Thursday, November 24, 2011

Gas Leases Conflict with Mortgage Rules

well pad construction behind home in Towanda, PA
According to attorney Elisabeth Radow, gas leases conflict with home mortgage rules. One problem: hydraulic fracturing for shale gas carries heavy industrialized risks, and those risks can spread with a ripple effect through residential communities.

 “A growing number of banks won’t give new mortgage loans on homes with gas leases because they don’t meet secondary mortgage market guidelines,” says Radow. Mortgages prohibit the storage, use, disposal or release of hazardous substances (including gas) on the mortgaged property. They also prohibit landowners from transferring an interest in the property, such as mineral or gas rights, without the written consent of the mortgage lender.

During a recent phone conversation, Radow delved into the messy conflicts between gas leases and mortgage rules. The main problem she sees is that a gas lease redistributes traditional rights of homeownership to the gas company.

“But not the responsibilities,” Radow emphasizes. One of the responsibilities that falls on the landowner is liability. That’s because the industry has not fully insured their operations, she notes. And it’s not clear whether the companies have funds reserved to self-insure to make up for a shortfall in insurance coverage.

In disclosure statements filed with the SEC, both Chesapeake Energy and Range Resources state that drilling is inherently risky; drilling operations can result in injury, loss of life, damage or destruction to property and environmental clean-up. But, they caution, their insurance may not cover all those risks.

In the Form 10-K included with its 2010 Annual Report, Chesapeake reported that it has $400 million in general liability insurance, Radow said. While they have interests in 45,800 productive wells, they control drilling on 25,700 of those wells – that’s about $15,500 in liability coverage for each well they’re drilling. On top of that they carry $75 million for sudden risks, such as blow-outs and $130 million for pollution liability insurance.

“But,” says Radow, “from what appears to be the current practice, the amount of liability insurance gas companies carry may be potentially inadequate for even one catastrophic event. Consider the costs associated with BP and the recent upstate flooding.”

What does this have to do with mortgages? We have a $6.7 trillion secondary mortgage market, Radow said.  As shale gas extraction takes hold nationwide, if the gas company passes the liability from drilling accidents onto the homeowner and the homeowner defaults on his loan, and pension plans and others investment vehicles have invested in the secondary mortgage market ….  “I see potential for another serious secondary mortgage market impact,” Radow said.

Bubble or no, there are other potential financial problems with gas leases on residential properties. Recent data show that the value of homes and property near wells is declining. If the assessed value of a property goes down, that property’s taxes could follow suit. On a municipal-wise basis, decreases in the assessed value of homes near drill sites could affect the rest of the town by increasing what they pay to make up for that loss in tax revenue. Even people who don’t lease to gas companies could find their finances adversely affected by drilling on their neighbor’s property, Radow said.

“We are all in this together,” says Radow, noting that tens of thousands of New Yorkers have signed gas leases. “While New Yorkers hope to reap royalties from their underground shale gas, on the expense side we haven’t an inkling of how it will all shake out.”

You can read the longer, print edition of this article at Tompkins Weekly.

For a more detailed study of this issue read Radow’s article, “Homeowners and Gas Drilling Leases: Boon or Bust” in the Nov/Dec 2011 issue of NYSBA Journal.

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