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• "Marcellus Shale: Update on Regulations, Case Law and Concerns," Mark J. Gesk, 2010.* - Winter 2010

* Acknowledgment
Wayman, Irvin & McAuley, LLC, acknowledges the contributions to the above Gesk Power Point materials provided by the Penn State Dickson School of Law, "Pa. Law Governing Natural Gas Exploration," from the Agricultural Law Resource and Reference Center, and Ross H. Pifer, J.D., LL.M., Director.

Minimum Royalties Act, 58 P.S. 33 (2009).
§ 33. Guarantee of minimum royalties A lease or other such agreement conveying the right to remove or recover oil, natural gas or gas of any other designation from lessor to lessee shall not be valid if such lease does not guarantee the lessor at least one-eighth royalty of all oil, natural gas or gas of other designations removed or recovered from the subject real property.

Kilmer v. Elexco, 2010 Pa. Lexis 517 (2010).
On Wednesday, March 24, 2010, the Pennsylvania Supreme Court, in a 6-0 decision, upheld a ruling by a Susquehanna County judge that validated lease agreements that subtract post-production costs from the calculation of landowner’s natural gas royalties. Several landowners desired to invalidate the leases they signed before the Marcellus Shale rush drove up area land values. The Landowners sued ElexCo Land Services Inc. and Southwest Energy Production Co. (“Gas Companies”) claiming that the leases were invalid because state law guarantees landowners a minimum one-eighth royalty from the production of oil and gas on their land. The case concerned the proper construction of the term “royalty” as used in the Guaranteed Minimum Royalty Act (“GMRA”), 58 P.S. § 33, which governs leases between Pennsylvania landowners and gas companies seeking to drill natural gas wells into Pennsylvania’s Marcellus Shale deposits. The GMRA requires that leases guarantee the landowner-lessor “at least one-eighth royalty of all oil, natural gas or gas of other designations removed or recovered from the subject real property.” Although the term “royalty” is not defined in the statute, the Court noted that many leases in the Commonwealth, including the leases before the Court, calculate royalties as one-eighth of the sale price of the gas minus one-eighth of the post-production costs of bringing the gas to market. The landowners filed for declaratory judgment seeking to void their leases, contending that this method of calculating royalties violates the GMRA. In an opinion authored by Justice Baer, the Court noted that developments in drilling technologies and the proximity of the Marcellus Shale to east coast energy markets has created a surge of interest in drilling in the area, in turn causing Gas Companies to offer much more lucrative lease terms to local landowners than they had in the past. As such, Landowners have started reviewing their older leases and questioning whether the terms provided therein comply with the GMRA. In March 2009, the trial court granted summary judgment in favor of the Gas Companies and denied the Landowners’ motion for summary judgment. The Landowners timely appealed to the Superior Court. However, because more than seventy suits were currently on hold pending the outcome of the appellate litigation in this case, the Gas Companies filed a petition asking the Supreme Court to exercise extraordinary jurisdiction to speed the resolution of this pure legal question of first impression, which was granted. In the present case, Landowners rejected the Gas Companies’ argument that the term “royalty” has developed a technical meaning in the oil and gas industry, and instead argued the Court should rely upon its ordinary definitions. According to the Landowners, the relevant determination should be the price at the point of sale, regardless of where the sale was made or the costs of getting to product from the wellhead to the point of sale. However, the Gas Companies contended that the plain language of the GMRA provides that the relevant point of reference is the moment the gas is removed from the ground, or in the wellhead. After considering both arguments, the Court held that it was required to interpret the valuation point which was most consistent with the language of the statute, requiring it to define the term “royalty.” In finding for the Gas Companies, the Court explained that the Statutory Construction Act instructed it to reject the common definition of “royalty” in favor of the definition it has acquired in the oil and gas industry. The Court noted that although the industry definition of “royalty” is not subject to the costs of production, post-production costs are generally deducted in the calculation of landowners’ royalties. Thus, the Court held that the GMRA should be read to permit the calculation of royalties at the wellhead, as provided by the net-back method in the leases, and therefore affirmed the trial court’s grant of summary judgment to the Gas Companies.

Valentino v. Range Resources, 2010 U.S.Dist. LEXIS 50692.
Plaintiffs owned approximately 114 acres of land in Washington County, Pennsylvania located over a layer of Marcellus Shale. Defendant was interested in entering into lease agreements with local landowners to locate, produce and extract the natural gas located under the Marcellus Shale. Therefore, Defendant contacted Plaintiffs regarding entering into a lease agreement which would permit Defendant to produce oil and gas from the Plaintiffs’ property, and included a side agreement giving Plaintiffs a bonus payment. In their Complaint, Plaintiffs alleged that they executed a lease granting Defendant an exclusive interest in exploring, drilling, operating for, producing and removing all oil and gas from their real property in exchange for royalty payments. Plaintiffs also contended that pursuant to the side agreement, Defendant was contractually obligated to pay them a bonus of approximately Four Hundred Fifty-Seven Thousand Dollars ($457,000). Defendant countered that it was never obligated to pay the bonus amount because the side agreement did not constitute a binding contract. In support of this theory, Defendant contended that both the lease and the side agreement were merely Plaintiffs’ offers to Defendant, and second, that even if the side agreement could be construed as a contract, it contained a “management approval” clause amounting to a condition precedent that was not fulfilled. Defendant claimed that management sent Plaintiffs a letter notifying them that the lease had not been approved, and therefore the condition precedent had not been met. Plaintiffs responded by arguing that the “management approval of the lease” clause was a condition subsequent, or in the alternative, that if it is a condition precedent, it was fulfilled. Furthermore, Plaintiffs contended that the side agreement indicated that Defendant had ninety days to surrender the lease from the date in which Plaintiffs executed it. The court held that because there was no term in the side agreement which required signatures from management for the formation of a valid contract, and because there was no definition of “management approval,” Plaintiffs’ allegations that management approval had occurred, provided the requisite facts, if accepted as true, to set forth a breach of contract claim that was plausible on its face and permitted the court to infer more than a mere possibility that a contract existed. The court further stated that under Pennsylvania law, a lease of real property for a term of more than three years must be made in writing and signed by the parties creating the lease, 68 Pa. Stat. Ann. § 250.202, and here the lease was not signed by Defendants. However, the court noted that the statute of frauds was not an issue the court could consider during the motion to dismiss stage of litigation. Therefore, the court denied Defendants’ motion to dismiss.

Foundation Coal Resources Corp. v. Department of Environmental Protection, and Penneco Oil Co., Inc. 993 A.2d 1277 (Pa. Cmwlth. 2010)
Foundation Coal Resources Corporation, Pennsylvania Land Holdings Corporation, and Realty Company of Pennsylvania (“Foundation Coal”) petitioned the Commonwealth Court of Pennsylvania for review of the order of the Environmental Hearing Board (“EHB”), upholding the issuance of seven oil and gas well permits by the Pennsylvania Department of Environmental Protection (“DEP”) to Penneco Oil Company, Inc. (“Penneco”). The issues before the court were whether Foundation Coal had standing to file objections to the permits under Section 202 of the Oil and Gas Act as a “projected and platted but not yet being operated” coal mine and whether the DEP improperly issued the permits without the conditions Foundation Coal proposed in order to avoid undue interference or endangerment to its coal mines. Foundation Coal owned a massive coal reserve in Greene County, Pennsylvania, upon which it intended beginning mining operations to extract the coal. Penneco had approximately 20,000 acres of oil and gas leases in Greene County, a substantial portion of which intersected with Foundation Coal’s reserves. As such, in order to reach the oil and gas reserves, Penneco would had to drill through Foundation Coal’s proposed mine. Over a period of approximately two years, Penneco filed permit applications to drill seven new wells. In accordance with Section 201(b) of the Oil and Gas Act, Penneco identified Foundation Coal as the owner of underlying coal seams in the tract to be drilled, and provided it with maps of the proposed well locations. 58 P.S. § 601.201(b). However, Foundation Coal objected to the permits, claiming it had an “already projected and platted but not yet being operated” coal mine pursuant to Section 202(b) of the Act. 58 P.S. § 601.202(b). As Foundation Coal alleged that the wells could jeopardize the safety of its miners and that the wells could impose economic burdens on it, it asked that the DEP include special conditions with each permit. However, at the time it raised its objections, Foundation Coal had not submitted a coal mining activity permit application to the DEP for the disputed area. Regardless, the DEP held conferences to discuss Foundation Coal’s objections to the permits. At the end of the conferences, the DEP granted all of Penneco’s permit applications. Foundation Coal then appealed the DEP’s grant of Penneco’s permits to the EHB. The EHB concluded that the evidence showed that Foundation Coal did not establish that it had a “projected and platted but not yet operating” coal mine as set forth under Section 202 of the Oil and Gas Act, as it was “impossible to establish the boundaries of the proposed Foundation Mine with any certainty,” that for it to be considered as a "projected and platted but not yet operating" coal mine, the owner should have filed a technically complete coal mining application. Moreover, the EHB determined that the maps submitted by Foundation Coal as proof were substantially undercut by the testimony of its own witnesses, who testified that the panels might even be increased and the fact that Penneco’s expert testified that widening the panels would completely realign the mine. In support of this determination, the EHB considered Penneco expert’s testimony, who stated that the only way to know if a specific well was going to impact the mine was to have detailed knowledge as to where the beginning and end of each panel would be located, and that Foundation Coal’s mining plans were a moving target without the necessary detail to qualify as a projected and platted coal mine. Additionally, the EHB determined that the actions of the DEP were reasonable in issuing the permits without Foundation Coal’s special conditions, and there was no legal requirement for the conditions to be included. Lastly, the EHB concluded that Foundation Coal failed to show that Penneco’s drilling would unduly interfere with or be necessary for safe operations at its future mine. On appeal, Foundation Coal argued that the EHB erred in holding that the mine was not a "projected and platted but not yet being operated" coal mine with standing to file objections to the permits under the Act. DEP and Penneco countered that the issue was moot, as Foundation Coal proceeded under Section 501 which allowed them to request a conference. Initially, the Commonwealth Court noted that Foundation Coal had the opportunity to set forth its arguments in favor of the special conditions, as though it had standing at the conferences as a “projected and platted but not yet being operated” coal mine. Upon review of the evidence, the court agreed with the EHB’s determination that the coal mine was not yet “projected and platted” within the meaning of the Act. Furthermore, the court did not find any error of law in the EHB’s determination that in order for a coal owner to be considered as a “projected and platted but not yet operating coal mine,” it had to have filed a “technically complete coal mining application.” Next, the Commonwealth Court found that the EHB was proper in holding that the DEP did not abuse its discretion by issuing permits without the special conditions requested by Coal Foundation pursuant to Section 601.201(e) of the Act, as there was ample evidence that either mining through a properly plugged well or mining around an unplugged or operating well could be done safely under the current statutory and regulatory framework. 58 Pa. Stat. Ann. § 601.201(e). The court noted that even assuming arguendo that the DEP had the authority to substitute different methods of plugging not provided specifically by statute, it had no obligation to do so where there was no showing that it was necessary for the safe operation of a mine. The court found that the EHB properly found that the DEP did not abuse its discretion by issuing the permits without the special conditions requested by Foundation Coal. Thus, the EHB’s decision was affirmed, and the DEP’s issuance of seven oil and gas well permits to Penneco was upheld.