A Big Firm Moves In; Landowners face new types of shale leases
Pittsburgh Post-Gazette
11 December 2011
By Erich Schwartzel and Elisabeth Ponsot,
OHIO COUNTY, W.Va. -- In its rapid ascent to become a top
leaseholder in the Marcellus Shale, Chesapeake Energy came to West
Virginia and put into play a strategy designed to narrow landowner
rights and expand company control over all phases of the drilling
cycle.
The Oklahoma City-based energy giant absorbed the region -- which
sits above the natural gas rock formation -- in just a few months,
driving down landowners' bargaining power, and in some cases
preventing leases from expiring, locking landowners into those
contracts indefinitely.
Chesapeake Energy moved into Ohio County through a quiet 2010 land
swap with Range Resources -- unknown even to the landowners whose
property rights changed hands.
Analysts on Wall Street and dairy farmers in this area now see the
same thing: One powerful firm suddenly overtook the leases, and
the rules of the game immediately changed.
A Pittsburgh Post-Gazette examination of hundreds of West Virginia
leases signed between 2006 and 2011 revealed new lease practices
that drastically changed the terms for landowners:
• Many leases were secured through land swaps (two companies
exchange a lease) and flipping (a company sells a lease to another
firm) that weren't publicized by the companies or announced to the
landowners. In several cases, the same lease in Ohio County had
four leaseholders or partial leaseholders in five years.
• Chesapeake, like other companies, turned to foreign firms and
multinational conglomerates to fund the upfront costs of acquiring
leases. The result is that multiple companies can have an interest
in a single rig, potentially further complicating business
dealings for landowners.
• Chesapeake has taken advantage of its ability to create "units,"
in which dozens of individual properties can be legally joined
into one giant property. The practice complicates individual lease
agreements and royalties because drilling operations on just one
property in a unit locks all landowners into their current
agreements. In West Virginia, sometimes just one property owner in
the entire unit sees a royalty check, even if gas is extracted
from underneath several plots of land.
• Longer leases presented by Chesapeake are written in greater
detail to favor driller rights. These leases often include
simultaneous agreements to allow pipelines and compressor stations
on the property, as well as agreements that specify all of the
post-production costs that may be deducted from leaseholder
royalty checks.
• Finally, Chesapeake has used an expanded definition of the
"force majeure" clause -- typically used in contracts to denote
unforeseeable, catastrophic events that hinder production -- to
extend lease terms, sometimes indefinitely, for new reasons that
go far beyond the "acts of god" traditionally included in such
clauses. Now, restrictive local regulations or a lack of
transportation equipment may be grounds for a "held lease" -- one
that the company continues to operate under past its expiration
date.
A new company in town
Though the land swap in Ohio County was unannounced,
Chesapeake's presence in the community came fast.
Farmers couldn't get lime for their land this spring because no
trucks were available. The Ohio County Clerk's Office set up a
dozen card tables in the hallway to accommodate overflow from gas
representatives scouring deed books. The landmen who negotiate
leases arrived in cars with phonebook-filled backseats, promising
millions.
When Chesapeake workers showed up to survey properties in Ohio
County, some landowners accused the crews of trespassing, saying
they had signed with Range Resources. What they didn't know was
that their leases had been swapped with Range for land in
southwestern Pennsylvania.
Neither driller was required by law to notify the leaseholders of
the change, which they say is an everyday occurrence.
"There are probably hundreds if not thousands of landmen putting
together deals and selling them to companies big and small," said
Matt Pitzarella, spokesman at Range Resources.
Sometimes the swaps and deals are between independent landmen and
regional companies. Other times they're internal transactions,
such as when Range
Resources absorbed a stake in the Great Lakes Energy Partners firm
that secured leases across the Marcellus.
The leases also go from small, local companies into huge,
multi-national firms playing catch-up to establish Marcellus
dominance overnight, such as when Chevron purchased 4,400 acres
from Brecksville, Ohio-based AB Resources earlier this year in
another transaction.
"They don't publicize it a whole lot," said Kit F. Pettit, an
attorney in Pittsburgh who specializes in representing landowners.
"Sometimes it occurs on a piece-by-piece basis, sometimes on a
much larger basis -- certainly there is a trend toward lease
swapping."
William A. and Beverly B. Fluty first leased their 96-acre Ridge
Runner Farm in Ohio County to Great Lake Energy Partners in 2006
for $960 per year.
"Since then everything kind of melded together into Chesapeake,"
said Mr. Fluty, 81.
First the lease was turned over to Range Resources in 2008.
Range swapped the Fluty lease with Chesapeake Energy in 2010,
which in turn sold a one-third stake in its Marcellus acreage as
part of a joint venture with Statoil of Stavanger, Norway.
Rapid acquisition
Chesapeake's portfolio includes nearly every shale play in the
country, but those rapid-fire acquisitions create an imbalance:
significant upfront costs for leases and a limited supply of
equipment to drill and make money from the land.
The company spent nearly $275 million for leases in the past three
years alone, and has said it is acquiring nearly 1,000 acres per
working day in the mid-Atlantic Utica Shale region (Utica is a
formation located deeper than the Marcellus).
The elbows-out approach is nothing new to Chesapeake, and indeed
helped it win many admirers over two decades as it grew from a
10-person firm to a
global energy giant with more than 10,000 employees. But critics
are wary of what they see as Chesapeake overstretching.
"Management's approach reminds us of a children's book titled,
'But I Waaannt It!' aimed at getting kids to realize they can't
have everything they want," said Philip Weiss, an analyst at Argus
Research, in a November paper urging shareholders to sell
Chesapeake stock. "We think it would be better if management would
show greater discipline and reduce its asset appetite."
To help finance the shale acquisitions, Chesapeake turns to
foreign and domestic firms.
Statoil of Norway has its stake in Marcellus. BP of London owned
partial Chesapeake holdings in the Fayetteville Shale in Arkansas
before the company divested the play from its portfolio. For the
Barnett Shale in Texas, the company teamed with Total S.A. of
Courbevoie, France. And Chesapeake's holdings in the Eagle Ford
Shale of South Texas are partially owned by the China National
Offshore Oil Corp. of Beijing.
Mr. Fluty follows news of the joint ventures in the Wall Street
Journal from his West Virginia farm and offered his advice for the
firm as it courts other companies.
"If you want to get married, you want to have the right partner,"
he said.
Unitization
As Chesapeake and other companies flip leases and bring on new
stakeholders, they are also rearranging the holdings they have --
joining several properties into a singular, odd-shaped unit that
is treated as one giant property.
This "unitization" pools properties based on seismic testing that
measures for sweet spots of natural gas. Gas companies say the
practice minimizes surface impact and allows them to extract gas
under multiple properties from a single rig.
But the units can stretch to 1,280 acres, pooling together several
different kinds of properties and treating them as one.
When drilling activity on one property starts, all properties
within the unit are considered "active" and therefore locked into
current leases, including those on the verge of expiration. Those
landowners then have no chance to renegotiate their leases or to
discontinue the contractural relationship with the company.
In its most recent annual report to shareholders, Chesapeake said
its "leasehold management efforts" included "scheduling our
drilling to establish production in paying quantities in order to
hold leases by production."
Chesapeake denies unitization is aimed at holding leases that
would otherwise expire. The company did not make senior officials
available for an interview, but issued a statement attributed to
Stacey Brodak, Chesapeake director of corporate development.
"Pooling or unitization is a tremendously beneficial provision
that enables lessors to share in development to which they would
not otherwise be entitled," said Ms. Brodak.
The Fluty lease that traded back and forth over the past five
years is now part of a Chesapeake unit with 28 leased properties.
The units' borders cross Marshall and Ohio counties, and contain
property owned by Elm Grove United Methodist Church and a
Salvation Army in Sandhill, W.Va.
Unitization can complicate royalty payments. A 2010 Pennsylvania
Supreme Court case ensured all landowners in a unit are
proportionately compensated, but West Virginia law provides no
such guarantee.
Instead, lease holders in West Virginia must have specific
provisions in their lease that give them the right to receive
royalties from their unit's drilling.
In a case where that isn't spelled out, only the property owner
who houses the rig would be guaranteed royalty payments.
Top leases
By 2011, Chesapeake had become a dominant driller in Ohio
County. The firm presented new agreements called "top leases" to
landowners whose original contracts with Great Lakes or Range were
soon to expire.
Some leases offered thousands of additional dollars per acre, and
an 18 percent cut on royalties -- which would reflect current
market conditions.
But they also often included terms that gave the driller more
latitude.
Mr. Fluty, who was now a widower, signed a new lease with the
company and bought 1,000 Chesapeake shares.
"I'm a land lessor and a stockholder," he said. "It's hedging my
bets."
Under the new lease, Chesapeake could include Mr. Fluty in a unit
of its design, and had the right to "change the size, shape, and
conditions of operations or payment of any unit created."
Some Chesapeake top leases include language that extend the lease
to other parts of the drilling life cycle, allowing for compressor
stations, pipelines or storage facilities. Compressor stations in
particular are seen as much more disruptive than a drilling rig
because they are noisy and permanent.
Other leases allow Chesapeake to deduct post-production costs such
as compression, transportation and equipment expenses from
royalties, shifting some of the company's costs to the landowner.
The companies must specifically say which costs are being taken
from the royalties, said Brian S. Wheeler, a Virginia attorney
who's written articles on post-production costs in royalty
payments.
Chesapeake's new top leases also safeguard against political
conditions that might delay drilling.
"Force majeure" is typically a clause that allows companies to put
a hold on leases in the event of an unforeseen situation, such as
a destructive hurricane or workers' strike.
Now, leases allow companies to declare force majeure on any cause
"not reasonably within [the company's] control." This includes
strict local ordinances or moratoriums, or a lack of
infrastructure like pipelines to take the gas to market.
By declaring force majeure, a company puts a hold on a lease,
which can stretch a lease's terms (and expiration date) by months
or years. And unless successfully negotiated otherwise, the leases
contain no time limits for how long a company can invoke force
majeure and lock a lease in place.
"It's possible that you will see companies claim force majeure
because they believe they cannot drill within that township," said
Mr. Pettit.
The issue is sure to play out in Pennsylvania, where communities
continue to pass local regulations that have been called overly
restrictive by gas companies.
And where Chesapeake holds thousands of leases.
Erich Schwartzel: eschwartzel@post-gazette.com or 412-263-1455.
Elisabeth
Ponsot: eponsot@post-gazette.com or 412-263-1497.