The Fine Print of Natural Gas Property Rights: Cautionary Lessons from Western Ohio and New York

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Much of the discussion about hydraulic fracturing has focused on the environmental, health and other community risks allegedly posed by the process.  While these perceived risks have taken center stage in the media, fracturing stakeholders need to be aware of other risks that arise long before a well is drilled—in the deeds, leases and other property-related documents that give stakeholders the right to access and develop natural gas in the first place.  This article briefly discusses two such risks.

“Through and Under,” and Perhaps Out of Business Altogether

Because developing and operating a hydraulically fractured well requires enormous capital investment, the economic viability of a well often depends on being able to reach natural gas resources located not only beneath the parcel of land where the well is physically located, but also beneath adjacent parcels for which the well operator has acquired mineral rights.  The ability to use a single well to reach natural gas trapped in bedrock below several adjacent parcels is made possible by horizontal drilling and hydraulic fracturing technologies.  Employing these technologies, an operator can use fewer wells to access more natural gas that, just a few years ago, was entirely unobtainable.  Fewer wells means fewer disruptive surface activities (e.g., road building, pad construction, well drilling), fewer air emissions from well stacks and fewer of the other environmental risks associated with individual well operations.

Essential to this one-well/multi-parcel approach, of course, is the operator’s ability to move all of this natural gas horizontally beneath adjacent parcels, then upward through the vertical well shaft to the surface.  Indeed, surface access is so essential to developing most natural resources that, historically, most coal companies, oil drillers and other mineral rights developers have ensured such access by purchasing the surface estate(s) that overlaid their mineral grants—or, at minimum, purchasing the surface estate of the particular parcel of land where they intended to bring the resource aboveground.  Even where surface access could not be purchased or leased, mineral rights holders long have enjoyed some legal protection: in most states, subsurface mineral rights carry an implied grant of reasonable access to the surface estate for purposes of exercising the mineral rights.

This implied right to access worked fine for the myriad coal and oil projects that were the hallmark of resource development last century.  But its application to today’s hydraulic fracturing operations—particularly the use of single wells to horizontally access natural gas resources beneath multiple parcels—has become more problematic.

At the center of Jewett Sportsmen Club v. Chesapeake Exploration, LLC, which is pending in the Court of Common Pleas in Harrison County, Ohio, is a dispute over an approximately 177-acre parcel of Western Ohio land the plaintiff purchased from the North American Coal Corporation (NACC) in 1959, which its members have since used for various outdoor activities.  The plaintiff acquired only the surface estate of this parcel, with the NACC retaining all subsurface mineral rights pursuant to a comprehensive mineral rights reservation in the deed.  Those mineral rights were sold by NACC to Chesapeake several decades later. 

Chesapeake intended to construct a single well-pad on the Jewett property, which could then be used to develop natural gas resources located beneath not only the entire 177-acre parcel, but also from beneath several adjacent parcels of land for which Chesapeake also had acquired (from NACC) mineral rights.  The plaintiff sued for an injunction, focusing on three particular clauses of the 1959 mineral rights reservation:

  1. EXCEPTING AND RESERVING from the above-described premises [the 177-acre parcel] all the Pittsburgh No. Eight (8) vein of coal remaining on said premises, and all veins of coal below the Pittsburgh or No. Eight (8) coal and all oil, gas or other minerals
  2. EXCEPTING AND RESERVING from the above-described premises … land at such points and in such manner as may be proper and necessary for the purpose of digging, mining, draining, ventilating and carrying away said coal, oil, gas or other minerals
  3. [T]ogether with the privileges of mining and removing through and under said described premises other coal, oil, gas or other minerals belonging to said Grantor or which may hereafter be acquired by Grantor [emphasis added]

The plaintiff argued that because “said coal, oil, gas or other minerals” in Clause 2 referred only to those resources located beneath “the above-described premises” in Clause 1, Chesapeake could use those premises—the Jewitt Sportsmen Club’s property—only to access natural gas that was physically located beneath the 177-acre parcel.   The plaintiff further argued that any natural gas originating from beneath properties other than the 177-acre parcel was considered “other … gas” that, per Clause 3, could only be moved “through and under” plaintiff’s property.  On these bases, the plaintiff argued that Chesapeake should be enjoined from constructing or operating on plaintiff’s property any well that would be used to remove natural gas originating from beneath adjacent parcels.  The court agreed and ruled that while Chesapeake could use the 177-acre parcel to remove natural gas originating from beneath that particular parcel, any gas originating from other parcels could only pass “through and under” plaintiff’s property and, therefore, could not be removed through the well that Chesapeake was developing.  The decision, which is being appealed, effectively shut down Chesapeake’s operations at the Jewett Sportsmen site.

The Jewett decision has attracted little attention in the media, but should not escape the close scrutiny of oil and gas stakeholders—particularly those with an interest in Ohio, Pennsylvania and West Virginia.  There is a very good chance the decision will survive appellate review.  The court’s decision is on defensible legal footing from both a contractual interpretation and a contractual intent standpoint.  Indeed, as the Jewett court explained in its decision, there was a good reason for the “through and under” language in old coal rights deeds such as this one: while landowners often were happy to allow coal mining beneath their properties (the royalty payments helped), many were heavily reliant on their surface estates (e.g., farmers) and wished to ensure the mining activity conducted beneath their properties remained well below ground.  In short, “through and under” arguably means exactly what the Jewett court said.

Most important, the decision cannot be ignored or dismissed as a “one-off” exception on facts unique to that particular case.  A second lawsuit already has been filed in Harrison County that asks the court to invoke stare decisis and grant a permanent injunction against another Chesapeake operation.  Buell v. Chesapeake Exploration, LLC, seeks to shut down operations at the most productive natural gas well in the United States, the heralded “Buell 8-H” well that Chesapeake’s CEO just a few weeks ago described as the company’s “best shale well ever.”  What makes this second case so potentially troubling is that, unlike Jewett, where the action was brought to prevent a project that was just getting underway, the plaintiff in Buell seeks to enjoin an ongoing operation that Chesapeake began and invested a lot of financial and engineering capital into long ago.  

These risks are not limited to Chesapeake.  With origins dating back to 1913, the NACC was one of the largest coal producers in the United States for much of the last century, and it remains among the top 10 coal producers today.  The company at one time owned almost one hundred thousand acres of land in Ohio, Pennsylvania and West Virginia alone.  A significant portion of those interests were sold off by the NACC years ago, with terms (and mineral rights reservations) that may look exactly like the ones at issue in Jewett and Buell.  Indeed, the leases and mineral deeds at issue in Buell alone reportedly cover not just the 8-H well property, but almost 3,000 additional acres of land Chesapeake has leased or acquired in the area.  Based on our research so far, mineral rights terms like those at issue in Jewett and Buell are far from uncommon—in fact, they may be the norm. 

Assuming Jewett withstands appellate review, Chesapeake’s options may be limited.  It can negotiate with the Jewett Sportsmen Club (and with the Buell plaintiff) to purchase the surface estate of the land where its wells are located, or for a lease that allows it to remove natural gas originating from other parcels, i.e., contract around the “through and under” language.  If plaintiffs do not want to sell or lease the surface estate, the company can negotiate with another nearby landowner to buy or lease surface rights, although this also would require the company to incur the additional (and significant) cost of relocating or reconstructing well pads and re-drilling wells, and potentially having to drill further than the company originally intended.  The other alternatives are even less attractive: construct a well pad and drill on each parcel of land (thus avoiding the “through and under” restriction) or walk away from the plays entirely. 

Chesapeake’s options, like the ruling in Jewett, provide several important lessons to other fracturing stakeholders: 

  • Surface access cannot be presumed.  A stakeholder should consider constructing wells only on land where it owns or has leased the surface estate.  If leased, the agreement should clearly identify the natural gas resources that will be developed and that may be removed through the surface estate.
  • Do not rely on “implied” surface access.  Although most mineral grants come with an implied right to access the surface, that does not mean the surface estate holder will embrace an oil and gas stakeholder setting up operations at the property.  The exercise of “implied” surface access is an invitation for litigation, and may be avoided by negotiating (or even just talking) directly with the surface estate holder in advance.  Though the legal validity of implied surface rights to a mineral interest holder is not at dispute, and negotiating or paying for access guaranteed by (most) state laws may seem counterintuitive and potentially prejudicial, in many cases, the short-term costs of purchasing and documenting a landowner’s consent to surface access will be far outweighed by the long-term certainty of knowing your access rights are in writing, and a significant impediment to litigation by the landowner.  
  • Know your mineral rights.  Because many mineral rights deeds are very old, they were drafted long before horizontal drilling and hydraulic fracturing made it possible for a well operator to reach below parcels of land not covered by a particular deed.  Stakeholders should “audit” their mineral rights closely, focusing on the specific grant language to identify “through and under” or other terms that may pose risk to present and future operations.  In short: know what your mineral deeds actually say. 
  • Follow the litigation.  Much can be learned, and many problems can be identified and avoided, by following the litigation that is already underway. 

It’s About Time

Hydraulic fracturing often is conducted on land for which the well owner or operator has leased the underlying mineral (oil and gas) estate from the real property owner, who retains possession of the surface estate.  Like most lease arrangements, these “oil and gas” leases will state a primary term (e.g., five years) and may allow for a secondary term or lease renewal.  In addition, most oil and gas leases have what is known as a “habendum clause” by which the primary term is automatically extended if, at the time the lease otherwise would expire, the lessee is producing oil and gas from the property.  This habendum clause prevents a property owner from evicting the lessee oil or gas producer when the latter is recognizing the very purpose for which it entered into the lease in the first place.

These temporal lease terms have served property owners and mineral rights developers so well for so long that they have become “boilerplate” in most oil and gas leases.  But such terms only work if the oil and gas developer is given the opportunity to do what is intended by the lease, i.e., actually develop the oil and gas.  And that is where several companies recently have gotten tripped up in New York.

A moratorium on high-volume hydraulic fracturing has been in place in New York since July 2008.  This moratorium will only be lifted if and when the state’s Department of Environmental Conservation (DEC)  finalizes new regulations to govern fracturing.  Those new regulations were expected sometime in the second half of this year, but with New York’s recent decision to involve the state’s Department of Health in a public health impact review, it is more likely that final regulations will not be issued until 2013 at the earliest, and only after another long round of public review and comment.

In the interim, and in anticipation of final rules that will permit fracturing, many oil and gas developers have signed mineral leases with property owners across the state.  Although the exact number of leases is not known, it is estimated that at least 2,200 were entered into from 2006 to 2011.  Over the past two years, many of those leases have come up for expiration—without any oil and gas development having taken place because of the moratorium.  Oil and gas developers, not wishing to lose the mineral rights for which many paid upfront, have been invoking the force majeure clause in these leases to suspend their expiration.  But so far the strategy has been met with a flood of litigation, and stakeholders have seen only mixed success.

Force majeure translates (from French) to “superior power.”  In contracts or leases, a force majeure clause essentially says that if a certain event occurs that is beyond the fault or control of one or both parties—e.g., an act of God or war—a party can invoke that event to excuse its non-performance under the agreement.  And therein lies the first hurdle that oil and gas developers have faced in invoking force majeure in New York.  While New York’s continuing moratorium on fracturing certainly is something beyond the control of the leasing parties, developers have invoked the legal concept not to excuse their own non-performance and get out of lease agreements, but rather to try and extend those agreements and compel continued performance by property owners.  The problem for operators is that force majeure works to excuse one party’s non-performance; it does not work to compel the other party’s performance.

This point has been one of several successfully made by New York landowners in a series of lawsuits challenging developers’ invocation of force majeure to suspend and extend lease agreements.  Landowners also have argued that, because New York’s moratorium is limited to high-volume hydraulic fracturing of horizontal well-bores with liquids, force majeure does not apply because most leases make no reference to a specific type of well stimulation operation and developers retain the ability to develop oil and gas by low-volume fracturing, non-liquid fracturing, vertical well fracturing and other means allowable under the lease agreements.  Moreover, because force majeure does not apply to events that were known or foreseeable at the time an agreement was signed, many landowners have argued that the legal concept cannot apply to leases entered into after 2008, when operators knew (or should have known) about New York’s moratorium. 

To date, landowners have had the better of it in the courts, winning motions to dismiss in two cases challenging force majeure claims.  New York Attorney General Eric Schneiderman also got involved in the issue earlier this year, investigating landowner complaints about Chesapeake’s invocation of force majeure clauses to extend hundreds of lease agreements.  That investigation culminated in a settlement whereby Chesapeake agreed to completely release approximately 50 landowners from their leases, and in return retained the right to renegotiate lease terms with its remaining lessors.

 

Published In: General Business Updates, Energy & Utilities Updates, Commercial Real Estate Updates, Zoning, Planning & Land Use Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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