Oct 20 2012

Compulsory Integration

Myth of “Free Ride” for Landowners Forced into Drilling Units;

Compulsory Integration Supporters vs. Opponents

New York State’s 2005 compulsory integration law was written by the oil and gas industry and passed unanimously with no public hearings, according to Attorney Chris Denton, an oil and gas lease attorney in New York.1 

Coincidentally in 2005, Range Resources began gas production from Renz #1, the first high-volume hydraulic fracturing (HVHF) well in the Marcellus Shale in Pennsylvania.  Shale gas extraction by HVHF had come to the northeast.

Today, experienced voices argue the pros and cons of New York’s law and I contacted several of them.

Compulsory Integration ‘Vulnerable’ or Valuable?

“Compulsory Integration has not gotten enough attention,” says Lou Allstadt, a former Mobil Oil Corporation executive with 31 years in the industry.  “I think it is vulnerable legally and politically when people understand it.”

Thomas West, Founder and Managing Partner of The West Firm in Albany, NY, “played a key role” on behalf of the gas/oil industry in writing the compulsory integration law, as the firm’s website states.  Link: http://www.westfirmlaw.com/practice-areas/oil-gas-law.cfm

Attorney West summarized its value:  “In a nutshell, New York’s spacing and compulsory integration statutory scheme is considered a conservation measure that promotes the full development of the resource and protects the correlative rights of all landowners in the unit.”

The 2005 law creates three legal options for property owners forced into a drilling unit.  For more background, see part one of this series on compulsory integration: http://www.spectraenergywatch.com/blog/?p=1674

Compulsory Integration:  No “Opt Out”

Attorney West notes (emphasis added):

  1. “The three options, include the right [of the landowner] to participate by paying the pro rata share of the estimated costs of the well, including plugging in abandonment costs.
  2.  “Second, an uncontrolled [property] owner can elect to be carried, which means that the well operator pays the estimated costs on behalf of the landowner and collects a 200% risk penalty before the landowner obtains rights of participation, but the landowner may be eligible for a graduated royalty during the risk penalty payout period.
  3. “Third, the landowner can be integrated as a royalty owner at the lowest royalty in the unit, but not less than 1/8th.”

Here is where the discussion gets emotional.  As Attorney West told me (emphasis added):

“Since the New York law is focused on maximizing the development of the resource, it does not allow people to opt out, which only serves to hurt their neighbors and preclude the orderly drainage of the resource.”

Industry veteran Andy Leahy agrees and speaks of property owners who would prefer not to lease and so are forced into a drilling unit as “hard-nosed folks” who get a “free ride” without “taking any risk.”

Leahy has been a contract oil and gas land title searcher for about a dozen years.  His resume includes work for Honor Resources Company and Mason Dixon Energy, Inc.  His website is NY Shale Gas Now!: http://nyshalegasnow.blogspot.com/

Equitable vs. Punitive Treatment

Leahy explains the compulsory integration law was passed at a time when there was excitement about the potential harvest of gas from the Trenton-Black River formation, via “conventional-but-high-tech-seismic” exploration techniques.

“The dry hole percentage there was significant,” Leahy says, “but not something industry often cares to publicize.”  

“So NY’s compulsory integration equity considerations (circa 2005-2006) were deeply affected by the question of how do you pay for all these dry holes, and how do you set it up in such a way that development is encouraged, and not thwarted by the law,” Leahy says.

Equitable:  Surface & Environmental Impact

Closer to Mr. Leahy’s idea of “equitable and non-punitive” treatment under compulsory integration is a landowner “Getting 12.5% to 20% of the proceeds out (royalty), plus bonus, etc. — without making much direct effort, but while accepting the chance of direct surface or nearby environmental impact ….”

He also notes that property owners who are compelled to be integrated, do “get the benefit of no-surface impact, which is very important for some people.”

In other words, landowners who are compelled to be integrated will not have drilling operations on the surface of their property.

“Myth of the Free Ride”

Attorney Chris Denton has represented property owners in more than 40 compulsory integration actions and says, “The ‘free rider’ charge always particularly galled me.”

As he notes in a paper he wrote (emphasis added):

“The entire risk penalty concept turns reality on its head.  It is the landowner who has the rights to the oil and gas, it is the landowner who pays the taxes all those years, it is the landowner who has the strict liability under law for pollution on her property regardless of who causes the spill.” 2

“The risk of which the oil and gas company speaks is the risk of a ‘dry hole’,” Denton says.  “In other words, the loss of its well drilling costs. With today’s 3D seismic for on shore drilling, that risk is minimal.”

“In business, exclusivity and monopoly franchises are valued at a premium,” according to Denton.   “Yet when DEC awards a permit which results in a compulsory integration order, the single permit drilling monopoly granted to the driller is not valued and paid to the landowner who no longer has the right to drill, no longer has the right to develop, and no longer has the right to produce his gas.  Instead the landowner is given back 12.5% of his gas while the company with the drilling monopoly receives 87.5% of the gas.  This makes no sense at any level.”

“… the real ‘free ride’ is by the driller,” Denton says.  “In Compulsory Integration the driller does not have to pay fair market rates for your gas or provide you with negotiated environmental protections.”

Note:  More to come in the next post as we unwind compulsory integration.

Links & Resources

1 Compulsory Integration in a Changing Energy World – Paper written by Attorney Chris Denton, oil and gas lease attorney, Elmira, New York.  This is published as a pdf file on the Tioga Gas Lease website (see p. 4):  http://www.tiogagaslease.org/images/Compulsory_Integration_2012.pdf

2 Compulsory Integration and Eminent Domain – Paper written by Attorney Chris Denton, oil and gas lease attorney, Elmira, New York.  See especially pp. 4-5, following section 5, “What about the claim of a free ride and the risk taken by the driller?”  Pdf file:  Compulsory Integration and Eminent Domain

NOTE:  This article is cross-posted on The Accountability Central website at this link: http://www.accountability-central.com/nc/single-view-default/article/myth-of-free-ride-for-landowners-forced-into-drilling-units-compulsory-integration-supporters/  Accountability Central is part of the Governance & Accountability Institute

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