Natural Gas Drilling Could be Boon for Landowners, But Be Cautious

Feb 09, 2011

 

 

COLUMBUS, Ohio -- Eastern Ohio landowners interested in leasing their land for natural-gas drilling into the rich resources of the Marcellus Shale need to be aware that such leases can carry some financial risk if they're not cautious. And, potential risks to the environment could be serious.

The Marcellus Shale formation encompasses about 95,000 square miles from New York to West Virginia, swinging through the southeastern corner of Ohio. The ancient formation, lying 8,000 to 15,000 feet below the surface, is estimated to be capable of producing more than 363 trillion cubic feet of clean-burning natural gas -- more than 15 times the natural gas used in the United States each year. The Utica formation, which lies beneath the Marcellus and reaches into parts of central Ohio, appears to have similar reserves.

These rich resources are fueling a "gas rush" in areas where drilling is taking place, but the rise of the new industry has also raised concerns about the possibility of contamination or depletion of groundwater reserves.

The drilling technology necessary to fracture the shale and release the gas requires millions of gallons of water, sand and chemicals, some hazardous, to be injected into the wells, which sometimes extend horizontally for a mile underground from the well hole on the surface. Potential problems with the disposal and treatment of the liquid waste that results from these drilling practices has also raised questions.

As with any type of drilling arrangement, landowners who are approached with leasing agreements to allow companies to tap into the Marcellus or Utica shale reserves should take steps to protect themselves, said Clif Little, an educator for Ohio State University Extension based in eastern Ohio.

"Some people jump at the initial offer," Little said. "I've heard of contracts offering as little as $10 an acre up to some offering $2,000 an acre. It's not surprising to see variations early in the process -- we don't have a lot of evidence yet on how well Ohio wells will produce. As we get that evidence, offers may change."

Right now, the stakes are huge. With the possibility of rental payments, sign-up bonuses and royalties, some landowners could see income of hundreds of thousands of dollars or more.

Little recommends that any landowner considering leasing land for drilling should work with an attorney before signing anything. Most landowners are approached with a "standard" oil and gas lease contract that is most likely written in the company's interests. Many of the terms are negotiable and can be revised to be more in the landowner's interests, he said.

"Water issues are always a concern, both for livestock and drinking water," Little said. He suggests that landowners:

  • Incorporate language into a contract to protect both the quality and quantity of the land's water supply.
  • Conduct water testing before drilling starts independent of any water tests the company performs. "Begin documenting now the yield and the quality of your water, so you have a baseline." Sometimes local health departments have records of water yields from private wells; they could be a good resource for landowners. One such lab capable of providing basic screening of oil and gas contaminants is Penn State's Agricultural Analytical Services Lab, which offers a special test for water supplies near gas or oil well-drilling activity. The cost is $65; OSU Extension educators often can supply testing kits, or landowners may contact the lab directly at 814-863-0841 or aaslab@psu.edu.
  • Include in the water protection clause that if the water supply is affected, it will be replaced with water of like quantity and quality at the company's expense. Specify which party (the company or the landowner) will be responsible for overseeing the process, and what types of reparation would be acceptable. "I once saw a huge plastic cistern in front of someone's house that became their new water supply," Little said. "If instead you want a new (water) well drilled, specify that."
  • Understand that the possibility exists that neighboring landowners' water could also be affected. Landowners should make sure the lease agreement puts all liability on the company's shoulders. Landowners within 1,000 feet of any potential drilling activity also should get their water tested: "To use extreme caution, get your water tested if you rely on a private water supply and you're within a mile of such activity," Little said. Property owners in these areas need to know that contamination problems resulting from this type of drilling are exempt from the federal Clean Water Act and Safe Drinking Water Act, so extra precautions would be advantageous.

Financial considerations in a leasing agreement also deserve scrutiny, Little said. Those issues are wide-ranging, including:

  • Unitization of properties involved in a lease. Unitization allows the drilling company to form a single unit with adjoining properties. "With unitization, you might be splitting royalties with many other landowners. The larger the unit, the smaller your percentage of the royalties," Little said. "You may want the agreement to specify a limit to the acreage the company can unitize."
  • Limiting the depth and length of the drilling permitted under the terms of the lease. "Think of your land as an apartment building, with many floors and long hallways," Little said. Today's horizontal drilling techniques allow companies to drill vertically and then branch off horizontally underground, for up to a mile. Landowners may want to limit exploration to a particular formation and retain the rights to other deeper and shallower formations.
  • Many standard contracts permit the company to remove any constituents found in the drilling area. "It might be wise to limit the lease to oil- and gas-related hydrocarbons. Or, you might specify your percentage if the company finds anything else of value and harvests it from your property."
  • A right-to-assign clause. The company may want an unlimited right to assign (or sublet) all or a portion of the lease. "From a landowner perspective, you may want to know who you're doing business with, and, if a portion or all of your lease is sold, you would want a share in the profit," Little said.
  • If the agreement includes free natural gas (up to a certain amount) for the landowner, it should also specify what happens if the landowner doesn't use up the entire allotment. "If you don't use all the cubic feet of gas entitled to you, then it's being sold to someone else. You should probably get most of that value, seven-eighths of it, back." Landowners who agree to a cash amount in lieu of free gas might want to consider adding a clause that the amount will increase over time, along with the value of natural gas.
  • Compensation for being unable to use the property while drilling is taking place. "A $10,000 to $15,000 spud fee would help compensate for loss of ground for potentially up to three years," Little said.
  • Specify where drilling, roadways, structures and electrical wires will be located on your property. "Use an aerial photo to mark the location of roads, wells, compressor stations and/or any structures related to drilling activity," Little said. "You don't want to be surprised later." Specify the type of fencing required to ensure livestock are protected, and how the company must maintain any structure or infrastructure. "The equipment used can leave some pretty big ruts behind, allowing water to pool and affecting drainage," Little said. "It may be wise to state in the lease the condition that hull roads and other structures are to be kept and whose opinion will hold sway in case of disagreement."
  • Rights of way given to the company should be a separate agreement, particularly for pipelines needed for transport of the natural gas. "Specify how deep lines need to be buried, especially if you do tillage on the land."
  • Be certain to include a negotiation or arbitration clause. "At some point, there will likely be some sort of disagreement and you'll need some type of mediation," Little said. "You should decide in advance if you want to take these matters into a court of law or use a simpler method of arbitration."
  • Specify what needs to be done after production ceases. "If you raise cattle, you'll want to specify what kind of forage you want for re-seeding, and what sort of soil tests and nutrient tests you'll want done."

There are many more issues to take into account when signing over rights to property for gas drilling, Little said. He strongly recommends that landowners do their homework and work with a lawyer before signing any type of leasing agreement. "There's a lot to consider besides money," he said.

For more information, visit the website of Ohio's Division of Mineral Resources Management by going to the Department of Natural Resources website, http://www.ohiodnr.gov, and clicking on "Shale Development."

In addition, OSU Extension's "Leasing Farmland for Oil and Gas Production" fact sheet, written by Little in 2008, may be helpful. The document is available free to download on OSU Extension's Ohioline website, http://ohioline.osu.edu/als-fact/.


Writers

Martha Filipic
614-292-9833
filipic.3@cfaes.osu.edu

Sources

Clif Little
740-489-5300 or 740-732-5681
little.16@osu.edu

 

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