The rush is the result of a convergence of factors: recent enhancements to gas well development and extraction technologies (e.g., horizontal and directional drilling and hydraulic fracturing), rich natural gas reserves in the Marcellus Shale and other shale plays, the growing domestic demand for natural gas and development of critical infrastructure to supply demand rich markets, such as the completion of the 182-mile Millennium Pipeline in New York, which connects to other pipelines that supply the East Coast market with natural gas. 

Current estimates project the Marcellus Shale to contain up to 489 trillion cubic feet of natural gas – enough to satisfy US domestic energy demand for the next 15 years.¹  To put this into context, the State of New York uses only about 1.1 trillion cubic feet of natural gas per year.²  

While the Marcellus Shale spans multiple states, a majority of the drilling activity within the Shale currently occurs in Pennsylvania.  In 2011, the Pennsylvania Department of Environmental Protection issued approximately 3,500 Marcellus Shale well permits; in 2007, it had issued only 180.³  Interest in the Marcellus Shale is also evident in West Virginia and New York.  The West Virginia Department of Environmental Protection issued approximately 450 well permits for Marcellus Shale wells in 2011 – a significant number when, to date, there are only about 1,500 completed wells in the Marcellus Shale in the entire state.⁴  In Ohio, although the Division of Mineral Resources only issued 15 Marcellus Shale drilling permits in 2010, unprecedented leasing activity there during 2010 has likely led to far more drilling applications and permits being filed and issued for 2011 (and into the new year).⁵  Thus far, most of the drilling activity for natural gas in Ohio has been limited to the Utica Shale.⁶

Robust natural gas development is relatively new to states within the Marcellus Shale, so the accelerated pace of the Shale’s development has created an array of issues that have compelled these states to revisit their current statutory and regulatory frameworks.  These issues touch on environmental protection, infrastructure, public health, water use and pollution, as well as forced pooling, which is the focus of this article.

Introduction to forced pooling

Forced pooling, also known in some states as compulsory pooling or compulsory integration, is the act of being forced by state law into participation in an oil and/or gas unit or pool.  This technique is used by operators (often oil and gas development companies) to organize an oil or gas field.  Landowners who have not elected to participate in a drilling unit that proposes to include their property can be forced or compelled to participate in such a drilling unit. 

When pooled, these landowners are then compensated typically based upon the proportionate percentage of their contributed property to the overall unit.  An operator must typically apply to the state to obtain a mandatory pooling order if a particular tract of land the operator seeks to drill upon is insufficient in size or shape, or fails to meet the statutory or spacing unit requirements for drilling a well. 

Currently, a majority of states have some form of pooling statute.  The policy rationale behind forced pooling is that it is a means to solve the problems of waste and inefficiency created by the antiquated common law “rule of capture.”  The common law rule of capture, subject to certain limitations (e.g., trespass), allows one to legitimately drain a neighbor’s hydrocarbons from a well on one’s own land.  Absent forced pooling, often the only remedy to the rule of capture was “self-help”: drilling off-set wells on one’s own land to prevent such individual’s hydrocarbons from being drained by another.  As a result, wells proliferated in close proximity to one another, thereby making oil and gas production less efficient due to a loss of pressure in the field.  Accordingly, among other regulatory hurdles such as production allowances, states began to require a minimum spacing unit to drill for hydrocarbons.  Forced or compulsory pooling – absent a negotiated agreement – was a means for regulators to ensure the creation of minimum spacing units and continued exploration and development activity, with “just” compensation for property owners otherwise compelled to participate.  Proponents of forced pooling contend that these statutes enable mineral owners to drill fewer wells – thereby preventing a mishmash network of leased and unleased land,⁷ and when forced pooling occurs, the pooled owner receives the economic benefits of production that would otherwise potentially be denied.⁸

On the other hand, forced pooling is perceived by many as just another tactic by the oil and gas industry to force a mineral owner to accept lease terms that are less than fair.⁹  Opponents to forced pooling contend that mineral owners, particularly small mineral owners, do not have the finances to negotiate a fair lease with oil and gas companies.¹⁰  Others also view it as an infringement on the rights of property owners and a form of state sanctioned, private eminent domain for oil and gas companies.  Many also view it as an infringement on correlative rights, or the rights of a person - with a right to produce from a common source of supply of oil or gas - to have a fair opportunity to produce his or her fair share of oil or gas from such source.¹¹   The issue of forced pooling is also an emotional one, especially for small mineral tract owners that have lived for generations on their property and are concerned about the environmental impact a nearby well may have on their health and way of life.¹²

So, as the shale gas boom continues to grow in the Marcellus Shale and elsewhere, oil and gas companies are turning to forced pooling statutes to access natural gas reservoirs beneath property owners with or without such property owners’ voluntary permission.  This is of particular relevance with respect to the use of horizontal wells.  Horizontal drilling enables one to reach and extract hydrocarbons from formations that are not otherwise accessible through traditional vertical drilling.  For example, a single horizontal well can extend in excess of 5,000 feet, which maximizes reservoir contact for improved recovery.  It would take multiple vertical wells to produce the area of a gas bearing formation that can be produced by only one horizontal well, especially with respect to the Marcellus Shale, which is of relatively shallow depth and limited thickness.  Given that tracts of land may be small, a horizontal well may need to cross more than one tract of land – thereby making forced pooling an important tool for oil and gas companies seeking to develop the Marcellus Shale. 

Summary of pooling statutes in states within the Marcellus Shale

Ohio

If a tract of land fails to meet the minimum acreage and distance requirements for drilling a well in Ohio, and if an owner¹³ of a particular tract is unsuccessful in forming a drilling unit to satisfy such requirements, then Ohio laws permit such person to make an application to the Ohio Division of Mineral Resources Management for a mandatory pooling order.

Once the application is determined to be completed by a geologist with the division, then a hearing is scheduled before the Technical Advisory Council of the division (which only meets on a quarterly basis).  Affected landowners are also notified that an application has been filed and that they have the right to attend the hearing.  After hearing testimony from all concerned parties, the Technical Advisory Council makes a recommendation to the chief of the division to either approve or deny the application.

In general, if the Technical Advisory Council determines that a mandatory pooling order is necessary to protect the correlative rights of landowners and promotes the effective use and development of natural gas and/or liquid hydrocarbons, then the division will issue a permit and mandatory pooling order that (i) designates the boundaries of the drilling unit, (ii) designates the production site, (iii) describes each tract subject to the pooling order, (iv) designates the basis upon which costs and expenses shall be shared if an owner of a pooled tract elects to participate in the drilling and operation of the well, (v) designates to whom the permit shall be issued and (vi) allocates on a surface acreage basis a pro rata portion of the production to each owner of a tract pooled by the order.¹⁴

Ohio laws provide that non-participating owners (i.e., those that do not elect to participate in the costs of drilling and operating the well) are not liable for any actions associated with the drilling or operation of a well.  However, a non-participating owner is not entitled to its share of production until the non-participating owner’s share of the costs has been recouped by the operator, plus an additional percentage of the share of costs as the division determines.  This additional percentage is commonly known as the “risk penalty,” which, under Ohio laws, is capped at 200 percent.  After receipt by the operator of such costs, the non-participating owner receives a proportionate share of the working interest in the well in addition to a proportionate share of the royalty interest (if any).

There are two additional requirements in order for the division to issue a mandatory pooling order.  First, while Ohio laws do not specify a required minimum percentage acreage leased for an operator to obtain a mandatory pooling order, the division generally has an unstated minimum requirement of 90 percent, which is relatively high compared to the forced pooling statutes of other states.  Second, Ohio laws specify that an operator seeking a mandatory pooling order must first attempt to enter into voluntary pooling agreements with lessees and owners to form a drilling unit.  While the requirement is rather vague, the requirement does allude to the division’s desire that an operator exhaust its opportunities to voluntarily form a drilling unit with other owners and lessees prior to issuing a mandatory pooling order.  This should also come as no surprise given the unusually high unofficial 90 percent minimum percentage acreage requirement referenced above, which is intended to motivate those seeking to drill a well to enter into voluntary pooling agreements.  Ohio laws also prohibit surface operations and disturbances on a pooled tract without the written consent of the owner of such tract.

New York

In New York, the issuance of a well permit automatically triggers the forced pooling hearing process if the well operator does not “control” all of the owners and lessees within the spacing unit designated in the well permit.¹⁵  Known as “uncontrolled owners”¹⁶ under New York forced pooling statutes, the hearing process with the Division of Mineral Resources is intended to protect the uncontrolled owners by offering them three options.  Thirty days prior to a forced pooling hearing, an uncontrolled owner in a spacing unit will receive notice of such hearing, as well as a form for electing how their interests will be integrated (of which they will have 21 days to make an election).

1.  Integrated non-participating owner

First, an uncontrolled owner can elect to be an “integrated non-participating owner.”  This type of owner receives the full share of production attributable to its acreage in the spacing unit, but only after the well operator has recouped its share of the costs, plus a fixed-rate risk penalty of 200 percent.  In essence, the well must pay for itself three times before an integrated non-participating owner is compensated. 

If the uncontrolled owner is a lessee, then the well operator must separately pay the lessee a royalty during the recoupment and penalty phase based on a graduated scale specified by statute.  After the penalty phase, the non-participating owner is treated the same as a participating owner.

2.  Integrated participating owner

An uncontrolled owner can also elect to be an “integrated participating owner.”  This type of owner pays its estimated share of the costs of drilling and operating up front and receives its full share of production, but is also liable for its share of any additional costs with respect to the operations of the well for the life of the well.

3.  Integrated royalty owner

Finally, an uncontrolled owner can elect to be an “integrated royalty owner.”   If a well ultimately produces, then the operator will pay the integrated royalty owner a royalty equal to the lowest royalty in an existing lease in the spacing unit, so long as the royalty will be no less than 1/8th of the revenue received by the operator for the share or production attributable to the integrated royalty owner.  Since this is also the default election for any uncontrolled owner that does not make a timely election, this is a potential trap for the unwary owner who is otherwise obliged to pay a royalty greater than 1/8th.  The uncontrolled owner will also have no obligations to the well operator or any other owner for charges, taxes or fees associated with the operation of the well.  

If no significant issues are raised at the hearing, then the division may issue a mandatory pooling order that confirms (i) the status of the uncontrolled owners in the spacing unit, (ii) the terms of the pooling, (iii) the acreage attributable to each owner and the proportion such acreage bears to the entire spacing unit and (iv) the royalty for each integrated royalty owner (if any).

Much like Ohio, New York also has required minimum acreage percentage, but unlike Ohio, this requirement is embedded within the well spacing statute, which provides that an applicant must “control” at least 60 percent of the acreage within the proposed spacing unit in order to be issued a well permit.¹⁷  Therefore, in order to obtain a mandatory pooling order in New York, a well operator must meet this 60 percent threshold because a hearing for mandatory pooling is triggered upon the issuance of a well permit.

However, despite the availability of forced pooling measures for Marcellus Shale development in New York, former Governor Paterson issued Executive Order No. 41 on December 13, 2010 banning high-volume horizontal hydraulic fracturing pending the completion of a final Supplemental Generic Environmental Impact Statement (SGEIS).  On September 7, 2011, the New York Department of Environmental Conservation (DEC) released a revised draft of the SGEIS that included a comprehensive review of the potential environmental impacts on natural gas exploration activity and how such impacts could be mitigated.  The public comment period ended on January 11, 2012, at which time the DEC began preparing a final SGEIS.  As a result, until such time the moratorium is lifted, the DEC will not issue any well permits for high-volume horizontal hydraulic fracturing in the Marcellus Shale and elsewhere in New York.

Pennsylvania

Pennsylvania has a forced pooling statute, but the Oil and Gas Conservation Law (which sets forth the state’s forced pooling statute) only applies to wells that extend 3,800 feet below the surface, which is below the Marcellus Shale. 

Politically, Pennsylvania has yet to adopt a forced pooling statute applicable to Marcellus Shale development despite several proposals in recent years that have been referred to the Pennsylvania Environmental Resources and Energy Committee.  In 2009, Pennsylvania State Representative Sandra Major introduced House Bill No. 977 that would have extended the Oil and Gas Conservation Law to development within the Marcellus Shale and allowed forced pooling at that depth.  In contrast to forced pooling statutes in Ohio and New York, House Bill No. 977 did not contain any minimum acreage requirement, did not specify a defined risk penalty for a nonparticipating owner and did not require an operator to make a good faith offer to non-participating owners and lessees before filing for a forced pooling application.  As a consequence, several legislators subsequently removed their support for the bill.¹⁸ 

Thereafter, on June 15, 2010, Pennsylvania State Representatives Marc Gergely and Garth Everett requested co-sponsorship for a new forced pooling proposal that addressed some of the criticism that House Bill No. 977 received for not containing enough protection for the correlative rights of landowners.  The proposal by Representatives Gergely and Everett, which was proposed to be named the Conservation Pooling Act, would have required a minimum acreage requirement of 90 percent to 95 percent and, much like Ohio, would have required parties to make a good-faith effort to negotiate a lease with property owners to be brought in under a pool on terms similar to the existing fair market value for leases in the area.¹⁹  The Conservation Pooling Act also offered three choices to unleased landowners who would be forced pooled: (i) accept the terms of the lease offered to others in the pool, (ii) pay the proportionate share of the costs of developing the well up front and share in any profits or (iii) share in the profits of the well after a 400 percent risk penalty.  However, despite the high minimum acreage requirement that would have, in part, protected the correlative rights of owners, the Conservation Pooling Act was also subjected to criticism as a form of private eminent domain, and was never voted on by the Pennsylvania General Assembly. 

As an alternative, Pennsylvania State Senator Gene Yaw introduced Senate Bill No. 477 on February 11, 2011.  This proposal would allow forced pooling, but it would only apply to oil or gas companies and not private landowners.  Senate Bill No. 477 provided that if an oil or gas company “controls” 65 percent of a proposed unit, then such company may apply to the Pennsylvania Public Utility Commission for an order that would integrate interests controlled by another oil or gas company for purposes of establishing a drilling unit.  The bill provided non-consenting parties with two options: (i) elect to be a “nonconsenting party” and be entitled to a proportionate share of profits, but only after being assessed a 300 percent risk penalty or (ii) elect to be a “consenting party” and be entitled to a proportionate share of the profits but also proportionately share in the costs associated with operating the well.  Any failure to make a timely election would render a party a nonconsenting party.  The General Assembly, however, never voted on this bill in the past legislative session.  

As a result of the foregoing failed legislative efforts, operators in Pennsylvania seeking to drill in the Marcellus Shale cannot use forced pooling measures to satisfy drilling and spacing unit requirements, and instead must rely on voluntary pooling from neighboring holdout owners.  Though possible, it is unlikely that the current session of the Pennsylvania General Assembly will see another round of forced pooling proposals because attention relating to Marcellus Shale legislation has largely been focused on impact fees, rather than on forced pooling matters.  Additionally, Pennsylvania’s Governor Tom Corbett, who has, in the past, been supportive of the drilling industry, has publicly opposed the practice of forced pooling, calling it a form of private eminent domain.  Governor Corbett also refused to sign previously pending legislation that would allow forced pooling in the Marcellus Shale.²⁰  

West Virginia

Like Pennsylvania, West Virginia also has a forced pooling statute that does not apply to “shallow wells,” generally defined by statute to mean any well drilled and completed in a formation above the top of the uppermost member of the Onondaga Group, which is where the Marcellus Shale in West Virginia lies. 

There have been, however, recent efforts to adopt forced pooling legislation in West Virginia.  For instance, Senate Bill No. 424 was introduced on February 4, 2011 and addressed, among other things, forced pooling matters in the Marcellus Shale.  The bill contained a minimum acreage requirement of 75 percent in order to apply for a drilling unit.  A party that did not voluntarily participate in the pool would then have three options: (i) elect to assign its oil and gas lease ownership interest to the operator as mutually agreed upon or lease an unleased oil and gas ownership interest pursuant to the terms of the oil and gas lease the operator submitted with the drilling unit application, (ii) elect to become a nonoperating working interest owner by participating in the risk and cost of the well or (iii) elect to participate in the operation of the well as a nonoperating carried interest owner, but be subject to a risk penalty determined by the commission (between 200 percent and 300 percent).  However, legislators were unable to come to a consensus on forced pooling matters during the last legislative session, so the bill that ultimately passed out of the West Virginia Senate did not address forced pooling matters. 

Thus, while it is unlikely that we will see enough support in West Virginia to adopt any forced pooling legislation this year, based on recent regulatory trends and the growing interest in the Marcellus Shale, the issue is still likely to resurface in future legislative sessions.

For more information about forced pooling statutes, please contact Michael Bolton and Erick Wang.

 
You may also be interested in our earlier Alerts about the Marcellus Shale, States' regulations on Marcellus Shale gas extraction continue to take shape and Marcellus Shale drillers face potential liability under Clean Air Act.