EnergyandNaturalResources

A Year in The Courtroom for Oil & Gas

Presented by Lucas Liben Pittsburgh +1 412 288 4041 lliben@reedsmith.com September 2017

Leggett v. EQT Prod. Co., 800 S.E2d 850 (W. Va. 2017).

Wellman v. Energy Resources, Inc., 557 S.E.2d 245 (W. Va. 2001).

•  The lease called for a royalty of “one-eighth (1/8) of the proceeds from the sale of gas as such at the mouth of the well ….”

•  The court held that “unless the lease provides otherwise,

the lessee must bear all costs incurred in exploring for, producing, marketing, and transporting the product to the point of sale.”

•  The court did not address what “at the mouth of the well” meant – there was no evidence to show the deductions taken were “actually incurred or that they were reasonable.”

Tawney v. Columbia Natural Resources, LLC, 663 S.E.2d 22 (W. Va. 2006).

•  A certified question: Is “at the well” language sufficient to “provide[] otherwise” under Wellman to allow for deductions to be taken?

•  Answer: No.

A sea change?

Leggett addressed post-production questions pursuant to W.V. Code § 22-6-8, “which provides that permits for flat-rate wells will not be issued unless the lessee swears by affidavit that it will pay the lessor no less than one-eighth ‘of the total amount paid to or received by or allowed to [the lessee] at the wellhead for the oil or gas so extracted, produced or marketed.’”

Leggett criticizes Wellman and Tawney: •  “noting simply”

•  “quickly conclud[ing]”

•  “without further analysis”

Leggett expounds upon the differences in interpreting a statute vs. a lease: •  A statute is not construed against a party.

•  Statutory language was chosen by the legislature,

not parties to a lease.

•  The implied covenant to market – relied upon by Wellman and Tawney – has no application to a statute.

The court finds that Wellman and Tawney are not applicable.

Back to criticizing Wellman and Tawney: •  “[C]ompelled to further illustrate the

faulty legs upon which this precedent and its iteration of the marketable product rule purports to stand.”

•  Cites and discusses a number of

secondary sources criticizing Wellman and Tawney for various reasons.

The conclusion on Wellman and Tawney: •  “[H]owever under-developed or

inadequately reasoned this Court observes Wellman and Tawney to be, the issue presently before the Court simply does not permit intrusion into these issues. We therefore leave for another day the continued vitality and scope of Wellman and Tawney.”

The Court finds “at the wellhead” is not ambiguous – a finding directly opposite of that made by Tawney: •  Held that the “‘at the wellhead’ language [is] clearly

indicative of a legislative intention to value the royalties paid pursuant to the statute based on the unprocessed wellhead price … .”

•  Determined “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.”

Leggett allows, in the context of leases governed by W.V. Code § 22-6-8, for “pro-rata deduction or allocation or all reasonable post-production expenses actually incurred by the Lessee.”

Kinney v. CNX Gas Co., LLC, -- F. Supp.3d --, 2017 WL 3774376 (N.D. W. Va. Aug. 24, 2017).

Lease called for: •  A fixed rate ($1.20 per MMBtu) to be deducted.

•  Listed a number of various post-production

expenses

•  Stated “the parties agreed [the amount] will be presumed to be actually incurred and reasonable.”

The court did not address Leggett – only Wellman and Tawney, finding the lease complied with both: •  The lease expressly states deductions can be taken.

•  The lease specifically identifies what deductions will be

taken.

•  The lease states the method of calculating the deductions: “as based on volume at $1.20 per MMBtu.”

•  The lease disclaims the application of any implied

covenants – this includes the implied covenant to market, on which Wellman and Tawney are based.

•  The parties agreed the deductions were “actually incurred

and reasonable,” and the “Court will honor that language.”

Lutz v. Chesapeake Appalachia, L.L.C., 71 N.E.3d 1010 (Oh. 2016)

Certified question from the Northern District of Ohio: •  Does Ohio follow the ‘at the well’ rule

(which permits the deduction of post-production costs) or does it follow some version of the ‘marketable product’ rule (which limits the deduction of post-production costs under certain circumstances)?

Ohio Supreme Court states: •  “[T]he right and remedies of the parties are

controlled by the specific language of their lease agreement ….”

•  “If the language of the lease is ambiguous, we

cannot give effect to the parties’ intent, because we do not have extrinsic evidence. If the language of the leases is not ambiguous, then the federal court should be able to interpret the leases without our assistance.”

One dissenting justice – Justice Pfeifer – supports the marketable-product rule; another – Justice O’Neil states that “[w]here a lease provides that the lessor’s royalty is based on value at the well, Ohio follows the ‘at the well’ rule. I would further hold that ‘at-the-well,’ under Ohio law, is defined as the gross proceeds of a sale minus postproduction costs.”

Canfield v. Statoil USA Onshore Properties Inc., 2017 WL 1078184 (M.D. Pa. Mar. 22, 2017).

The lease:

•  “[A]llowed for the deduction of post-production fees[,]” o  Has an addendum which “modified the royalty

provision of the lease, and expressly provides that the lessee shall not deduct certain post-production fees.”

The sale structure

•  The marketing affiliate took “title to the raw product at the wellhead … .”

•  The lessee was paid pursuant to an agreement with its marketing affiliate that “fixes the price of the raw natural gas to a uniform hub price or index price for natural gas, regardless of whether the natural gas is ever delivered to that particular hub on the interstate pipeline system.”

The F findings: •  The use of the actual price – an index price – was permissible,

because the lease called for payment on the amount realized, thus the price had to be the one actually used for the sale.

•  Because the lease called for royalties to be calculated at the

well, and did not allow post-production deductions, “[t]he only way” to construe those requirements was “to require a sale at the physical location of the well.”

•  A simple allegation of an affiliate sale, by itself, does not state a

claim for a breach of the implied duty to market. o  There was also an index price claim, however, and the

court could not, at the motion to dismiss stage, assess whether the hub prices were reasonable or reflected “the lessee’s good faith business judgment.” §  This is basically the only claim that survived in the

Canfield case.

No claims survive against the marketing company.

Corban v. Chesapeake Exploration, L.L.C., 76 N.E.3d 1089 (Oh. 2016).

A certified question from the Southern District of Ohio: •  If the 2006 version or the 1989 version of the

ODMA applies to claims asserted after 2006 alleging that the rights to oil, gas, and other minerals automatically vested in the surface landholder prior to the 2006 amendments as a result of abandonment.

The 1989 ODMA was not self-executing. •  In a plurality opinion, the court holds that the ODMA

created a “conclusive presumption” of abandonment of the mineral interest if, in the 20 year period, no savings event occurs.

o  The “conclusive presumption” is an evidentiary

device to be used in a quiet title action – thus the ODMA does not automatically transfer rights from the mineral owner to the surface owner.

§  Under the 1989 ODMA, a surface owner had to

commence a quiet title action.

The 2006 amendments to the ODMA were not unconstitutional. •  A surface holder’s right to abandoned mineral interests

was not removed; the method and procedure by which it was recognized and protected was merely changed.

•  Claims brought after June 30, 2006 had to follow the procedures set forth in the 2006 amendments.

Walker v. Shondrick-Nau, 74 N.E.3d 427 (Oh. 2016) cert denied 127 S.Ct. 824 (Mem) (2017).

•  Walker was decided the same day as Corban, and held that the 2006 amendments applied, preventing the transfer of the mineral interest to the surface owner under the facts of the case.

•  The Walker surface owners sought certiorari

from the Supreme Court of the United States, but the petition was denied.

•  Chesapeake Exploration, L.L.C., et al. v. Buell, et al., No. 2:12-cv-916 (S.D. Oh. May 4, 2017).

•  Village of Jewett v. North American Coal

Royalty Co., et al., No. 2:14-cv-175 (S.D. Oh. June 8, 2017).

•  Both recently adopted by District Judges.

Buell and Village of Jewett •  Surface owners seek to “expressly assert” the “conclusive

presumption” granted by Corban, if it is constitutional; or

•  Request leave to seek a declaratory judgment that: o  Corban deprived the surface owners of a property

right in the mineral interests, in violation of the Fourteenth Amendment of the US Constitution.

The constitutional challenges are rebuffed: •  The “conclusive presumption” language only applies to quiet

title actions filed under the 1989 Act; because these cases were filed after 2006, they were governed by the 2006 amendments.

•  No rights of the surface owners had been acquired or lost, and

the Supreme Court denied certiorari in Walker – thus there was not any “plausible argument that the Ohio Supreme Court unconstitutionally deprived [the surface owners] of a right.”

•  Darrah v. Baumberger, 2017-Ohio-8025 (Oh. Ct. App. 7th Dist.

2017) (refusing to find Corban unconstitutional despite arguments that it deprived surface owners of vested rights).

Chesapeake Appalachia, L.L.C. v. Scout Petroleum LLC, 809 F.3d 746 (3d Cir. 2016) (“Scout I”).

Holding: •  Courts, not arbitrators, must decide whether a

class action dispute should be governed by arbitration unless the arbitration clause “clearly and unmistakably” delegates the decision to the arbitrator.

o  There must be “express contractual language unambiguously delegating the question of [class] arbitrability to the arbitrator[s].”

Chesapeake Appalachia, L.L.C. v. Scout Petroleum, L.L.C., 2017 WL 1541659 (M.D. Pa. Apr. 28, 2017 (“Scout II”).

After the Third Circuit’s confirmation that the court should decide the class arbitration decision, the District Court had to do just that.

Chesapeake Appalachia, L.L.C. v. Ostroski, 199 F.Supp.3d 912 (M.D. Pa. 2016).

Ostroski and Scout II •  Ostroski followed United States Supreme Court

jurisprudence stating that class arbitration is only permissible when both sides consent; that consent would not be found in a lease silent on the issue of class arbitration.

•  Scout II followed Ostroski.

Chesapeake Exploration, L.L.C. v. Henceroth, 2016 WL 5661611 (N.D. Ohio Sept. 29, 2016).

“[U]nder the FAA, when an arbitration provision is silent as to the availability of class arbitration, a court may not impose it.”

Travis L. Brannon, Pittsburgh, PA Phone: +1.412.355.7443 Email: travis.brannon@klgates.com

A Year in the Courtroom for Oil and Gas

Paulus v. Beck Energy Corp. No. 16 MO 0008, 2017 WL 2839567

(Ohio Ct. App. June 16, 2017)

Key Facts

•  Lessees alleged that the lease should be terminated based on the lessor’s failure to produce oil or gas in paying quantities.

•  Lessors argued that the “in paying quantities” analysis should have taken into account the following: –  theamountpaidtoreplaceapumpin2013asanopera5ngexpenseoran

excludable“reworking”expense;–  includeroyal5esasopera5ngexpenses;–  givethelessee'sjudgmentonpayingquan55esproperweight;–  shouldnotconsiderthelessee'smo5vetocon5nueproducingevenatlow

amounts;merelytopreservetheleaserightsforspecula5on;–  andshouldconsiderlowmarketprices.

Paulus v. Beck Energy Corp.Ohio’s “in paying quantities” analysis

•  Blausey equation: –  Production in paying quantities is “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 Ohio, the Court will defer to the operator’s good

faith judgment when it comes to the “in paying quantities” analysis by allowing the lessee to continue even though the operation as a whole does not profit. However, the Court stated it will only give such deference if “the income minus the current operating expenses makes a profit.”

Paulus v. Beck Energy Corp.Key Takeaways

Income: •  A lessee cannot report

income without first subtracting the royalties paid to the lessor from income or adding the royalties to the operating expenses.

Operating Expenses: •  non-recurring, capital

investments, such as installing or replacing pump equipment, are excluded from operating expenses

•  labor directly related to production is considered an operating expense

In Ohio, production in paying quantities requires a profit. *5 year period at issue = loss of $551.51

Lang v. Weiss Drilling Co. 70 N.E.3d 625, 632 (Ohio Ct. App. 2016)

Key Facts •  Lessor sought termination of the lease based on lack of profitable

production, and evidence showed the well was not profitable from 1983 to 1987 and from 2003 to 2007.

•  Lessees argued the gaps in operation and production of the well was due to pump malfunction and repairs and constituted merely a cessation of operations, and the lessee operated the well at a profit from 1988 through 2002 and again from 2008 forward.

Lang v. Weiss Drilling Co.Ohio’s “in paying quantities” analysis

•  Ohio’s Blausey equation applies, and “while the lessee has

discretion to determine a well's profitability, the determination of whether a well is profitable cannot be arbitrary,” so “courts impose a standard of good faith on the lessee.”

•  The Court explained lessee “claims that during 2005 and 2006 the Well did not produce any gas because of the broken pump, but this does not account for the other years. Daniel Weiss himself called the Well a bad well and admitted it was not profitable from 1983 through 2007.”

•  The Court stated the evidence showed that the well was not profitable for 4-year periods at least twice, which cannot be considered temporary cessation.

Lang v. Weiss Drilling Co.Key Takeaways

•  The Court held the lease was terminated, because “any evidence that the Well has been profitable from 2008 to the present would be irrelevant because the Lease would have terminated prior to 2008 due to lack of production.”

•  Therefore, recent profitability of a well was not persuasive in Lang to cure a lack of profitability for more than two years in the past.

Novosel v. Seneca Res. No. 1704 WDA 2014, 2016 WL 237954, at *5 (Pa. Super.

Ct. Jan. 20, 2016)

Key Facts

•  Lessor sought termination of the lease for lack of production in paying quantities based solely on the fact that she received no royalties.

•  Although discovery was completed, there was a total lack of evidence as to production or non-production from 1986 to 2005.

Novosel v. Seneca Res.Burden of Proof: Production in paying quantities

•  A party seeking to terminate a lease bears the burden of proof.

•  The lower court explained: •  The Court has been asked by the Defendants to find

circumstantially that if there was production during all periods of time from which records can be found, i.e.[,] up to 1986 and after 2005, that production must have occurred in the interim. The Court cannot decide the issue on speculation.

•  Such evidence does not satisfy the test of circumstantial evidence that the facts proven must lead to the existence of the facts in dispute.

Novosel v. Seneca Res.Key Takeaways

•  The lower court explained “the Court cannot speculate that a lack of

records of oil or gas sales to a purchaser and a failure of one party to receive royalties constitute sufficient evidence of non-production.”

•  The Superior Court affirmed the lower court’s granting of lessors’ motions for summary judgment, stating it was the lessor’s burden to prove a lack of production in paying quantities, which she failed to do.

Pennsylvania Environmental Defense Foundation v. Commonwealth (“PEDF”)

161 A.3d 911 (Pa. 2017)

Pennsylvania Environmental Defense Foundation v. Commonwealth

Pennsylvania Environmental Defense Foundation v. Commonwealth

Gastar Exploration, Inc. v. Contraguerro 2017 WL 2418399 (W. Va. May 31, 2017)

Gastar Exploration, Inc. v. Contraguerro

Gastar Exploration, Inc. v. Contraguerro

EQT Production Company v. Wender No. 16-1938, 2017 WL 3722448, at *1 (4th Cir. Aug. 30,

2017) Key Facts

•  In January of 2016, Commissioners of Fayette County, West Virginia enacted an “Ordinance Banning the Storage, Disposal, or Use of Oil and Natural Gas Waste in Fayette County,” which explicitly prohibited the use of UIC wells for purposes of permanently disposing of natural gas waste and oil waste.

•  Immediately afterwards, EQT challenged the Ordinance in the district court, asserting that it was preempted by the comprehensive state and federal regulations that are associated with West Virginia's UIC permit program, the federal Safe Drinking Water Act, and the Oil and Gas Act.

•  In response, the County argued that the savings clause in West Virginia's Water Pollution Control Act (“WPCA”) gives it the authority to abate anything that its commission determines to be a public nuisance, including UIC wells.

EQT Production Company v. Wender Preemption in West Virginia

•  In West Virginia, county commissions have only the powers that are

granted to them by the state, meaning that when a “provision of a municipal ordinance is inconsistent or in conflict with a statute enacted by the Legislature the statute prevails and the municipal ordinance is of no force and effect.”

•  West Virginia’s Water Pollution Control Act establishes a permit

program for UIC wells. •  Under West Virginia’s Oil and Gas Act, “the legislature has vested in

the state DEP the exclusive authority over regulation of the state’s oil and gas resources.”

EQT Production Company v. WenderKey Takeaways

•  “West Virginia law simply does not permit a county to ban an activity

—here, the permanent disposal of wastewater in Class 2 UIC wells—that is licensed and regulated by the state pursuant to a comprehensive and complex permit program.”

•  Also, the Fourth Circuit concluded that by banning wastewater storage unless the storage was temporary and the wastewater would be permanently disposed in another county, the Ordinance was in conflict with the Oil and Gas Act and DEP regulations, which do not prohibit or impose temporal limits on wastewater storage.

•  Therefore, a municipal ordinance purporting to ban the operation of UIC wells was preempted by West Virginia state law.

Other Cases of Note