Archive for January, 2010

SRBC Orders Stop to Site Preparation at Marcellus Shale Site — Prior to Water Withdrawal

Carl B. Everett, Esq.

Saul Ewing, LLP

Philadelphia

 

On January 12, 2010, the Susquehanna River Basin Commission ordered natural gas drilling company Novus Operating, LLC to cease all water related activities at two Marcellus Shale drilling pad sites in Tioga County and to cease drilling.  The company had begun drilling two wells despite having been informed by the SRBC that its prior approval was required.   The company had not yet begun water withdrawals, which presents an interesting question of SRBC authority.  A link to the SRBC Press Release is avaiable by clicking here.

 

The SRBC regulations are codified at 18 CFR 801-808.  Section 806.4(a) says that no person shall undertake any of the following projects without prior review and approval by the Commission…(8) any natural gas well development project in the basin targeting the Marcellus or Utica shale formations… for exploration or production of natural gas involving a withdrawal, diversion or consumptive use, regardless of quantity.*  Each of the key words is defined.  The definition of “project” contains the following: “For purposes of natural gas development activities, the project shall be considered to be the drilling pad upon which one or more exploratory or production wells are undertaken, and all water-related appurtenant facilities and activities related thereto.” 

 

The regulations addressing violations impose a duty to comply (section 808.11) and further authorize the imposition of civil penalties for violations of the compact or commission rules pursuant to section 15.17 of the compact (section 808.17).  The compact authorizes penalties of not less than $50 nor more than $1,000, with each day of violation to be considered a separate offense.

 

The federal environmental statutes vary with respect to the need for construction permits.  The Clean Water Act applies to discharges; construction is at the risk of the owner.  The Clean Air Act contains rigorous pre-construction requirements.  The SRBC regulations are on the CAA end of the spectrum.  However, the compact itself seems more similar to the Clean Water Act as its focus is on the water resources.  Interestingly, the compact does not mention gas (or coal).  There may be an argument that the regulations, notwithstanding compliance with procedural requirements in their promulgation, exceed the authority granted by the compact.  Perhaps Novus Operating, LLC plans to press that issue.

 

*Section 806.4(a)(8) was erroneously proposed to be deleted, but the error was corrected 74 Fed. Reg. 49810 (September 29, 2009). 

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Texas Agency Study Shows No VOC Air Pollution From Shale Gas Well Sites

The Texas Commission on Environmental Quality took air samples from more than 100 shale gas production facilities in Fort Worth, Texas and found no hazardous air pollution.  The TCEQ announced yesterday the results from their mid-December study in which they sampled for 22 volatile organic compounds, finding no hazardous levels of volatile organic compounds and in most cases no detectable levels at all.  A copy of their press release can be viewed by clicking here.

A link to the TCEQ Barnet Shale site with more information can be accessed by clicking here.

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Bids for State Forest Gas Leases Exceed Minimum Bid by 2X

The opening of bids for gas leases on 32,000 acres of Pennsylvania’s 2.1 million acres forest controlled by the Department of Conservation and Natural Resources exceeded the $2,000 per acre minimum bid by more than double, according to the Philadelphia Inquirer.  In addition to the primary payment of $128.5M, royalties will be set at 18.5%.  According to Secretary John Quigley, this brings to 692,000 the acreage of DCNR forest that is subject to gas leases.  The state does not own gas rights under all of its forest.  The excess paid over the minimum bid, $68.5M, will be placed in the Oil and Gas Fund and used for yet-to-be-determined conservation purposes.  An article in the Philadephia Inquirer can be viewed by clicking here.   The leases in this round contain some strict limitations on land disturbance from the gas exploration and production process.  The continued leasing of state forest for this purposes raises some interesting and important policy issues:  how to spend the proceeds of this leasing of this valuable and limited public asset, how to protect the varying longstanding surface purposes of the forest including public recreation and protection of the natural environment while using this important energy resource, how much to lease at this time or defer for a future time or generation, whether to purchase gas rights not owned by the state but which underlie state forest to prevent exploitation of the resource to the detriment of the public surface uses.  Managing gas leasing is not new to DCNR.  There are more than 700 gas wells in state forest now, and only three are Marcellus formation wells.  Good stewardship by the state will, one hopes, be also a model for private stewardship–both of the subsurface and surface resources.

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PENNSYLVANIA MINIMUM ROYALTY ACT LITIGATION

By:  Joel R. Burcat, Esquire, Saul Ewing LLP, Harrisburg, PA

 

The hottest legal issue right now affecting Marcellus gas exploration is Pennsylvania’s Minimum Royalty Act litigation.  This is the subject of numerous cases that have been filed in state and Federal courts, several judicial opinions and, most importantly, one case pending before the Pennsylvania Supreme Court.  The 1/8th minimum royalty provision has been ruled upon by a number of state and Federal Courts.  More importantly, the Pennsylvania Supreme Court has a case before it that is ripe for a determination.  When that case is decided, we believe the question of whether certain costs may be deducted from the 1/8th minimum royalty should be resolved in Pennsylvania.  This could have a huge impact on many leases (those that provide the Lessor with the bare 1/8th royalty) as the law seems to imply that if the Act’s provision is violated the lease is invalidated.  Many landowners and exploration companies are anxiously awaiting the ruling of the Supreme Court.

Pennsylvania’s minimum Royalty Act provision provides as follows:

A lease or other such agreement conveying the right to remove or recover oil, natural gas or gas of any other designation from lessor to lessee shall not be valid if such lease does not guarantee the lessor at least one-eighth royalty of all oil or natural gas recovered or removed.

58 P.S. § 33.

Pennsylvania and Federal Courts have gone in a variety of directions on whether or not the provision of the Minimum Royalty Act mandates that costs cannot be deducted from the 1/8th royalty.

Case permitting the deduction:

Kilmer v. Elexco Land Servs., Inc., No. 2008-57 (Susquehanna Co. C.P., March 3, 2009), appeal granted, No. 63 MAP 2009 (Pa.).

 

In Kilmer, the Susquehanna County Court of Common Pleas ruled in favor of the gas company that had deducted the post-production costs from the royalty.  The court ruled that, “58 P.S. Sec. 33 does not preclude parties from contracting that ‘post-production’ costs be factored into the determination of the amount of royalty payable under and [sic] oil or gas lease.” 

Cases not allowing any deduction:

 

Kropa v. Cabot Oil & Gas Corp., 609 F. Supp.2d 372 (M.D. Pa. 2009).

 

Gas rights lessor brought action against lessee, alleging that he was fraudulently induced to enter into an oil and gas lease, and seeking a declaratory judgment that the lease was invalid.  Lessee moved to dismiss.  The court granted the motion in part and denied it in part.

The defendant paid a bonus of $25 per acre to the plaintiff for 521 acres, amounting to a total bonus payment of $1,275.  Plaintiff claimed the defendant’s representative told him, it would “never pay any more than $25 per acre so he better take the $25 per acre.”  After learning that others received more money, plaintiff sued seeking to void the contract claiming fraudulent inducement and also sought a declaration that the royalty provision, which pays 1/8th less certain expenses, violates Pennsylvania law.

The court examined the integration clause of the lease but also examined three writings that were all a part of the contract at the time it was signed.  One did not contain an integration clause.  The court refused to dismiss that portion of the claim dealing with the statement that plaintiff would never be offered more than $25, since that part of the claim was not covered by an integration clause.  609 F. Supp.2d at 378.  The court did dismiss that part of the claim that there was fraud regarding the statements having to do with the amount of royalty, since that was covered by an integration clause.  Id.

As to the royalty issue, the court held that “a plain reading of 58 P.S.§ 33 guarantees one-eighth royalty and does not provide for the subtraction of any costs.”  Id. at 379.  This court disagreed with the holding of the Pennsylvania Court of Common Pleas in Kilmer.

Cases leaving the door open on the validity of the deduction:

 

Stone v. Elexco Land Servs., Inc., 2009 U.S. Dist. LEXIS 45897 (M.D. Pa. June 1, 2009).

 

Plaintiff landowners sought a declaration that the oil and gas lease the parties signed was invalid under Pennsylvania law because it did not provide a minimum royalty payment as required by statute.  Id. at *4.  The lease provided for a royalty of one-eighth of the amount realized from the sale of gas produced from the well, less one-eighth of the post-production costs and one-eighth of the taxes incurred on the gas.  Id. at *6.  Plaintiff argued that because the lease called for the subtraction of costs from the royalty, it did not comply with Pennsylvania law.  Id.

The court noted that “a plain reading” of the statute supported the Plaintiff’s position because it does not provide for subtraction of any costs.

Defendants argued that reduction of costs is standard in the industry and the court noted that the question would turn on how “royalty” should be interpreted.  Plaintiffs pointed to other jurisdictions’ definitions of “royalty” and to the “First Marketable Product Doctrine,” which provides that post-production costs should not be deducted from a royalty.  Id. at *10.  The court noted that Pennsylvania recognized this theory over 100 years ago, and that it is apparently still good law.  Id. 

The court declined to dismiss the case because two schools of thought exist as to what the term “royalty” means, id. at *12, and because the court would be required to look to materials outside of the pleadings to determine “industry practice,” which the court could not do at the motion to dismiss stage of the litigation, id. at *13. 

See also, Price v. Elexco Land Servs., Inc., 2009 WL 2045135 (M.D. Pa., July 9, 2009) (same result).

Pennsylvania Supreme Court Appeal:

Kilmer v. Elexco Land Servs., Inc., No. 63 MAP 2009 (Pa.).

 

On June 16, 2009, the Pennsylvania Supreme Court asserted its extraordinary jurisdiction to bypass the Superior Court and take a case directly from the Court of Common Pleas of Susquehanna County explicitly on the question of whether a lease violated the Minimum Royalty Act because post-production costs were to be deducted from the royalty.  The Court identified the question before it as:

Whether 58 P.S. § 33 precludes parties from contracting that post-production costs be factored into the determination of the amount of royalty payable under an oil or natural gas lease.”

Seven amicus curiae briefs were filed.  The case was argued before the Supreme Court on September 16, 2009.  No ruling has yet been handed down by the Court.  We expect that a ruling will be issued in the next several months.

    When the Supreme Court finally issues its ruling on the Minimum Royalty Act, it may have a profound effect on existing leases for Marcellus gas as well as other oil and gas interests.  A strong possibility exists that the Supreme Court will issue a ruling to preserve the status quo, which will have no impact on existing Marcellus gas leases.  Any interpretation that production and other costs may not be deducted from a 1/8th minimum royalty, however, will have an impact on literally thousands of Marcellus and other leases.  This will require both lessors and lessees to revisit all of their 1/8th minimum royalty Marcellus (and other oil and gas) leases to make sure they are in compliance with the Court’s requirements.  Stay tuned.

 

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Tangible Economic Benefits From Marcellus Shale Beginning to Emerge

In a struggling economy nothing would be more noticeable than private capital investment from a strong industry, generating jobs.   And so it goes in this timely article from the Williamsport Sun-Gazette, cataloguing the specific areas of development activity and new employment emerging in Lycoming County.  The article can be accessed by clicking here.

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