Legal Landscape: Protecting Your Investment in Marcellus Shale
as published in West Virginia Executive magazine, June 2011
The past few years have been an exciting time for oil and gas operators. The Marcellus Shale, previously uneconomical to produce, has been unlocked through the deployment of advanced drilling techniques, namely horizontal drilling and large-volume hydraulic fracturing. Using this advanced technology makes every well significantly more expensive to drill and makes it imperative that operators minimize risk to protect their investments.
Operators new to West Virginia, as well as those expanding their operations to develop the Marcellus Shale, need to consider the legal pitfalls that may arise due to unique aspects of West Virginia law, as well as the plaintiff-friendly nature of some of our courts. Here we will discuss the types of legal issues that may arise during all stages of a well’s lifespan—issues that may not be at the forefront of an operator’s mind when the immediate focus often tends to lean toward ensuring that their sizable investment produces an acceptable volume of gas.
Acquiring and Retaining Development Rights
Whether an operator is acquiring land to drill via lease, transaction or acquisition, there are several important considerations to contemplate. First, if an operator is acquiring the right to drill the Marcellus Shale through a transaction with another party, it is imperative to confirm that the other party actually holds the right to drill the Marcellus. Increasingly, leases are being used solely to include certain named formations or otherwise limit drilling and production to certain depths. To avoid further complications, the operator should assure that the leased premises do not lie within or near the boundaries of a gas storage field. Access to transportation pipelines with available capacity at market rates must also be addressed. Without such provisions for transportation, valuable gas reserves may become stranded.
If the operator is leasing the gas rights directly from the property owner, which could be the fee simple owner or the mineral owner (in the case of severed estates), different concerns emerge. First, does the lease form comply with West Virginia law? With the competition between operators being so fierce at present, any defect could be used to invalidate the lease and give the gas owner the right to lease the property on more favorable terms. Secondly, does the lease have operator-oriented language commonly used in other states that may not be commonly used in West Virginia, and if so, what complications could that cause? For example, does the royalty clause allow the deduction of certain post-production expenses from the royalty calculation in a manner that complies with the Tawney v. Columbia Natural Resources decision by the West Virginia Supreme Court? In some instances a land agent or other representative of the operator may have had the property owner sign a lease that required corporate approval only to see that approval denied at a supervisory level.
Although this type of lease is common elsewhere in the country, it is new to West Virginia and has spurred litigation on behalf of landowners seeking to enforce the terms of those leases. In horizontal drilling, a unitization or pooling rights clause that complies with West Virginia requirements for well spacing and unit size is a very valuable term in a Marcellus lease.
Finally, an investigation into whether a competing operator or land agent is aggressively pursuing top leases can prevent unnecessary conflicts with other operators. Conducting the appropriate due diligence using attorneys who not only understand the law in West Virginia but also have experience with the practical implications of such lease provisions can help avoid expensive problems and assure the success of a Marcellus Shale development program.
Drilling the Well
Once the right to drill the well is in hand, the next phase is to acquire the well work permit and drill the well. As if drilling gas wells several thousands of feet beneath the Earth’s surface was not sufficiently challenging, there are a number of other potential obstacles that can threaten full realization of return on investment goals.
Examining the environmental regulations that govern the drilling and extraction processes, one quickly finds a few potential trouble spots. The 2011 Regular Session of the West Virginia Legislature ended without the passage of any new regulations on drilling activities, despite the fact that proposed bills related to horizontal wells had been the focus of the West Virginia Department of Environmental Protection (WVDEP) and many legislative hearings. Although it is too early to predict what may occur in future sessions with respect to this sort of legislation, operators can expect WVDEP to step up enforcement at Marcellus sites based on the increased scrutiny the industry and the agency received during the 2011 Legislative Session. In fact, acting-Governor Earl Ray Tomblin is aggressively seeking funding to increase the number of staff members in WVDEP’s Office of Oil and Gas.
The U.S. Environmental Protection Agency is also becoming interested in applying the permitting and enforcement tools under the Federal Clean Water Act and Safe Drinking Water Act to the horizontal drilling industry. Increased federal interest and involvement in the oil and gas industry is likely to continue in the near term and may result in a shifting regulatory landscape for operators in coming years.
Safety issues may also arise during the drilling of a well. West Virginia currently has no safety agency devoted to industrial safety; therefore, the U.S. Occupational Safety and Health Administration (OSHA) is responsible for inspecting oil and gas sites. OSHA has become much more engaged with the industry as a result of the boom in the Marcellus Shale. Invariably, with increased scrutiny comes increased enforcement actions. Operators should be proactive in promoting an active safety culture at their well sites not only during the drilling phase but also during production.
Ranging in variety from air to water to workplace safety, the regulations pertaining to horizontal drilling operations have become moving targets as governments and agencies scramble to adapt to new technologies, new challenges and greatly increased service loads. Under such circumstances, operators need sage advice. The wise manager or owner will seek counselors and advisors with specific experience—plus the connections and capabilities enabling them to monitor, interpret and apply these ever-changing regulations. Such support can help bring a measure of predictability to an area otherwise fraught with uncertainty.
Producing the Well
Once the well is drilled, the risks for the operator would seem to diminish. Surprisingly, this is the phase of Marcellus Shale development in which high-stakes litigation is most likely to emerge. This is partly due to the time it takes for problems caused during drilling to manifest themselves but also because once the well is drilled, perceptions may arise that the operator is raking in profits and is, therefore, ripe for a lawsuit.
An emerging area of suits against operators relates to allegations that horizontal drilling in general, and hydraulic fracturing in particular, are causing groundwater contamination. In other industries, some of the largest verdicts in West Virginia history have resulted from groundwater contamination allegations. Though such suits typically have been brought against chemical companies, Marcellus Shale developers and operators must also beware. Operators should consider whether the current voluntary compliance provisions related to pre-drilling water sampling could be useful in combating potential suits in the future. It might make sense from a business and legal perspective to spend additional money and effort on water sampling at the time of drilling to reduce the potential for future exposure or liability.
Another important consideration for the production phase relates to hiring employees to work at the well site. Operators whose base of production experience lies in the Midwest, Texas Gulf Coast or afar may encounter a few unfamiliar wrinkles in labor and employment law. For example, West Virginia courts have held that some employee manuals create an enforceable employment contract, making it more difficult to terminate underperforming employees. Operators hiring workers in West Virginia should take care to have any employee handbook reviewed to ensure it is not creating a contract with a new employee. Otherwise, that employer is opening itself to the possibility of employment suits, which are often expensive to defend and have the potential to result in significant adverse verdicts.
Potential legal pitfalls can arise at any stage of the development and production of a well. Companies entering the Marcellus Shale and supported by legal counsel that understands the laws, the regulations and the realities of the Marcellus Shale energy play are well poised to protect their Marcellus investments.
For more information, please contact: