APPELLATE COURT REVERSES RULING IN HAYNESVILLE SHALE LAWSUIT - shreveporttimes.com

The 2nd Circuit Court of Appeal has reversed a DeSoto district judge's ruling that partially canceled the mineral lease of a DeSoto Parish landowner who sued Questar Exploration and Production Co., for failing to develop lower producing levels, including the Haynesville Shale.

In the 19-page ruling released Wednesday, the appellate court rejected District Judge Charles B. Adams' finding that Questar never intended to develop the Annie and Santo Ferraras' deep rights.

"The record does not support a finding that Questar failed to act as a reasonably prudent operator for the mutual benefit of itself and its lessor" as required by state law, the court states.

It further notes: "We certainly understand the district court's sense of awe at the potential of the Haynesville Shale, but there is inadequate support for a blanket finding of 'plans to drill wells in every section or every square mile.' More importantly, there was no evidence that a prudent operator utilizing geological data would have drilled on the Ferraras' property to the Haynesville Shale depth by the date of trial."

It's unknown if the Ferraras will appeal. Their attorney, Randall Davidson, did not return a phone call seeking comment Wednesday.

The Ferraras own 47 acres in DeSoto Parish. The land was first leased in 1988. In 2001, Questar drilled a well in the Hosston unit. Santo Ferrara made a demand on Questar in August 2008 to further develop the deep rights.

He filed suit in 2008 seeking dissolution of the lease based on Questar's failure to develop the Haynesville Shale, which gained the public's attention in March 2008.

Questar did not respond to the demand letter or lawsuit. And during a two-day trial in May 2010, the company did not present any evidence on its behalf.

Adams cited the company's lack of communication in his June 2010 judgment. Adams said it was clear Questar did not intend to develop Ferrara's deep rights.

The panel of 2nd Circuit judges said it completely understood the Ferraras' and district court's "impatience and indignation at Questar's inexplicable failure even to acknowledge the demand letter, its dilatory conduct after suit was filed and its unhelpful strategy of putting on no evidence. However, the Ferraras received royalties from shallow strata continuously since 1988 and made no demand for further exploration or development since 1994. The instant demand came a mere one week after the commissioner recognized the potential of the Haynesville Shale by dispensing with test wells; suit was filed only 46 days after the unanswered demand letter. The record is utterly devoid of evidence that any reasonably prudent operator could have begun exploration, much less drilled a well to the deep Haynesville Shale stratum, within this remarkably short time."

Questar also objected to Adams' use of an expert witness and his reliance of evidence of post-suit activity in the Haynesville Shale play to determine of the company breached its obligation. The appellate court, however, rejected those arguments and found no error in Adams' actions.

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Permalink Reply by Skip Peel - Mineral Consultant on July 6, 2011 at 2:41

Vertical Pugh clauses that limit drilling rights to depths produced prior to the end of the primary term of the lease can successfully address this particular situation.  And a standard depth clause should be a part of every mineral lease.  Many modern lease forms contain that language but the actual wording, and therefore the level of protection, can vary.  For those with leases that do not have a depth clause, the Demand To Develop statute is their only avenue of redress.  Considering the magnitude of historical exploration and production in NW. LA., there are a lot of lessors bound by older leases without depth limitations who have not benefited from the Haynesville Play.  Nor will they from the Bossier Shale.  This is an issue of state-wide importance as those in Central Louisiana will find themselves in the same situation if the Tuscaloosa Marine Shale and the Austin Chalk Play turns out to be economic. 

 

There are two avenues to approach reform of the state mineral statutes;  incrementally through court rulings or through legislative action to amend and modernize the code.  There would need to be a ground swell of public interest and political action as the O&G industry will use any and everything at their disposal to defeat those attempts.

Permalink Reply by P.G. on July 6, 2011 at 4:35

Even with depth clauses, Lessors are still stuck with lessees sitting on their minerals if just one well is drilled at those depths...I'm sure many lessees would bulk at a lease that would require them to further  or fully develop a unit...but if enough Lessors  insisted..maybe this stuck forever with one well stuff would go away..

How many lessors are there that has thought, "boy if only I had this to do over again, I'd change a few things"..?

 

Perhaps a vertical depth clause that will only bind the lease to wells at a given depth that are drilled within a certain time frame..

Permalink Reply by Henry on July 4, 2011 at 23:17
I have a question related to this issue....  Let's look out 5 years from now.  Some landowners will be cashing checks from the multiple wells in their sections.  Other landowners will be cashing checks for pennies, as the first (and only) well in their section is producing at a few percent of its initial rate.  Does the owner in that single-well section have legal basis for a demand to fully develop the section?
Permalink Reply by Skip Peel - Mineral Consultant on July 5, 2011 at 3:09
Henry, see my response to adubu above.
Permalink Reply by The_Baron on July 5, 2011 at 8:12
I imagine at the currrent price stucture, and the fact that many HA wells will never pay out at $4 gas, you could make a sound legal argumant that further developemnt at this time is not prudent.
Permalink Reply by Skip Peel - Mineral Consultant on July 5, 2011 at 9:22
None would do so, IMO.  In the case of a private company, it would negatively affect their ability to borrow capital.  And public energy companies would take a beating on The Street and from their shareholders.  Of course such an argument would have the challenge of addressing alternate unit wells.  But then we just get back to the argument of allowing a single well to HBP an entire section when it can only effectively drain 80 acres.
Permalink Reply by Henry on July 5, 2011 at 12:12
If so, then why are EnCana, EXCO, Questar, and El Paso aggressively drilling their alternate unit wells?
Permalink Reply by Skip Peel - Mineral Consultant on July 5, 2011 at 12:23
Henry, do you think those sections where the companies you mention are drilling alternate unit wells are the result of Demand to Develop litigation?  I doubt it.  My point is that it is a rational and reasonable business decision to expend the capital to build the infrastructure and drill the first well even if doing so does not generate an immediate profit.  The long term benefits of the existing infrastructure and the production from  alternate unit wells for HS energy companies will prove those initial investments to be well spent.  It would be a mistake to base a determination of profitability on the first well.  The true value is in the drilling of multiple alternate unit wells over time.  I think it a more than reasonable assumption that the majority of production from those alternate wells will be at natural gas prices significantly higher than current prices.
Permalink Reply by Henry on July 5, 2011 at 12:31

Skip,

I think we agree.  They drill the wells because they will make money.  I was responding to Baron's possible legal argument that the companies will not develop the sections because it is not prudent to develop the wells at this time.  And maybe it could be argued that while the companies are making money, a prudent operator might make more money by waiting. (I, personally, would not issue a "demand to develop" at these low prices.  But someone might try.)

Permalink Reply by Skip Peel - Mineral Consultant on July 5, 2011 at 12:41
The salient fact in the Ferrara case is that Questar is a minority lessee in the section.  J-W owns the majority of the leases.  Questar could have replied to the Demand that they were actively seeking an operator to partner with in the development of the HS in that section.  They chose not to do so.  As mentioned above, they desired to delay their participation until they could gain a favorable operating agreement with J-W or another interested operator.  They were willing to hold the development rights indefinitely based on their old lease and their willingness to litigate a reasonable Demand suit until they got the deal they were looking for.  That is not consistent with the letter nor the spirit of the Demand To Develop statute contained in the LA. Mineral Code.  It is not acting in the "mutual interest" of lessor and lessee.  It is harming the lessor in pursuit of a favorable benefit for the lessee.
Permalink Reply by Bacon on July 6, 2011 at 4:00
Skip, What happens when you "issue a demand to develop" to the opperator? Is it just a step to a lawsuit?  Are you putting them "on notice"? Any negatives for the Landowner?  Thanks.
Permalink Reply by Skip Peel - Mineral Consultant on July 6, 2011 at 4:14
A Demand letter is required as part of the process to seek relief through the courts under the state statutes requiring lessees to develop all formations deemed to be economically productive.  The letter establishes the date of the demand and starts the clock on a response from the lessee.  If the lessee does not respond or does not agree to develop the specific formation or zone within 90 days, the lessor may seek relief in court.  Operators generally aren't too impressed unless the letter comes from an O&G attorney they regard as competent and who has a record of following through with litigation if the Demand is ignored or denied for less than compelling reasons.  I know experienced O&G attorneys who decline to write Demand letters unless the client is intent on filing suite if the lessee does not agree to develop.  Unfortunately there are plenty of lawyers out there who will compose and send a letter for a mineral owner for a fee with know ability or intent to go beyond that step.  IANAL!

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