Is Marcellus Shale a “Mineral,” and Who Owns the Natural Gas in the Shale?

September 20, 2011

Introduction
In Butler v. Charles Powers Estate[1] the Pennsylvania Superior Court recently decided preliminary matters in the case in a way that potentially opens the door for operators who acquired tens of thousands of deeds or leases to be stripped of their rights to drill for shale gas. In Butler, the Superior Court remanded a case to the trial court for further proceedings to determine whether the heirs of a grantor who reserved only “minerals” and “petroleum oils” in a deed also reserved natural gas from the Marcellus shale formation. Although the decision at this point is not definitive and has the potential for more bark than bite, it suggests a possible exception to the longstanding “Dunham Rule” that those in the oil and gas industry have long relied upon in acquiring natural gas rights. For example, if after remand, Pennsylvania courts ultimately rule that the word “mineral” in a deed includes the Marcellus shale formation, and whoever owns the shale formation owns the gas, then the tens of thousands of deeds or leases acquired by producers in Pennsylvania may suddenly have a meaning that was never contemplated or intended. For this reason, the oil and gas industry should keep a keen eye on the proceedings and find ways to participate in the decision-making process to be sure that the industry’s perspective – not just the perspective of the individual parties in the case – is properly heard and understood.

What is the “Dunham Rule”?
Pennsylvania courts interpret deeds and reservations in accordance with the parties’ intent. For over a century, Pennsylvania courts have applied the so-called Dunham Rule. Under the Dunham Rule[2] , Pennsylvania courts have held that a grant or reservation of “minerals” in a deed generally does not mean that the parties intended to grant or reserve the oil or gas. About 80 years later, the Pennsylvania Supreme Court in Highland v. Commonwealth[3] held that, to rebut the Dunham presumption, one must present “clear and convincing” evidence that the parties to the conveyance intended to include natural gas within the word “minerals.”

What happened in Butler?
Butlerinvolved an 1881 deed in which the grantor (Mr. Powers) excepted and reserved to himself “one half of the minerals and Petroleum Oils.” The Butlers (heirs to the grantee) brought an action against the heirs of Mr. Powers to quiet title to the natural gas. The heirs of Mr. Powers, in turn, sought a declaratory judgment that they owned the natural gas by virtue of the reservation of “minerals.”

The Butlers preliminarily objected to the request for declaratory relief and argued that, under the Dunham rule, the heirs of Mr. Powers only reserved the “minerals” and “petroleum oils” such that Mr. Powers did not reserve the natural gas. Applying the Dunham Rule, the trial court agreed with the Butlers and held that (through the chain of title) they now own the natural gas as a matter of law. The Powers heirs appealed.

On appeal, the heirs of Mr. Powers argued that (1) Dunham and Highland only apply to grants or reservations of conventional “wild” gas, not “unconventional” gas from a shale formation; (2) the Marcellus shale is a “mineral”; and (3) producing gas from the Marcellus shale is similar to producing coalbed methane from a vein of coal. The rule for coalbed methane is that whoever owns the coal owns the coalbed methane.[4] Arguing by analogy, the Powers heirs argued that whoever owns the shale owns the shale gas.

What did the Superior Court decide?
The Superior Court remanded the case for further proceedings. The court seemed interested in a number of issues that are peculiar to modern production of gas from “tight” shale formations. For example, the court noted potential similarities between coalbed methane and shale gas, in that they both can contain natural gas that the court characterized as not “ferae naturae,” or free flowing “wild” gas. The Superior Court further analogized shale gas to coalbed methane, noting that the development of gas from both coal and shale requires fracturing to release the gas. Ultimately, the Superior Court remanded the case for further proceedings to understand: (1) whether the Marcellus shale is a “mineral”; (2) whether gas from the Marcellus shale constitutes the type of natural gas contemplated in Dunham and Highland; and (3) whether Marcellus shale is similar to coal to the extent that whoever owns the shale, owns the shale gas.

What are the concerns?
Although the court remanded the case for further proceedings and made no definitive pronouncements of law, the Superior Court’s decision raises a number of significant concerns:

Parties’ Intent. The issue in any case involving deed interpretation is the intent of the parties. The deed in Butler is 130 year old. It seems very likely that the original parties could not have anticipated the ability to develop natural gas from a shale formation. The court, however, seems to be inviting a reading of the intent of the parties to a century-old deed through a modern lens that could not reflect their knowledge and intent at the time of the conveyance.

Definition of “minerals.” Although there is no precise definition of the term in the case law, the courts have held that the word “mineral” as used in conveyances means something that is mined and sold (e.g., coal).[5] The Marcellus shale is a gas-bearing rock formation buried thousands of feet beneath the surface of the earth. In this sense, such shale rock is not typically thought of as something that is (or even can be) mined and sold and seems to fall outside of the meaning of “minerals” as parties ordinarily use that word in deeds and other conveyances.

The wild-gas vs. trapped-gas distinction. To some extent, all natural gas is restricted depending upon subsurface pressures and the permeability of the rock or other formations (e.g., tight sands) in which the gas is contained. The movement (flow) of the gas is governed by the relative characteristics of the rock formations in which it is contained. Gas within shale formations is not really different. When the shale is penetrated (whether by vertical or horizontal wells), gas is released and at that point flows freely, other formations may have higher porosity, permeability and transmissivity, but these are geologic characteristics that involve a matter of degree. If shale gas is to be treated differently than “wild” gas for purposes of determining the parties’ intent in a deed, how will the courts determine whether gas is “wild” enough to qualify for the Dunham presumption? It seems the Superior court is inviting a rule that will inevitably lead to much litigation involving experts to determine where to draw the line within a continuum of geologic parameters that govern gas movement when the focus should be on whether the parties intended to convey (or reserve) natural gas rights regardless of the source rock or how freely the gas flows.

Analogy to coalbed methane. The rule for coalbed methane as it developed in Pennsylvania is a unique one. Historically, coal operators had to maintain control over the methane gas trapped in coal beds to avoid dangerous conditions while mining the coal. In addition, the methane historically had no commercial value. For these reasons, courts held that when parties conveyed “gas,” by deed or lease, they could not have intended to convey coalbed methane. The court seems to have overlooked the history and policy reasons underlying the coalbed methane rule and the dissimilarities between coalbed methane and development of shale gas.

What should the industry do?
The oil and gas industry should attempt to get involved in the case so that its interests are properly heard and understood. If, for example, the Pennsylvania Supreme Court exercises its discretion to accept any appeal from the Butlers, interested parties will have the opportunity to file amicus briefs during the appeal. If the case proceeds on remand, development of the record will be particularly important. The issues identified by the Superior Court will be developed from the perspective of the individual parties to the case and not from the perspective of the industry. It seems clear that the courts may benefit from the perspective of the oil and gas industry in cases that call for the application of well settled rules that govern the ownership of natural gas rights.

Notes:

[1] ---A.3d---, 2011 WL 3906897 (Pa. Super. Ct. Sep. 7, 2011).

[2] 101 Pa. 36 (Pa. 1882).

[3] 161 A.2d 390 (Pa. 1960), cert. denied, 364 U.S. 901 (1960).

[4] U.S. Steel Corp. v. Hoge, 468 A.2d 1380 (Pa. 1983).

[5] Silver v. Bush, 62 A. 832, 833 (Pa. 1906).

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