Proposed legislation would benefit landowners forced into drilling units

New York isn't allowing any horizontal drilling in the Marcellus Shale just yet, but that hasn't stopped some companies from planning ahead. Epsilon Energy is drilling into the Oriskany (just below the Marcellus layer) and at the last meeting with the Van Etten town board the Epsilon representative admitted that they were developing the pads and access roads for future Marcellus wells.

Over the hills, in the town of Maine, Inflection Energy has leased 3,000 acres for future Marcellus drilling. They told the press that they've signed leases for $6,000/acre with 20 percent royalties (minus "a few expenses"). All well and good for the landowners with leases, but what happens to people who are forced into drilling units through the process of "compulsory integration"?

Compulsory Integration assures that landowners involuntarily forced into drilling units will get paid for oil or gas taken from beneath their land - at the lowest royalty rate signed by a leaseholder in the unit, but no lower than 12.5 percent.

This practice does not sit well with most landowners who characterize it as nothing less than theft. So recently the NY Farm Bureau, goaded into action by landowner coalitions and outraged citizens, outlined some legislation changing this practice - and as of last week it looks like they found some sponsors in Albany. Assemblywoman Donna Lupardo introduced Assembly Bill 10956  (Senate bill 7758) that will, if it passes, provide "integrated" drilling unit landowners a royalty equal to the highest royalty in an existing lease in the spacing unit, but no less than 18.75 percent.

That, my friends, is a huge chunk of change! 

Lupardo justifies her bill this way: When a natural gas drilling company applies for a permit from the Department of Environmental Conservation (DEC) to drill a well, the company proposes the drilling unit from which gas will be extracted. Unit boundaries may cut across property lines and include land owned by people that have not signed a lease with a gas company for development.

The gas company only needs to have 60 percent of the land in the drilling unit leased to drill. Any other land in the unit is forced in through compulsory integration. Of course - that only allows the gas company the right to suck up the gas; no surface rights are transferred through compulsory integration.

Now, Lupardo points out, the technical advances in the drilling industry and the prospect of exploration in the Marcellus Shale formation have pushed up both the rental and the average royalty payments dramatically. Royalty payments are consistently in the 18 to 20 percent range, with some lease agreements offering up to 30 percent royalties.

This means that landowners who are involuntarily integrated into drilling units now are receiving considerably lower royalty rates than their neighbors in the same unit. Landowners don't think that's fair. Now they've managed to convince Assemblywoman Lupardo. On May 5 her bill was referred to the environmental conservation committee. That means, should the NY legislature ever pass a budget, the bill might actually get read.

Even if you don't have a lease, they can take your gas

At least here in New York. I live in the southern tier, land of rolling hills and forests and hayfields. Underneath is all is the Marcellus Shale, a much-coveted resource that energy companies would like to convert from cold hard rock to cold hard cash.

With so much potential wealth beneath our feet you'd think we'd be inundated with leasing agents. If it weren't for the DEC's year-long break to prepare a Supplemental Generic Environmental Impact Statement (SGEIS) we would be. Still, even though DEC is not handing out permits for horizontal drilling in the Marcellus, they will soon. In fact, Fortuna Energy has 11 applications pending in our little town andn I am sure there are more on the way.

Once DEC approves their final version of the SGEIS the land rush will begin in earnest. You see, to drill a well a company has to show that 60 percent of the land in the drilling unit is leased.  What happens to those not leased? If their land falls within a drilling unit, their gas is taken through a process called "Compulsory Integration".

Now some landmen, when  they come to your door, speak of "compulsory integration" in much the same tone as "the goblins 'll get ya if ya don't watch out".

It doesn't matter that you might not want to lease or have drilling anywhere near your farm or water well. What matters for the DEC is that they can assure that the mineral resources are extracted in the most efficient manner possible. So they pull you in kicking and screaming.

Still, they do have some rules to protect you - er, to make sure that you receive "just" compensation for the extracted gas. And those rules are what compulsory integration is about. Basically they assure that a landowner will receive at least 12.5 percent royalty for gas removed.

Maybe that was OK back in the 1800's when that rule was first written. But now, with landowner groups negotiating for 20 percent and higher royalties, the state's "protection" seems more like a rip-off.

Well, say the gas folks, that's only the floor. The person who is forced - er, "integrated" into the unit will receive the lowest royalty on the unit leases. So if that's 20 percent, they're doing well. BUT given that many of the leases were signed when 12.5 percent was the "going rate" it looks like integrated landowners are screwed.

Not so fast, say the gas folks. Landowners can choose to be "participating owners" in the gas well.  That means you take on some risk - such as covering your part of the cost for drilling the well - but you receive 100 percent of the royalties. For your portion of the well.

Or you can be a "non-participating owner". Instead of forking over the money upfront, you pay a "risk penalty" of 200 percent, plus your costs  - a grand total of 300 percent - before you see any income. But hey, once the costs are recovered, you get to cash those royalty checks.

There are some other options. One idea landowners have considered is incorporating as an LLC and leasing their land to their LLC. The royalty set-up is better, but at this point the insurance agents and lawyers don't seem to be too sure about liability issues.

Some neighbors in the next town over had their own creative solutions to compulsory integration. You can read about it here.