Two states recently addressed regulation of hydraulic fracturing of gas wells in two radically different ways. 

Ohio

The Ohio legislature has passed Senate Bill 315, to be signed by the governor, requiring reporting of information on all wells that are stimulated (If you go to the link, the new legislation is underlined).  To summarize: Operators and contractors injecting substances into the formation must report the trade name and volume of all of all fluids and substances injected, the supplier of all such substances, the maximum concentration of each additive, a list of chemicals intentionally added to the fluids and the chemical abstracts service number of each. 

The person making the report is allowed to withhold information protected as a trade secret. Records must be kept for two years from the date the chemical was placed in the well.

The law also requires that the source of groundwater and surface water to be used in operations and the estimated rate of withdrawal be reported. There must be sampling of water from water wells within 300 feet of operations in urbanized areas and within 1,500 feet of operations on horizontal wells. The operator is required to make agreements with local authorities for maintenance and use of roads used in connnection with horizontel wells.

The bill has detractors. Environmental groups, who are said to prefer natural gas as an energy source over coal, neverthless oppose what they call “loopholes” in the act.  For example, they oppose a prohibition against physicians who learn the content of  frack fluids protected as trade secrets from revealing that information to their patients.

Some environmental groups want Ohio to withhold permits for gas wells that will employ fracking until the EPA concludes its anticipated study of the process. 

According to the Cleveland Plain Dealer, the law is flawed.  Legislative term limits “… let Ohio legislators off the hook for long-term consequences of short-term decisions”, and the process for permitting of gas wells means “destruction of city and village home rule by letting Statehouse lobbyists make decisions that Ohioans want to make for themselves.”

A 2004 law reserved to the Ohio Department of Natural Resources the exclusive authority to determine permitting, location and spacing of gas wells. Opponents had hoped to repeal this regulatory structure and leave such decisions to local governments. 

The legislation looks like a reasoanble approach.  Consider the chaos if, for example, an operator had to comply with different permitting requirements for every county and city in the state. 

Vermont

In a symbolic gesture devoid of meaning anywhere that could contribute to America’s energy independence, Vermont has enacted an outright ban on hydraulic fracturing. Vermont has no known gas deposits and no current or planned drilling activities.

 

Breaking news

It has been reported, but not yet verified, that the Vermont legislature has passed a bill banning a state-sponsored navy on the ground that they are opposed to war with Quebec, New York and New Hampshire.

Was it your long-time confidant who says your fiancee isn’t good enough for you and then runs off and marries her, or a seller’s remorse on a hundred-million dollar scale? We don’t know yet, but in Allen v. Devon Energy Holdings, a Houston court set guidelines for the trial of a case involving redemption of a member’s ownership interest in a limited liability company for a fraction of the amount he would have received in the sale of the entire company 20 months later.

This was an appeal of a summary judgment, not a trial, so no actual wrongdoing by anyone was established.

The facts are complicated and the legal analysis is detailed, which makes this post longer than usual. For lawyers, it is a quick treatise on the ins and outs of fraud claims and a warning that the “boilerplate” in your agreements might not be as effective as you think. For non-lawyers, it is about legal issues that could affect behavior among members of LLCs and shareholders of corporations, whether majority or minority owners.

Having tried in vain to avoid the turgid legalese non-lawyers have come to expect from people like me, I’ve inserted musical interludes about cheatin’ and betrayal that should help alleviate the stupefying boredom you are about to experience. For example:

 http://www.youtube.com/watch?v=9OIgZQj1aqs

 Enjoy!

Continue Reading Fraud in Texas: A Primer

John Maynard Keynes is no favorite of fiscal conservatives (There is more to like from Friedrich Hayek), but Mr. Keynes did have it right when he said, “The avoidance of taxes is the only intellectual pursuit that carries any reward”.

In two separate Texas suits, oil and gas producers are attempting to live out Mr. Keynes’ maxim. In TXOGA and TIPRO v. City of Arlington, two industry trade groups sued the city over an annual assessment on gas well operators. The rationale is denial of the operators’ constitutional right to equal protection of the laws and a taking of their vested rights in permitted wells – in short, they claim the city is taxing one industry to address risks posed by a wide range of other businesses and industries. The city’s stated rationale for the assessment is the need for more funds for firefighting, in particular for hazardous materials response teams to fight gas well fires and accidents.

In Southwest Royalties v. Combs a district court in Austin, Texas, ruled that the scope of an exemption from the Texas sales and use tax on equipment used in oil and gas extraction does not apply to downhole equipment such as casing and tubing. The trial court agreed with Southwest that oil and gas change their physical characteristics when they are produced, but did not agree that the downhole equipment causes those changes. Both of those factors must be present for the exemption to apply.

Bonus – Good News for PR Graduates

The Onion, by its own admission, “America’s Finest News Source”, had this encouraging article on PR grads and the gas industry. Serously, while the tongue-in-cheek “news”  is funny, the comparison of the gas business to big tobacco and the gun lobby isn’t exactly good for the industry’s image among people – most of Americans – who don’t pay enough attention to the industry to understand what fracking is all about.

Contract law 101: To have a binding contract there must be an offer and an acceptance. And so it is in oil and gas leasing in Louisiana. Thus, in Ballard v. XTO there was no binding agreement to take a lease.

 

 

 

 

 

 

 A landowner representing an unknown number of potential lessors and an XTO landman exchanged a series of emails. XTO made an offer. The landowner said “we have collectively agreed to accept your proposal; however …” followed by a request that four terms be confirmed. The landman confirmed the details. He then informed the landowner that only “upper management” had the authority for a lease package of that size, which was north of $3,000,000.

More Negotiating after “Acceptance” Means No Binding Contract

The landowner asserted that landman had accepted the offer.  But the email then asked the landman to send a formal commitment letter on which the landowner would fill in the blanks. There would be an addendum to be approved by XTO. The court determined that this was not an acceptance of XTO’s offer.  According to the court, the parties understood that they would execute additional documents before they would form a binding contract. The landowner’s claims were denied.

The court’s ability to ferret out the facts was made much easier with emails that if the conversations had been oral. When it comes to who-said-what and what they really meant, writings offer less wiggle room than oral testimony of feuding witnesses in a trial.

Can Emails Make a Contract?

In Louisiana, who knows? The court did not determine whether in Louisiana an email exchange is sufficient to form a lease or a contract to lease. About that question, the court said “we are not sure”. That issue remains for another lawsuit on another day.

How About in Texas?

Yes …  sometimes … if you do it right. Thanks to my Looper Reed partners Jamie Ribman and Cleve Clinton, that question was addressed in another of our firm blogs, “Tilting the Scales”. 

The Purity of the Civil Law is Preserved

As surely as Louisianians prefer a bowl of spicy seafood gumbo and an ice-cold Abita Turbo Dog to a slab of well-done brisket and a glass of sweet tea, the court revealed disdain for the common law by rejecting the plaintiff’s claim of promissory estoppel. According to the court, this theory is “relatively disfavored under Louisiana law because it developed in Common Law jurisdictions as a substitute for consideration, to make gratuitous promises binding despite their lack of consideration.” 

There was a also fraud claim. Given the language of the email communications, the court determined that the plaintiff’s reliance on the landman’s promises was not reasonable.

I can imagine other defenses. Was the speaker actuallly the agent for all of the prospective lessors, did the emails sufficiently describe the land to be leased?

Sponsoring the most paranoid Texas conspiracy theory since the puff of smoke from the grassy knoll, groups of neighborhood associations, homeowners, and businesses sued virtually all of the major Barnett Shale producers over their failure to complete negotiations for oil and gas leases for bonuses of up to $20,000 per acre. Cessation of negotiations – or culmination of the sinister and well-orchestrated scheme if you prefer to see it that way – occurred in October 2008 when the bottom fell out of gas prices.

 In two cases described by the appellate court rendering them as having no substantive differences, Eastland Express, L.P. vs. XTO Energy, Inc. et al, and Maddox v. Vantage Energy, L.L.C, there was no valid written contract between the prospective lessees and the associations that were negotiating for everyone, and no claims existed for promissory estoppel, negligent misrepresentation, and antitrust violations.

You Must Be a Party To the Contract You Try to Enforce

SEACTX and SFWA were formed to negotiate the best oil and gas leases for many mineral owners in various portions of Tarrant County, Texas. The mineral-owner plaintiffs claimed that agreements had been reached by a series of emails. The producers took thousands of leases, but when gas prices dropped the producers were no longer willing to acquire additional leases on the same terms.

There was an agreement with an approved lease form, which said each individual property owner was not obligated to sign the form, but had the right to negotiate his or her own terms with any oil and gas company of their choosing, and should conduct their own investigation. The negotiating entities did not have authority to, and did not, negotiate individual leases for each of the mineral owners, or for anyone.   The contract did not identify any individual mineral owner by name as a person who would benefit from a lease. The plaintiffs failed in their claim to be third-party beneficiaries of the contract to lease.   Under Texas law, a third party beneficiary must be named in the contract he is trying to enforce. 

Promissory estoppel didn’t work because the promise was not made to the plaintiffs, but to the associations who spoke for them. Thus, they did not have standing to bring that claim. On negligent misrepresentation, under Texas law reliance damages, and not benefit-of-the-bargain damages, are recoverable. The plaintiffs could not point to any out-of-pocket expenditures made in reliance on the representations.

The court threw out the antitrust claim on the basis that the plaintiffs were not consumers of an alleged violator’s goods or services or a competitor of the alleged violator in the market.

 

Surely, the Pennsylvania Supreme Court has been busy since century before last, but apparently not on a lot of oil and gas cases. The court revisited the standard, first established in 1899, for determining whether an oil and gas lease has produced in paying quantities. In T.W. Phillips Gas & Oil Co. v. Jedlicka, the court said that where production has been marginal or sporadic such that for some period profits did not exceed operating costs “paying quantities” must be construed with reference to the operator’s “good faith judgment”.

The Texas Standard

The court reviewed paying quantities cases, in particular the seminal Texas case, Clifton v. Koontz, in which the Texas Supreme Court said the question is, “ … whether or not under all the relevant circumstances a reasonably prudent operator would, for the purpose of making a profit and not merely for speculation, continue to operato a well in the manner in which the well in question was operated.”

The lease was granted in 1928. (If you are wondering how times have changed, Burleigh Grimes of the Pittsburgh Pirates pitched 330 innings that year with a 2.99 ERA). First production was in 1929. In 1959 the operator lost approximately $40.00 from operations. It appears that at all other times during the life of the lease the well was profitable. Think about what the plaintiff was trying to terminate: A venture that had been profitable to the operator for 79 of the 80 years it had produced, not to mention the royalties paid to the lessor over that time.

According to the court, Jedlicka was the first time the issue of paying quantities has been addressed since the 1899 case of Young v. Forrest Oil Co., and the court said it was reaffirming its opinion in that case.

Good Faith vs. Reasonable Prudent Operator

The court found that the Texas inquiry implicates the issue of whether a lessee is exercising his judgment in good faith. However, I’m not aware that the Texas court has ever held that the operator’s subjective good faith is, in and of itself, a factor. The dissent in Jedlicka focused on this question, and observed that when looking at the lessee’s operations, the good faith judgment test and the reasonable prudent operator standard are two distinct concepts. One is subjective and the other is objective, said the dissent.

The court also looked at cases from Oklahoma and Kentucky, which apply a variation of the good-faith test.

It could be said that the “good faith” standard is similar to the Texas approach when the question is whether the operator is maintaining production for “speculative purposes”. Other than that, the tests do not appear to be the same. Surely the proof at trial and the questions to be answered by the jury would be different.

My last post featured editorial kudos for the EPA’s evenhanded approach to regulation of one aspect of drilling: handling of methane and volatile organic compounds during fracking.  Perhaps the accolades were premature.  I speak of the recently exposed and widely distributed video of the then-new and recently-resigned EPA Region 6 director Al Armendariz invoking an inappropriate analogy to his “philosphy” of regulating oil and gas producers. If you haven’ t seen it yet, you  are too late. You Tube removed the video from its web site.

Mr. Armendariz said:  “The Romans used to conquer little villages in the Mediterranean. They’d go into a little Turkish town somewhere, they’d find the first five guys they saw and they would crucify them.” 

To be fair, earlier in the video he referred to enforcement against producers who break the law. He could have been referring to the scofflaws as the only candidates for immediate crucifixion. Unfortunately, that’s not what he said.  

Mr. Armendariz apologized and resigned, and the White House declared the comments to be “entirely inaccurate as a characterizaton of the work the EPA does”. Whether or not you believe that, it raises questions about the agenda behind recent EPA enforcement actions.   

We now know who the wolf is, and we now know that it comes disguised in the sheep’s clothing of a seemingly reasonable regulation (assuming that a 588-page regulation is reasonable, but that is for another day).  We should expect that regardless of the winner, after the next election there will be big changes in the EPA’s approach to the energy industry.  If the status quo remains, the wolf will  throw off its sheep’s disguise and the crucifixions will resume. 

The current EPA:

 

 

The real EPA, to be revealed in November should the status quo remain:

 

 

 

“The wolf will live with the lamb,

the leopard will lie down with the goat,

the calf and the lion and the yearling together . . .”

(Isaiah 11:6)

What does the Old Testament have to do with the oil business? It seems the EPA’s new rules on the capture of methane and volatile organic compounds resulting from fracking have generated favorable reviews by factions in our political world that do not ordinarily agree on anything. The rule is an unholy 588 pages, you are warned if you want to read it, but the reviews are interesting.

The New York Times described the rules as “a win for the environment, for the public and for industry”.

The Wall Street Journal , surprised, in an editorial entitled “The EPA’s Fracking Miracle” praised the EPA for using ‘restraint”.

The Mother Nature Network opined that “. . . somehow, against all odds, it seems to be working.” , in referring to the new rules. And further , “not everyone is thrilled, but no one seems outraged, either.

According to the American Petroleum Institute, “The EPA has made some improvements in the rules that allow our companies to continue reducing emissions while producing the oil and natural gas our country needs.

Not everyone is thrilled, or even satisfied. The Bloomberg Report asked, “Does the Obama administration care about air quality? It isn’t always easy to tell . . ”, complaining that the rule will not go into effect until 2015.  Several other editorials and articles reveal serious areas of disagreement, and there are plenty of other dissenters. The Houston Chronicle reported on a few.   But the relative harmony suggests that much could be gained by common sense and compromise.

Wolves and lions being what they are, the story isn’t over (Remember the scorpion who hitched a ride across the river with the frog. It was a bad ending for the frog). It doesn’t matter who you consider to be the wolves and lions in the national debate over our energy future. One could predict that they will join the lambs and the calves in the celestial choir only until the next regulation, or environmental mishap, or election.

 

In a recent entry on the blog Exxon Perspectives, the huge producer presents a number of reasons why relying on compressed natural gas as a transportation fuel might be misplaced, at least for the near future. Among the obstacles:

  • Vehicle costs are high
  • Infrastructure is nonexistent and costs will be high
  •  CNG has lower energy density than gasoline and therefore less efficient

ExxonMobil’s answer:

  • Wait for LNG to develop. It is a better vehicle fuel
  • Let the market, not the government, decide
  • Use CNG to fuel fleets, but not your car or mine

To get a fuller perspective, read the comments posted after the entry, where the Exxon viewpoint is either “so biased it’s pathetic”, “misleading”, or worse. The commentors argue with Exxon, then they argue with each other.  Dislike for “Big Oil” is palpable. 

Pro-CNG web sites www.cngchat.com and www.cngnow.com are mentioned.  The latter appears to be sponsored by natural gas producers.  Query: Why would ExxonMobil (the biggest natural gas producer in the continental US?) be against CNG vehicles if there weren’t good economic reasons to be against it?  Maybe theyare right. 

In encourging news for natural gas producers, the Federal Energy Regulatory Commission approved construction of Cheniere Energy Inc.’s $4.5 Billion LNG export facility at its existing import terminal in Hackberry, Cameron Parish, Louisiana.   Also, Sempra Energy, Inc. will invest $6 Billion in an LNG export facility at Lake Charles.  Sempra has an import terminal at the same location.  Quite a turnaround in the natural gas markets, and boon for employment in southwestern Louisiana.

And there is even more to look forward to regarding federal regulation of domestic oil and gas exploration:

 

So said the lessor-plaintiffs in Walker v. Chesapeake Louisiana, L.P. The lessee-defendant, the trial court, and the court of appeals said “Yes, but . . .”. The lessors accused the lessee of breaching six leases and sought cancellation. The court invoked the doctrine of “judicial control” that allows a court to avoid cancellation when equity requires it.

The “Gotcha” Lease

The leases had three provisions that the lessee allegedly breached:

  • There would be no surface operations without the lessor’s consent (Operations were minimal and there was no damage to the land);
  • Subject to a mutually agreed data license agreement, the lessee was required to furnish lessor certain information regarding wells on the premises (The agreement hadn’t been negotiated, and the lessee contacted the lessor the day after receiving a demand for cancellation);
  • If a seismic permit was obtained within one mile of the premises, the lessee must negotiate in good faith to include the premises and surrounding acreage in the seismic coverage (The court construed this clause in lessee’s favor, so there was no breach).

The Court’s View

La.  Civil Code Art. 2013 allows judicial dissolution of a contract when the obligor fails to perform.  There are several ways for a court to let a breaching lessee off the hook in the face of a claim for lease cancellation. Louisiana, like virtually all states, frowns upon forfeiture of a contract. This is especially true, said the court, where the breach is not substantial and there is no injury to the lessor. Such was the case here.

The court also pointed to a Louisiana case that discussed the “good faith” of the breaching party, holding that the court would deny cancellation if the breach was of minor importance and was caused by no fault of the obligor or is based on a good faith mistake of fact.

Takeaways

This case has several lessons for all of us.

  • Lessor: You have the right to enforce each unreasonable provision in your lease, or enforce each reasonable provision in an unreasonble way. But don’t expect every court to be enthusiastic about helping you. Listen to this advice:   http://www.youtube.com/watch?v=kn481KcjvMo 
  • Lessee: Resist unreasonable lease terms when you can.  You might survive a fight over arbitrary or unreasonable lease terms, but it will be troublesome and expensive. You don’t want to have to rely on equity (a/k/a, the court’s mercy) to avoid a bad result.
  • Landman: When your geologist says that without that certain tract her favorite prospect will be worthless and the company’s future doomed, warn her how painful it will be when the lessor insists on enforcing the “gotcha” lease that you will have to live with. And don’t fall for aw-shucks platitudes from the lessor: “Gosh, I wouldn’t ever enforce any of this stuff. I don’t even understand it, but my lawyer says I need it to keep people like you honest”.
  • Out-of-state lessee who has been sued on the lessor’s home turf: Think about getting to the federal courthouse. See my March 27, 2012, post to see what can happen if you don’t.

The Back Story?

Just as history is written by the victors, opinions are written by the judges who see facts and equities in a certain way. Rare is the losing party who agrees. Any analysis of a decision is based on what you see in the opinion, which is usually a lot less than everything that happened.

With that caveat, let’s speculate. One can see what motivations might have been in play here. The leases were signed in 2008 for land in Caddo Parish. Looks like a good Haynesville well was drilled when gas prices were far higher than the anemic sub-$2.00 now being paid. The lessors refused to negotiate with the lessee over the breaches, and the suit swung for the fences: nothing less that cancellation of all six leases. The result would be a windfall – ownership of a nice well after the lessee risked millions of dollars to buy the leases and drill the wells.