Leases will expire unless production begins
By DAN SHINGLER
4:30 am, March 27, 2012
4:30 am, March 27, 2012
The leases that thousands of Ohio landowners have signed with oil and gas companies will drive the development of thousands of shale gas wells in the eastern half of the state during the next five years, even if the state proceeds with raising its taxes on the energy industry, according to experts on minerals rights.
There's no escape clause for an energy company to say that it needs more time to develop a property because of a change in Ohio's tax code. And a change appears likely, as a 10-point energy policy Gov. John Kasich unveiled two weeks ago calls for raising the state's tax on oil and gas producers in order to pay for a reduction in personal income tax rates.
The governor, and others, say Ohio taxes the oil and gas business less than other states and should adjust its rates upward. The energy industry has complained that any increase in taxes would raise the risk that drilling would slow in Ohio. But industry observers are not convinced.
“For better or worse, the companies have created a contractual obligation to drill,” said Andrew Thomas, a geologist and former oil and gas attorney in New Orleans who now serves as executive in residence at Cleveland State University.
Dr. Thomas was one of the lead authors of a Feb. 28 study done on behalf of the Ohio Shale Coalition by researchers at CSU's Levin College of Urban Affairs, Marietta College and Ohio State University. The study outlined the status and likely future development of Ohio's shale gas industry, including the economic benefits it will provide to the state. Dr. Thomas predicts that Ohio will see a total of about 2,000 wells drilled between now and the end of 2014. By then, well development should be on pace to create 1,000 more new wells per year.
“I think, after that, it will sustain that level of activity for 20 years,” said Dr. Thomas, who based his prediction on estimates of how much gas and oil lies trapped in Ohio's deep Utica shale deposits, about 8,000 feet below ground.
Doling out big dollars
Since each well costs as much as $6 million to drill, Dr. Thomas and his fellow researchers are predicting an annual investment in Ohio by energy companies of as much as $6 billion a year by 2014. That figure is just for the drilling work itself and does not include investments in pipelines, processing facilities, water treatment installations and many other tangential aspects of what is becoming Ohio's most famous industry.
It's a big number, but it isn't as big as those the drillers themselves have thrown around.
Last August, Chesapeake Energy Corp. CEO Aubrey McLendon, whose company has spent about $2.2 billon on shale gas leases in Ohio, predicted his company and others like it will invest an estimated $20 billion a year in Ohio's shale gas and oil industry for the next decade.
The ultimate driver of all this activity is the money to be made by extracting valuable natural gas and oil once believed to be trapped underground forever. The natural resources drillers seek are simply too valuable to be left alone, say both drillers and industry observers such as Dr. Thomas.
But the lease clauses are going to add significantly to the urgency drillers feel to produce, Dr. Thomas said, because if they don't, it will cost them plenty.
"A difficult dilemma'
Brad Hillyer, a lawyer in Uhrichs-ville at the law firm Connolly, Hill-yer, Lindsay & Ong, estimates he's worked on 2,500 shale gas leases in the last three years. Some leases require drillers to start production three years after the lease is signed, but five years is pretty much the industry standard in most Ohio leases, Mr. Hillyer said.
The leases also have automatic renewal clauses, Mr. Hillyer said, which means an energy company can keep a lease but must pay for it all over again once it expires.
Attorney Matt Warnock, who works on oil and gas leases for the law firm Bricker & Eckler in Columbus, said lease renewal payments can be as little as 60% of the initial bonus paid to secure a lease, or can be more than original amount.
“We try to get as much as we can, so we usually push for the 115%,” Mr. Warnock said of his work on behalf of landowners.
As a result of those potential costs, lawyers say, even if the state raises the taxes it collects on the production of Ohio's gas and oil, the energy companies still will need to drill if they want to keep their leases and avoid paying for them all over again.
“It does put them in a difficult dilemma,” said David Hudson, a minerals rights attorney in the Toledo office of the Reminger Co. law firm. He now spends much of his time in the eastern half of the state's shale gas territory.
“These oil companies have spent billions of dollars on bonuses for these leases,” Dr. Thomas said. “If they want to maximize that, they need to get moving. ... They've got three years to develop a lot of acreage.”
Too big a bite?
Energy companies have not addressed publicly whether they'll pay bonuses all over again to keep their rights in place if the state increases taxes on their production. The Ohio Oil and Gas Association did not respond to requests for comment by phone and email to discuss the matter.
Mr. Hudson predicted that drillers might respond to the situation by performing a sort of hydrocarbon triage, where they select what they think will be the most profitable drilling sites for exploration while leaving others to sit so their leases either can be renewed or abandoned later.
They even might try to hold acreage by putting tiny, shallow wells in place, which would yield just a fraction of what a deep horizontal fracking well would produce. However, it isn't known how the courts would view such a “tricky” act, Mr. Hudson said.
Mr. Hillyer, the attorney in Uhrichsville, said he supports an increase in Ohio's oil and gas tax — known as the severance tax — because he believes it won't slow down development and could provide needed funds for Ohio's small towns. Many of those towns have seen deep cuts in the money they receive from the state, he said, and now they are worried about added infrastructure expenses due to oil and gas activity.
“They want (the governor) to increase the severance tax, but not reduce the income tax” and instead restore some of their lost state support, Mr. Hillyer said.
Regardless of what happens with taxes or how much drillers hurry, they probably won't be able to meet the requirements of all their leases, said Cleveland State's Dr. Thomas. There simply won't be enough time for them to drill wells on each of the thousands of properties they hold before the leases for those lands are more than five years old.
Others agree.
“They may have bitten off more than they can chew,” Mr. Hudson said.
Added Mr. Hillyer: “There probably aren't enough drilling rigs on the planet to drill all the wells they need to drill.”
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