The Oil and Gas Addendum

Time travel.  The idea of traveling back in time has been a fascinating part of popular culture for over a hundred years. From H.G. Wells’ classic novella The Time Machine in 1895 to Huey Lewis & the News 1985 hit Back in Time, we have all dreamed of going back in time and changing history.  Unfortunately, the concept remains just a part of science fiction. Unless, of course, you are a gas driller.  Throughout the Marcellus Shale region, gas drillers are trying to go back in time and change royalty calculations. The practice has become so brazen that, in some instances, the “royalty time travel” results in the landowner actually owing money back to the gas driller. Landowners across Pennsylvania need to be aware of this disturbing and troubling practice.

To understand what is going on, imagine that ABC Drilling Company pooled your seventy-six (76) acre farm into the XYZ Unit on May 15, 2017. Since that time, you have always been paid royalties from the four horizontal wells located within the 700 acre XYZ Unit. Then, in early 2021, you do not receive a royalty. You call ABC Drilling Company and inquire about what happened to your January royalty payment. You are informed that your royalty account is in “suspense” until ABC Drilling Company can recoup the amounts that you were “overpaid” from the last three years.

You inform ABC Drilling Company that you were not overpaid. You carefully verified the decimal interest calculation in each royalty payment for each of the four wells and there were no errors or overpayments.  In response, ABC Drilling Company tells you that they just expanded the XYZ Unit from 700 acres to 1250 acres. Also, two of the four wells were removed from the unit in November 2020 and placed in a new unit called the “QRS Unit”.  ABC Drilling Company explains that your seventy-six (76) acres will not be part of this new unit. Then, ABC Drilling Company delivers the news that these unit changes were made retroactive to the date of first production, May 2017. As a result of the unit expansion and the removal of the two wells, ABC Drilling Company remarkably contends that you were now “overpaid” between May 2017 and January 2021. You are told that your royalty will remain in “suspense” until they can recapture the amount of the royalty overpayment. You are shocked, angry, and confused. How can ABC Drilling Company make these changes retroactive and now claim that you have been “overpaid”?

Landowners should take note because this is actually happening. Gas drillers are revising units and claiming that such revisions are retroactive, resulting in “after-the-fact” overpayments. This is not only unfair but it also may be a breach of your oil/gas lease.

A pooling or unitization clause permits a lessee to consolidate a lease with neighboring leases into a single production unit. See, Chambers v. Chesapeake Appalachia, LLC, 359 F. Supp. 3d 258, 272-73 (M.D.Pa. 2019); See also, Stewart v. SWEPI, LP, 918 F.Supp.2d 333, 337-38 (M.D. Pa. 2013). The purpose of pooling and unitization is to more efficiently capture underground oil and gas resources, which, by their nature, are not neatly divided between surface parcels. See, Ohio Oil Co. v. Indiana, 177 U.S. 190, 209-10 (1900).

Outside of a “forced pooling” situation, the extent of the driller’s authority to pool your lease is set forth in the lease itself.  There is no implied right to pool.  It is well-established throughout the United States that absent express authority in the lease, a lessee has no power or authority to pool.  See, Southeastern Pipe Line Co. v. Tichacek, 997 S.W. 2d 166, 170 (Tex. 1999) (“A lessee has no power to pool without the lessor’s express authorization, usually contained in the lease’s pooling clause”); Jones v. Killingsworth, 403 S.W.2d 325, 327-28 (Tex. 1965) (“Absent express authority, a lessee has no power to pool interests in the estate retained by the lessor with those of other lessors.”).  For pooling to be valid, it must be done in accordance with the method and purpose specified in the lease.  See, Tittizer v. Union Gas Corp., 171 S.W.3d 857 (Tex. 2005) (court recognizing that lessee has no implied power to pool); Amoco Production Co. v. Heimann, 904 F.2d 1405 (10th Cir. 1990) (“Without such a clause, the lessee has no authority to pool or unitize the interest of the lessor”).  Since the pooling must be expressly authorized, courts have refrained from implying such a right when the lease is silent.  See, Leonard v. Barnes, 404 P.2d 292 (N.M. 1965) (since parties’ lease contained no express authority to pool, the court will not strain to interpret the contract to provide for pooling).

The first step for any landowner is to carefully examine the pooling and unitization clauses in their underlying lease.  These clauses may expressly prohibit and restrict a driller from retroactively changing your decimal interest.

In Tittizer v. Union Gas Corp., 171 S.W.3d 857, 860–61 (Tex. 2005) the Texas Supreme Court was confronted with the question of whether a different “effective date” for pooling could be used that was prior to the actual recording of the unit declaration. The lease unitization provision stated that:

Lessee shall exercise said option as to each desired unit by executing an instrument identifying such unit and filing it for record in the public office in which this lease is recorded. Each of said options may be exercised by lessee at any time and from time to time while this lease is in force, and whether before or after production has been established either on said land, or on the portion of said land included in the unit, or on other land unitized therewith.

Based on this language, the Texas Supreme Court opined that “this lease does not authorize the lessee to execute a pooling designation with a retroactive effect. The lease provides that unitization can be effective only upon recordation.” Tittizer, 171 S.W. 3d at 861.

Along similar lines, in Union Gas Corp v. Gisler, 129 S.W. 3d 145 (Tex. App. 2003) the Texas appeals court addressed a situation where the driller argued that pooling was retroactively effective to the date of first production. Id. at 151. The pooling clause in the lease stated:

Lessee shall file for record in the appropriate records of the county in which the leased premises are situated an instrument describing and designating the pooled acreage as a pooled unit; and upon such recordation the unit shall be effective as to all parties hereto, their heirs, successors, and assigns, irrespective of whether or not the unit is likewise effective as to all other owners of surface, mineral, royalty or other rights in land included in such unit.

Id. at 149-50. The court sided with the landowner and ruled that the driller could not unilaterally amend the express pooling language by making the pooling retroactive to the date of first production versus the date of recording. Id. at 151.

In the more recent case of Ohrt v. Union Gas Corp., 398 S.W. 3d 315 (Tex. App. 2012) the Texas appellate court once again reviewed a question about the timing of a pooling declaration. The lease in Ohrt provided that:

Lessee is hereby granted the right, at its option, to pool or unitize any land covered by this lease with any other land covered by this lease and/or with any other land, lease, or leases …. Lessee shall exercise said option as to each desired unit [to pool] by executing an instrument identifying such unit and filing it for record in the public office in which this lease is recorded.

Id. at 325. The pooling declaration was recorded on January 15, 2001, but stated that it would be effective “as of the first day of production from the Union Gas Operating Company–Ohrt–Heinold # 1 well, which was in September 2000.” Id. The appeals court agreed with the landowner and observed that “pooling is effectuated upon recordation of an instrument identifying the pooled unit and the lessee cannot effect pooling on a date prior to the recordation.” Id. at 326.

The authors submit that even though these cases are from Texas, the logic and rationale espoused by these courts is persuasive and should be followed here in Pennsylvania. The right to pool and unitize is generally set forth in the parties’ oil and gas lease. If the lease specifies that pooling and unitization is effectuated only by the recording of the unit declaration, then that is the procedure that the driller must follow. The driller cannot unilaterally amend or modify the underlying lease by changing the effective date of the pooling instrument.  This, in turn, means that the driller cannot go back in time and make retroactive changes to the previously recorded unit declaration.  The driller can change or modify the size, shape, and boundary of the unit but those changes can only affect your royalty prospectively.

But, what if the pooling clause in your lease does not have the same language as the Texas cases discussed above? The authors submit that there may still be language in the lease that creates a timing element for royalty payments which may prohibit retroactive changes to the production unit. These provisions may include the royalty clause or other aspects of the pooling and unitization clause. If you suspect that your royalty is being diluted or suspended because the driller retroactively changed the size or shape of the production unit, it is important that you immediately review your lease and contact experienced oil and gas counsel.