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 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.

Posted by Dale A. Tice on February 08, 2011

New Marcellus Shale Legislation for Pennsylvania on the Horizon

Pennsylvania State Senator Eugene Yaw was recently discussing legislation he plans to introduce that will impact Marcellus Shale development.

http://thedailyreview.com/news/sen-yaw-introduces-marcellus-shale-legislation-1.1089334

Of the various legislative initiatives that have been discussed, forced pooling (or “fair pooling” if you work for the oil and gas industry) has been the most controversial. Landowners who oppose natural gas development have been outraged by a proposal that would allow their property to be included in a natural gas production unit without their consent, even though there would be no surface impact on the land and they would be entitled to receive royalties. Although there was no legislation officially introduced, just the mention of forced pooling ignited a vociferous debate.

Senator Yaw has gracefully sidestepped the issue by proposing a forced pooling statute that would only apply to properties already subject to an oil and gas lease. Rather than including un-leased landowners in a production unit, his proposal would facilitate Marcellus development by allowing pooling of multiple properties that are leased to different gas companies. This “company-to company” pooling would solve the problem created when a hold-out gas company with a minority of the leases in an area refuses to cooperate with another company that wants to drill.

A proposal that would allow counties to assess a property tax on producing gas wells may be less popular with constituents in the areas where the gas companies are drilling. Yaw notes, however, that his proposal would generate revenue for the local counties, as opposed to a severance tax that would be funneled through Harrisburg.

In the opinion of this commentator, the other legislative proposals discussed, such as a statutory Pugh Clause and requirements for information provided on gas royalty check stubs, are very favorable for landowners in the Marcellus Shale, though of course the devil is in the details. Hopefully we will see progress on this legislation in the coming months.