Dave Cain: Welcome to unsuitable on Rea Radio, the award-winning financial services and business advisory podcast that challenges your old school business practices and the traditional business suit culture. Our guests are industry professionals and experts who will challenge you to think beyond the suit and tie while offering you meaningful, modern solutions to help you enhance your company’s growth.
I’m your host, Dave Cain. In recent years, we’ve heard a lot about the oil and gas activity in the Marcellus and Utica Shale region. Influx of activity has impacted the lives of the family that called this area home. Yesterday, their land was just land. Today, it’s a gold mine.
A lot of these land owners are left thinking, “Now, what can I do?” Which is why we are welcoming Scott Moyer and Jim Fracker to the podcast today. Scott and Jim work with many landowners in this region. Their work has led them to develop a strategy for helping these families realize the full earning potential of their land.
Welcome to unsuitable, Scott and Jim.
Jim Fracker: Thank you, Dave.
Scott Moyer: Thank you, Dave.
Dave: First of all, we want to start out. Scott, I want to congratulate you in your recent promotion to principal at Rea & Associates. My understanding is you’re probably one of the youngest ever to be promoted to that position.
Scott: Yeah, I appreciate that, Dave. A lot of thanks obviously goes to you, Chad Bice, Jim Fracker for really being great mentors to me along the way.
Dave: Jim, on the other hand, you’re probably one of the more mature principals we have in the firm, and you might be the most mature participant in this podcast.
Jim: I would say there’s a strong likelihood that could be the case.
Dave: Usually, we start out the podcast with something personal, such as a golf tip, but I play golf with both of you guys. You’re both lousy golfers. I think we’ll bypass that for that part of it.
Also, I want you guys … You guys apparently have not been listening to Unsuitable on Rea Radio, the name is Unsuitable. Scott, you’re dressed accordingly. You have shorts and flip-flops on, which is good. You’re nice and comfortable. Jim, on the other hand, has a three piece suit with a well positioned tie.
Jim: I guess, David, you just can’t break old habits.
Dave: You’re the GQ of the oil and gas team.
Jim: I’m the GC of the oil and gas guys.
Dave: Jim, I have a confession. I think I met you back in the early 80s. You were an auditor for the State of Ohio. I think you were auditing a client of Rea & Associates, and I didn’t lied to you, but I’m not sure I gave you all the work papers.
Jim: That’s quite an interesting observation, Dave. I’m sure you’re probably not the only one that ever did that with me while I worked for the State of Ohio as an auditor.
Dave: Anyway, my apologies. I think we made out okay on that audit.
Jim: Very well accepted.
Dave: Speaking of audits, I’m familiar with a financial statement audit, IRS audit, tax audit, but you guys are going to talk about royalty audits. Talk to me. Scott, what is a royalty audit?
Scott: Dave, realty audit, really, is a consulting service offering that allows the landowner, royalty recipient, to ensure that they are being paid the correct amount from the oil and gas company. It’s not your typical financial statement audit. Really, it’s just us making sure that the numbers on the checks and the numbers hitting the oil and gas royalty recipient’s bank accounts are correct. That’s really what it is, Dave.
Jim: Actually, Dave, to add to that, as Scott said, it’s really not an audit per se. As we think of it in the financial accounting realm, it’s not an attest service. However, what it is exactly what Scott said. We’re actually looking at data to ensure that our clients, our royalty recipients are being fairly and correctly paid.
Dave: Guys, this really sounds like an innovation, an innovative service offering within the state of Ohio in the oil and gas field. My hats off to you for developing a service here.
Now, we need to dig in to this a little further, because I’m not exactly sure what you all are doing in that area. Jim, let’s start with identify. If I’m a landowner, how big do I have to be? How big do those checks have to be before a royalty audit makes some sense?
Jim: Dave, that’s a very good question. I think, probably, a general answer to that would be that anyone receiving royalties and questioning the accuracy and/or the trust that they might have or not have with the payer of the royalty, would be a primed candidate.
Now, with that, everything starts with examining each individual lease. Even within the same unit of production, you could have a number of different royalty recipients, and they all could hold different leases. It’s very important to realize that what one’s neighbor finds may not be the case for them depending on what their lease says compared to their neighbor.
Dave: Both of you guys … I’m not sure who we want to answer that. Scott, maybe I’ll throw this to you, but on your royalty team, your oil and gas team, who’s smarter between the two of you?
Scott: Jim.
Jim: I don’t know about that, Scott. I would say that we do very well as a team, so we’re very proud of the group that we have assembled to do this. I think it should be pointed out that it’s just not the Rea group that does the royalty auditing. It’s actually a team approach, and the team would involve legal council, very familiar with horizontal drilling, and lease terms, terminology. We work with a consultant out of Colorado that has been working in the royalty audit area for about … What, Scott? 30 years?
Scott: Yeah, just over 30 years.
Dave: Scott, as you start down the audit, understand the first step is; what does the lease contract look like? Would that be your very first step? Maybe a conversation with the attorney and go through the lease language?
Scott: Yeah, we always like to start introducing the client to an attorney either for lease interpretation if the lease has already been signed, or we currently recommend that if you don’t have a lease in place, get in front of an attorney, an oil and gas attorney who specializes in this to help negotiate your lease to get the correct terms in that lease.
Yes Dave, we always start with a lease and we depend upon an attorney to interpret that lease as well as the division orders that come from the oil and gas company, which basically shows the decimal interest that will be due to the royalty recipient.
Dave: That’s a starting point. Jim, maybe I’ll throw this in your direction. Do you look for data errors, math errors, formula errors in the computation of the check or the royalty?
Jim: Dave, the answer to that would be yes, yes, and yes.
Dave: I guess that answer is yes then, right?
Jim: That answer is yes. The royalty audit itself actually centers around the revenue side as well as the deduction side. For folks in Ohio and other states that really are not familiar with horizontal shale related wells, that whole deduction side is brand new to them. It’s actually an area that, at least, in Ohio is not very well interpreted in terms of case law. Because of that, anybody that has check stubs that would have deductions on them would certainly be a very good candidate to, at least, consider for royalty auditing.
Dave: Scott, on these cost or deductions that are creeping up, would those be things like marketing cost, transportation cost? What are some of the cost that might crop up that maybe we haven’t seen before?
Scott: Yeah, on the check stubs, the costs for oil, they might list oil, being paid for oil, the cost might show up to transport the oil from the pad site. The royalty recipient might be paid for natural gas, and the cost that might show up there are the cost to gather it, the cost to compress it through the pipeline, the cost to get it to market. Those are the kinds of costs that come up usually.
Dave: Is it possible in one of these transactions that the minerals that you’re talking about might be sold a blow cost, blow market? Scott, I’ll throw that to you. You look like you’re ready to jump all over that question.
Scott: Absolutely. For instance, Jim and I, we can see daily what we think natural gas is being traded for on the market, okay? If it’s being traded for $3 per MCF and we see somebody’s royalty check stub and they list the price that they were paid for that same period, if we see it well below market, we’ll bring that to the royalty owners. We’ll bring that to their attention.
Dave: How long do these audits normally last, Jim?
Jim: The actual timeframe of the audit, Dave, would depend on the number of areas that we’re actually looking at. For example, if we’re really only looking at the revenue side of the audit, it could be two, three days. If we’re looking at the revenue as well as the deduction side, it could well be two or three weeks or longer.
Dave: Apparently, you guys might not be the most popular with producers.
Jim: I would definitely say that that might be the case. You know Dave, for me, it’s like going back to the same old same old from the Ohio Department of Taxation days. It’s quite interesting in that. I’m glad you brought that up, because one of the concerns of landowners as it relates to the royalty audit is, “Well, gee-wiz. Will we automatically be blackballed by the producer, or simply because we request an audit?”
The reality of that is if you ask the producer would it be one of their favorite things to do, and I’m sure their answer would be no. With that being said, they also fully expect that to happen. In fact, most of the larger producers have what they call auditing areas, where when you schedule for the audit, you very well could be scheduling out, in some cases, two months.
Dave: Scott, do you guys ever go on site, go out to the pad, go out to the well to examine the well, or is this just put your nose down and tick and tie and put something on an Excel spreadsheet? You go out to a well site, I want to know that.
Scott: Yes, that comes recommended, especially to understand how they transport the natural gas. We like to see how far away is the compressor site that is going to compress this natural gas nad get it to market. How far does the oil truck have to travel from the pad site to get away from there as well? Where are the gas meters that the company is using to … They are reading these gas meters and determining how to pay the royalty owner. How far does the gas have to travel before it gets to that gas meter to be read?
Dave: Since you boys are from Muskingum and Guernsey County, you got to have a pickup truck to go out to these well sites. Jim, I know you got a pickup truck.
Jim: Pickup truck or SUV, David, but we’re still working on Scott. We got to get him ahead of that direction.
Dave: You ever kick-up any deer when you’re out looking around?
Scott: Not as of yet.
Dave: Okay. We started the conversation, I want to go back a little bit. How do you identify a good candidate for a royalty audit? These things just don’t come out of nowhere, and it’s not for everybody. It’s got to be a size or some demographics you look at. Can you share those with our listeners?
Scott: Many different things go into that, Dave. We rely upon our referral sources, attorneys we’ve touched base with. They’ll sometimes recognize issues with the leases. It might be a net lease … Excuse me. It might be a gross lease where the royalty owner should have no cost taken out, and we look at their checks and they have cost taken out. The attorney will identify that right away. Will recommend a royalty audit, and that’s where Jim and I would go meet with the client.
On the flip side, Jim and I had been fortunate enough to meet a lot of oil and gas landowners and they’ve become tax compliance, longterm planning clients. We’re seeing their royalty stubs firsthand, and that’s the flip side. Then we become the first contact and we might introduce them to an attorney and then get the royalty audit ball rolling as well.
Jim: Dave, to add to that, the common themes is the lease itself simply because something looks a little out of line on the check stub doesn’t necessarily mean that they’re definitely audit candidates, those particular check stubs. Certainly, would say that, “Look, we really need to look at the lease to see what’s going on here.
Dave: Okay. Jim, what are you finding on these audits? Let’s talk about what’s some of the results. What are you finding?
Jim: I think what we’re finding, I guess at a high level, is a lot of the producers are out there and they’re trying to get all the accounting data aligned so they can start cutting the royalty checks. They have a large volume of transactions that they have to try to process and it makes it difficult for them. Sometimes, you would even see mistakes at that level.
In other words, they think they should be taking deductions out, but the reality is the lease says they can’t. Those type of things. We find some discrepancies, as Scott had mentioned earlier, in the revenue side of it whereby it appears that landowners are not being paid what they should be as far as market side, or MCF, or per barrel of oil. It really just, I guess, run the gamut between revenue and deduction.
Dave: Okay.
Scott: To follow up on that, Dave, it’s so broad. Are they being paid the right price per MCF, the right price per barrel? Should they be taking cost? Should they not be taking cost? It is very, very broad. It’s the decimal interest that they’re being paid correct.
You got to understand, the producer has an accounting department, and they’re human, they can make mistakes. Those mistakes just … Our job is to bring those to the forefront.
Dave: If you find an error, does the producer … You work with the producer to make it right, or do you have to litigate to get it corrected?
Jim: I think in all cases, the idea would not be to ultimately end up in a litigation situation. Yes, we would work directly with the producer through our client, and our client might either be the landowner or the landowner’s legal council. We would be actually issuing a claims letter and talking to the production company about what we think the error is and what the actual amount of the error is as well.
Dave: I’m not sure exactly how to phrase this. Scott, I’ll throw this to you. What is the range of percentage of royalties that you see? You’re using decimal points. Expand on that, if you can.
Scott: The decimal interest is calculated and it goes to eight slots to the right of the decimal point. Jim and I have worked with four and a half percent owners of a pad. We’ve worked with 20% owners of the pad. The common rule of thumb is if somebody with just one acre of a thousand acre pad wants to challenge their royalties, we can do a simple royalty monitoring project for the one acre realty owner.
Really, what we’re looking for is, is for that one acre royalty owner maybe to amass a group of folks to come in and go on a royalty audit together, or if a singular royalty owner wants to do it, we usually look at, probably, 50 to … At least 50 to 100 acres to make it worthwhile for the royalty landowner.
Dave: Jim, what in the world does this cost? What’s an average cost of an audit?
Jim: It would depend, Dave. When I say it depends, it would really depend on the scope of the audit. We recently … We’re actually just recently finishing up an audit, and it’s probably going to be somewhere in the vicinity of $35,000. It was pretty extensive. A lot of issues within that. It could run anywhere from probably … I don’t know. Probably 2,500 if it’s very, very, very simple, getting back to Scott’s one acre example. Probably all the way up through 30, 40, perhaps, $50,000 if in fact we’re taking into account gas plant accounting and there’s a significant travel involved, as well as major issues.
Dave: Sure. Scott, what would … In your experience. What has been one of the larges findings aggregate in an audit? In other words, the landowner has owned X because of errors. What’s one of the largest findings that you have uncovered thus far?
Scott: It’s been interesting … That’s an interesting question, Dave.
Dave: That’s why I asked it.
Scott: Basically-
Dave: We ask interesting questions on this podcast. Are you stumped?
Scott: I am. I am.
Jim: I think with that, Dave, that as it stands right now, given the fact that the shale activity in Ohio is not that old, or really just getting rolling on the actual audit side. Findings versus settlement is really two different things. Findings … I don’t know. Scott, what would you think the last one we worked on could turn into … Would have been on the revenue side, 60, $70,000, I believe?
Scott: Yeah. We have a potential to make a claim for payment between 60 and $70,000 to the oil and gas producer. Again, as Jim said, we can make that claim for payment. The producer could challenge it and then we could be looking at litigation.
Dave: Scott, to your point, even though there might not be a dollar amount finding, maybe there’s a comfort level that the landowner receives as a result of the audit that things are happening the way they should according to the lease.
Scott: That’s really what we talk about with the landowner when we meet with them. There’s a real opportunity for a positive adjustment in their favor from a monetary standpoint.
Also, what we’re looking at here is we’re looking at trying to get peace of mind. These are silent partners. You’re a silent partner with a large oil and gas company. Sometimes, publicly traded. You want to know that over the life of these wells; 5, 10, 15, 20 years, that you’re going to be paid correctly from that big partner, and you’re silent in that regard. Really, peace of mind is the main thing that folks can take from this.
Dave: Good. Good. Guys, we’ll wrap up with this question. What are the alternatives to royalty audit? Are there any other services that … I don’t want to do a deep dive audit, but are there some things you can scratch the surface on. Jim, I’ll throw that to you?
Jim: Yes, absolutely Dave. Scott mentioned earlier that we do have a monitoring program. We have what we call a pre-audit program. Actually, a lot of the folks within the royalty audit arena think of it as level one, level two, level three. What we’ve been talking a lot about today is level two and three. Level one would fall more under the monitoring pre-audit.
What we would end up doing is taking check stubs that the landowners or the royalty recipients would have received, and actually slicing and dicing those with spreadsheet analysis and trying to developing trends where potential errors may end up surfacing as a result of that.
Dave: Our guest today have been Scott Moyer and Jim Fracker with Rea & Associates Oil & Gas Specialty Team. We might add, not only do you guys specialize in royalty audits, but there’s also various tax planning and strategies that go along with your service. You guys are quickly becoming famous in the area of oil and gas in the State of Ohio and the surrounding states. Nice job on innovating product service offering. Very unique, and hats off to both of you.
Before we wrap up, we always want to end with a question. Since 2017 is here, can you guys share a business resolution or 2017 piece of advice for one of our clients? Jim, you go first.
Jim: Absolutely, Dave. I think that you probably will be familiar with this piece of advice, I believe. It’s simply is, and I’m actually stealing somebody else’s phrase, I believe, but I’ll do it anyway. That is, that I would certainly hope that every business owner would have the opportunity to work on their business and not in their business.
Dave: Scott?
Scott: I would ask all business owners to expect more from your professionals. You deserve the best, and I know our team at Rea & Associates can provide you the best. I’ll tell you what. Client service is the priority and we could provide that to you.
Dave: Well done. Thanks again for joining us unsuitable. Scott and Jim, well done. This has been a very informative discussion. I hope more people take advantage of the services you guys are offering. Maybe a ride in the pickup truck out to the pad might be an order.
I also want to thank our listeners for continuing to tune in every week. If this is your first time listening to Unsuitable on Rea Radio, take a look at iTunes and SoundCloud. Also, don’t forget to check out our website at reacpa.com for some more great insight into four pillar strategy from landowners.
Until next time, I’m Dave Cain encouraging you to loosen up your tie and think outside the box.