Saturday, May 1, 2010

Louisiana Drilling Unit Lawsuit

I've been reluctant to comment over the past year or two about the various lawsuits that have been filed by a few landowners against the state trying to change the size of Haynesville Shale drilling units.  Earlier this week, another lawsuit was filed by a group of landowners challenging the state's determination of 640 acre drilling units for the Haynesville Shale and its ability to force pool landowners into a unit.  (Note the sidebar in the Shreveport Times article about similar efforts in Texas.)

I've been reluctant to comment because I don't fully understand the motives of the plaintiffs.  I understand them on the surface, but I feel sure there are some deeper unseen motives.  I have my suspicions, but I'm trying to be objective.

I'm not a lawyer, but I play one on the internet... seriously, though, I deferred to some others who have more experience in this field.  There is not a clear answer as far as I can tell.  The current system (I say "system" because the recent lawsuit challenges whether the state's laws are being applied correctly), has been in place a long time and is generally understood by all participants.  It is a fair method for allocating the economics of a below-ground formation, and leases were signed on the basis of this understanding.  But it applies to traditional hydrocarbon reservoirs, and shale is anything but typical.  Ultimately, new rules might be required for shale and/or horizontal drilling, but the proverbial horse has left the barn and it might be too late to make any substantive changes.

The article quotes a plaintiff in this recent suit who says that changing the current system would lead to a huge economic boom for the area.  I have serious doubts about that.  What might happen if the 640 acre section is carved up into a bunch of smaller sections is that operators will lose lots of pieces of their leases that are undrilled in the next couple of years.  I'm assuming the boom the plaintiff expects would come from a mad rush to drill leases or the re-leasing of the land to other operators.  I don't see that as likely.  Right now the producers can barely drill as many wells as they plan now in the current price environment.  Plus, if they can't drill the wells, they damn sure aren't going to re-lease the land for $25K/acre as they foolishly did two years ago.
The suggested action doesn't change the underlying economics on the royalty side.  If you own 20 acres of a 640 acre section, you might get a small fraction of the revenue generated by the well on your property, but you are also getting a share of wells drilled a good distance from your property in that same unit.  If you own 20 acres of an 80 acre unit, you get paid more for the well on your property, but you get nothing for wells outside the small unit.  With the methodical plans operators have for drilling the Haynesville Shale, it is likely that all viable sections will have around eight wells and the landowners will get pieces of the relevant ones in their neighborhood.  It just won't happen all at once.

I think a large part of the argument is about operators who are holding sections by drilling one meager vertical well.  Their strategy might be to slowly exploit the section as cash flow becomes available or more likely it might be to monetize it by selling the rights to a bigger operator down the line.  Because of the magnitude of the economics of shale drilling, it is a game best played by big operators with deep pockets, not the traditional small operators that dot the region. Unfortunately we didn't all know that going in.

I can see the frustration of these landowners.  There certainly are a number of landowners with "non-operating operators" who see their neighbors collecting royalty checks while only a single crappy vertical has been drilled on their section.  Same goes for those landowners whose land was held by production because of old activity or because of the lack of a vertical Pugh clause in the lease. 

As a landowner, I might like the prospect of re-leasing some more mineral rights in a few years.  But it is not
really fair to producers and it may not be in my long-term economic interest.  I don't need to defend the producers - they will mount a furious defense on their own - it's just that they are struggling enough as it is to drill wells and produce gas in this crappy price environment.  Even in good times, they risk outspending their cash flow to constantly drill new wells.  As a royalty owner, I absolutely do not want to force them to produce gas when my royalty is pegged to wellhead prices in the $2-4/MMBtu range.  It hurts my share of the take.  Leave it in the ground and wait for higher prices.  This is a marathon, not a sprint.  Drilling more wells now leads to less wealth creation down the line.

This is a complicated issue, and I think there are greater implications here than what is we see on the surface.  I don't think it is just about people who don't understand fractions or want another bite at the leasing apple.  Maybe I'm paranoid and need to up my meds, but I think there are deeper ulterior motives to these suits.


Anonymous said...

Lawsuits like this are about one thing - making a bunch of lawyers rich. It is absurd to imply making this change would result in 4 to 8 times more drilling rigs working in the play. Operators can only drill so many wells a year so this a zero sum game. For every winner there is a loser. Except overall the mineral owners lose since part of the money has to go to the lawyers' pockets.

Look at the typical "class action" lawsuit. Individual plaintifs get pennies while the lawyers get millions.

Trying to go to 80 acre units for the Haynesville Shale would be highly inefficient and would dramatically slow the development process. We would probably have to increase government resources tenfold just to keep up with all the additional paperwork associated with the increased number of unit permits.

This also increases the disparency between individual mineral owners because your single well may be poor rather than participating in multiple wells.

Lawyers lack the practical experience or technical knowledge to deal with such a topic but of course that is not their primary interest anyway. Just fill their pockets with gold and they will move on to the next victims.

Robert Hutchinson said...

While I think there is something fishy going on here, I don't think it is ambulance chasing class action lawyers lining their pockets. As far as I can tell, nobody is asking for any significant monetary damages. At least not yet. The people being harmed here seem to be those who can't do math.

I think the motives lie elsewhere.

I agree that changing the system would be very inefficient and would actually harm more landowners than it helps. Sort of a "tyranny of the few" situation.

Anonymous said...

These lawsuits have a "robin hood" ring to them which appeals to landowners who got suckered by the industry. However, there is simply no way that the state can allow an industry to plan the development of this massive resource then after hundreds of sections being drilled change the definition of a section. I think this issue will fall to the wayside rather quickly as the courts back up with more relevant proceedings.

Robert Hutchinson said...

One thing I failed to mention in the post is that Louisiana is known to have some of the best conservation laws in the country. They may not be applied to the letter of the circa 1940's law as written (that is up for debate), but the fair application of our conservation laws helps preserve the resources and prevent wasteful and unfair drilling practices.

It is a rare when we can honestly say that a Louisiana system of regulation successfully blances environmental and business interests.