Class Claims Marathon Oil Stiffs on Royalties

OKLAHOMA CITY (CN) — Property owners in Oklahoma say in a federal class action that Marathon Oil owes them more than $5 million in gas and oil royalties.

Lead plaintiffs James and Judy Grellner sued on Oct. 6 on behalf of all Oklahomans who have had mineral leases with Marathon since Sept. 1, 2011. They claim the oil giant improperly reduced their royalties for costs of "marketing, gathering, compressing, dehydrating, treating, processing or transporting of hydrocarbons produced from the unit."

Marathon pays royalties based on the net revenue it receives under its gas contracts, the terms of which the landowners do not know or approve, the Grellners say. The contracts are for services needed to put the gas and its constituent parts into marketable condition.

Oklahoma law requires the lessee (in this case Marathon) to bear the costs of placing gas and its constituents into "Marketable Condition" products, according to the 28-page complaint.

The Grellners say the deal was supposed to work this way: "The lessor and lessee enter into a lease that allows the lessee to take the minerals from the lessor's land. The usual revenue split from a well was 1/8th to the lessor (royalty owner) and 7/8ths to the lessee." But as wells have become more prevalent and drilling rigs more efficient, royalty owners on recent leases have received 3/16th to 1/4th of the revenue, the complaint states.

The Grellners say that Marathon, like other lessees, uses internal accounting methods to keep as much of the well revenue for itself as possible.

"Rather than adopting transparency in its royalty calculation formula, Marathon, like most lessees, has guarded its production and accounting processes as confidential or proprietary, thereby, depriving the royalty owners of information necessary to understand how Marathon calculates royalties. Consequently, the royalty owner is unaware of the lessee's actual practices, thereby enabling the lessee to breach the oil and gas lease without accountability," the complaint states.

The lawsuit discusses at length how raw gas from each well is transformed into the two main products — methane and fractionated natural gas liquids (NGLs) — before being sold on the market.

The gaseous mixture from a single well cannot be processed economically, so mixtures from many wells are "gathered" together into pipelines and delivered to a processing plant. These costs include gathering, dehydration and compression.

Once enough gas mixture has been gathered, it goes to a processing plant where it will be transformed into methane and mixed NGLs. This leads to a cost to remove impurities, called a treatment cost, as well as the final processing cost to turn the mixture into methane gas.

The raw NGLs are separated from the gaseous mixture and processed by a fractionator into marketable products. The NGLs, which are used as a feedstock in the petrochemical and oil refining industries, are considered a more valuable commodity than the methane.

Neither the methane nor NGLs are commercially marketable at this point. The producer (Marathon) sells the products in an arm's length transaction at the prices established by commercial markets.

The so-called "starting price" for gas products is always achieved at a commercial market price, the complaint states. "Whichever starting price is used in an arm's length transaction, that price is the highest and best reasonable price for the valuable gas products."

The Grellners say the "extraordinarily large dollars at stake and the one-sided nature of the gas lessor-lessee relationship" all help Marathon wrongfully retain gas revenue.

"All payment formulas, all affiliate and non-affiliate contractual relationships, and all calculations are firmly kept in the exclusive control of lessees, and they involve undisclosed accounting and operational practices. As a result, there are many ways that royalty owners are underpaid on their royalty interests, and they never know it. The common thread through all of these schemes is that they are typically buried in the internal lessee accounting systems or royalty-payment formulas," the complaint states.

The Grellners say Marathon underpays royalties for residue gas, NGLs, drip condensate and other products, such as helium, by taking excessive deductions under midstream services contracts.

Marathon settled a similar class action from 2010, the Grellners say. This indicates to them that the company "continues its improper payment practices with actual and willful knowledge and intent."

Marathon said it does not comment on pending litigation.

The Grellners seek class certification and more than $5 million in damages for breach of lease, breach of fiduciary duty and fraud.

They are represented by Reagan Bradford with the Lanier Law Firm in Houston, and Rex Sharp of Prairie Village, Kan.

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