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Ostroski v. Chesapeake Appalachia, L.L.C.

United States District Court, W.D. Pennsylvania

November 18, 2019

EDWARD and KATHLEEN OSTROSKI, Plaintiffs,
v.
CHESAPEAKE APPALACHIA, L.L.C., CHESAPEAKE OPERATING, L.L.C., and CHESAPEAKE ENERGY CORPORATION, Defendants.

          MEMORANDUM OPINION

          David Stewart Cercone Senior United States District Judge.

         I. Introduction

         Plaintiffs, Edward Ostroski and Kathleen Ostroski (the “Ostroskis” or “Plaintiffs”) initiated this action against Defendants, Chesapeake Appalachia, LLC (“ChesApp”) and two (2) related companies, Chesapeake Operating, LLC (“ChesOp”) and Chesapeake Energy Corporation (“CEC”)(together the “Chesapeake Defendants”) by filing a Complaint to Vacate Arbitration Award. The Ostroskis filed an Arbitration Complaint and Demand against the Chesapeake Defendants alleging the underpayment of natural gas royalties under a Paid-Up Oil and Gas Lease they entered into with ChesApp. After the filing of cross motions for summary judgment, the arbitrator entered a Final Award in favor of the Chesapeake Defendants. By their Complaint, the Ostroskis now seek to vacate the Final Award.

         II. Statement of the Case

         On or about September 15, 2007, the Ostroskis entered into a Paid-Up Oil and Gas Lease (the “Lease”) with ChesApp pursuant to which the Ostroskis leased oil and gas rights to real property in Bradford County, Pennsylvania. Plaintiffs' Appendix (“Pl. Appdx.”) Ex. 9, p. 191.

         The Lease provides for a royalty payment for natural gas as follows:

(B) ROYALTY: To pay Lessor as Royalty, less all taxes, assessments, and adjustments on production from the Leasehold as follows . . .
(2) GAS: To pay Lessor an amount equal to one-eighth (1/8) of the revenue realized by Lessee for all gas and the constituents thereof produced and marketed from the Leasehold, less the cost to transport, treat and process the gas and any losses in volumes to point of measurement that determines the revenue realized by Lessee. . .

Pl. Appdx. Ex. 12, pp. 214-215. Plaintiffs contend that ChesApp breached the lease by paying the royalties on the wrong price. Complaint ¶ 19.

         Plaintiffs admit that ChesApp is a gas producer, not a gas marketer. ChesApp Resp. Ex. 2 ¶ 9. In order to market its gas, ChesApp transfers title to the raw gas at the well to its gas marketing affiliate, Chesapeake Energy Marketing, L.L.C. (“CEM”)[1]. Complaint ¶ 20, ChesApp Resp. Ex. 2 ¶ 10. CEM processes the raw gas into marketable natural gas and markets the processed gas to third-party buyers in downstream markets. Id.

         In a letter to Plaintiffs describing how it markets its gas, CEC stated as follows:

By way of background, gas produced from the Lease is in marketable form at the well, and is sold by [ChesApp] to [CEM] at this point. [CEM] is a marketing company, which takes title to and possession of gas at the well and aggregates it with gas from multiple other wells into a downstream pool typically on an interstate pipeline. The volume of natural gas aggregated in this pool is then sold to many different buyers, at different prices. On a monthly basis, [CEM] determines a weighted average sales price for the gas sold from the pool at the downstream, value-added points of sale. The weighted average sales price is calculated by averaging the price received from the individual sales from this pool across the entire volume contained in the pool. [CEM] pays [ChesApp] 97% of this weighted average sales price ([CEM] retains a 3 percent marketing fee which is born solely by [ChesApp] and is not passed on to the Lessor), less costs [CEM] incurs between the point of sale at the well and the downstream points of sale. The costs incurred by [CEM] are itemized in your royalty statement.

ChesApp Resp. Ex. 2 ¶ 14.

         Plaintiffs argue that ChesApp is calculating the royalties based upon a “theoretical well head price, calculated as the price paid by the third-party buyers less the costs incurred by [CEM] between the well and the sale to the third-party, including the costs of gathering, compression and interstate transportation through the interstate pipeline system[, ] but should be paying royalties on ...


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