1. The “unit”.     Leasing all of one’s acreage to an energy company does not necessarily mean that the land owner will receive royalties on all of those acres.  The land owner will receive royalties only on that portion of his or her land which is actually included within a “unit”.  Therefore, an understanding of unitization is essential.

The energy company must assemble a large block of adjoining leased parcels, consisting of several hundred acres or more (the “unit”) in order to drill horizontally for thousands of feet under the ground.  The unit designation is a part of the energy company’s permit application to the Pennsylvania Department of Environmental Protection.  The unit designation is surveyed, and might follow property lines, or it might be the subject of a survey which divides individual properties.  Only that acreage actually located within the unit designation will receive royalties.  Acreage outside of the unit will not be included in the royalty calculation, even though it is under lease.  Therefore, it is critical to know what portion of your acreage is actually located within the unit in order to determine what royalty you will receive.  Don’t assume that you will receive royalties based on your 100 acres under lease; if only 20 of those acres are within the unit, you will receive royalty based only on 20 acres.

1. Lease language.   Oil and gas leases contain a variety of methods for calculating royalties.  Some leases provide that the land owner will pay for a proportionate share of a very broad assortment of “post-production” costs before royalty is calculated.  These can include”… all costs of gathering, marketing, compression, dehydration, transportation, processing… or any other treatment… required”.  This broad language could include anything, even sales commissions.

Other lease forms say that ”… proceeds accruing to the Lessor… shall be without deduction…for the cost of producing, gathering, …etc.”  Lease language can make a critical difference.  Which is a better deal for the land owner:  17% royalty under the first example above?  Or 15% royalty under the second example?

1. The price of natural gas.   Royalties, of course, are a percentage of the sale price the energy company receives when it sells the gas it produces.  Natural gas is a commodity, and its price changes daily.  The higher the price the energy company receives for the sale of its gas, the greater the royalty the land owner will receive.  Conversely, lower natural gas prices mean lower royalties.

The land owner has no control over the price of natural gas, which right now is at historic lows.  It is actually below the breakeven point for many of the energy companies.  Both the energy companies and those who receive royalties want the price of natural gas to increase substantially.  About 50% of all of the royalties a land owner will ever receive will be paid in the first two to three years of production; after that, production declines sharply.  Obviously, it is far better for the land owner to receive royalties based on a high price of natural gas, especially in the early years of production.

Here is how royalties are calculated.  Assume a unit of 640 acres.  Assume the land owner leased all 50 of his or her acres, but that only 30 acres are actually included within the unit designation.  The land owner’s share of royalties is 30/640 or .0468 of the land within the unit (less than 5%).  At a 17% royalty, the land owner’s share is .0468 x .17 or .007956 of the production of the unit before post-production costs are deducted.  This could result in a low royalty because the price of natural gas is so low.

Although most oil and gas leases permit the lessor to inspect the books of the energy company to determine that royalties are being calculated properly, as a practical matter this is an impossible task for an individual.  The cost would be prohibitive, even if the individual knew what to look for and how to read the data.  Owners of very large tracts under lease can hire professional royalty managers, who for a fee monitor the activity of the driller, and the calculation of royalties.  NARO (the National Association of Royalty Owners) can provide support for those who receive royalties.  Sometimes blocks of land owners under lease can combine their resources, and hire a professional royalty manager.

The energy industry is trying hard to create new markets for natural gas and cause the price to rise.  The conversion of motor vehicle fleets to natural gas, especially over the road trucks, will help greatly, as will the conversion of coal-fired power plants to natural gas.  The price of natural gas will eventually increase, and that will spell good news for those who receive royalties, and for our region’s economy.

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In order for a drilling company to put together a large tract of gas rights for the purpose of horizontal drilling, the drilling company must form a “unit”.  This typically means that several adjoining tracts of gas rights under lease are “unitized,” and all developed together at the same time.  A unit can consist of one or two large parcels or a great many smaller parcels.  Typical units can consist of several hundred to more than 1,000 acres.

These large units are necessary to allow the drilling companies to justify the large capital expenditures required.  Unitization also reduces the disruption of the surface because fewer drill sites are needed.

The companies cannot drill through a gas owner’s land without permission; that is, without a negotiated lease in place.  All of the gas owners who have leased and are located within the unit will share in the royalty created by gas production within the unit.  It should be noted that the method of configuration of the unit by the drilling company is not regulated by law in Pennsylvania.  The unit can be any shape the company chooses.  It can follow property lines, or not, as the company may decide.

There is no requirement that the owner of gas in the Marcellusformation lease that gas.  If an owner of gas chooses not to lease it, then that gas would therefore remain undeveloped, with a number of negative consequences.  The owner of oil and gas
on the opposite side of the non-leasing gas owner would be “blocked” and the lateral could not reach the blocked gas owner.  That gas owner would end up in the very unhappy position of not being able to realize royalty income even though they wished to.  The non-leasing gas owner may also cause one or more laterals not to be developed at all because the companies cannot afford economically to drill laterals that are too short.  As a result of this “stranded” gas, a number of consequences flow:

1.  No local, state and federal income tax is paid because no royalty is paid;
2.  No gas is produced from the unleased land, thereby developing the remainder of the gas field in a very inefficient manner;
3.  A certain number of Marcellus related jobs will be lost; and
4.  Owners of “blocked” gas will not be able to profit from their valuable property right.

All geologists and engineers who study the energy industry agree that the development of gas in the Marcellus fairway should be “efficient”.  That means that where drilling takes place, as much gas as reasonably possible should be extracted, and pockets of unleased gas should not be left behind because they may not be recoverable in the future.

The failure to maximize development of the gas field is caused not only by reluctant gas owners to refuse to lease.  Sometimes the drilling companies have leased tracts of gas interspersed with each other, and they cannot agree on how units could or should be configured; they cannot agree on how leased parcels should be “swapped”.

Some states have reduced these problems somewhat by adopting laws requiring “compulsory integration,” sometimes referred to as “forced pooling”.  Compulsory integration simply means that under certain circumstances, a drilling company is permitted to develop the oil and gas owned by parties who have not leased.

Compulsory integration is not a new concept in Pennsylvania.  The Pennsylvania Oil and Gas Conservation Law presently provides for compulsory integration for certain other gas deposits, but does not include the Marcellus Shale by definition.  Compulsory integration is the law in certain other energy states including Texas.

A well-drafted compulsory integration statute can maximize the efficiency of gas production, and ensure minimal disruption of the surface.  Compulsory integration statutes typically have certain characteristics in common, such as:

1.  Absolutely no disturbance of the surface is permitted on unleased land;
2. The owner of the gas placed into a unit because of compulsory integration will receive royalties according to an agreed upon accepted formula;
3. Compulsory integration actually can protect the owners of smaller parcels during lease negotiations because it creates a royalty “floor,” which the company cannot go below;
4. The statute typically provides for notice and a hearing before gas rights can be placed into a unit by means of compulsory integration;
5. Most statutes require the drilling company to have leased already a certain amount of acreage surrounding the unleased parcel before compulsory integration can be imposed.  This number ranges from 51% to 95% depending on the jurisdiction;
6. Compulsory integration can eliminate “stranded gas” and provide that all owners of oil and gas who wish to be leased cannot be blocked;
7. Both gas owners, and the drilling companies can petition to have gas included in a unit by means of compulsory integration.

Compulsory integration is similar in the minds of some opponents to eminent domain.  They view it as the taking of private property by the government against the wishes of
the owner.  However, in every case, compulsory integration has no impact on the surface; all activities on the land in question are being done thousands of feet under the surface.  There are other common intrusions on private property rights about which people don’t complain.  For example, aircraft fly through our private air space on a daily basis.  We don’t object because the need for air transportation is something we all accept; these aircraft typically have no impact on us at all.  Compulsory integration involves a similar concept.  Most of us agree that the need to develop domestic energy resources in an efficient manner is very important.  This public policy consideration may  outweigh the technical trespass that occurs a mile under our feet.

The Governor’s Marcellus Shale Advisory Committee has recommended that the Pennsylvania Oil and Gas Conservation Law be updated to include the Marcellus Shale formation.  The National Association of Royalty Owners (NARO), an organization that represents the rights of land owners, is in favor of a reasonable compulsory integration law.  Compulsory integration of the Marcellus Shale may become a reality in the near future.
Visit our website at www.bmvlaw.com.

James H. McCune, Esquire

Partner at Bassi, McCune, & Vreeland, P.C.

Seth A. Tongchinsub, Esquire is an associate at Bassi, McCune & Vreeland, P.C.

James H. McCune, Esquire is a partner at Bassi, McCune & Vreeland, P.C.

The natural gas boom has created a need for many different types of pipelines.  All of this gas must be transported from the site of the well, and must go through many stages before it can heat your home or dry your clothes.

Generally speaking, gas pipelines can be separated into three major catagories: 1) gathering lines transport the gas from the well site to either a processing plant, or to a transmission line; 2) transmission lines are large pipelines that transport gas for long distances, for example from Texas or Louisiana to Boston or New York; and 3) distribution lines which transport the gas from the transmission lines to the ultimate end user.

If the company seeking the right to install a pipeline does not already have the right to do so under an existing oil and gas lease, then the company must approach the surface owner and negotiate a separate right of way (also called an “easement”) agreement.  The same pipeline issues ought to be considered and negotiated as a part of the oil and gas lease.

The typical oil and gas lease does a lot more than just lease your oil and gas.  It also contains provisions whereby the land owner grants to the drilling company the right to install several different types of pipelines.  Obviously, the drilling company must have the right to install a gathering pipeline to transport the gas off of the well site.  However, the lease might also grant to the drilling company the right to install above ground water lines because the drilling process can use millions of gallons of water.  This can be true whether the well site is on your land or not.  Of particular concern is the “foreign gas” pipeline.  This lease provision permits the drilling company to install pipelines to transport gas over your land, regardless of where that gas is produced.  In other words, your land can be used for a pipeline that has nothing to do with your land, or the unit of which your land is a part.  The worst part is that the foreign gas pipeline easement can be permanent, even if the drilling company never develops your gas, and allows the lease with you to expire.

Most oil and gas leases provide that the lessee can install an unspecified number of pipelines, throughout an unspecified period of time.  The lease also grants to the lessee the right to install other large installations above ground, such as a compressor station or a “pig trap,”- an above ground installation where a device to clean the pipeline (the “pig”) is inserted or removed.  These could be installed years after the oil and gas lease has been executed.  Some pipelines can be quite large, and under very high pressure.  Once these have been installed, the land owner cannot build any type of improvement on top of them, or within a certain distance from them.

Here are some things to keep in mind when you are approached by a company that wants to build pipelines across your land:

1. Clarify exactly what it is that the pipeline company wants and needs, and make sure that the pipeline right of way agreement very clearly describes what is to be installed.  Is it only a single pipeline the company wants?  Or do they also want to install a compressor station?
2. Agree upon the number of pipelines the company wants.  Don’t leave it open-ended.
3. The easement should carefully describe the location of the pipeline.  Is it close to the property line?  Will trees be removed?  Attach a drawing as an exhibit.
4. Agree upon how the company is to gain access to the pipeline with trucks and equipment when repair or maintenance is necessary. Will any additional fencing or gates be necessary?
5. Make sure the right of way agreement provides that the company will repair all fences or other improvements disrupted by the installation of the pipeline.  How deep will the pipeline be?  Must the company use the “double ditch” method?
6. In appropriate cases, provide for plantings or earthen walls as a buffer from anything on the surface that may be unsightly or noisy.
7. Include a comprehensive indemnity clause that makes the company responsible for all injury, death or damage, including any environmental liability.
8. Last, but certainly not least, the land owner is entitled to reasonable compensation for the granting of one or more pipelines.  Once you execute an oil and gas lease that contains the right to install multiple pipelines, you have little bargaining power.

All of these pipelines and surface installations are a very necessary and important part of the exploration for and production of the Marcellus Shale gas formation.  The production of gas, and the accompanying financial benefit to the land owner and the economy, would not be possible without this complex infrastructure.  However, the rights of land owners need to be protected.  Careful preparation and negotiation can result in an agreement that is satisfactory to both parties.

Visit our website at www.bmvlaw.com.

James H. McCune, Esquire

Partner at Bassi, McCune, & Vreeland, P.C.

Many people, including some lawyers and some of those employed in the oil and gas industry, misunderstand some basic terms and definitions relative to the ownership and leasing of oil and gas.  One of the most confusing terms used is “minerals”.  Many people might assume that the term “minerals” automatically includes oil and gas.  This can be a big mistake.

Pennsylvania law includes a peculiar rule of real estate law known as “The Rule in Dunham’s Case”.  This rule of law, which was the result of a Pennsylvania Supreme Court decision from 1882, provides that the term “minerals” used in a deed or other real estate document typically does NOT include oil and gas.  Dunham’s Rule has been with us for 130 years, and many real estate titles rely on its continued existence; it is with us to stay.

Dunham’s Rule provides that the use of the term minerals creates a “presumption” that the parties did NOT INTEND to include oil and gas within that definition.  Proof of a different intention can be very difficult to come by.  The relevant document using the term minerals might be quite old, and the parties to the document may be deceased.

The advent of the development of the Marcellus Shale has brought Dunham’s Rule to the forefront in oil and gas legal work.  The large drilling companies will apply Dunham’s Rule strictly, and some prospective lessors may be very disappointed when they learn that they do not own the oil and gas underlying their land because an old document used the term “minerals” instead of “oil and gas”.

Dunham’s Rule is very much criticized because of the confusion it can generate.  In the 1950s, the late Pennsylvania Supreme Court Justice Michael Musmanno, known for his flowery language, in a dissent in a case upholding the Rule in Dunham’s Case, stated:  “Since time immemorial, the firmament has been divided into the animal, the vegetable and the mineral.  We can agree that oil and gas is not an animal, nor is it a vegetable.  If it is not a mineral, then what is it?  Have we created a fourth estate to be occupied solely by oil and gas?  Or have we cut it loose to wander aimlessly in search of a home?”

The use of incorrect language can have huge consequences.   An understanding of basic oil and gas law is critical in creating or reviewing leases, deeds, and other legal documents.  The lawyers at Bassi, McCune & Vreeland, P.C. understand the law.  Visit our website at www.bmvlaw.com.

James H. McCune, Esquire

Partner at Bassi, McCune, & Vreeland, P.C.

To avoid this restriction and to free up the land that is not part of the unit, you should consider the inclusion of a clause in your lease that will permit the portion of your property that is not unitized to revert back to your control once the primary term of the lease ends. To free up the rest of your acreage that is not in the unit of production, you should insert a clause in your lease that allows the acreage that is not part of the unit to revert back to you. This clause will prevent the operator from arguing that the entirety of your acreage is being held by production and still within its control. This clause will allow you to lease the remainder of your property to another producer. This clause is commonly referred to as a Pugh clause.

Keep in mind that Pugh clauses can be both vertical and horizontal. Moreover the use of this clause may require specific language to effectively accomplish your intent. If you are a landowner with a sizeable amount of acreage, you should consider inserting a Pugh clause in your lease or addendum. The attorneys in our law firm would be pleased to assist you in understanding more about this concept.

Bradley M. Bassi, Esquire

Partner at Bassi, McCune, & Vreeland, P.C.