HOW THE OIL & GAS INDUSTRY CUT REGULATORY CORNERS AND DISADVANTAGED HAYNESVILLE SHALE MINERAL OWNERS, THE STATE AND SMALL INDEPENDENT OIL COMPANIES

COMPETITION IN THE LAND RUSH.  The race to lock up drilling rights not only created an increase in bonus payments and royalty fractions, it also passed over many small mineral tracts that never received a lease offer who were then subject to the LA Mineral Code as Unleased Mineral Interests (UMI) who were “force pooled” into drilling and production units.  Among the many corners in traditional leasing programs that were cut was the use of Letter Agreements.  Many mineral owners that executed those agreements for favorable terms never got a lease with those terms as Chesapeake backed out of them in the fall of 2008.  If those mineral owners eventually signed a lease, it was vastly lower bonus terms.

DIFFICULTY IN RECEIVING QUARTERLY UMI REPORTS.  All Haynesville operating companies then cheated those UMIs by ignoring the clear language in the state mineral code and proceeding to charge post production deductions for gathering and treating, compression and marketing from UMI production revenue.  For laymen UMIs this was difficult to track much less be aware of because of how companies responded to requests for quarterly production reports as required by the mineral code.  Without professional assistance which many could not afford, it was extraordinarily difficult to get reports that detailed how much was being deducted and for what operator costs.  There may be as many as ten thousand UMIs in northwest Louisiana and the total illegal deductions may be in the hundreds of millions of dollars, if not more sixteen years after the play began.

RUSH TO HOLD LEASES.  In the beginning of the land rush many leases were for standard three-year lease terms although some had extension options for an additional two years.  As the acreage under lease continued to increase over the leasing period from 2007 to 2010, the challenge of drilling enough wells within the primary term of the leases grew.  The industry term is Held by Production (HBP) and preserves the lease rights as long as production is ongoing.  The rush to HBP was such that there was little to no effort to improve well designs especially completion designs.  The majority of early unit wells were under stimulated and ultimately penalized all those UMI owners when natural gas prices fell and caused most of the wells not to recover their cost to drill and complete (payout).  Many of those wells have not reached pay out after fourteen years.

CUTTING REGULATORY CORNERS.  The early frenzied pace of drilling caused Haynesville operating companies to ignore the regulation that unit surveys were due to be submitted to the state within 90 days of a well’s first production.  All the operators failed to varying degrees to adhere to this regulation and the Louisiana Office of Conservation did not require compliance.  A unit survey contains important information for mineral owners in each drilling and production unit.  Without a unit survey, mineral lessors and UMIs don’t know the acreage of their tract or the number of acres in the unit.  Not only did this not give them the opportunity to question their tract acreage, it effectively kept them from performing the simple math to see if the decimal fraction on their royalty statements were correct.  Many are incorrect.  In my experience, mostly in the oil companies favor.

USING NONCOMPLYING UNIT SURVEYS.  The State of Louisiana recognized a small number of types of land surveys for certain situations and purposes.  The proper approved survey for a drilling and production unit was an expense that the Haynesville operating companies did not wish to pay.  Working with the State Board of Surveyors and the Louisiana Office of Conservation, they came up with a more streamlined and less expensive survey approach that although less accurate was approved by the Board and the State.  Many Haynesville mineral owners were surprised to get many pages of royalty adjustments when the state approved cross unit laterals.  This was the result of those less than accurate surveys that were then being replaced by more accurate surveys and the companies adjusting the proportional pay for those mineral lessors and UMIs whose tract acreage changed.  With no advance warning many mineral lessors stopped receiving monthly payments in order for companies to make up those who were under paid by recouping pay from those who were over paid.  After the state sent compliance letters regarding the delinquent unit surveys to operators, the 850 missing surveys as of late 2018 have now been materially reduced although there are still some that are now over twelve years past due.

LACK OF HONEST REGULATORS.  The Louisiana Department of Natural Resources Division of Office of Conservation is tasked with reducing the waste of hydrocarbons and maximizing production and revenue to the state.  As many O&G companies seemingly bragged in their press releases or corporate presentations, Louisiana was seen as having a “friendly” regulatory system.  When the industry wanted to drill long lateral wells, the state did away with the requirement for a horizontal well to produce only from a single unit.  When the industry wanted to have the option for an operator to drill a long lateral well that included one or more of their units and one or more of another operator’s units, the state rescinded the one operator per unit rule.  Seemingly no regulation, no matter how reasonable and in force for decades, would be upheld by the state if it interfered with what the industry wished to do.  The regulators were the servants of the O&G industry.  Bureaucrats often get little praise and are made scapegoats when things go awry however it is the Secretary of the Department of Natural Resources and Commissioner of Conservation along with the governor who appointed them that are to blame.

A MISSED OPPORTUNITY.  Both of those changes did not disadvantage mineral owners directly but another one did and not just for those private land owners but for the state in direct conflict with the Office of Conservation’s stated task of reducing waste and maximizing the production of mineral assets.  The race to HBP all those early horizontal wells led the industry to press the state to do away with the requirement for each well to have an electric log run and filed with the state.  As the Haynesville Shale fairway covered much of Northwest Louisiana that had little or no prior drilling activity especially to depths down to the Haynesville formation, the opportunity to discover and produced hydrocarbons from formations and zones shallower than the Haynesville was lost. 

A BLOW TO THE INDEPENDENT OPERATORS OF NORTHWEST LOUISIANA.  That lose extended to the smaller, regional O&G companies that were not capable of developing the Haynesville Shale but were experienced and capable of drilling wells in those shallower conventional formations.  Those same smaller operators were also disadvantaged by the lease terms offered by Haynesville Shale operators as it was not economic for them to pay Haynesville lease prices for the shallower depths that were their primary focus.  A decline in historic independent operators was an economic loss for mineral owners, small operating companies and the many workers that they employed.

INFLATED SALES PRICES AND TERMS OF GATHERING AND TREATING SYSTEMS.  Existing mid-stream (pipeline) infrastructure was inadequate to handle the huge volumes of natural gas that Haynesville horizontal wells produce in their first few years of life.  In order to support their rapid drilling schedules, operators built their own gathering pipelines and treating facilities.  With debit piling up amid increasing capital requirements to HBP large leasehold acreages, those assets were too valuable not to monetize by sales to pure mid-stream companies.  The problem for mineral lessors and UMIs was the terms of those sales.  In order to get the maximum cash up front, Haynesville operators loaded up those sales with numerous advantages for the buyers.  The operators agreed to guaranteed high per mcf charges for gathering and treating.  They also agreed to Minimum Volume Commitments (MVC) that included stiff financial penalties when the operators did not meet the volumes contracted.  All of those post-production costs are passed on to the mineral owners and continue to reduce their royalty revenue or production payments. 

A TAX GIVEAWAY FOR NATURAL GAS COMPANIES.  Horizontal and Deep Well severance tax abatement.  In 1994 Louisiana implemented a severance tax exemption for “Deep” and “Horizontal” wells.  Both types were rare in 1994 and the tax exemption was seen as a means to incentivize those early and more risky types of expensive wells.  Fast forward fourteen years to the beginnings of the Haynesville Shale Play.  Except for a hand full of early vertical test wells, all the Haynesville wells are horizontal completions.  Horizontal wells by that time were no longer rare and in fact they were being drilled in a number of unconventional basins.  Haynesville horizontal wells are “front end loaded” meaning they produce 80% of their lifetime volume in the first 24 months.

HORIZONTAL WELL REQUIREMENTS**

• Must commence after July 31, 1994 and are “Eligible for a two-year reduction in severance taxes from the date of first production or until payout of qualified costs, whichever comes first.”

Many of the early Haynesville horizontal wells never “paid out” owing to low natural gas prices during their first 24 months of production.  The state received no severance tax income.  In years where the price of natural gas is high enough for wells to reach payout, the state may get severance tax on some portion of those 24 months but effectively the state is giving up 75% to 80% of potential severance tax revenue and collecting 25% to 20% even though horizontal wells are no longer rare and are the norm.  The severance tax exemption should have been retired soon after the Haynesville Shale Play began but state regulators, legislators and governors are so tied to the O&G industry that the exemption continues to this day depriving the state of hundreds of millions, if not billions of dollars in state revenue.  It is a give away to the industry that serves to put the tax load on the average Louisianian.

DELAYED ROYALTY PAYMENTS

All Haynesville operating companies delay royalty payments to owners of record in their drilling and production units.  It is not unusual for royalty to be delayed for four to six months after a well’s first production.  Although this is seemingly normal occurrence, it allows the company to use that income owed to royalty interests for their own operating expenses before first payment to mineral owners without the benefit of interest.  There are some companies that delay much longer.  I have clients who have had to wait eight months to be paid.  The first payment for new wells is larger than usual because it covers multiple months of production volume and companies rely on this to assuage the concerns of their lessors over the companies’ use of their money.  In a majority of cases, the units with new production have older wells which have already had pay decks long in use that define who to pay and what percentage of production they are owed.  There is no logical excuse for a payment delay over two to three months.