Energy & Environmental Law Blog

Energy & Environmental Law Blog

VORYS Helping Clients With Their Energy and Environmental Needs

Ohio Court Elaborates on Paying Quantities Test

Posted in Energy

On June 16, 2017, Ohio’s Seventh District Court of Appeals issued its decision in Paulus v. Beck Energy Corp. 2017-Ohio-5716, which addresses a number of issues concerning Ohio’s standard for determining whether an oil and gas lease is producing in “paying quantities,” a test that must ordinarily be met in order to continue a lease during its secondary term. The Supreme Court of Ohio first established the state’s paying quantities test nearly 40 years ago in Blausey v. Stein, finding that “paying quantities” are “quantities of oil or gas sufficient to yield a profit, even small, to the lessee over operating expenses, even though the drilling costs, or equipping costs, are not recovered, and even though the undertaking as a whole may thus result in a loss.”

In Paulus, the court ruled on several disputed issues surrounding the application of the Blausey test. Among other things, the court found:

  • Royalties paid to the lessor must be deducted either from the lessee’s gross income or included as operating expenses when determining profitability.
  • A one-time cost incurred by the lessee during the secondary term to replace a downhole pump and to rebuild the wellhead as a result of the pump replacement was in the nature of a non-recurring capital investment that is not subtracted from the lessee’s gross income.
  • Although Blausey recognized that an individual lessee’s own labor is not an operating expense when the lessee made no direct expenditure from gross receipts for his labor, the same is not true for the labor of a corporate lessee’s salaried employee. Such labor is a direct operating expense to be subtracted from the lessee’s income.
  • The determination of the “base period,” i.e., the period of time used to measure paying quantities, is made by examining the totality of the circumstances and requires consideration of the good faith of the lessee.
  • In the particular facts of Paulus, the only well on the lease, which began producing in 2007, experienced a gradual decline in production through 2014. After accounting for royalties, if the base period was measured from 2007, when the well came online, to 2014, when the complaint was filed, the well would have produced roughly $6,800 in net profit. But the court found that applying this time frame may not reasonably reflect the current state of the well, in light of a considerable and continued decline in production beginning in 2010. Between 2010 and 2014, the well experienced an approximate $550 net loss, after accounting for the expense associated with the lessee’s salaries employee. And such a loss would only continue to grow, according to available figures from several months of 2015. Additionally, there was evidence that the lessee experienced difficulty supplying household gas to the lessor’s home, and that the well may have run out of producible gas. Based on the totality of the circumstances, the court upheld the trial court’s finding that the lease had expired due to lack of paying quantities.


D.C. Circuit Vacates Stay of Oil and Gas Methane Emissions Rule

Posted in Energy, Environment

This post provides an important update to our April 20, 2017 post regarding U.S. EPA’s reconsideration of its rule regulating methane emissions from the oil and gas industry (“NSPS OOOOa”).

On June 5, 2017, EPA published a notice of reconsideration and partial stay of NSPS OOOOa. Specifically, EPA stayed the effectiveness of the fugitive emissions requirements, the standards for pneumatic pumps at well sites, and the professional engineer certification requirements for 90 days, effective June 2, 2017, pending EPA’s reconsideration of the final rule. Shortly after EPA published the notice, six environmental groups filed an emergency motion in the Court of Appeals for the D.C. Circuit requesting that EPA’s stay be vacated. The Court granted the motion and issued an order vacating EPA’s stay of the final rule.

In reaching its decision, the Court first determined that it had jurisdiction to hear the case. The Court held that EPA’s stay was a final agency action and, as such, is reviewable by the Court. The Court also noted that its authority to review EPA’s stay of the final rule is a logical extension of its authority to stay a final rule pursuant to CAA section 307(d)(7)(B).

The Court then turned to its review of EPA’s 90-day stay and held that the stay was unauthorized under CAA § 307(d)(7)(B). The Court explained that EPA is bound by NSPS OOOOa “until that rule is amended or revoked and may not alter [the] rule without notice and comment.” The Court equated the stay, which was issued without notice and comment, to an amendment of the final rule and, because reconsideration of NSPS OOOOa was not mandatory, the Court vacated EPA’s stay of the rule as arbitrary and capricious.

While the Court’s order reinstates the effectiveness of the stayed provisions, those same provisions may soon be stayed again. On June 16, 2017, EPA published a proposed rule that would stay the fugitive emissions requirements, pneumatic pump standards, and professional engineer certification requirements for 2 years. Comments on the proposed 2-year stay are due by July 17, 2017.

Court Clarifies which References are “Specific” for Purposes of Applying the Ohio Marketable Title Act

Posted in Energy

Ohio’s Seventh District Court of Appeals recently interpreted a statutory exception to “marketable record title” under Ohio’s Marketable Title Act (R.C. 5301.47 et seq.) (OMTA). In Blackstone v. Moore, 2017-Ohio-5704, the court held that whether a reference to an interest inherent in the muniments of the chain of record title is “specific” – and thus not extinguished by the OMTA – or general depends upon four factors:  (1) does the reference state the type of mineral right created; (2) does the reference state the nature of the encumbrance (an estate, profit, lease, or easement); (3) does the reference state the original owner of the interest; and (4) does the reference identify the instrument creating the interest. In so holding, the Court expressly rejected Ohio’s Fifth District Court of Appeals decision in Duvall v. Hibbs, 1983 Ohio App. LEXIS 13042, which held that a reference to an interest inherent in the muniments of the chain of record title is specific only if it recites the volume and page number of the instrument creating the interest.

Appellate Court Holds a Recorded Release of an Oil and Gas Lease is a “Savings Event” under the Ohio Dormant Mineral Act

Posted in Energy

In Davis v. Consolidation Coal Company, 2017-Ohio-5703, Ohio’s Seventh District Court of Appeals held that a recorded release of an oil and gas lease qualifies as a “savings event” under the Ohio Dormant Mineral Act (R.C. 5301.56) (ODMA). One of the six savings events under the ODMA occurs whenever the mineral interest has been the subject of a title transaction – i.e., any transaction that affects title to any interest in land – that has been recorded in the office of the county recorder where the mineral interest is located.  The court in Davis found that a recorded release of an oil and gas lease qualifies as a title transaction savings event because the release provides notice both of the expiration of the lease and the reversion of rights to the lessor.

Ohio’s Seventh District Court of Appeals is the first appellate court to hold that a recorded release of an oil and gas lease qualifies as a “savings event” under the ODMA.


BLM Postpones Waste Prevention Rule Compliance Date

Posted in Energy, Environment

On June 15, 2017, the Bureau of Land Management (BLM) issued notice that it was postponing compliance date for certain sections of its Waste Prevention, Production Subject to Royalties, and Resource Conservation Rule, 81 Fed. Reg. 83008 (“Waste Prevention Rule”). The Waste Prevention Rule regulates the loss of natural gas through venting, flaring, and leaks during the production of oil and natural gas on Federal and Indian land, and requires operators to capture a certain percentage of gas produced, upgrade or replace pneumatic equipment, capture or combust storage tank vapors and implement leak detection and repair programs. The rule established a January 17, 2018 compliance date for these requirements. However, due to pending litigation challenging the Waste Production Rule, BLM decided that “justice requires it to postpone the compliance dates” for the following sections of the rule: 43 CFR 3179.7, 3179.9, 3179.201, 3179.202, 3179.203, and 3179.301 – 3179.305.

BLM will publish a document announcing the outcome of the review of the rule. It should be noted that BLM’s postponement of the requirements subject to the January 17, 2018 compliance date does not affect the provisions of the rule with compliance dates that have already passed, including 43 CFR 3162.3 – 1, 43 CFR subpart 3178, 43 CFR 3179.4, 3179.101 – 105, and 3179.204.

Bohlen v. Anadarko

Posted in Energy

On June 1, 2017, the Supreme Court of Ohio issued its decision in Bohlen v. Anadarko. We summarized the facts of this case in our earlier post:

The Bohlens entered into a lease with Alliance in 2006 for a one year primary term.  Paragraph 3 of the lease contained a delay rental provision:

This lease, however, shall become null and void and all rights of either party hereunder shall cease and terminate unless the Lessee shall thereafter pay a delay rental of $5,500.00 Dollars each year, payments to be made yearly, but in no event not less than yearly, for the privilege of deferring the commencement of a well.

In an addendum, the parties also provided:

In the event that during any calendar year the total royalties paid from production of the leased premises, shall be less than the annual rental of $5,500.00, Lessee shall tender to Lessor such sum that will equal to the $5,500.00 annual rental payment.

Within seven months of signing the lease, Alliance drilled two wells, one of which was a producer.  Between 2008 and 2013, Alliance paid royalties to the Bohlens, but the royalty amounts fell below the $5,500 per year required by the lease.

The Bohlens filed suit, making a twofold argument that the lease had terminated.  First, they claimed that the lease had lapsed due to Alliance’s failure to pay the entire $5,500 minimum annual royalty payment, which the Bohlens characterized as a delay rental required by Paragraph 3 of the lease (and therefore, subject to the termination provision in the delay rental clause).  Next, the Bohlens claimed that regardless of whether the lease had terminated for failure to pay the required payments, the lease allowed Alliance to make delay rental payments during the secondary term, and therefore was a perpetual lease that was void ab initio as offensive to Ohio public policy.

Affirming the court of appeals’ ruling in favor of Alliance and Anadarko, the Supreme Court held that the royalty shortfall did not trigger the automatic termination of the lease. “The plain language of the parties’ oil and gas lease requires the lessee to pay a delay rental for deferring commencement of a well, otherwise the lease terminates.” But here, “the lessee did not defer commencement of a well beyond the primary term of the lease, because at least one well was drilled within the first year,” Justice Fischer wrote. “Therefore, the lease did not terminate under the delay-rental clause.” And the requirement in the addendum that provided for the $5,500 minimum annual rental was not tied to the automatic termination language in the delay-rental clause. The Court also rejected the Bohlens’ characterization that the lease was perpetual and thus void for public policy, concluding that the lease could not be extended indefinitely through the payment of delay rentals.

[Disclosure: Vorys represented amicus curiae Ohio Oil and Gas Association in this case.]

West Virginia Supreme Court of Appeals Holds Certain Lessees May Deduct Post-Production Costs

Posted in Energy

On Friday, May 26, 2017, the West Virginia Supreme Court of Appeals released its decision in Patrick D. Leggett, et al. v. EQT Production Company, et al. and held that lessees subject to West Virginia Code § 22-6-8 may deduct post-production costs actually incurred from the lessor’s royalty.  The reasonableness of post-production expenses, however, is a question of fact. The Court’s decision is more fully explained below.

As background, West Virginia Code § 22-6-8 prohibits the “extraction, production or marketing of oil or gas under a lease . . . providing a flat well royalty or any similar provisions for compensation to the owner of the oil and gas in place, which is not inherently related to the volume of oil or gas produced or marketed * * *”  To this end, West Virginia Code § 22-6-8 (1994) prohibits the issuance of any permit to drill, deepen, fracture, or stimulate a well “where the right to develop, extract, produce or market the same is based upon such leases * * *.” Lessees may avoid this prohibition if they file an affidavit certifying that they shall “tender to the owner of the oil or gas in place not less than one eighth of the total amount paid to or received by or allowed to the owner of the working interest at the wellhead for the oil or gas so extracted, produced or marketed * * *” (emphasis added).

The plaintiffs/petitioners argued that the foregoing statutory language is ambiguous and should be interpreted to prohibit the deduction of post-production costs.  Such an interpretation, plaintiffs/petitioners contended, would be consistent with West Virginia’s common law rule. The defendants/respondents, on the other hand, argued that the statute was not ambiguous since “at the wellhead” is a very precise and definite location. In the wake of deregulation, the only method to mathematically calculate the lessor’s royalty at the wellhead is to utilize a “net-back” or “work-back” method. This method utilizes the interstate pipeline sales price and makes deduction for post-production costs.

In reaching its decision, the Court first rejected the notion that West Virginia Code § 22-6-8 must be interpreted in light of the policy-driven issues of whether West Virginia is a “marketable product” state or “at the well” state. The Court found that the issue presented is solely one of statutory interpretation.  Next, the Court applied well-established canons of statutory construction and found that the phrase “at the wellhead” as used in the statute is not ambiguous on its face. The Court noted that the phrase “at the wellhead” has a very precise and definite meaning in the oil and gas industry. That phrase, when used with reference to oil and gas royalty valuation, is understood to mean that oil and gas will be valued in its unprocessed state as it comes to the surface at the mouth of the well. As a result, the Court was persuaded that “the most logical way to ascertain the wellhead price is, in fact, to deduct the post-production costs from the ‘value-added’ downstream price in an effort to replicate the statutory wellhead value.”

The Court’s decision may be viewed here. It is important to note that oil and gas lessees not subject to West Virginia Code § 22-6-8 are not bound by this decision.

Lightning v. Anadarko

Posted in Energy

On May 19, 2017, the Supreme Court of Texas issued its long-awaited decision in Lightning v. Anadarko (see here for our earlier coverage of this case)—holding that when minerals are severed from the surface, the mineral owner’s permission is not required for a producer to drill through the surface tract in order to produce minerals from an adjacent tract.

Lightning obtained an oil and gas lease covering the severed mineral estate underlying Tract A.   Anadarko held an oil and gas lease on an adjacent tract, Tract B. To develop Tract B, Anadarko entered into an agreement with the surface owner of Tract A to place a pad site on Tract A and drill five wells, which would be drilled vertically through Tract A before “kicking-off” horizontally and completing in—and producing from—Tract B.   Lightning sued Anadarko for trespass and for tortious interference with its oil and gas lease on Tract A. The trial court found in favor of Anadarko and the appellate court affirmed.

Continue Reading

Sunoco’s Eminent Domain Rights for Mariner East 2

Posted in Energy, Environment

On May 15, 2017, the Commonwealth Court issued a 2 to 1 decision holding that Sunoco Pipeline has the statutory power of eminent domain in relation to the Mariner East 2 pipeline project.  The court determined that Sunoco provides a public benefit and that its pipeline is a necessary accommodation within the public’s interest.  Further, because the pipeline will provide both an intrastate and interstate service, the Pennsylvania Public Utility Commission has regulatory jurisdiction over that portion of the pipeline to be used for intrastate commerce.  The court also held that the Pennsylvania Supreme Court’s striking down of a portion of Act 13 (Pennsylvania’s beleaguered Oil and Gas Act) that permitted a corporation to take private property as unconstitutional was limited to “private, non-regulated corporations.”  Therefore, because Sunoco is a “public utility,” it is entitled to the granting of certificates of public  convenience.

Judge Cosgrove disagreed and warned that the court’s decision was headed for a reversal before the Supreme Court: “[W]e are issuing a decision on a case submitted without argument before a three judge panel (let alone en banc) which implicates one of the most important environmental decisions our Supreme Court has issued in recent times.”

The Commonwealth Court’s decision is captioned In Re: Condemnation by Sunoco Pipeline, L.P. (No. 220 C.D. 2016).

Ohio: Updated Statutory Unitization Guidelines

Posted in Energy

On May 3, 2017, the Ohio Department of Natural Resources, Division of Oil and Gas Resources Management (the Division) issued revised guidelines for statutory unitization applications. The guidance document–largely rewritten from the previous version (issued in May 2014)—contains a number of notable changes, including the following (among others):

  • Unitization applications will now be processed on a rolling basis (the prior guidelines required that applications be submitted 120 days prior to a scheduled hearing date). Upon receiving an application, the Division will perform a completeness review and notify the applicant of any deficiencies. Once the application is deemed complete and accurate, the Division will set a hearing date.
  • The application must include six separate interest exhibits, including one that lists all tracts within the unit subject to Ohio Dormant Mineral Act disputes.
  • Applications must be accompanied by the pre-filed testimony of a geologist, engineer and landman (applicants have typically included these testimonies with their applications, but their submission was not required under the previous guidelines).
  • Hearing notices can now be published in weekly or daily publications. For weekly publications, the notice must be published for four consecutive weeks, at least two weeks prior to the hearing.
  • Any revisions to an application must be submitted in two sets—a set of only the revised documents, and a full application with the revised documents incorporated. Additionally, with any revised application, “Exhibit A-2” must include an additional column explaining all changes that apply to a given tract.
  • At the hearing, the applicant must provide the Division with a PowerPoint that contains all of the information required by the guidelines, along with copies of affidavits attesting to the fact that the applicant holds a lease for all the acreage that the applicant claims to own in the application, along with an affidavit attesting that the applicant possesses the right to drill and produce from the unitized formation.

Check out the new guidelines here.