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Proposed Unitization Change In Ohio Budget Bill Could Rankle Oil/Gas Leaseholders

Proposed changes to Ohio's unitization law buried in nearly 3,000 pages of Gov. John Kasich's biennial budget would make it easier for oil and natural gas companies to expand the size of their drilling units and undermine the rights of leaseholders in the process.

The changes are included in one of hundreds of amendments to HB 64, the state budget bill introduced early last month and currently under consideration in the state House of Representatives' Finance Committee. Unitization, similar to pooling, allows an operator to gather landowners into a unit, in which they proportionately share royalties based on the acreage they own within it. Aimed at reducing surface disruption and maximizing oil and gas volumes, the law also prevents a small minority of landowners, or holdouts, who may be opposed to drilling from preventing a majority of those who wish to capitalize on their mineral rights.

Currently, the statute gives the Ohio Department of Natural Resources (ODNR) the authority to force unleased landowners to participate in a drilling unit at the request of an operator that has leased at least 65% of the land in a proposed unit.

As development of the Utica Shale has increased sharply in recent years, operators have increasingly relied on the law to help streamline development and reduce costs. From 1965, when the law was passed, until 2011, records show ODNR approved just two unitization requests. But spokesman Eric Heis said the agency has approved 30 requests in the last four years alone. The amendment in HB 64 would make it easier for operators to avoid negotiating with leaseholders to expand a unit's size.

Alan Wenger, chairman of the oil and gas law group at Ohio-based Harrington Hoppe & Mitchell, said language included in the amendment is "just ambiguous enough to hide its intent." A new provision says if an operator that has applied for unitization with ODNR has not reached a voluntary agreement with a leaseholder in the proposed unit, "the mineral rights owner of such a tract included in the unit shall be considered an unleased mineral rights owner" by the agency.

That would effectively deny the leaseholder of certain rights under the private contract they have with an operator, said Wenger, who reviewed the amendment and has implored leaseholders to contact their state lawmakers in opposition.

Wenger said operators have been able to negotiate thousands of amendments in recent years, especially on leases that restrict larger unit sizes in exchange for adjusted royalties, signing bonuses or no surface operations, among other things. If leaseholders could be treated as unleased mineral rights owners, they would lose their right to negotiate for better terms and a “popular tool to maximize the value of their rights”, Wenger said.

"There would be no real reason for the [operator] to offer consideration to the lessor in return for an amendment, or even try to amend the existing lease at all because the [operator] could get the desired result from the [ODNR unitization order]."

What’s more, given the amendment’s vague language,  it is unclear how a leaseholder would be treated if they’re forced to participate in a drilling unit as an unleased mineral rights owner. Currently, unleased landowners forced to participate in a drilling unit can choose to become either a working-interest owner or a non-consenting working-interest owner, which have different terms for cost-sharing and royalties compared to property owners with leases.

“That’s a good question, no one knows,” Wenger said of whether a landowner’s lease would be valid if they’re forced into a unit under the proposed amendment. “All the [operators] want is to get their unitization and let the landowner fight for whatever they get. The [lessor] is at a huge disadvantage. To hire counsel and fight this stuff costs a mountain of money. It’s a wide open question as to how you treat someone like they’re unleased.”

Wenger said if the amendment is passed, he can already see it backfiring for landowners. He's currently working for clients in Monroe County, OH, where a large exploration and production company is trying to expand a 60-acre unit to a 1,000-acre unit.

"What's happening now is [companies] would come hat in hand, they would say 'we need a larger unit, let us amend your lease.' The owner would say 'fine, but I want some benefit or change.' If the lessor refuses, under this legislation, it causes a problem," he said. "If it works right, a larger unit with eight wells can be more lucrative for the landowner than a 60-acre unit with one well. It can work to everyone's benefit, but the basic issue here is whether the legislature, by force, can allow the amendment of a private contract. I would think that's unconstitutional."

The amendment also says that a unitization order "takes precedence" over any agreement between the operator and participants in the unit.

It's unclear who wrote the amendment. The Kasich administration referred questions to ODNR, where officials said they were reviewing the language for a response. Wenger suggested that state trade groups may be behind the language, but it couldn’t be verified.

University of Akron political science professor David Cohen said it’s possible that industry lobbyists helped draft the amendment.

"The bigger the bill, the easier it is to hide stuff in it," Cohen said. "In an omnibus bill like this, there's so much detail. I think it's very rare that any lawmaker reads every word of the budget. So, I think with a bigger bill there's an increased chance something can be in there and go through unscathed without any notice."

Ohio Oil and Gas Association officials were unavailable to comment on Wednesday. API Ohio Executive Director Chris Zeigler said his organization had nothing to do with HB 64 or the unitization amendment. He said although the organization is aware of some of its language and the concerns about it, he didn’t know what the impact could be if it’s passed.

“What I can tell you about what’s in the budget is that API Ohio was not involved in any language included in it,” he said. “We had no discussions with the administration prior to the budget being rolled out.

“We’re looking into the language as well,” Zeigler added. “We have our own unitization legislation, HB 8, we’re working on, but it’s not part of the budget. We’re trying to get a read on this too.”

HB 8 would allow operators to unitize state-owned land, such as roads owned by the Ohio Department of Transportation.

“These units are set up to petroleum engineering standards to ensure access and extraction in the most efficient manner,” Zeigler said in reference to HB 8 and the general benefits of larger units. “A highway or whatever could sever those units and impact their efficiency. I mean, depending on where a particular property is, if it can’t be included, it could sterilize that unit from ever being developed.”

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