In audit of royalties in escrow, Gas and oil Board narrows its scope

For 20 years, natural-gas royalties belonging to Southwest Virginia property owners have been accumulating in state-controlled escrow accounts, largely unchecked for accuracy. That was supposed to change with the first independent audit of the accounts in a decade.

But the audit of $26 million overseen by the Virginia Gas and Oil Board is on track to be less comprehensive than board members prescribed, and more expensive than some anticipated.

After the first bill exceeded the original dollar quote, the board voted Aug. 17 to narrow the scope from auditing 40 individual accounts to just six.

An audit of so few accounts would lose its statistical value to broadly gauge whether energy corporations are making the required deposits into escrow, an auditor warned the board in correspondence obtained by the Bristol Herald Courier.

The millions in escrow are mostly royalties from the production of a natural gas claimed by both landowners and the companies that purchased their coal; the money belongs to potentially thousands of people who have never been compensated for their coalbed methane. Whenever an energy company produces gas that is in dispute, the board orders that company to deposit royalties into escrow accounts – pending a court order or an agreement between the parties in conflict.

The board authorized the long-discussed audit last December, days after a Herald Courier investigation revealed that some companies had failed to make required deposits. Since then, energy corporations have deposited more than $1 million into accounts the newspaper identified as missing royalties.

The board had requested that the auditor perform two key tasks. The relatively straightforward assignment would compare the bank’s receipts with energy corporations’ deposits into escrow. The more difficult task would analyze at least 35 of the more than 800 individual accounts to test whether corporations are depositing the required amounts.

Robinson, Farmer, Cox Associates, the accounting firm hired to perform the audit, submitted what was by far the lowest bid: $27,040. But that total came with a crucial asterisk: It did not include the detailed audit of individual accounts, which would require between 8,000 and 12,500 additional hours of work.

Despite that caveat, the state official in charge of administering the escrow accounts appeared surprised when he received the first bill for the audit in late May – for $31,000.

David Asbury, director of the Division of Gas and Oil, wrote in a May 27 e-mail to the firm’s managing director that “the original approved quote was for $27,040.” The invoice, Asbury wrote, “raises questions that should be presented to the board” at its next hearing, in June.

Two weeks later, the board considered those questions in closed session – given what the chairman described as the “sensitive nature of this audit request.”

By that time, auditors had mostly finished analyzing just two of the 40 individual accounts they proposed to comprehensively audit. They had not billed for any work associated with the only known cost – the $27,040. That cost would be on top of the work already performed.

Asbury wasn’t the only one who raised eyebrows at the expense.

“It does shock me that it costs that much already,” Bill Harris, a public member of the board from Wise County, said in a telephone interview.

Harris, who was not present at the June or August hearings, reviewed a copy of Robinson, Farmer, Cox’s audit proposal.

“It plainly says that [the quote] does not include the actual sub-accounts,” he said, referring to the detailed audit of selected accounts. “After reading it over now, how could we have missed that this was only part of it, and Part B wasn’t given?

“I guess I’m as guilty as the next,” Harris said. “I guess it’s somewhat embarrassing for us. We have spent quite a bit of money, and I haven’t seen the results.”

The upshot of the board’s private discussions in June was a letter to Corbin Stone, managing director for Robinson, Farmer, Cox, instructing him to proceed on a narrower course.

“Because the audit costs presented are near or have exceeded the original Request for Proposal contract,” Board Chairman Butch Lambert wrote to Stone, the auditors should limit the detailed analysis to just four more accounts.

Unknown costs materialize

From the beginning, the cost of an audit was a bone of contention among the board’s seven members.

Two members advocated for a forensic audit of the accounts. One member argued that auditing gas corporations’ financial records would be “opening a door I do not think we want to or need to go through.” Another simply favored the least expensive bid, “as the end result should ultimately be the same,” according to e-mails obtained by the Herald Courier.

On Dec. 15, the board voted on three bids. The next lowest bid, after Robinson, Farmer, Cox, came in at $83,000, and did not include expenses for travel, postage or preparation of reports. The high bid was $118,000.

When state officials evaluated the bids, Robinson, Farmer, Cox received a perfect score for cost – earning three times as many points for that category as its closest competitor – even though the firm had made clear that the only dollar figure quoted was incomplete.

At 8:13 a.m. Dec. 15, an hour before the board voted to award his firm the contract, Stone e-mailed Asbury with a “time estimate” to complete the detailed audit of the accounts.

“There are many variables that would affect pricing,” Stone wrote, including cooperation from the companies, their recordkeeping and how much data they relied on to calculate payments into escrow. In an attachment, Stone estimated it would take 8,575 staff hours just to complete the audit of individual accounts.

Stone reminded Asbury and Lambert of this disclosure in a July 7 letter. Though he pledged that his firm would follow the board’s instruction to narrow the scope of the audit, he added a cautionary note.

Reducing the analysis to just six accounts “diminishes and severely limits the analyses’ value as a statistically valid analytic tool. Any findings simply become general indicators,” Stone wrote. Reducing the scope would also mean losing the nearly $6,000 discount the firm withheld from its first bill.

In a December interview, Stone said his team would seek to identify whether energy corporations have failed to pay the required amounts into escrow, and then evaluate the likelihood of collecting that money. The scope of the audit would be adjustable.

“When it’s no longer beneficial, then the audit stops – at the board’s discretion,” Stone said then.

Stone’s July 7 letter also contained a veiled reference to problems he and his team have identified in the two accounts they’ve analyzed, which were apparently discussed in the closed session in June.

The firm identified “certain conditions” in deposits corresponding to wells operated by Range Resources and GeoMet. Stone advised that the firm should hold off on reconciling the deposits and receipts associated with those wells “until such time as the identified conditions are ameliorated.” He underlined the sentence.

Stone would not elaborate on the findings.

“Unfortunately, we do not comment on ongoing audits as the early release of data and/or findings may hinder audit cooperation and reduce audit effectiveness,” Stone e-mailed the Herald Courier on Aug. 25. “I am sorry I can not discuss the audit and trust you understand.”

From least to most expensive

In a complicated audit, $31,000 does not go very far.

That money covered the auditors’ meetings with Asbury and staff, collecting and reviewing Gas and Oil Board data, requesting data from companies, and the “purchase and review of authoritative oil industry accounting standards publications,” according to an itemized invoice.

The money also went toward expenses for auditors’ meetings with company representatives, out-of-state travel and the “preliminary analysis” of data for the Range Resources and GeoMet wells.

Stone now estimates that the full cost of auditing 40 individual accounts would total more than $121,300. That includes a 10 percent contingency fee, which assumes the firm would recover $48,600 from energy corporations. Combined with the $27,040 to reconcile the escrow receipts and the companies’ deposits, the full figure reaches almost $150,000.

In August, Gas and Oil Board members directed the firm to pursue the more limited course of analyzing only six accounts. That comes with a price tag of more than $73,700, and tops $100,000 when factoring in the reconciliation of accounts.

“I’m sure we have to be in a panic as a board,” said Harris, the public member from Wise County.

Still, despite the high cost, Harris favors paying for the full, 40-account audit.

“I would vote to pay the extra money to complete the audit as they proposed,” he said.

Even if the board does not recover more money from companies than it spends on the audit, Harris said, “It is important enough for our knowledge, and for the public that’s watching this, that we make every reasonable effort that their money is correct in the escrow accounts.”

After missing the August vote to narrow the audit’s scope, Harris said he would e-mail board members to recommend they revisit the issue.

dgilbert@bristolnews.com | (276) 645-2558