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Fight Brewing Over Well Plugging Liabilities in Appalachia

Diversified Gas & Oil plc is doubling down on its well plugging obligations across the Appalachian Basin, defending its commitment to the process in West Virginia, where it’s being challenged by a skeptical landowner rights organization that’s concerned about how far the company is willing to go to fulfill its responsibilities.

Alabama-based Diversified has grown a massive position throughout the basin and now operates about 60,000 mostly legacy wells across millions of acres in Kentucky, Ohio, Pennsylvania, Tennessee, Virginia and West Virginia. While the company has drilled wells and remains interested in doing so, it’s primarily focused on operating its existing asset base, generating free cash flow from producing wells and keeping its overhead costs down to generate stable returns for investors on the London Stock Exchange’s AIM market for small growing companies.

Diversified’s older inventory now has the West Virginia Surface Owners’ Rights Organization (SORO) on edge. SORO came forward last month, announcing that it had asked the West Virginia Department of Environmental Protection (WVDEP) for hearings to stop the transfer of thousands of conventional wells to Diversified or its affiliates bonds.

Diversified insists that the organization’s concerns are unfounded. “The company has consistently emphasized that it is a responsible and committed custodian of its wells and takes plugging liabilities seriously, ensuring it has in place a program to ensure those wells no longer producing are safely plugged,” said spokesperson Ben Romney.

The company owns about 17,000 wells in the state. SORO launched its salvo with the initial aim of challenging the transfer of EQT’s Huron wells to Diversified, claiming EQT is better equipped to fulfill plugging obligations as the nation’s largest natural gas producer. Diversified acquired the Huron assets for $575 million in a sale that closed earlier this year.

The latest exchange has brought into sharp relief widespread concerns shared by operators, regulators, landowners and other stakeholders across the basin, where there are thought to be hundreds of thousands of abandoned and orphaned wells, many of them drilled in the early- or mid-20th century when regulations and records to keep their numbers in check didn’t exist.

In West Virginia, mineral and surface rights are severed, meaning surface owners don’t often reap the same kind of royalty benefits as mineral owners. SORO co-founder David McMahon, an attorney who is leading the group’s charge against Diversified, is wary of the company’s commitment to plugging, arguing that it is likely to take advantage of the portfolio’s steep decline curve in the coming years, leaving little production to cover the costs of plugging in the future.

Environmental and property rights problems are likely to come farther down the road, McMahon claims, especially given the scale of Diversified’s inventory. The problem is compounded by what he sees as weak state laws and even weaker enforcement. While higher than in Ohio and Pennsylvania, the state requires only a $50,000 blanket bond to cover two or more wells or a $5,000 bond for individual wells, which is far less common.

“At the end of these wells’ useful lives, they do not produce enough gas to pay to plug them, and of course, the operators want to keep the wells there because they’re trying to hold the leases so they won’t have to get new leases if they want to drill later,” he said. “So, they have every incentive not to plug them.”

Diversified pushes back

But Diversified, which has wrestled with similar issues in other states, is pushing back hard. The company on Tuesday announced a 15-year agreement with the WVDEP highlighting a comprehensive plan for its decommissioning liabilities and posting a $3 million bond for the duration of the agreement.

Under the deal, the company is required to complete an assessment of all its wells in the state by June 30, 2019. From 2020-2024, Diversified said it would plug at least 20 wells per year. The company has decommissioned 41 wells this year at an average cost of $23,800 each and plans to plug another 30 wells next year.

The company has a similar agreement in Ohio and is working on others with regulators in Pennsylvania and Kentucky. Romney said the company’s balance sheet is strong and its strategy depends on maximizing production, with plans to invest in the portfolio over time to do so. He added that the company’s average well life expectancy of 40-50 years, and its plugging and abandonment cost estimates, are backed by the research of  Wright & Company Inc., an independent consultant. 

Diversified said it “recognizes that the cost of plugging activities can vary over time with variables such as the type and total depth of a well among those that can affect its cost to decommission. In turn, the company said it is “actively developing its plugging programs to manage the work in a timely and cost effective manner.

“...Accordingly, [Diversified] budgets annually for the number of wells it expects to plug and continues to improve cost and operational efficiencies as the company builds its growing body of decommissioning work.” CEO Rusty Hutson told NGI’s Shale Daily last month that the company also factors plugging costs into its acquisitions. Hutson is a native of West Virginia, whose father, grandfather and great grandfather all worked in Appalachian oil and gas fields.

“I’ve been given pretty clear-cut indications that [Diversified] is inspecting every legacy well that they have purchased to determine if it is actually abandoned or not abandoned, and whether or not there could have been a mistake about production being reported on the wells by the previous owner,” said Charlie Burd, executive director of the West Virginia Independent Oil and Gas Association (WVIOGA).

The company also said that its “smarter well management” programs have restored 130 wells to production over the last 90 days. Overall, the company is currently producing 420 MMcf/d, according to its latest investor presentation.

EQT announced a deal over the summer to sell its legacy Huron formation assets to Diversified, a package that included 12,000 wells in Kentucky, Virginia and southern West Virginia. The deal also included $200 million of plugging and other liabilities associated with the assets. The sale has already closed, but the assets have still not been transferred to a Diversified bond in West Virginia, a WVDEP spokesperson confirmed. 

The right to be ‘suspicious’

While McMahon said SORO wants to challenge the transfer of all wells now owned by Diversified, it has filed at WVDEP to protest the transfer of the first 3,865 wells for which approval has been sought, mainly related to the EQT sale, so it can present evidence showing how its members would be harmed.

McMahon said the agency has yet to schedule that hearing, but he expects word soon. EQT spokesperson Linda Robertson also confirmed that the Huron wells have not yet been transferred to another bond in the state, adding that the company is “fully cooperating” with regulators on its requirements for approval of the transfer.

McMahon said unplugged wells can leak gas, oil and brine into the air and groundwater if not properly managed. The effects can decrease property value in “perpetuity,” SORO said. Burd characterized those claims as an “overreaction.”

But abandoned and orphaned wells dot the landscape throughout the region, located in front yards, forested areas behind properties, along streams and even in landscaping where homeowners have made efforts to conceal them. 

“They have every right be suspicious because these wells have often times been neglected and not cared for, sometimes for decades,” said Tom Huber, president of the West Virginia Royalty Owners Association, of SORO’s concerns. He added that his group has a good working relationship with Diversified and for now believes that the company is serious about fulfilling its plugging obligations. 

A well is typically considered abandoned if it hasn’t produced in a year. It’s orphaned when an owner can’t be identified. But for landowners, regulators and operators, the definition isn’t always so clear.

In addition to property value considerations, Huber noted that plugging wells can also free up acreage for new leases. “From that perspective,” he said, “a lot of royalty owners would like the old vertical well on their property to be plugged, but at the same time, we recognize that if you can produce that well in paying quantities you have the right to hold the lease.”

In any event, McMahon said more needs to be done to address the issue. There are currently 12,674 abandoned wells in West Virginia, according to WVDEP records obtained by SORO and shared with NGI’s Shale Daily. More than 4,000 of those are orphaned.

“Behind each of those orphaned wells is a person that owns a piece of property, that’s got one of these wells decreasing their property value, perhaps leaking out onto the ground,” McMahon said. ”It’s real. It’s not just an environmental issue; it’s a personal, farmer and property-owner rights issue.”

While WVDEP conducts annual assessments to determine which wells are abandoned or orphaned, it has limited funding to cut into the numbers. The state’s reclamation fund, financed with well fees, forfeited bonds and operator penalties, had a balance of about $367,000 in June 2017, according to WVDEP’s annual report. Diversified has pegged its own costs to plug wells at $15,000-25,000 each.

The documents obtained by SORO show that the state has plugged two or fewer wells annually between fiscal years 2012 and 2016. When combined with federal funds, the agency was able to plug 10 or fewer wells each year.

“Unplugged natural gas wells are a concern to WVDEP because of their potential to be a public safety and environmental hazard and because they represent what could be a financial liability to the state if left unplugged by defunct companies,” said agency spokesperson Jacob Glance. As for the transfer of assets from one company to another, he said it’s common, noting that the agency has transferred 10,000 wells between operators this year.  

Staying ahead

McMahon said the laws should be tougher. If the hearings fall short of stopping the transfer to Diversified, his organization would not rule out pushing for legislation or other actions to address the issue, he said.

“Very few bonds are forfeited because if the bond is forfeited, the company can’t produce anymore,” he said. “They have to have a bond to drill and produce. So, the DEP knows if the [operator] forfeits a bond, there’s never a chance that the operator will plug that well cause it won’t be able to produce.” 

Orphaned and abandoned wells are an even greater concern in Pennsylvania, where it is estimated that they number in the range of 100,000-560,000, according to the state Department of Environmental Protection (DEP).

DEP in July ordered CNX Resources Corp., XTO Energy Inc. and Diversified affiliate Alliance Petroleum Corp. to plug more than 1,000 wells. The agency issued orders for Alliance to plug 638 wells; CNX to plug 327 and XTO to plug another 93. All three companies have appealed the order and are currently negotiating with the agency, DEP spokesperson Neil Shader said.

CNX said 190 of the wells in question were sold to Diversified earlier this year. XTO also said it appealed the order because the wells it’s been ordered to plug were also sold in a broader sale to Alliance in 2016. According to the company’s appeal with the state Environmental Hearing Board, DEP ordered Alliance and XTO to plug 82 of the same wells.

Alliance argued in its appeal that it has not abandoned the wells in question, saying some could be put back into production. Alliance also maintains that the DEP has ordered it to complete an unfeasible amount of work and noted that the agency has issued just one plugging violation for all the wells on the list. CNX, represented by the same law firm in the proceeding, also filed a similarly-worded appeal noting that the rest of its wells haven’t been abandoned.

“I think in the end, what you’ll find is the classification of an abandoned well can mean more than one thing,” Burd said. “It can mean that that well has maybe just not had production reported for some reason or another, is actually producing, and shouldn’t be on the abandoned well list.

“I think overall, if you take a look at the total number of abandoned wells, and as companies continue to reassess those wells, I think you’re going to see many of those wells fall off that list,” he said of West Virginia.

Perhaps mindful of the region’s dilapidated brownfield manufacturing sites and the abandoned coal mines that have dogged other sectors over the years, the oil and gas industry is trying to stay ahead of the well plugging issue.

WVIOGA strongly supported provisions included in the milestone co-tenancy legislation that became law in the state earlier this year. Over time, the bill provides more funding for the state’s reclamation fund, among other things. Industry representatives are also currently working to introduce new legislation that would establish another funding source for reclamation.

In Ohio, meanwhile, a bill passed earlier this year with the support of both environmentalists and industry to increase funding for the Department of Natural Resources by requiring the agency to spend 30% of the state’s Oil and Gas Well Fund on plugging orphaned wells. The fund generates money through fees, severance taxes and penalties paid by the industry. The law also requires state regulators to report their well plugging progress to the legislature annually.

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