On April 8, the Allegheny County Court of Common Pleas upheld an operator’s rights to develop multiple, contiguous leaseholds by horizontal drilling. It is hoped that the court’s opinion in the matter of EQT Production v. Opatkiewicz, G.D. No. 13-013489 (Pa. Ct. Com. Pl. Allegheny Cnty. April 8, 2014), will define the scope of and bring clarity of intent to a misunderstood and oft-maligned piece of legislation, Section 34.1 of the Pennsylvania Oil and Gas Lease Act.
Enacted on July 9, 2013, Section 34.1 provides, in pertinent part, “where an operator has the right to develop multiple contiguous leases separately, the operator may develop those leases jointly by horizontal drilling unless expressly prohibited by a lease.” Despite the fact that Section 34.1 makes plain that it is applicable only when an operator has the right to develop multiple contiguous leases—meaning, when the operator already has leases covering the affected lands—it has been railed against as facilitating forced pooling within the state.
Forced pooling, also known as compulsory pooling, is the process of bringing together separately owned small tracts of land, or those in which there are separate interests, in order to meet the legal or regulatory requirement for the granting of a well permit under applicable spacing rules. Under a forced pooling statute, operators may incorporate unleased lands into a development area or unit in order to prevent waste and reduce the likelihood of drilling dry or economically inefficient wells. Admittedly, forced pooling may be viewed as an impingement on the rights of landowners to freely develop (or not develop, as the case may be) their private property. However, forced pooling is not now, nor has it ever been, the intent of Section 34.1.
Section 34.1 addresses only the right of a lessee to jointly develop multiple leaseholds when the leases covering the subject area neither specifically grant nor prohibit pooling, unitization or joint development rights to the lessee. To be clear, Section 34.1 only addresses the ability of operators to jointly develop lands that are already leased—it does not grant operators the ability to develop or extract oil and gas from lands that are not leased.
The significance of Section 34.1 should not be understated. At present, there are countless oil and gas leases covering lands throughout the state that do not specifically grant operators the right to pool, unitize or otherwise jointly develop their leased premises. However, operators typically require the inclusion of pooling or unitization language in their leases to ensure that they will have the ability to explore and develop oil and gas interests as efficiently as possible.
Prior to the enactment of Section 34.1, when an operator wished to include a tract of land in a drilling unit but the lease covering the tract did not have pooling or unitization language, the operator would typically return to the lessor to secure an amendment to the lease. What often ensued was a protracted negotiation process during which the lessor required additional payment from the operator, despite the fact that the lessor has a vested interest in any oil and gas production under their lease.
This contractual shakedown has soured developers and, if permitted to continue, may have a chilling effect on future oil and gas development in Pennsylvania. However, under Section 34.1, operators are no longer subject to additional, unanticipated negotiations and are finally free to pursue development of their leaseholds by means that are most economically advantageous.
The recent ruling out of Allegheny County affirmed these principles and a lessee’s right to develop its leases in the most efficient way possible. In EQT Production, the central issue before the court was whether the lessee, EQT Production Co., could jointly develop multiple oil and gas leases covering contiguous properties by horizontal deep drilling in accordance with Section 34.1. In granting EQT’s cross-motion for partial judgment on the pleadings, the court held that Section 34.1 does not violate the Pennsylvania or U.S. constitutions and that EQT’s proposed development plan is permissible.
In its memorandum opinion, the court held that the interest transferred by an oil and gas lease is “substantial,” creating in a lessee an estate in real property and, upon production under the oil and gas lease, effectively severs the oil and gas estate from the remainder of the lessor’s estate. The court found no evidence to support the defendants’ claims that the absence of pooling or unitization language in their leases resulted in their implicit retention of “the right to dictate the manner of EQT’s subsurface development of its lease.” To the contrary, the court held that, “so long as the lessors’ rights granted by lease and law are not impinged upon, the lessee has broad powers to develop the oil and gas estate as it sees fit, including crossing property lines between contiguous leases while engaging in horizontal drilling.”
Additionally, the court found that Section 34.1 does not constitute a taking without compensation. The defendants claimed that their respective leases only granted the lessee the right to develop their leaseholds individually and did not grant the lessee the right to develop their interests in common with others. The defendants argued that combining their oil and gas interests with those of another lessor resulted in dilution of their interests, which is tantamount to an unconstitutional taking without compensation. The court found this argument meritless, holding that Section 34.1 does not amount to a taking without compensation. Further, the court held that unless specifically retained by the lessor within their lease, an oil and gas lease transfers the right to determine how best to develop an oil and gas leasehold to the lessee.
Although the economic impact of Section 34.1 will benefit operators and lessors alike, its potential environmental benefits may be enjoyed by all. For example, it stands to reason that if operators are able to jointly develop contiguous leaseholds, then the need for numerous well pads in one area will be greatly diminished. In turn, the reduced number of well pads and rigs will result in decreased noise and preproduction activities and ultimately reducing the overall environmental impact of exploration activities.
Steven Chadwick is an associate in Reed Smith’s real estate group. Robert Jochen is a member of the energy and natural resources group at the firm. Michael Joy is a partner in the energy and natural resources group at the firm.