Chapter 19 Recent Decisions in Oil and Gas Jurisprudence

Chapter 19 Recent Decisions in Oil and Gas Jurisprudence Kevin L. Colosimo 1 James D. Mazzocco 2 Daniel P. Craig 3 Burleson LLP Pittsburgh, Pennsylvania CITE AS 36 Energy & Min. L. Inst. 19 (2015) Synopsis 19.01. Introduction...734 19.02. Land, Leasing and Conveyancing...735 [1] Questar Exploration & Prod. Co. v. Woodard Villa, Inc...735 [2] Key Operating & Equip., Inc. v. Hegar...738 [3] Sabella v. Appalachian Dev. Corp...740 [4] Cade v. Cosgrove...744 [5] Hess Corp. v. ENI Petroleum US, LLC...746 [6] Kennedy v. Consol Energy Inc...748 19.03. Calculating Royalties...750 [1] French v. Occidental Permian Ltd...750 [2] Warren v. Chesapeake Exploration, L.L.C...752 [3] Chesapeake Exploration, L.L.C. v. Hyder...754 19.04. State Preemption vs. Local Control...755 [1] ONEOK, Inc. v. Learjet, Inc...756 [2] Norse Energy Corp. USA v. Town of Dryden...758 [3] Pennsylvania Envtl. Defense Foundation v. Commonwealth...760 [4] Alliance Pipeline L.P. v. 4.360 Acres of Land, More or Less, in S/2 of Section 29, Twp. 163 N., Range 85 W., Renville Cnty., N.D...764 19.05. Ohio s Dormant Mineral Act (ODMA)...766 [1] Title Transaction...768 [2] The 1989 ODMA...769 [3] The 2006 ODMA...769 [4] The Continued Applicability of the 1989 ODMA...770 1 Kevin L. Colosimo, Managing Partner. 2 James D. Mazzocco, Associate. 3 Daniel P. Craig, Associate.

19.01 ENERGY & MINERAL LAW INSTITUTE 19.06. Litigation and Miscellaneous Issues Bankruptcy, Trade Secrets and Lone Pine Orders...771 [1] Breton Energy, L.L.C. v. Mariner Energy Res., Inc...771 [2] In re Johnson...773 [3] Lightning Oil Co. v. Anadarko E & P Onshore, LLC...776 [4] Lamont v. Vaquillas Energy Lopeno Ltd., LLP...778 [5] Antero Resources v. Strudley...780 19.07. Conclusion What the Future Holds...784 19.01. Introduction. The past year has been a time of transition for the oil and gas industry. Prior to 2014, domestic oil and gas production was the impetus of one of the largest energy booms in American history. Chiefly due to the advent and success of hydraulic fracturing, American energy production expanded at a breakneck pace and countless individuals and organizations sought to share in the bounty of this revolutionary industry. While the industry s success and rate of expansion was nothing short of remarkable, it also had the unintended effect of contributing to a considerable drop in the price of crude oil and natural gas. In turn, this shift in the global energy markets finally managed to curb domestic oil and gas development. In addition to forcing many operators to drastically reduce rig counts, implement steep reductions in drilling budgets and generally rethink their operational strategies, these economic happenings also had a significant impact on many ancillary businesses that relied on domestic energy production. The oil and gas industry s abrupt shift was also felt in the judiciary, as courts across the country were faced with a number of novel legal issues impacting oil and gas development. By recounting some of the most important oil-and-gas-related judicial developments of the past year from Appalachia and beyond, this chapter will assist oil and gas practitioners in staying abreast of the industry s constantly changing legal landscape. This chapter opens with a discussion of issues related to leasing and conveyancing in Louisiana, Texas and New York. It proceeds with an examination of decisions concerning the calculation of royalties in Texas. Next, this chapter addresses local and state preemption in New York, North Dakota and Pennsylvania. It continues with a review of important decisions from Ohio regarding the State s Dormant 734

Decisions in Oil and Gas Jurisprudence 19.02 Mineral Act. It then recounts an array of important judicial decisions which address unique legal issues from several jurisdictions. Finally, this chapter concludes with an eye to the future, predicting which legal issues will rise to the forefront in years to come and providing guidance to oil and gas practitioners as to how to best protect client interests in a rapidly shifting legal environment. 19.02. Land, Leasing and Conveyancing. With many operators focusing on already-producing wells and slowing expansion to a fraction of what it was just a year ago, numerous lessors have become dissatisfied that their leases are not as profitable as they had hoped they would be. As a result, many lessors have moved to try to avoid their leases, in the (largely misguided) hopes of signing a more advantageous lease with another operator. Courts across the country have been tasked with assessing the validity of these leases. The following decisions are several of the most interesting and impactful cases to deal with leasing and conveyancing in 2014. [1] Questar Exploration & Prod. Co. v. Woodard Villa, Inc. 4 Decided in late 2013, this decision addressed the novel issue of whether a well drilled off-lease, but reaching horizontally into a formation under the lease, can maintain operations as to all or part of the lease. The lease at issue contained a standard Pugh clause 5 and horizontal Pugh clause, 6 both of which proved determinative in construing the effect of the lease itself. 7 During the lease s primary term, Questar Exploration 4 Questar Exploration & Prod. Co. v. Woodard Villa, Inc., 48,401 (La. App. 2 Cir. 8/7/13), 123 So. 3d 734, 736, reh g denied (Sept. 19, 2013), writ denied, 2013-2467 (La. 2/21/14), 133 So. 3d 682. 5 A clause designed to sever the pooled and the non-pooled portions of the leasehold in the event of a partial pooling by the lessee. 4-6 Williams & Meyers, Oil and Gas Law 670.4. 6 Severing a leasehold on the basis of horizontal planes, as opposed to a typical Pugh clause which severs the leasehold on the basis of vertical planes only. Id. 7 Questar Exploration, 123 So. 3d at 736. 735

19.02 ENERGY & MINERAL LAW INSTITUTE and Production Company (QEP) drilled at least one well into the Cotton Valley shale formation 8 (the Cotton Valley formation ) on each of the five units encompassing the leased premises, but did not drill any wells into the Haynesville shale formation 9 (the Haynesville formation ). 10 While the lease was still in effect QEP also began drilling on a surface location not part of the leased premises and not in a unit containing any part of the leased premises. 11 Prior to the expiration of the subject lease s primary term, this horizontal off-lease well reached into the Haynesville formation underlying one of the units which included the leased premises, but was not completed until after the lease expired. 12 After the expiration of the primary term, the lessors demanded that QEP execute a release as to all depths below the Cotton Valley formation, including the Haynesville formation. 13 QEP refused to release any depths above the Haynesville formation and filed suit seeking declaratory judgment, arguing that the entire lease had been maintained to the bottom of the Haynesville formation by virtue of the off-lease well that reached horizontally into a unit encompassing the leased premises. 14 The lessor argued that, once the Pugh clause was triggered, a well producing from one unit would only apply to satisfy the maintenance requirement of that unit. 15 Additionally, the lessor argued that to allow QEP to maintain the entire acreage via a producing well 8 Located approximately 7,800-10,000 feet below Northeast Texas and Northwest Louisiana and just above the Haynesville/Bossier Shale, the Cotton Valley subsurface formation is mainly a natural gas play, but has produced some oil. Cotton Valley Tight Gas, Oil & Gas Journal, http://www.ogj.com/unconventional-resources/cotton-valley.html (accessed 4-15-15). 9 Running through northwestern Louisiana, northeastern Texas and the southwestern tip of Arkansas, the Haynesville formation is believed to contain up to 30-40 trillion cubic feet of natural gas. Haynesville, Oil & Gas Journal, http://www.ogj.com/unconventionalresources/haynesville-shale.html (accessed 4-15-15). 10 Questar Exploration, 123 So. 3d at 736. 11 Id. 12 Id. 13 Id. 14 Id. at 737. 15 Id. 736

Decisions in Oil and Gas Jurisprudence 19.02 outside of the unit would create a loophole whereby the whole lease could be maintained by dividing the leased premises into several units and only drilling one well on one unit. 16 In response to the lessor s argument, the court noted that the main purpose of a Pugh clause is to protect the lessor from the anomaly of having the entire property held under lease by production from a very small portion. 17 The court also focused on the language of the Pugh clause itself: [t]his lease may be maintained as to acreage not included in such unit or units in any other manner provided for herein, including continuous development. 18 Because the Pugh clause specifically mentioned this lease and did not reference any separate leases or division of the lease, the clause demonstrated that the parties did not intend for the clause to separate or divide the lease. 19 Therefore, there was no absurd consequence in holding that the entire acreage was maintained by the operation of the off-lease well because, pursuant to the language of the parties agreement, operations on all five units clearly maintained the entire lease beyond the primary term. 20 Additionally, the lessors tried to convince the court that, because the well in question was off-lease and was not drilled on, completed or producing from land within a unit embracing some part of the leased premises prior to the expiration of the primary term, the horizontal Pugh clause ceased to affect depths below the Cotton Valley formation. 21 The court disagreed, focusing on how the horizontal Pugh clause did not specifically require actual production to maintain depths, as well as the fact that the off-lease well was spudded and had entered into a formation on the leased premises prior to the expiration of the primary term. 22 16 Id. 17 Id. (citing small Will-Drill Res., Inc. v. Huggs Inc., 32,179 ((La. App. 2 Cir. 8/18/99)), 738 So. 2d 1196, 1200 writ denied, 99-2957 ((La. 12/17/99)), 751 So. 2d 885). 18 Id. at 739. 19 Id. 20 Id. 21 Id. 22 Id. 737

19.02 ENERGY & MINERAL LAW INSTITUTE Practice Point: Pugh clauses can be drafted so as to permit a well drilled off-lease, but reaching into a formation located under the leased premises, to maintain operations as to all of the subject lease. [2] Key Operating & Equip., Inc. v. Hegar. 23 This case tasked the Texas Supreme Court with determining whether, when two mineral leases have been pooled but production is only from one lease, the lessee has the right to utilize the surface of the non-producing lease in order to access the producing lease. 24 Key Operating Equipment, Inc. (Key) began operating the Richardson No. 1 Well on the 60-acre Richardson Tract in 1987. 25 In 1994, Key acquired multiple oil and gas leases on the contiguous Curbo-Rosenbaum Tract, and reworked the Rosenbaum No. 2 well, which already existed on that acreage. 26 Also in 1994, Key built an access road across the Curbo-Rosenbaum Tract that enabled it to access both that tract and the Richardson Tract. 27 When the Rosenbaum No. 2 well stopped producing in 2000, Key s lease on the Curbo- Rosenbaum Tract expired and its owners purchased an undivided fractional mineral interest in the Curbo-Rosenbaum Tract. 28 Key s owners promptly leased this fractional interest to Key, and the terms of the lease permitted Key to pool a portion of the acreage from the Curbo-Rosenbaum Tract with a portion of the acreage from the adjacent Richardson Tract. 29 In 2002, Will and Loree Hegar (the Hegars) bought a portion of the Curbo-Richardson Tract (the Hegar Tract ), including a portion of the road used by Key to access the Richardson No. 1 well. 30 The Hegars were aware when they purchased the acreage that Key used the road to access its existing operations on the 23 Key Operating & Equip., Inc. v. Hegar, 435 S.W.3d 794 (Tex. 2014). 24 Id. at 796. 25 Id. 26 Id. 27 Id. 28 Id. 29 Id. 30 Id. 738

Decisions in Oil and Gas Jurisprudence 19.02 Richardson Tract, but they did not object to this usage until 2004 when Key drilled the Richardson No. 4 well and traffic on the road increased. 31 The Hegars brought suit alleging that Key s use of the road was trespassory, and sought declaratory judgment that Key had no legal right to access or use the surface of the Hegar Tract in order to produce minerals from the Richardson Tract. 32 After hearing evidence that Key s only producing well was drawing from a reservoir that did not underlie the Hegar Tract, the trial court enjoined Key from using the section of road on the Hegar Tract. 33 The court reasoned that, because no minerals were being extracted from beneath the Hegar Tract by wells on the Richardson Tract, Key s use of the surface of the Curbo-Richardson Tract was not reasonably necessary. 34 The court of appeals initially reversed, but on rehearing determined that evidence supported the trial court s finding that Key was only producing oil from the adjacent Richardson Tract and therefore had no right to use the Hegars surface for production exclusively from the Richardson Tract. 35 The court also held that Key could not contractually expand its right to use the Hegars surface because Key s lease and pooling agreement were not part of the Hegars chain of title. 36 However, the Texas Supreme Court reversed, holding that Key had a right to use the surface of the Hegar Tract due to both its status as a partial mineral owner and the fact that both the Curbo-Rosenbaum and Richardson leases permitted pooling. 37 Because it owned a portion of the minerals underlying the Hegar Tract, the accommodation doctrine 38 granted Key 31 Id. 32 Id. 33 Id. at 796-797. 34 Id. 35 Id. at 797. 36 Id. 37 Id. at 799. 38 See Merriman v. XTO Energy, Inc., 407 S.W.3d 244, 248 49 (Tex.2013) (holding that the owner of the dominant mineral estate in a tract has the right to go upon the surface of that land to produce and remove the minerals). 739

19.02 ENERGY & MINERAL LAW INSTITUTE implied property rights in the Hegars surface. 39 Additionally, the court cited to Texas longstanding policy of encouraging pooling to avoid waste and stated that the primary legal consequence of pooling is that production and operations anywhere on the pooled unit are treated as if they have taken place on each tract within the unit. 40 Once pooling occurred, the pooled parts of the Richardson and Hegar Tracts no longer maintained separate identities as to where production from the pooled interests was located. 41 And because production from the pooled portion of the Richardson Tract was legally considered to be production from the pooled portion of the Hegar Tract, Key had a right to use the road passing over the Hegar Tract to access the Richardson Tract. 42 Therefore, Key was permitted the right of ingress and egress over the Hegar Tract because its owners did not increase the burden on the surface estate by leasing their minerals to Key or by pooling the two tracts at issue. 43 Practice Point: Through its mineral lease, Key had the right of ingress and egress over the surface in order to develop and remove minerals from the tract, as well as a right to pool. And because the right of ingress and egress included the right to access the surface of any pooled acreage for the purpose of producing minerals, Key was permitted to utilize a non-producing tract to access a producing tract in that same unit. [3] Sabella v. Appalachian Dev. Corp. 44 Dennis Sabella purchased the mineral rights underlying 66 acres of land at a sheriff s sale in 1997. 45 Sabella properly recorded his deed and drove the public road adjacent to the land under which his mineral estate 39 Key Operating, 435 S.W.3d at 799. 40 Id. at 798 (citing Pipe Line Co. v. Tichacek, 997 S.W.2d 166, 170 (Tex.1999)). 41 Id. at 799. 42 Id. 43 Id. at 800. 44 Sabella v. Appalachian Dev. Corp., 103 A.3d 83 (Pa. Super. 2014), reargument denied (Dec. 10, 2014). 45 Id. at 86. 740

Decisions in Oil and Gas Jurisprudence 19.02 was located to look for any signs of oil and gas development. 46 Finding that the property was secluded and observing no activity from the road, Sabella assumed (incorrectly, but seemingly in good faith) that there was no oil and gas production occurring on the property. 47 In 2001, Mark and Virginia Harvey (the Harveys ), who owned 104 surface acres above the 66 mineral acres owned by Sabella, signed an oil and gas lease (the Harvey Lease ) with Appalachian Development Corp. ( Appalachian ). 48 Although the Harvey Lease was duly recorded, neither the Harveys nor Appalachian were aware that 66 of the subsurface acres were already owned by Sabella. 49 Appalachian eventually sold some of its holdings, including the Harvey Lease, to Brian Haner, warranting good, marketable title. 50 In finalizing the purchase from Appalachian, Haner elected to perform only a bring down title search 51 of his newly acquired properties. 52 At the time of the sale to Haner there existed two producing oil and natural gas wells on the property, and Haner proceeded to drill seven more. 53 In connection with other operations, Haner eventually met Sabella and the two men reviewed a map depicting the Harveys acreage and Sabella s mineral estate. 54 Despite conflicting testimony about what exactly the two men said during this meeting, the evidence demonstrated Haner concluded that he was operating on Sabella s land. 55 Despite this realization, Haner failed to disclose his operations to Sabella and even implied that there was no oil and gas activity occurring on Sabella s property. 56 After realizing he was producing minerals owned by Sabella, Haner conferred only with 46 Id. 47 Id. 48 Id. at 87. 49 Id. 50 Id. 51 A search of the applicable records only from the date of the conveyance to Haner. 52 Id. 53 Id. 54 Id. 55 Id. at 88. 56 Id. 741

19.02 ENERGY & MINERAL LAW INSTITUTE Appalachian s partners, who assured Haner that he had good title. 57 Instead of performing a full title search on the property or placing royalty funds in escrow, Haner proceeded to continue operating on Sabella s land, even going so far as to engage in further development of the property. 58 After discovering the full extent of Haner s operations, Sabella brought suit and the trial court found Haner liable for trespass and conversion. 59 On review, the Pennsylvania Superior Court addressed several procedural issues in addition to the substantive claims. Regarding subject matter jurisdiction, Haner argued that the Harveys were indispensable parties to the action because they had an interest in the outcome of the litigation. 60 Both the trial court and the superior court disagreed, holding that the Harveys had no interest in the litigation because they only ever owned an interest in the surface estate and a mistaken belief regarding the ownership of the minerals was insufficient to confer a justiciable interest. 61 Additionally, the trial court and the superior court agreed that the discovery rule 62 functioned to toll the applicable two-year statute of limitations. 63 Sabella purchased the oil and gas rights at a tax sale, properly recorded the deed and observed no oil and gas development when he examined the surface of the parcel. 64 Because Pennsylvania has strong protections as a race-notice 65 state, it was reasonable for Sabella to assume that his right would be protected by both his recordation of the deed and 57 Id. 58 Id. 59 Id. at 89. 60 Id. at 90-91. 61 Id. at 91-92. 62 See Lewey v. Fricke Coke Co., 31 A. 261 (Pa. 1895) (holding that the start of the statutory limitation on an action in tort may be delayed by plaintiff s ignorance of his injury and its cause, until such time as he could or should have discovered it by the exercise of reasonable diligence. ). 63 Sabella, 103 A.3d at 92. 64 Id. at 94. 65 Giving priority of title to the party that records first, but only if the recording party also lacked notice of prior unrecorded claims on the same property. 742

Decisions in Oil and Gas Jurisprudence 19.02 subsequent inspection. 66 Furthermore, even though Sabella s examination of the premises did not uncover the fact that oil and gas development was occurring on the property at the time of his purchase, the existing wells were secluded and almost impossible to see from the public road without binoculars. 67 And although Sabella was a mineral owner who had the right to enter onto the surface to aid in development of his interest pursuant to the accommodation doctrine, he did not have a right to enter onto the surface with impunity merely to investigate whether development was occurring. 68 Therefore, a reasonably prudent landowner exercising reasonable efforts would not have discovered oil and gas development on the land at issue and the discovery rule function to toll the applicable statute of limitations. 69 After resolving these procedural issues, the superior court then focused on the substantive issue of good faith vs. bad faith trespass. 70 Generally, when a good-faith trespasser makes improvements to land, the injured party is entitled to the trespasser s net profits, i.e., the revenues generated upon the land minus the money expended in facilitating the profitable activity. 71 Yet when a party trespasses in bad faith, the injured party is entitled to all moneys derived from the trespass without any offset. 72 The trial court held that Haner was a good faith trespasser until meeting with Sabella and a bad faith trespasser thereafter because, after meeting Sabella, Haner knew or should have known that he was trespassing upon Sabella s property yet chose to 66 Id. 67 Id. at 95. 68 Id. at 97. 69 Id. 70 Id. at 98. 71 Id. at 98-99 (citing Matthews v. Rush,105 A. 817, 818 (Pa. 1919); Crawford v. Forest Oil Co., 57 A. 47 (Pa. 1904); Appeal of Coleman, 62 Pa. 252, 278 79 (Pa. 1869); Herdic v. Young, 55 Pa. 176, 178-79 (Pa. 1867); see also United States v. Wyoming, 331 U.S. 440, 458, 67 S. Ct. 1319, 91 L. Ed. 1590 (1947) ( [O]ne who willfully or in bad faith trespasses on the land of another, and removes minerals, is liable to the owner for their full value computed as of the time the trespasser converted them to his own use, by sale or otherwise, but... an innocent trespasser, who has acted in good faith, may deduct from such value the expenses of extraction. )). 72 Id. (internal citations omitted). 743

19.02 ENERGY & MINERAL LAW INSTITUTE expand production without making any effort to determine Sabella s potential interest in the minerals underlying the property or to compensate him. 73 However, the superior court disagreed, stating that Haner was a bad faith trespasser for the duration of his drilling operations because Sabella s recordation of his deed put Haner on constructive notice of Sabella s interest in the property. 74 After discussing the relevant Pennsylvania statutes regarding notice and restitution, as well as reviewing the nature of an oil and gas lease and how such a lease functions to convey a defeasible fee in the property, the superior court held that Haner lost his bona fide purchaser status when he neglected to perform a full title search of the property. 75 By failing to perform a relatively simple search that would have uncovered Sabella s interest, Haner also failed to act in good faith and was not entitled to any offsets whatsoever. 76 Practice Points: In certain situations, the discovery rule can function to toll the statute of limitations regarding knowledge of oil and gas development occurring on property. Also, due to the unique nature of the rights conveyed by an oil and gas lease, the failure to perform a full title search before proceeding with development can qualify an operator s actions as bad faith for the duration of the drilling activity. [4] Cade v. Cosgrove. 77 In 2006, Michael and Billie Cade (the Cades) sold property subject to an oil, gas and mineral lease to Barbara Cosgrove. 78 Although the sales contract stated that the Cades were to retain the mineral rights, the parties inadvertently failed to include a mineral reservation in the warranty deed. 79 Although the parties subsequently took actions consistent with the belief that the Cades owned the minerals, the operator eventually determined that the 73 Id. at 99. 74 Id. 75 Id. at 104. 76 Id. 77 Cade v. Cosgrove, 430 S.W.3d 488 (Tex. App. 2014), review granted (Jan. 30, 2015). 78 Id. at 492. 79 Id. 744

Decisions in Oil and Gas Jurisprudence 19.02 warranty deed actually conveyed the mineral rights to Cosgrove and notified the Cades. 80 Realizing the mistake, the Cades asked Cosgrove to execute a correction deed, but she refused. 81 After the Cades sought declaratory judgment that they owned the minerals, the trial court granted summary judgment for Cosgrove based on the merger doctrine and the statute of limitations. 82 Pursuant to the common law merger doctrine, the deed is considered the final expression of the parties agreement because the terms of the sales contract ultimately merge into those of the deed. 83 Yet the application of this doctrine can be avoided if a party alleges or proves a mistake in the execution of the deed. 84 Importantly, mutual mistake can be used as grounds to reform a deed, and the common law treats knowledge by one party of a unilateral mistake by another party as the equivalent of mutual mistake. 85 In this situation, the contract between the Cades and Cosgrove reflected that the Cades would retain their mineral rights, and Cosgrove neither disputed this fact nor offered any evidence to contradict the contract. 86 Therefore, the deed s mistaken omission of mineral reservation on behalf of the Cades constituted a mutual mistake that permitted reformation of the deed despite the merger doctrine. 87 Addressing a related issue, the court held that, although a grantor is presumed to know the contents of the deed immediately upon executing it, mutual mistake can toll the statute of limitations until such time as the claimant knows or with reasonable diligence should have known of the 80 Id. 81 Id. 82 Id. 83 Id. at 493 (citing Harris v. Rowe, 593 S.W.2d 303, 306 (Tex.1979); Munawar v. Cadle Co., 2 S.W.3d 12, 16 17 (Tex. App.-Corpus Christi 1999, pet. denied)). 84 Id. (citing Harris, 593 S.W.2d at 306; Turberville v. Upper Valley Farms, Inc., 616 S.W.2d 676, 678 (Tex. Civ. App.-Corpus Christi 1981)). 85 Id. (citing Davis v. Grammer, 750 S.W.2d 766, 768 (Tex. 1988)). 86 Id. 87 Id. 745

19.02 ENERGY & MINERAL LAW INSTITUTE mistake. 88 And after exhaustively assessing established precedent on the statute of limitations and accrual of claims to reform a deed, the court reversed the trial court s order of summary judgment and remanded the case for further proceedings because there was a question of fact as to when the Cades knew or should have known of the mistake. 89 Practice Point: Regardless of the merger doctrine, mutual mistake can function to reform a deed and determine which party owns the mineral rights, as well as toll the applicable statute of limitations. Yet a court decision to reform the deed will likely hinge on the factual issue of when the parties knew or should have known of the mistake, making this situation inappropriate for resolution via summary judgment. [5] Hess Corp. v. ENI Petroleum US, LLC. 90 ENI Petroleum (ENI) agreed to sell and deliver natural gas to Hess Corporation (Hess) pursuant to a Base Contract that contained only basic provisions applicable only to subsequent sales of natural gas between the parties. 91 The details of each successive sale were memorialized in Transaction Confirmations which specified that the parties obligations were firm, meaning that performance was interruptible only be force majeure. 92 Notably, the Transaction Confirmations did not specify a particular source from which the gas would be sold or which transporter would be utilized. 93 During one such sale, a pipeline leak prevented ENI from delivering natural gas from its preferred transporter to the pool specified in the Transaction Confirmation. 94 ENI then informed Hess that it was claiming force majeure under the terms of the Base Agreement and would not be delivering any gas. 95 88 Id. at 501. 89 Id. at 508. 90 Hess Corp. v. ENI Petroleum US, LLC, 435 N.J. Super. 39 (App. Div. 2014). 91 Id. at 41-42. 92 Id. at 42. 93 Id. at 43. 94 Id. at 44. 95 Id. 746

Decisions in Oil and Gas Jurisprudence 19.02 In pertinent part, the force majeure clause stated that [n]either party shall be liable to the other for failure to perform... to the extent such failure was caused by a Force Majeure. The term Force Majeure as employed herein means any cause not reasonably within the control of the party claiming suspension[.]... Force Majeure shall include, but not be limited to... interruption and/or curtailment of Firm transportation and/or storage by Transporters[.] 96 Hess rejected ENI s declaration of force majeure on the grounds that the Transaction Confirmation did not identify a particular transporter. 97 Hess also denied force majeure because the pool at which ENI was supposed to deliver the gas was fed by several different transporters and pipelines controlled by ENI, meaning that the pipeline leak would merely require ENI to allocate identical gas delivered by a different transporter in order to fulfill its obligations to Hess. 98 ENI still refused to deliver the gas and Hess filed suit for breach of contract after being forced to purchase replacement gas for $300,000 over the contract price. 99 Focusing on how neither the Base Contract nor the Transaction Agreement specified the source of the natural gas ENI would sell to Hess or the specific transporter or pipeline that would be used to deliver the gas, the court held in favor of Hess. 100 Because other pipelines were available and capable of fulfilling ENI s obligations under the contract, ENI could not claim force majeure as a defense based purely on the fact that its preferred transporter was unable to deliver the gas. 101 96 Id. 97 Id. at 44-45. 98 Id. 99 Id. at 45. 100 Id. at 47-48. 101 Id. at 48. 747

19.02 ENERGY & MINERAL LAW INSTITUTE Practice Point: A force majeure clause may not function to negate a party s obligations under a contract where other methods of performance are available and are not specifically prohibited by the parties agreement. [6] Kennedy v. Consol Energy Inc. 102 Issued April 22, 2015, this opinion concluded that methane gas contained in coal belongs to the owner of the coal estate when the severance deed is silent. The plaintiff appellants (the Kennedys ) owned oil and gas rights underlying a 790-acre tract of land. 103 However, Consol Energy Inc. (Consol) owned the coal underlying that tract and drilled several wells to extract coalbed methane gas from the coal seam. 104 The Kennedys sought to quiet title to the coalbed methane gas and filed suit against Consol for trespass, conversion, unjust enrichment and replevin based on Consol s alleged intrusion into the adjacent strata owned by the Kennedys (the oil and gas estate) during its degasification of the coal seam in preparation for mining. 105 The trial court granted judgment on the pleadings in favor of Consol on all claims, and the superior court affirmed. 106 The superior court stated that the facts of the instant case were essentially indistinguishable from the 1983 Pennsylvania Supreme Court ruling in U.S. Steel Corp. v. Hoge, 107 which established that, when a coal severance deed is silent or does not expressly reserve the ownership of the coalbed methane, the gas contained in the coal belongs to the owner of the coal. 108 Specifically, both cases involved a situation where different parties owned the oil and gas and coal estates underlying a single tract, and neither of the coal severance deeds mentioned ownership of the coalbed methane. 109 102 Kennedy v. Consol Energy Inc., 2015 Pa. Super. 93 (Apr. 22, 2015). 103 Id. at 1. 104 Id. 105 Id. 106 Id. 107 U.S. Steel Corp. v. Hoge, 468 A.2d 1380 (Pa. 1983). 108 2015 Pa. Super. at 3-6. 109 Id. at 6. 748

Decisions in Oil and Gas Jurisprudence 19.02 Looking to the intent of the grantors at the time of the severance, the superior court stated that the reservation of oil and gas did not include coalbed methane (which was actually regarded as a nuisance at the time of the conveyance) and the severance deeds expressly reserved the right to drill for natural gas. 110 This demonstrated that the grantor only intended to reserve natural gas and that the coalbed methane was conveyed with the coal. 111 In resolving the other claims brought by the Kennedys, the superior court ruled that the Kennedys claim of trespass against Consol was refuted by the language of the reservation in the deed which permitted the holder to dig, mine, ventilate, drain and carry away the coal on the land. 112 Despite the Kennedys argument that the right-of-way granted to Consol did not permit commercial production of the coalbed methane, the language in the deed directly refuted this claim and rendered immaterial the fact that the operation of degasification is often a profitable enterprise. 113 Finally, the superior court also refused to validate any of the Kennedys claims that Consol has possibly converted any of the natural gas belonging to the Kennedys when Consol entered the adjacent strata to ventilate the coalbed methane. 114 Although the evidence could lead to the conclusion that Consol s operations caused some of the Kennedys natural gas to migrate to Consol s wells and was produced, the court refused to entertain this argument because the Kennedys were unable to offer any evidence establishing the value of the gas lost or show that Consol acted in bad faith or with fraudulent intent. 115 Practice Point: The owner of the coal estate owns the coalbed methane in Pennsylvania and claims of conversion premised on an operator s entrance into an adjacent strata require evidence of bad faith or fraudulent intent. 110 Id. 111 Id. 112 Id. at 8. 113 Id. 114 Id. at 638. 115 Id. at 638-39. 749

19.03 ENERGY & MINERAL LAW INSTITUTE 19.03. Calculating Royalties. As the technology driving modern oil and gas development continues to advance by leaps and bounds, many lessors are implementing innovative new methods of extraction and production that function to minimize waste and increase profits. In an effort to share the costs associated with these new techniques, many lessees have attempted to classify these operations as post-production activities that are deductible from the lessor s royalties. But many lessors are still unfamiliar with these cutting-edge processes and the current oil and gas market has made many lessors increasingly wary of unexpected deductions from their royalty checks. Disputes have now arisen over how best to equitably allocate these new expenses, requiring courts to reestablish the distinction between production and post-production activities. [1] French v. Occidental Permian Ltd. 116 A royalty is generally free of the expenses of production, [but] is often subject to certain post-production costs. 117 These post-production costs usually include the cost of treatment to render [production] marketable, but the parties may modify this general rule by agreement. 118 In this case, the subject leases allowed for enhanced oil recovery via the injection of carbon dioxide (CO 2 )) into a reservoir to sweep [ ]oil to the production wells. 119 The CO 2 eventually returned to the surface entrained in casinghead gas, 120 and the operator contracted with a third party to separate the CO 2 from the other casinghead compounds so that the CO 2 could be reused. 121 The operator 116 French v. Occidental Permian Ltd., 440 S.W.3d 1 (Tex. 2014), reh g denied (Oct. 3, 2014). 117 Id. at 3 (citing Heritage Res., Inc. v. NationsBank, 939 S.W.2d 118, 121 122, 123 (Tex. 1996)). 118 Id. 119 French, 440 S.W.3d at 2. 120 See Railroad Comm n of Tex. v. Lone Star Gas Co., 844 S.W.2d 679, 684 n. 5 (Tex.1992) (quoting 8 H. Williams & C. Meyers, Oil and Gas Law: Manual of Oil and Gas Terms 156 (1991)) (defining casinghead gas as [g]as produced with oil in oil wells, the gas being taken from the well through the casinghead at the top of the well, as distinguished from gas produced from a gas well ). 121 French, 440 S.W. 3d at 2. 750

Decisions in Oil and Gas Jurisprudence 19.03 deducted the cost of separating the CO 2 from the lessor s royalty. 122 The lessor claimed that, under the terms of the parties agreement, the royalty due on the casinghead gas... must be determined as if the injected CO 2 were not present, and that the working interest owners were not required to share in the expense of removing the CO 2 from the gas. 123 Pursuant to the parties unitization agreement, no royalty was due and none was paid on casinghead gas. 124 Although the operator had the option of simply reinjecting the casinghead gas back into the field without any type of refinement or separation, it chose not to do so because the recovered casinghead gas did not have an optimal CO 2 concentration and also contained natural gas liquids (NGLs) and other valuable compounds that could be sold after the CO 2 was extracted. 125 In order to achieve an adequate CO 2 concentration for reinjection and to realize the value of the NGLs contained in the casinghead gas, the operator paid a third party to process the gas and separate the CO 2 from the NGLs. 126 Although neither party objected to sharing in the cost of removing the NGLs and other contaminants from the casinghead gas, the lessor sued the operator for underpayment of royalties due to the operator s inclusion of the cost of removing the CO 2 as part of post-production expenses to be shared by both parties. 127 Looking to precedent for guidance, the court noted that, although royalty owners are typically required to share in the cost of removing contaminants indigenous to the production field, no cases involved the allocation of cost for the separation of extraneous substances injected in the field. 128 The court ultimately compared the CO 2 separation process to that of separating water from oil when production occurs via waterflooding, 129 but noted 122 Id. 123 Id. 124 Id. at 6. 125 Id. 126 Id. 127 Id. at 7. 128 Id. at 9. 129 The injection of water into an oil reservoir in order to increase pressure and stimulate production. 751

19.03 ENERGY & MINERAL LAW INSTITUTE that separating the CO 2 from the casinghead gas was not necessary for the continued production of oil or to render the oil marketable. 130 However, the separation of the gases did lead to more efficient production and prevented waste in that both parties shared in the value of the NGLs and the operator obtained a concentrated strain of CO 2 for reinjection. 131 Furthermore, the parties Unitization Agreement gave the lessee the option of reinjecting the casinghead gas directly into the field, but the operator chose to process the gas instead. 132 Had the operator chosen to reinject the entire production of casinghead gas, the lessor would not be entitled to any royalty on the casinghead gas. 133 Therefore, because the parties agreement gave the operator the right and discretion to decide whether to reinject or process the casinghead gas, and because the decision to separate the CO 2 allowed for more efficient production and granted the lessor a royalty that it would not otherwise have received, the court held that the lessor must share in the cost of CO 2 extraction. 134 Practice Point: A lessor may be required to share in the post-production cost of removing extraneous substances from oil or gas if the lessor realizes some additional benefit as a result of the extraction process that it would not have realized otherwise. [2] Warren v. Chesapeake Exploration, L.L.C. 135 Also addressing the deduction of post-production expenses from the lessor s royalty, this case focuses on whether the lease s royalty clause permitted the deduction of costs incurred in delivering the marketable natural gas from the mouth of the well to the actual point of sale. The oil and gas leases at issue provided that the lessors were entitled to 22.5 percent of the amount realized by Lessee, computed at the mouth of 130 Id. at 10. 131 Id. 132 Id. 133 Id. 134 Id. 135 Warren v. Chesapeake Exploration, L.L.C., 759 F.3d 413 (5th Cir. 2014). 752

Decisions in Oil and Gas Jurisprudence 19.03 the well. 136 The term amount realized typically require[s] measurement of the royalty based on the amount the lessee [] receives under its sales contract for the gas. 137 However, the addition of the language at the mouth of the well means that the royalty is calculated based on net proceeds, and the physical point to be used as the basis for [this] calculation... is the mouth of the well. 138 Therefore, based on this language alone, the lessees were permitted to deduct the cost of delivering marketable gas from the mouth of the well to the point of sale. 139 However, the leases also contained an addendum that provided that it was to supersede any inconsistent portion of the original lease, including the royalty clause. 140 Yet when the court compared the addendum s royalty clause to that of the original lease, it determined that the language of the two clauses had the same effect. 141 The original lease stated that all royalties, regardless of where the gas sales occurred, were to be free of post-production costs, including transportation. 142 The addendum provided that all royalties paid to the lessors would be free of costs and expenses, including costs of transportation. 143 Yet the addendum did not alter the point at which the royalty was computed: the mouth of the well. 144 The court also noted that, if the parties wanted the lessors to receive 22.5 percent of the proceeds of sales regardless of where the sales occurred, they could have accomplished that in a number of ways, the most obvious of which being to delete the phrase at the mouth of the well. 145 Therefore, the language of the royalty clause permitted deduction of post-production costs incurred by the lessees 136 Id. at 416. 137 Id. at 417. 138 Id. 139 Id. 140 Id. at 418. 141 Id. 142 Id. 143 Id. 144 Id. 145 Id. 753

19.03 ENERGY & MINERAL LAW INSTITUTE in delivering marketable gas from the mouth of the well to the actual point of sale. 146 [3] Chesapeake Exploration, L.L.C. v. Hyder. 147 Functioning as the inverse of the Warren decision, this case involves an operator seeking to recover overpaid royalties on the grounds that the royalty clause permitted the operator to deduct from the lessor s royalty certain post-production costs incurred between the point of delivery and the point of sale. 148 The lease at issue stated that the royalty was to be free and clear of all production and post-production costs and expenses, including transporting and delivering the gas, along with any other costs and expenses incurred between the wellhead and the [lessee s] point of delivery or sale. 149 While acknowledging that the lease excluded production costs and expenses, the lessee argued that the royalty clause permitted deduction of post-production costs and expenses, including third-party transportation costs incurred between the point of delivery and the point of sale. 150 The lessees argued that the disjunctive nature of the language regarding expenses incurred between the wellhead and [appellants] point of delivery or sale, allowed them to choose either the point of delivery or sale to determine whether to deduct post-production costs and expenses. 151 The court disagreed, stating that this interpretation ignored the free and clear provision of the royalty clause. 152 Specifically, the court interpreted the parties agreement as excluding all costs and expenses of production and post-production from the royalty, 146 Id. 147 Chesapeake Exploration, L.L.C. v. Hyder, 427 S.W.3d 472 (Tex. App. 2014), review granted (Jan. 30, 2015). 148 Id. at 476. 149 Id. 150 Id. at 477. 151 Id. at 476 (emphasis added). 152 Id. at 477. 754

Decisions in Oil and Gas Jurisprudence 19.04 including post-production costs and expenses incurred between the point of delivery and the point of sale. 153 Additionally, the court assessed whether the operator was entitled to an overriding royalty free from all production and post-production costs when the parties agreement stated that lessees were entitled to a cost-free overriding royalty. 154 Examining the four corners of the instrument, the court held that to adopt the lessor s position in regards to the lease would require it to render the term cost-free meaningless and determine whether the parties true intent was to provide a traditional overriding royalty interest (ORI) or a cost-free ORI (except only to its portion of production taxes and post-production costs). 155 Because such an interpretation would require the court to rewrite the lease and alter the parties contract, the court concluded that the parties had expressly excluded the ORI from deductions for postproduction costs. 156 19.04. State Preemption vs. Local Control. The debate as to whether federal, state or local governments are better equipped to regulate oil and gas development is as old as the industry itself. Those who favor federal oversight argue that pre-existing federal acts regulating air, water and federal lands present the best framework for oil and gas regulation. Proponents of state regulation cite to the benefits of statewide permitting, reporting and bonding controls, as well as taxes for severance, road use and permitting fees. Finally, supporters of local control focus on a local government s familiarity with zoning and setbacks, along with regulations governing road use, hours of operation and noise. A number of recent decisions demonstrate how courts are still attempting to find an acceptable mechanism for allocating power and control among these factions. 153 Id. 154 Id. at 478. 155 Id. at 480. 156 Id. 755

19.04 ENERGY & MINERAL LAW INSTITUTE [1] ONEOK, Inc. v. Learjet, Inc. 157 In a 7-2 decision on April 21, 2015, the U.S. Supreme Court ruled that state and federal lawsuits brought under state antitrust laws by retail customers against interstate pipeline companies were not preempted by the Natural Gas Act (NGA) 158 and, therefore, may proceed. In 2005, a plaintiffs group composed of manufacturers buying natural gas directly from interstate pipelines (collectively the Traders ) filed claims under both federal and state law alleging that various natural gas pipelines (collectively the Pipelines ) engaged in wash sales 159 and misrepresented price figures to trade publications, thereby distorting the market for natural gas and inflating gas prices. 160 In 2007, the case was consolidated and the Nevada District Court granted the Pipelines motion for summary judgment on the grounds that the NGA preempted the Traders state-law antitrust claims. 161 The Ninth Circuit reversed, emphasizing that the price manipulation complained of affected not only jurisdictional (i.e., wholesale)[], but also nonjurisdictional (i.e., retail) sales. 162 The Ninth Circuit construed the NGA s preemptive scope as only preserving the states authority to regulate nonjurisdictional sales, and held that the NGA did not preempt state law claims aimed at price manipulation, even if the manipulation also raised wholesale rates. 163 The Supreme Court granted certiorari and the Pipelines argued that the Traders state antitrust lawsuits were within the field that the NGA preempts and that the claims target anticompetitive activities that affected wholesale as well as retail rates. 164 They also noted that the NGA expressly grants the [Federal Energy Regulatory Commission] (FERC) the authority to 157 ONEOK, Inc. v. Learjet, Inc., 135 S. Ct. 1591 (U.S. Apr. 21, 2015). 158 15 U.S.C. 717. 159 A wash sale occurs when a party sells a security at a loss and then purchases the same or substantially similar security shortly after. 160 ONEOK, Inc., 135 S. Ct. at 1598. 161 Id. 162 Id. at 1599. 163 Id. 164 Id. 756

Decisions in Oil and Gas Jurisprudence 19.04 keep wholesale rates at reasonable levels and, in exercising its authority, FERC has prohibited the very kind of anticompetitive conduct that the state actions attack. 165 The Pipelines contended that allowing these lawsuits to proceed would permit state antitrust courts to reach conclusions regarding pipeline conduct that differ from those reached by the FERC. 166 The court rejected the Pipelines argument, stating that the NGA was drawn with meticulous regard for the continued exercise of state power, not to handicap or dilute it in any way. 167 Accordingly, where [] state law can be applied to nonjurisdictional as well as jurisdictional sales, [the court must proceed cautiously, finding preemption only where detailed examination convinces [it] that a matter falls within the preempted field as defined by [] precedent []. 168 Furthermore, the target at which the state law aims is important in determining whether that law is preempted. 169 The Supreme Court noted that here, as well as in several precedential decisions, the state lawsuits were directed at practices affecting retail rates which are firmly on the States side of that dividing line. 170 Therefore, because the NGA was carefully drawn so as to not dilute state power, the NGA can only be held to preempt a claim when that claim falls 165 Id. 166 Id. 167 Id. (citing Panhandle Eastern Pipe Line Co. v. Public Serv. Comm n of Ind., 332 U.S. 507, 517 518, 68 S. Ct. 190, 92 L. Ed. 128 (1947); see also Northwest Central, 489 U.S. at 511, 109 S. Ct. 1262 (the legislative history of the [Act] is replete with assurances that the Act takes nothing from the State [regulatory] commissions (quoting 81 Cong. Rec. 6721 (1937)))). 168 Id. (citing Panhandle Eastern, supra, at 516 518, 68 S. Ct. 190; Interstate Natural Gas Co. v. FPC, 331 U.S. 682, 689 693, 67 S. Ct. 1482, 91 L. Ed. 1742 (1947)). 169 Id. See also Northern Natural Gas Co. v. State Corp. Comm n of Kan., 372 U. S. 84 (1963) (holding that the Supreme Court has consistently recognized that the significant distinction for purposes of preemption in the natural gas context is the distinction between measures aimed directly at interstate purchasers and wholesales for resale and those aimed at subjects left to the states to regulate). 170 ONEOK, Inc., 135 S. Ct. at 1600 (citing Nw. Cent. Pipeline Corp. v. State Corp. Comm n of Kansas, 489 U.S. 493, 513 (1989) (quoting N. Natural Gas Co. v. State Corp. Comm n of Kan., 372 U.S. 84, 92 (1963))). 757