

But for some landowners in the state, getting lower royalty checks while production has stayed relatively constant has renewed a disdain for the post production costs deducted from their payments. Pennsylvania law requires gas companies to pay at least 12.5% royalties to landowners they lease from. But because of a 2010 state Supreme Court decision, the companies can deduct post-production costs from payments to anyone they lease from, even if their contract didn't mention the deductions. In some cases, that's resulted in negative checks, said Pennsylvania Oil and Gas Landowner Alliance board member Jackie Root.

"Ever since that decision, they have been monkeying with [the post production costs]," Root said. "And then the deductions have become very egregious."

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