Marcellus Shale Law Monitor

By Attorney Dale A. Tice, Marshall, Parker & Associates

This blog has followed the developments as Pennsylvania legislators debated the details regarding the impact fee legislation.  When Governor Corbett signed Act 13 on February 14, 2012 most of the public attention was focused on the actual impact fee, but the new law included many additional provisions that updated the Commonwealth’s regulation of oil and gas development. Most controversial, however, was a restriction of municipalities’ authority to enact zoning ordinances that regulate where oil and gas development may occur. Act 13 provides that all local ordinances regulating oil and gas operations shall allow for reasonable development of oil and gas resources and section 3304 specifically requires that local ordinances must allow well drilling and pipeline operations as a permitted use in all zoning districts.

An earlier blog post discussing Act 13 may be found here.

The Pennsylvania Commonwealth Court has now held that section 3304 is unconstitutional. Writing for the 4-3 majority, President Judge Dan Pellegrini stated:

Because 58 Pa. C.S. §3304 requires all oil and gas operations in all zoning districts, including residential districts, as a matter of law, we hold that 58 Pa. C.S. §3304 violates substantive due process because it allows incompatible uses in zoning districts and does not protect the interests of neighboring property owners from harm, alters the character of the neighborhood, and makes irrational classifications. 

The complete text of an amended version the opinion may be viewed here.

Although representatives of the seven municipalities that filed the petition for review are calling the ruling a great victory, celebrations may be premature. While the Commonwealth is enjoined from enforcing the provisions of section 3304 at this time, the reprieve may the temporary as it seems certain that the decision will be appealed to the Pennsylvania Supreme Court.

The Marcellus Shale Law Monitor will continue to follow developments in this case – check back for updates.

By Attorney Dale A. Tice, Marshall, Parker & Associates

Those of us who were working on oil and gas law way back in 2008 remember the heady days of the Marcellus gas leasing boom. Before the major oil and gas companies had shown any interest in the Marcellus, a number of smaller, independent drilling companies were leasing acreage in the core areas as rapidly as possible. The New York Times quoted this Commentator describing the leasing land grab as a “feeding frenzy.”

Thanks to the efforts of the Penn State Cooperative Extension, many landowners were aware of the potential pitfalls in the leasing process and realized that the leasing frenzy created an opportunity to negotiate favorable lease terms. Landowners in the hot spots were often presented with offers to lease from multiple companies, each trying to establish a dominant leasehold position. It was this intense competition for prime Marcellus acreage that placed educated landowners in a fortunate posture from which to negotiate, and those of us working with landowners became accustomed to seeing long lists of landowner-friendly addenda attached to gas leases.

The Times They Are a-Changin’

At this point in 2012 several long-term trends have become apparent that are significantly impacting Marcellus landowners.  The large majority of the land available in the prospective areas of the Marcellus has been acquired by the gas companies; the leasing boom has come and gone. The major oil and gas companies recognize the critical importance of unconventional shale gas for our nation’s energy future and have invested heavily in Pennsylvania Marcellus, with the result that various sections of the core acreage are now held by a handful of dominant players. 

A very significant result of the Penn State educational blitz was that landowners realized the importance of requesting a gas lease with a straight five-year term, with no option to extend the lease for an additional five-year term. In order to keep these leases from terminating, the gas companies need to get the acreage drilled and begin producing natural gas. A key goal of the gas companies now is to keep the acreage that is leased “held by production” so the five-year leases don’t expire.

Residents of the core areas of the Marcellus are living with the results of the race to hold land by production. Drilling activity has taken off in the years following the leasing boom and as wells are completed and go online, natural gas production from unconventional shale has increased significantly. However, as the supply of methane natural gas has increased, the price of natural gas has consequentially dropped. This trend toward lower prices for “dry” natural gas has occurred just as the price of oil and natural gas liquids has spiked.

The Impact on Pennsylvania Landowners

How are these long-term trends impacting Pennsylvania royalty owners? What we see now are strategies from the gas companies to hold more land with less drilling. The standard 640 acre production unit seen in earlier leases has been abandoned for much larger pooled production units, in some cases over 1,200 acres. As the size of the production unit increases, more land is held by production and fewer leases will expire, but each landowner's proportional share of royalties from the unit is diluted.

Landowners with expiring leases who hope to sign a new lease face a vastly different leasing environment. Competition for new leases is no longer the norm. Many landowners will instead be dealing with the one gas company that holds the dominant position in their area. And without competition for leases, landowners will be in a far less advantageous position from which to negotiate. Provisions that landowners and their lawyers have become accustomed to seeing in leases, such as a Pugh clause or royalties paid without deductions for post-production costs, may be difficult to obtain.

Some property owners with land outside the core areas for Marcellus development may find no interest in leasing their acreage. Although the gas companies were willing to lease over a broad area during the height of the leasing frenzy, leasing activity now is much more targeted in the areas where drilling activity is focused.

In fact, Marcellus acreage no longer appears to be the hot commodity. As the market has been flooded with unconventional shale natural gas and the price has plummeted, the gas industry has shifted focus to areas such as Ohio and North Dakota where higher priced oil and “wet” gas with associated liquids such as butane or propane may be found.

A Bright Future

But there may be a silver lining to this dismal cloud of bad news for Pennsylvania royalty owners. Although low-priced natural gas may dim the prospects for Marcellus development in the short-term, the big picture over the long-term looks increasingly bright. We are just beginning to see a huge shift in national policy away from coal and imported oil toward use of domestic natural gas for electricity production and even natural gas vehicles. Energy independence for our nation finally appears within reach. Ultimately, what is driving this shift is cheap natural gas.

Pennsylvania royalty owners need to keep their chin up and look forward to the day when Marcellus natural gas is powering our nation’s energy future.

By Attorney Dale A. Tice, Marshall, Parker & Associates

In an earlier post on this blog I had expressed confidence that the Pennsylvania legislature would enact a Marcellus drilling impact fee. Although the legislative negotiations have taken longer than I had anticipated, the Pennsylvania House and Senate have now passed House Bill 1950 and the bill was signed by Governor Tom Corbett last week. The legislation imposes an annual impact fee on each natural gas well drilled into an unconventional formation such as the Marcellus or Utica shale, and also significantly updates the existing Oil and Gas Law.

Reaction to the bill that was passed has been mixed. Some organizations with an environmental agenda have labeled the legislation a gift to the oil and gas industry. Other commentators have suggested that the new fee structure, coupled with current low natural gas prices, will drive oil and gas development elsewhere. Aside from the actual impact fee, perhaps the most controversial aspect of the new law is a limitation on the ability of local municipalities to regulate drilling activity and enact zoning ordinances.

An interesting twist added by the legislature is tying the revenue that will be generated to the current price of natural gas. For instance, if the price of natural gas averages less than $2.25, the impact fee will be $40,000 for the first year of the well. On the other hand, if the annual average price of natural gas is $6.00 or more, the first year impact fee will be $60,000. With the recent rock-bottom prices for natural gas, it seems likely that the revenue from the impact fee will be on the lower end of the scale. Sixty percent of the revenues will be distributed to counties and municipalities where wells are located, with the remainder going to the state.

One of the more divisive issues regarding the legislation was who would have the authority to levy the fee. The final version of the legislation requires that the fee be adopted by individual counties, rather than the state government. If a county should choose to not enact the fee, an affirmative vote by fifty percent of the municipalities in the county will override the decision. The legislators’ efforts notwithstanding, Grover Norquist still calls the fee a tax.

Viewed from the perspective of the local landowner, some of the more important provisions in the new legislation are as follows:

Setbacks

The previous regulations require that oil and gas wells be located at a minimum distance of 200 feet from an existing building or water source. Section 3215 of H.B. 1950 increases the minimum setback to 500 feet for an unconventional well, unless the owner of the property consents to a reduced distance. Unconventional wells must also be located at least 300 feet from any spring or other body of water.

H.B. 1950 does, however, provide an exception to the minimum distance requirement when the owner of the building or water well does not give consent and the distance restriction would deprive the owner of the oil and gas underneath the property of the right to share in production. A similar exception appeared in the previous version of the Oil and Gas Law, which provided that a well operator may be granted a variance from the distance requirement upon submission of a plan with additional measures to protect the property. But while the previous regulation states that the well operator may be granted a variance, H.B. 1950 provides that the operator shall be granted a variance. Time will tell whether the change from the permissive “may” to the mandatory “shall” will prove to be significant.

Water Testing

As anyone who even casually scans the news is aware, there have been ongoing concerns about the potential impact on water supplies from Marcellus drilling. Pennsylvania has provided an important protection for landowners with a presumption that a well operator is responsible for water pollution if the water well is within one thousand feet of drilling and the pollution occurred within six months of the completion of operations.

H.B. 1950 significantly adds to this protection by extending the presumption to water wells within 2,500 feet of unconventional drilling operations and increasing the period in which the presumption applies from six months to one year.

Hydrofracturing Disclosure

In an effort to allay concerns about hydraulic fracturing some operators in the oil and gas industry have moved to voluntarily disclose the contents of fracking fluids. H.B. 1950 now requires that a well operator disclose the identity of the chemicals used in hydraulic fracturing on a public chemical disclosure registry. This legislative mandate that the industry disclose the details of fracturing fluids is one of the provisions in the new law that has received the most positive media attention.

But the legislature has also provided the industry with an exception to the rule requiring disclosure if “the specific identity of a chemical or the concentration of a chemical, or both, are a trade secret or confidential proprietary information.” In that case, the operator need only disclose the chemical family or similar description associated with the chemical.

It may be hoped that the oil and gas operators in Pennsylvania will see the public relations benefit from transparency in hydraulic fracturing operations and will not take advantage of the exception to the disclosure rule generously provided to the industry by the Pennsylvania legislature.

Local Municipal Regulation

As discussed above, the restriction on the ability of local municipalities to enact zoning ordinances that regulate where oil and gas drilling activities may occur is probably the most controversial aspect of H.B. 1950. The bill explicitly preempts all local ordinances regulating oil and gas operations and requires that all such ordinances allow for reasonable development of oil and gas resources.

The oil and gas industry has consistently argued that it needs uniformity in terms of regulation across the state; adapting to a patchwork of varying regulations from different municipalities would significantly add to the cost of operations and may drive the industry to shift development to areas with lower operating costs. Governor Corbett and the legislature clearly take this concern seriously and the result is that Section 3304 of H.B. 1950 requires that local ordinances allow oil and gas activities, other than activities at impoundment areas, compressor stations and processing plants, as a permitted use in all zoning districts.

Section 3304 also provides that a municipality may not impose requirements or limitations on oil and gas operations that are more restrictive than those placed on other industrial activities.

The final version of this legislation appoints the state Public Utility Commission as the arbiter of disputes between local governments and operators as to whether an ordinance violates the requirements of Section 3304.

The bill appears to be designed to discourage such disputes. Section 3307 provides that a court can award attorney fees and costs if it finds that a municipality enacted an ordinance with willful disregard for the requirements in H.B. 1950. The municipality will also be ineligible to receive funds collected under the impact fee until it amends or repeals the ordinance.

Conclusion

Pennsylvania has been considering some form of a severance tax or impact fee since the Marcellus boom began. H.B. 1950 is the product of extensive negotiations and reflects a compromise between the various competing interests. Though the legislation leaves room for improvement, in the opinion of this Commentator it is nevertheless a significant step in the right direction.

I was recently invited to join a panel discussion at the statewide business meetings of the Pennsylvania Association of Realtors^® (PAR). The meeting was held at the Hilton Harrisburg on January 22, 2012. Other panelists included Hank Lerner, the Director of Professional Practice for PAR , and David Evenhuis, an attorney with the Harrisburg law firm Caldwell & Kearns.

A link to a video recording of the panel discussion can be found here.

PAR recognizes that Marcellus development is having a significant impact on the business practices of its members. Working with property subject to an oil and gas lease raises concerns for both the buyers and sellers of real estate and PAR is committed to educating its members about the issues that realtors in the Marcellus region need to have on the radar.

Ensuring that a buyer of real estate is fully informed about the property being purchased is critical and today that clearly includes knowing the status of the gas rights and any oil and gas lease covering the property. Buyers will need to know about the specific rights granted to the gas company in the gas lease, which means that buyers must have a copy of the signed lease available for review. However, buyers of real estate cannot in most cases obtain a copy of the lease from the county recorder of deeds because the gas companies don’t typically record the actual lease; instead, the industry practice is to  record an abbreviated memorandum of lease that doesn’t included all of the information necessary for a buyer to review. Mr. Evenhuis has extensively researched the legality of this practice and discussed his concerns at the PAR meeting.

The primary focus of my discussion was the impact of various terms in a lease on a buyer’s ability to use and enjoy the property, and the property value. The gas lease will in most cases give a very broad grant of rights to the gas company, including the rights to drill wells, construct roads, place pipelines and related facilities, to use the property for underground gas storage and to drill wells for disposal of waste fluids. In many cases the seller will have worked with a qualified attorney to restrict this broad grant of rights, but a buyer of property will obviously need to know these details before entering into an agreement of sale.

There was also a discussion of the general trends that we see in Marcellus development today.

It was a pleasure presenting with Hank Lerner and David Evenhuis and I commend the Pennsylvania Association of Realtors^®  for its educational efforts on behalf of its members.

In a recent post I suggested that some form of a Marcellus Shale impact fee was on its way. Although there are significant differences between the House and Senate versions of the bills that have been passed, I was nevertheless optimistic that our Pennsylvania legislators would agree on a compromise. It’s beginning to appear that my prediction may have been overly-optimistic.

There are a number of issues that will need to be addressed in reconciling the competing versions of the bills. For instance, the amounts that will be collected by the impact fee vary considerably. Here is a link to an article which includes a chart that nicely summarizes the key differences in the amounts collected and the allocation of the proceeds.

The more critical difference may be regarding who is responsible for collecting the fee; while Governor Corbett and the House agree that the individual counties should asses the fee, the Senate version of the bill gives that duty to the state Public Utility Commission.  

Discussing the Marcellus Shale legislation, the Pittsburgh Post Gazette concludes that “large question marks still loom regarding whether that measure will find its way to the governor's desk by the end of the year”.

The Pennsylvania legislature has been considering some type of severance tax or impact fee since the Marcellus boom began. Whether or not it will happen this year remains to be seen – with only three session days left for the Senate in 2011, our legislators are certainly taking it down to the wire.

Posted below is an article that I wrote for the most recent edition of the PENNROAR - the newsletter for the Pennsylvania chapter of the National Association of Royalty Owners. Please note that forced pooling was not included in the recent legislative proposal from PA Governor Tom Corbett.

Oil and gas leasing and Marcellus development are often perceived as controversial and divisive issues in Pennsylvania. While the large majority of landowners in the Marcellus fairway have been amenable to leasing their property for gas drilling, there is a vocal minority of landowners who vehemently oppose Marcellus development and have refused to proceed with an oil and gas lease for their property.

Readers of the PENNROAR (or this blog) are by now familiar with the operation of the pooling provision found in the gas leases used by Marcellus operators. It is readily apparent that these holdout landowners will make it difficult or impossible for the gas companies to proceed with development of a production unit in the area where the un-leased land is located. For the gas companies, the solution to this problem has been forced pooling – also sometimes referred to as “statutory pooling” or compulsory integration.

Pennsylvania has previously enacted a forced pooling law known as the Oil and Gas Conservation Law, but the current law does not apply to the Marcellus shale. As a result, there has been an ongoing, heated discussion among the various stakeholders about the possibility of drafting a new version of the Conservation Law that would allow compulsory integration of the Marcellus. At this time, it appears that forced pooling may be such a hot topic that legislators will refuse to touch it, but the issue is likely to resurface in future legislative sessions.

It is not the purpose of this article to advocate for adoption of a new forced pooling law in the Commonwealth. Rather, the discussion below highlights a number of issues that should be addressed in the legislative discussion about a forced pooling law, in the event that such legislation is introduced in Pennsylvania.

Good Faith Offer

Texas has enacted a forced pooling law. However, the law requires that the oil and gas company first make a good faith lease offer to a holdout landowner before proceeding with a forced pooling proceeding. As a result, the forced pooling law has been rarely used in Texas. Pennsylvania legislators may consider including such a requirement in any forced pooling proposal.

Minimum Leased Acreage

Some states with forced pooling laws have included a requirement that the operator have a certain minimum amount of acreage leased in the area of the proposed pooled unit. This type of requirement forces the gas company to lease some percentage of the landowners in the area intended for drilling before proceeding with compulsory integration. The percentage of land required to be leased may vary anywhere from 51% to 95%. Obviously, as the minimum percentage required increases, it will be increasingly difficult for the gas company to utilize forced pooling.

Risk Penalty

When an oil and gas company drills a well, there is always some risk that the well will be unproductive and the operator will be unable to recoup its drilling costs. The amount of risk will vary from well to well and will also vary depending on the target formation being drilled.

The concept of the “risk penalty” recognizes that the non-participating landowner who is being forced-pooled should share in the risks involved in drilling. Forced pooling laws accomplish this risk sharing by providing that the non-participating landowner will not receive gas production payments until the gas company has recouped the landowner’s proportional share of the costs to drill the well, plus some additional percentage of the costs as compensation to the operator for undertaking the risk of drilling.

Pennsylvania’s current Conservation Law sets the risk penalty at 200% of the landowner’s proportional share of the drilling costs. Until the gas company recoups double the landowner’s share of the costs, the un-leased landowner will receive a royalty payment of 1/8 (12.5%) of his or her proportional share of production. After 200% of the landowner’s share of costs is recovered by the gas company, the non-participating landowner is then entitled to his or her entire proportional share of the total gas production.

Legislators may also address the specific types of drilling costs that may be charged against the landowner’s share.

The most recent forced pooling proposal discussed here in Pennsylvania set the risk penalty at 400%. It may be questioned whether the risks involved in Marcellus drilling justify a risk penalty in that range.

Landowner Surface Protection

A forced pooling law should explicitly provide that the surface of the land of a non-participating landowner may not be used for drilling operations. Legislators may also consider a provision requiring that the operator provide compensation to the landowner in the event that there is some inadvertent impact on the un-leased landowner’s property or water supply.

Conclusion

This commentator does not intend to suggest that forced pooling is either good or bad for Pennsylvania landowners. But clearly, Pennsylvania royalty owners must understand that when evaluating any future forced pooling proposal, the devil is in the details.

When meeting with clients who own land in the Marcellus Shale, I frequently sense that they are suffering from information overload. Every media outlet streams a confusing mix of fact and opinion, and every week there is a new seminar to attend providing more information to process. One week they are told that the sky is falling, while the next speaker calmly informs them that there is nothing to worry about. Where is the truth?

There seems to be particular confusion about the tax risks for Marcellus landowners. While minimizing taxes is an almost universal goal, landowners are unsure what the tax risks may be and are even more uncertain about how and when to plan. Although they may be hearing mixed messages, the plain facts are abundantly clear.

Just the facts.

Production estimates for the Marcellus continue to increase. For instance, Range Resources reports that the estimated ultimate recovery for wells drilled in 2009 and 2010 averages 5.7 billion cubic feet of gas per well – two to three times greater than the lifetime production from wells drilled in the Barnett Shale of Texas, which has been the most prolific natural gas field in the nation.

These production numbers have attracted the attention of the major oil and gas companies. We have seen investment in the Marcellus from Exxon, Chevron, Shell, Hess, Norway’s Statoil and India’s Reliance Industries, among others.

An earlier post on this Blog further notes the potential for a “triple play” for many Pennsylvania landowners as the drillers may produce gas not just from the Marcellus, but also from the Utica and Upper Devonian shales. With more target formations available to the operators, the production potential must increase.

The gas reserves in the Marcellus have recently received a great deal of attention in the national news. The U.S. Geological Survey has dramatically increased its estimate of recoverable natural gas from the Marcellus to 84 trillion cubic feet – 42 times higher than the previous estimate from 2002. While this estimate is lower than the most recent projection from the Energy Information Administration, the amount of recoverable gas is still tremendous.

Dramatically more natural gas means dramatically more wealth for landowners with Marcellus acreage.

The future of the Federal Estate Tax?

Further complicating matters is the uncertainty about the future of the estate tax. Today, individuals can transfer up to $5 million tax free to their children, whether as a lifetime gift or upon their passing. However, the government’s generosity is schedule to end in 2013, when the estate tax exclusion will return to $1 million – unless congress and the president agree to raise the exclusion.  With concerns about the budget deficit and cries for fiscal austerity, it’s beyond the ability of this Commentator’s crystal ball to predict the actions of our polarized and paralyzed government over the next year.

What we do know is that the estate tax is based upon the value of the landowner’s assets as of the date of death, including the value of Marcellus gas rights. An appraisal will be required to determine the value of the gas rights. The most generally accepted appraisal methodology for proven gas reserves projects the stream of royalty income over the lifetime of a well, reduced to its present value. For non-producing properties, the royalty stream is calculated based on the production estimates that are accepted as of the date of the appraisal. This means that as production data improves and the estimates of natural gas reserves increase, the appraised values will also increase.

Because of the uncertainty about future Marcellus development, non-producing gas rights may have a low value today. But as the wells are drilled, gas is produced and production reports are filed with the PA Department of Environmental Protection, the uncertainty disappears and the appraised value of the gas rights is likely to skyrocket.

What does this mean for landowners?

What landowners with substantial Marcellus acreage need to understand is that when maximum gas production is obtained, there is tremendous potential that the value of the gas rights could exceed the federal estate tax exclusion. This means that if a landowner with large acreage dies when the gas rights reach peak value, the estate may well be subject to federal estate tax. If the landowner’s children are unable to produce the cash necessary to satisfy the IRS within nine months of the date of death, the unfortunate result may be that the children will be forced to sell some portion of the gas rights for pennies on the dollar to pay the estate tax that is due.

This is the nightmare scenario that keeps estate planning attorneys in the Marcellus awake at night.

The key takeaway here is that this nightmare can be avoided with proper planning done at the right time. The time to accomplish effective planning is when we have a favorable transfer tax regime and the value of the gas rights is low. In other words, the time to plan is now.

This is an important day for everyone who has an interest in Marcellus Shale development. Pennsylvania Governor Tom Corbett’s Marcellus Shale Advisory Commission is completing its final meeting as I type and has unanimously voted to approve a report with a series of recommendations, some of which are destined for controversy.

A link to a live blog following the meeting can be found here.

The debate that we have seen in the Commonwealth over the last year regarding a severance tax and the proposed impact fee has received national attention. Last month the Governor signed a state budget with the impact fee endorsed by leading state republicans noticeably absent. At the time, Corbett stated he intended to wait for the report from the Advisory Commission. That wait is now over as the final report will be released next week and will include the Commission’s recommendation that the state adopt some form of an impact fee. Debate over the details may continue, but it is apparent to this Commentator that an impact fee is on its way.

As contentious as the impact fee has been, this controversy will pale in comparison to that we will see over the Commission’s recommendation that the state adopt a forced pooling law. Whether the state will adopt this recommendation is less clear – it would involve some back-pedaling from the Governor, who has previously stated that he opposes forced pooling.

We can also expect debate over the Commission’s vote to allow further leasing of state forests for natural gas drilling.

It will be interesting to follow the discussion of these issues over the coming weeks and months – stay tuned.

It was announced last week that Exxon Mobil has purchased Phillips Resources and TWP Inc. at a price of $1.7 billion.

These are both Pennsylvania-based exploration and production companies with significant Marcellus Shale reserves and likely exposure to the emerging Utica Shale as well. This acquisition provides Exxon with 317,000 acres prospective for the Marcellus.

Last week’s purchase follows on the heels of Exxon’s acquisition of XTO Energy in 2010. While the XTO purchase gave Exxon a diversified portfolio of natural gas reserves in various conventional and unconventional plays, the Phillips acquisition more narrowly targets the Marcellus.

Exxon’s most recent investment confirms the interest of the major oil and gas companies in Pennsylvania’s unconventional shale deposits. European companies Royal Dutch Shell and Statoil have both invested heavily in Keystone State shale, while Chevron recently paid $3.2 billion for Pennsylvania based Atlas Energy.

Perhaps the most interesting aspect of this deal is the price.

Exxon has paid approximately $5,000 per acre for the Phillips – TWP acquisition. A New York Times article notes that this is barely half the price companies were paying for comparable acreage last year. For instance, Japan’s Mitsui and India’s Reliance Industries both paid $14,000 per acre for Marcellus assets in 2010, while EXCO purchased acreage in Pennsylvania at the rate of $9,000 per acre last December.

This decline in price mirrors what this Commentator and others have observed with lower cash-bonus prices offered for gas leases in Central and North Eastern PA.

It seems that dry gas reserves are no longer the hot commodity. Instead, liquids-rich plays such as the Eagle Ford Shale in Texas are gaining increased prominence in terms of energy investment. The NYT article mentioned above cites a recent purchase of Texas oil acreage by Marathon Oil for $20,000 per acre.

With the current disparity between the price of oil and the price of natural gas, this shift of interest makes perfect sense. It may also make sense for the majors to invest further in the Marcellus and the Utica now, taking advantage of today’s bargain prices for Pennsylvania shale.

When meeting with clients to discuss gas leasing or other Marcellus development issues, the concern most frequently voiced by landowners is the possibility of water contamination. And it’s very understandable that landowners are concerned. The problems with methane gas migration in Dimock, Pennsylvania, have received national attention. Perhaps even more alarming was the article that appeared in the New York Times in February, detailing the levels of radioactivity present in some drilling wastewater which was treated and then ultimately discharged into Pennsylvania rivers.

Compounding the anxiety for landowners are the conflicting claims from those who oppose shale gas drilling and the advocates for responsible Marcellus development. Landowners are left perplexed. Is hydrofracking actually ruining landowners’ water wells? Is disposal of wastewater degrading the quality of drinking water for those of us who live downstream from drilling?

What is often absent from the debate are hard facts that objectively document the impact of Marcellus drilling on individual landowner and public water supplies, as opposed to carefully selected talking-points that support an ideological position, or anecdotal stories. In light of the dearth of hard data, the following news is encouraging, even if not entirely reassuring.

It was recently announced that a team from Mansfield University is studying the impact of gas drilling on private water wells, searching for evidence of water contamination.  After the data is collected and analyzed, it will be published in a peer-reviewed scientific journal and be made available locally. More information on the study is available here.

Penn State researchers are also examining the potential water impacts from drilling. An article in the Towanda Daily Review includes additional information for landowners interested in participating in the well testing program.

When the New York Times article discussed above first appeared, public fears of radioactive drinking water spiked. Those calling for increased water testing included U.S. Senator Bob Casey, who demanded increased inspections of water supplies and an accounting for why sufficient testing hadn’t taken place. The Pennsylvania Department of Environmental Protection responded swiftly, releasing the results of testing that showed water downriver from plants treating Marcellus wastewater met federal drinking water standards.

However, significant concerns about water quality continue. Most recently, research by Carnegie Mellon University and the Pittsburgh Water and Sewer Authority suggests that disposal of drilling wastewater is contributing to elevated levels of bromides in state rivers. Though bromide alone does not pose a health hazard, bromides can combine with chlorine in drinking water treatment plants to form brominated trihalomethanes, which are potentially hazardous. In response, DEP has requested (though not ordered) that companies drilling in the Marcellus stop taking wastewater to treatment plants that do not meet the stricter discharge standards that were implemented last year under the previous Secretary of DEP, John Hanger.

This commentator lives in Danville, a lovely town located on the banks of the Susquehanna River in Central Pennsylvania, downstream from Towanda, Wyalusing and Tunkhannock – ground zero for Marcellus development in Northeastern Pennsylvania. My children and I drink water drawn from the Susquehanna. While I am encouraged by the response of regulators to the reports discussed above, I would add my voice to the chorus of those asking the state to substantially increase water testing and for the operators in the Marcellus Shale to adopt the best industry practices to safeguard water supplies.

The Utica Shale has recently been receiving increasing attention in the press and from the oil and gas industry.

An informative article discussing the Utica Shale can be found on Geology.com.

Range Resources was one of the first major gas companies to recognize the potential of the Marcellus, and now Range appears to be blazing the trail into the Utica. Range CEO John Pinkerton was recently discussing the potential for a “triple play” in the Marcellus, with drilling targeting both the Utica and Upper Devonian shales that cover about 60 percent of the acreage Range has leased in the Marcellus.

As development has progressed, the Marcellus has gradually transitioned from an unknown quantity into a well-understood reserve. The same is not true of the Utica, which has not yet been tested extensively. However, the initial results look promising; Range Resources has reported that its first Utica well drilled in Pennsylvania has averaged 4.4 MMcf/day in a seven day production test.

At this point, the major gas companies have enough acreage leased in the Marcellus to keep them busy drilling for quite a while. With the well known Marcellus readily available, it seems likely that there might not be much push to rapidly develop the Utica, at least while the price of natural gas remains low. Nevertheless, this commentator would suggest that there are some points that landowners (and professionals serving landowners) in areas prospective for the Utica Shale should keep in mind:

-       Natural gas development and production in the sweet spots of Pennsylvania could go on for a very long time.  There seems to be a general consensus that Marcellus wells could produce for twenty years or more.  Now, landowners may possibly add on an additional twenty years after drilling for the Utica begins.  Truly, this is a multi-generational play.

-       Current projections and estimates of the wealth that landowners could receive from natural gas royalties may be low. The appraised value of gas rights may run into millions of dollars for substantial Marcellus acreage when fully developed. Those numbers will only go up as the potential for production from the Utica and Upper Devonian is factored in.

For most Pennsylvania landowners who have signed an oil and gas lease, the possibility of receiving royalties sounds exciting. As landowners see drilling development approaching their property, the potential royalties seem ever more real. When a landowner receives notification that her land has been included in a pooled production unit, these life-changing royalties seem just around the corner.

Imagine the landowner's dismay when she reads the Declaration of Pooling and Unitization and realizes that her property has been "clipped" and that and only a small portion of her land has been included in the production unit. Unfortunately, this is the reality for many Pennsylvania property owners.

The gas leases used by the companies drilling in Pennsylvania allow the gas company to combine multiple properties into a pooled production unit. The landowners in the unit will share in the royalties from wells drilled based on their proportional ownership of the unit. While some production units may follow property boundaries, in most cases the unit is in the form of a rectangle with the boundaries of the unit not following property lines. Although the landowner will only receive royalties for the portion of the land included in the unit, the entire property is extended into the secondary term of the lease and held by production. For a landowner with only a small portion of her land in a production unit this is not a good outcome.

The solution to this problem is a Pugh Clause. Usually added to the lease as an addendum, the pugh clause provides that at the end of the primary term (typically five years) the lease will terminate as to any acreage outside of a production unit. This allows the landowner to sign a new lease for the property not included in the unit at the end of the five year primary term. The cash bonus received for signing the new lease provides compensation to the landowner for the property not included in the unit.

Naturally, the gas companies don't want to lose leased acreage and won't offer a pugh clause to landowners signing a gas lease. However, this is an important provision that should always be requested in gas lease negotiations.

Landowners who have signed a lease without a pugh clause and find that their property has been "clipped" can take comfort from the accelerating pace of development in the Marcellus shale. Over time it is likely that additional production units will be formed including the acreage left out initially. However, landowners who have not signed a lease should understand the importance of working with an experienced oil and gas attorney who can draft an effective pugh clause and assist in negotiating with the gas company to include this important provision in their gas lease.