Posted by Dale A. Tice on April 17, 2012

Current Trends in Marcellus Shale Development

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.

 

Posted by Dale A. Tice on February 22, 2012

Pennsylvania Passes Marcellus Shale Impact Fee Legislation

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.

Posted by Dale A. Tice on February 14, 2012

Natural-Gas Fee May Be Too Late

This is an article that recently appeared in the Opinion section of the Philadelphia Inquirer. It was written by Arthur Sterngold, an associate professor of business and former director of the Institute for Management Studies at Lycoming College in Williamsport, Pennsylvania.  He's written several articles about the misuses of economic impact studies and market analyses.  Before pursuing an academic career, Sterngold worked as a government economist and advertising account manager.  He earned a B.A. degree in economics from Princeton, MBA from Northwestern, and Ph.D. from Penn State.

I have met Dr. Sterngold and respect his opinion.

With natural-gas drilling booming in Pennsylvania's Marcellus Shale region, state lawmakers might seem to have chosen the perfect time to impose an impact fee on gas producers. The new fee has been projected to generate $191 million in retroactive 2011 fees, $220 million in 2012, and larger amounts over time.

Unfortunately, though, the legislature may have procrastinated for too long. Natural-gas prices have plummeted from their lofty levels of a few years ago, squeezing industry profits and forcing producers to start scaling back their activity. As a result, the impact fees may generate less revenue than expected and induce some cash-strapped drillers to shift resources to other states.

After years of avid promotion of natural-gas development by the Marcellus Shale Coalition, the industry's chief lobby, it's hard to imagine a slowdown in drilling. As part of its campaign to win public approval, the coalition funded a series of economic impact studies by Penn State researchers. The three studies, released in 2009, 2010, and 2011, forecast increasingly larger jumps in employment, incomes, and tax revenues as a result of shale exploitation. In the most recent study, released last summer, the authors concluded that "the outlook for Marcellus production is remarkable."

While the Penn State researchers were preparing their reports, however, evidence was mounting that the industry was in trouble. From an average of $8.85 per million British thermal units in 2008, natural-gas prices fell sharply to $4.39 in 2010, and $3.94 in 2011. Last month, prices dropped below $2.50, and they are expected to stay under $5 for another decade.

Signs of a slump

Lower gas prices mean smaller profit margins. So it's no surprise that gas producers are scaling back their Marcellus Shale drilling, putting growth on hold, or moving resources to states with lower costs and more deposits rich in oil and other liquid fuels. The companies doing so include Talisman Energy, EQT Corp., Consol Energy, and Occidental Petroleum Corp. Chesapeake Energy, which has the largest Marcellus Shale holdings in the state, has announced the most drastic cutbacks in Pennsylvania and elsewhere.

In a recent Inquirer op-ed, Louis D. D'Amico, president of the Pennsylvania Independent Oil & Gas Association, explained that "low natural-gas prices are bad for producers, many of whom can't continue to spend money on wells that aren't profitable under current and foreseeable conditions. In the coming months, Pennsylvanians can expect to see fewer ... wells drilled."

There have been signs of a coming correction for years. In May 2010, energy consultant Andrew Weissman observed in the American Oil and Gas Reporter that falling natural-gas prices had already caused markets to tumble, warning: "Current price levels will inevitably lead to further cutbacks in drilling." A year later, the Wall Street Journal reported, "With natural-gas profit margins all but disappearing, companies are cutting back on new gas drilling."

The 2009 Penn State study noted that "a prolonged slump in prices could dampen" Marcellus Shale activity. By the time last year's report was released, the slump was obviously in progress, but the researchers made their most optimistic forecast to date. They should have made the possibility of a lull clearer - even if that's not what the Marcellus Shale Coalition wanted to hear.

Boom and bust

It's too early to say how long a gas slowdown could last or how it will affect drilling impact fees. But even if natural-gas development grows at a slower rate than anticipated, people may suffer from having overinvested. Rural residents who decided to fix up family farms rather than move to smaller homes may be hard-pressed if their gas leases aren't renewed. Small-business owners who expanded their operations to serve gas companies may find they can't pay their bills. Let's hope the Marcellus Shale Coalition's relentless boosterism didn't exacerbate a climate of overspeculation and make the pain worse.

In the long run, natural-gas development may be good for Pennsylvania, especially compared with the economic stagnation we lived through before the drilling started. But industries that grow too quickly and then pull back painfully create a toxic boom-and-bust cycle. Pennsylvania needs an energy industry that is economically and environmentally sustainable, guided by academics who provide prudent advice and careful analysis. That would do more to safeguard our communities and natural resources than any amount of impact fees.

 

Posted by Dale A. Tice on September 09, 2011

Is the Federal Estate Tax a Risk for Landowners in the Marcellus Shale?

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.

 

Posted by Dale A. Tice on June 13, 2011

Exxon Purchases 317,000 Acres of Marcellus Shale

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.

 

Posted by Dale A. Tice on April 07, 2011

Shale Gas in the News

The political winds seem to be shifting in favor of natural gas.

Domestically produced shale gas has been noticeably absent from the political discussion of our nation’s energy future. With the exception of T. Boone Pickens, no one has been talking much about gas. Now, that is beginning to change.

In his energy speech at Georgetown University last month, President Obama finally acknowledged the potential of shale gas, stating:

"Recent innovations have given us the opportunity to tap large reserves—perhaps a century's worth—in the shale under our feet. The potential here is enormous." 

The public awareness of unconventional shale gas is also increasing. The cover of the current edition of Time magazine features a chunk of black shale, with the caption “This Rock Could Power the World”. The well-balanced article behind the cover can be read here.

An interesting essay discussing the promise of shale gas as a solution to our energy problems was recently featured in the Wall Street Journal. Suddenly, everyone (almost) seems to recognize the incredible potential of the Marcellus Shale and the other shale plays throughout the nation to transform the energy economics of the country.

What does this mean for landowners in the Marcellus?

Hopefully it means that we will begin to see increased domestic use of natural gas, whether as a fuel for fleet vehicles or for electricity generation. As the demand for natural gas increases, the price for gas should correspondingly increase up from the rock-bottom prices seen over the last year. Not that any of us want to pay more to heat our homes, but for landowners hoping to see royalties from gas drilling this would be a welcome development.

It also means that valuations of gas rights that are based on a projection of the income stream from gas royalties may be coming in substantially lower today than they will in the coming months and years, as the price of natural gas goes up. This provides another good reason for landowners in the Marcellus to think about estate planning sooner, rather than later.

Posted by Dale A. Tice on March 10, 2011

First the Marcellus, Next the Utica Shale

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.