Articles, Newsletters and Advisories
(The 2019 Babst Calland Report)
This article is an excerpt of The 2019 Babst Calland Report, which represents the collective legal perspective of Babst Calland’s energy, environmental and pipeline safety attorneys addressing the most current business and regulatory issues facing the oil and natural gas industry. A full copy of the report is available by writing firstname.lastname@example.org.
Emerging trend of allocation wells and cross unit drilling in the Appalachian Basin
Allocation wells and cross unit drilling have the potential to create more economic wells using longer laterals, while overcoming unit size limitations commonly found in oil and gas leases. An allocation well is a lateral wellbore that crosses multiple lease boundaries of tracts that have not been pooled or unitized. Similarly, cross unit drilling involves laterals that traverse multiple units.
The use of allocation wells and cross unit drilling in Texas and Oklahoma has evolved out of legislation, administrative rulings and case law. Allocation drilling and cross unit drilling are not yet widely used in the Appalachian Basin, but as drilling technology evolves it is likely that operators will look to the feasibility of employing that technology across the basin.
The biggest risk with allocation wells in the Appalachian Basin is the lack of specific authority under most standard Appalachian Basin leases granting the operator the authority to drill allocation wells. Consequently, possible claims might be asserted challenging an operator’s transportation of non-native gas across leased lands or the commingling of native and non-native gas produced from separate units or leases. Another issue associated with the potential use of allocation wells is determining the appropriate method of allocating production royalties between the different lessors. Absent an agreement between the lessors, there is no comprehensive guidance in the Appalachian Basin for the appropriate method for allocation of royalties between lessors from production via an allocation well.
There are signs that these risks and unanswered questions will be addressed in the near future. In 2019, House Bill 247 was introduced in the Pennsylvania House of Representatives which provides for a process and accounting method for allocation wells. Similarly, operators in Texas and Oklahoma are beginning to obtain production sharing agreements from the various lessors that explicitly govern how payments will be made via production from an allocation well. This is a practice that could work in the Appalachian Basin if operators include allocation well language in a standard lease form or amend existing leases to allow for allocation wells.
Briggs v. Southwestern Energy
In November 2018, the Pennsylvania Supreme Court agreed to hear the appeal of the Superior Court’s decision in Briggs v. Southwestern Energy Production Company, which held that the rule of capture does not preclude liability for trespass due to hydraulic fracturing. The Supreme Court’s acceptance of the appeal and the court’s rephrasing of the question it will decide has led the Pennsylvania Independent Oil & Gas Association, Pennsylvania Chamber of Commerce, American Petroleum Institute and other industry groups to file friend of the court briefs advocating that the decision be overturned. The Supreme Court reframed the issue as:
Does the rule of capture apply to oil and gas produced from wells that were completed using hydraulic fracturing and preclude trespass liability for allegedly draining oil or gas from under nearby property, where the well is drilled solely on and beneath the driller’s own property and the hydraulic fracturing fluids are injected solely on or beneath the driller’s own property?
On January 30, 2019, Southwestern Energy filed its brief with the court. In addition, various amicus briefs were filed in support of overturning the Superior Court’s decision. The Briggs’ brief was filed on April 3, 2019, and reply briefs are expected to follow. Oral argument has yet to be scheduled.
Interpretation of oil and gas reservations in conveyances
The holding in a recent Superior Court unpublished decision, Julia v. Huntley, is a reminder that exception and reservation clauses should be specific and any restrictions or limitation to an interest should be clearly expressed. The Julia court resolved a deed interpretation issue on whether a 1931 exception and reservation of an oil and gas interest applied only to the lease then in effect or to all subsequent leases. The court held that the reserved interest survived the expiration of subsequent 1933 lease recited in the deed. The oil and gas reservation stated that the conveyance was “made subject to the terms, conditions and stipulation of a certain lease entered into by the said William E. Huntley with Northern Pa. Development Co.” and reserved to the grantor, and his heirs, “one-half of any and all royalties and income or return from any oil or gas which may be produced on or from the premises hereby conveyed.” On appeal, the plaintiff argued that the deed only reserved onealf of the royalty payments from the oil and gas produced under the then existing lease. Ultimately, the Superior Court disagreed, holding that the reservation clause successfully reserved to the grantor one-half of the royalties under any future lease. By the intentional placement of the word “and” between the clauses “one half of any and all royalties” and “income or return from any oil or gas,” the grantor intended to reference circumstances in addition to the lease, i.e., royalties and oil and gas rights. The court further reasoned that if the grantor had sought to limit the reservation to the then existing lease, he would have included “language reflecting that intent.”
Co-tenancy reform implementation begins
Development of co-owned properties has often been delayed or even avoided because West Virginia courts long followed a minority position requiring 100 percent consent from co-owners. To alleviate that constraint, the legislature passed HB 4268, entitled the “Co-Tenancy Modernization and Majority Protection Act,” which went into effect on July 1, 2018. The act permits operators to develop certain mineral tracts with less than 100 percent consent from co-owners by providing a statutory defense to claims of trespass and waste where the specific requirements and procedures of the act are followed. The act applies solely to the formation targeted for development. If additional formations are developed later, the operator must also comply with the act as to those formations.
Eligibility under the act is determined by three criteria, including whether: (1) the tract has seven or more “royalty owners;” (2) the operator has made “reasonable efforts” to negotiate with all royalty owners to develop the tract; and (3) the operator has secured consent to develop the oil and gas from at least three-fourths of the royalty owners. Consent to develop typically means obtaining a lease, but can also include acquiring fee title, subleases, farmouts and other joint venture arrangements.
The act addresses both unwilling royalty owners and unknown or unlocatable owners. For unwilling owners, the operator is required to give the unwilling owner a final lease offer and provide notice of their right to elect either a production royalty or to participate in development. The operator must then send a final lease offer which advises that if the lease offer is not accepted, the operator is proceeding under the act and sets forth the owner’s election rights. The owner then has 45 days to either accept the lease offer or elect either a production royalty or to participate in development. An owner who doesn’t respond is deemed to have elected a production royalty.
Owners who elect to share in production receive their pro rata market share of revenue and costs to be calculated once their share of production is double their share of the costs. These owners are also subject to, and benefit from, the terms governing participation in deep wells under W.Va. Code §22C-9-7(b)(5)(B). Owners who elect or are deemed to have elected a production royalty are entitled to the highest royalty rate paid to other co-owners of the tract and to a bonus based on a net weighted average of bonus, rentals and other nonroyalty payments. The owner is also entitled to the most favorable lease terms granted to other owners.
Finally, there are certain lease provisions which may not be enforced against a nonconsenting co-owner including arbitration, choice of law, title warranty, injection wells and storage rights. In essence, a statutory lease is created under the terms set by the act. A nonconsenting owner who doesn’t agree with the terms of the production royalty has 30 days from the end of the election period to file an appeal to the Oil and Gas Conservation Commission. Although the act does not require that the operator record its development plan, an operator filing of some form is beneficial to put third parties on notice of the targeted formation.
For unknown or unlocated owners, the election process does not apply, and those owners are automatically provided a production royalty. The operator is required to search certain sets of public records and other sources to attempt to identify and/or locate owners.
Although not required, it is recommended that these efforts be documented by affidavit or other means to demonstrate compliance with the Act. In summary, the act is a positive step forward for operators in developing co-owned properties.
Clarity on title issues involving tax sales
An analysis of tax sales and the interests that they convey is critical to determining correct oil and gas ownership. A relatively common problem arises when the tax sale involves an interest that is assessed multiple times.
Since 2016, the West Virginia Supreme Court of Appeals has issued three opinions stemming from the duplicate assessment of oil and gas interests located in Harrison County. Most recently, in L&D Investments, Inc. v. Mike Ross, Inc., the court reaffirmed long-standing precedent holding that in the case of two assessments of the same land under the same claim of title, the state can only require one payment of taxes under either assessment.
In L&D Investments, the oil and gas underlying a parcel was severed from the surface in 1903 and conveyed through various instruments to several parties. From 1946 through 1999, 100 percent of the interest was assessed under one “master assessment.” In 1988, the county assessor’s office reworked its real property assessments to include production-based assessments for the same properties that were also subject to the master assessment in the personal property tax books. As to those properties where the personal property assessment could not be matched with a real property assessment, a double assessment occurred.
In 2000, taxes under the master assessment became delinquent and the tax lien was purchased at tax sale by the respondent. At the time of the tax sale, L&D Investments’ predecessors were paying the production-based tax assessments for the owners’ undivided interests in the mineral tract. The court found that the production-based assessments were double assessments because they covered the same interests encompassed by the master assessment. Since L&D Investments’ predecessors continuously paid the production-based assessments, the court held that those payments were all that the state could require and ruled that the tax deed issued to respondent was void as a matter of law. Further, the court held that L&D Investments’ claims were not time barred by W.Va. Code §11A-4-4 because tax sales that are the result of duplicate assessments are not subject to a statute of limitations.
Dundics and landman registration statute
On September 25, 2018, the Ohio Supreme Court ruled in Dundics v. Eric Petro. Corp. that independent landmen, who acquire oil and gas leases on behalf of operators, are required to be licensed real estate brokers under O.R.C. §4735.01(A) since an oil and gas lease constitutes “real estate” as defined in O.R.C. §4735.01(B). The court found that the statute was unambiguous as to the definition of “real estate” and “real estate broker,” and it did not provide for an exception for independent landmen. The court stated that determining whether a landman should be required to be a licensed real estate broker is a policy decision for the Ohio General Assembly and not the court’s responsibility to create an exception that clearly does not exist in the statute.
Following the Dundics decision, the Ohio General Assembly acted in response to the ruling and passed SB 263, effective March 19, 2019. SB 263 revised O.R.C. §4735 to specifically exclude from the licensed real estate broker requirement an “oil and gas land professional” employed by a person or company for which they are performing his or her duties or a professional that complies with the conditions of O.R.C. §4735.023(A). The statute defines an oil and gas land professional as a “person regularly engaged in the preparation and negotiation of agreements for the purpose of exploring for, transporting, producing, or developing oil and gas mineral interests, including, but not limited to, oil and gas leases and pipeline easements.”
It also requires an independent professional to register annually with the superintendent of real estate and pay an annual fee set, which shall not exceed $100. O.R.C. §4735.023. In order to register with the superintendent, the professional must provide evidence of membership in good standing in a professional organization with an established set of performance and ethics standards. Additionally, prior to beginning negotiations with a landowner, the professional is required to disclose that he or she is a registered oil and gas land professional and a member of a landman professional organization, but is not a licensed real estate broker.
Under this new legislation, a registered, independent landman is no longer required to be a licensed real estate broker in order to acquire oil and gas leases. However, this exception does not apply to fee simple transactions involving oil and gas rights, which continue to require the landman to be a licensed real estate broker.
Developments in Marketable Title Act and Dormant Mineral Act
Ohio’s Marketable Title Act (MTA) continues to be a contentious statute for disputes involving ownership of oil and gas. The MTA extinguishes various property rights, including severed oil and gas rights, existing prior to the root of title (i.e., the most recent instrument of record older than 40 years) unless an exception applies. As to the exceptions, the MTA provides a mechanism that allows an owner to actively preserve a severed interest from extinguishment. In addition, even with no action by its owner, MTA preserves a severed interest specifically identified in the record chain of title of the individual claiming the extinguished interest. This past year, Ohio courts have applied the MTA to both severed fee and royalty interests, but have undertaken drastically different approaches to whether those interests were extinguished under the statute.
On December 13, 2018 the Supreme Court in Blackstone v. Moore determined that a severed royalty interest had not been extinguished under the MTA because the surface owners’ root of title specifically referenced the severed interest. While the Supreme Court refrained from establishing a bright-line rule as to what information was necessary to distinguish a general reference from a specific reference, the court instead looked to whether the reference to the severed interest included details and particulars to accurately describe the interest. Because the root of title in Blackstone identified the type of interest created and identified to whom the interest was originally reserved, the court found that the reference was sufficiently specific to preserve the interest under the MTA.
The Seventh District Court of Appeals recently issued two opinions which appear to divert from the Supreme Court’s holding in Blackstone. Tasked with determining whether the roots of title contained sufficiently specific references to preserve severed mineral interests from extinguishment under the MTA, in Soucik and Mellott the Seventh District held that because the roots of title contained exceptions, the surface owners were precluded from claiming the mineral interest had been extinguished under the MTA. The Seventh District even held that a perfunctory exception to oil and gas “as heretofore reserved” in the root of title barred the surface owner from claiming title to the mineral interest. These decisions appear to disregard the Blackstone holding requiring a reference to include sufficient details and particulars accurately describing the interest.
Ohio courts also continue to address claims to minerals by surface owners under the Ohio Dormant Mineral Act (DMA). In Soucik and Mellott, the Seventh District confirmed that for a surface owner’s DMA attempt to avoid being declared void, the surface owner must attempt service by certified mail on the holders of the mineral interest. If, after “reasonable due diligence” the surface owner is unable to locate the holders of the mineral interest, then service of notice by publication may be utilized. While refraining from establishing a bright-line rule, the court looked to see if surface owners searched probate and deed records, Ohio Department of Natural Resources records, and conducted an internet search. Additionally, the Seventh District made it clear that, if challenged, the surface owner must be prepared to present their efforts to locate holders in the form of an affidavit before proceeding with notice by publication. The decision calls into question previously completed DMA attempts where notice was served through publication only.
With the likelihood of Soucik and Mellott being appealed, the Ohio Supreme Court will probably have an opportunity to address the apparent conflict between its holding in Blackstone and the holdings in Soucik and Mellott. Although not squarely at issue in Blackstone, the Supreme Court may also address the potential conflict between the MTA and DMA and whether both statutes can be utilized by a surface owner to claim severed mineral interests.
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