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.