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Oil and Gas Alert: The shale revolution

Over the past several months, it has become increasingly clear that Ohio will soon be a significant player in the production of U.S. oil and other hydrocarbons. Lawyers from our Energy Group’s oil and gas team have been advising public utilities and the oil and gas industry for decades. Today, we are helping our clients navigate the complex issues and opportunities in this rapidly changing energy environment.

The shale revolution is just the latest development in the Ohio oil and gas industry, which dates back to the 19th century. In fact, more than 200,000 wells have been drilled.

Marcellus shale

Approximately five years ago, the Marcellus shale formation in Pennsylvania, New York, West Virginia, and Ohio began to receive a significant amount of attention from the oil and gas industry. Although the industry believed that the Marcellus formation contained vast amounts of natural gas, retrieving the gas, which was locked away in the tight shale rock thousands of feet below the ground, presented a problem. With the advent of improved hydraulic fracturing (fracking) technology and the development of technology to drill horizontally through shale rock formations, the production of natural gas from Marcellus shale became economically feasible. In fact, an entire new industry has settled into Western Pennsylvania to extract the vast amounts of natural gas in the Marcellus formation. Landowners have been paid hundreds of thousands of dollars in bonus payments just to sign leases and many are now receiving royalty payments far in excess of any amount they could have imagined. Communities that once had high levels of unemployment now have a shortage of workers. At the same time, however, questions are being raised about the safety of fracking, the dramatic disruptions in rural life that have been caused by the drilling boom, and the earthquakes that may be associated with certain injection wells used for the deposit of the waste products from the new drilling technology.

Utica shale

As the Marcellus drilling boom continued to expand in Pennsylvania, residents of Ohio’s counties that border the Keystone State looked on with a mixture of desire and dread as the drilling boom moved closer. Eighteen months ago, it looked as if the revolution was about to arrive. Landmen began appearing in rural communities and small towns in Southeastern Ohio to negotiate oil and gas leases with landowners on behalf of companies such as the Chesapeake Energy Corporation. As it turned out, however, geologists determined that the Marcellus formation thins rapidly as it enters the state and generally is not as desirable as in the Pennsylvania counties. Geologists also discovered, however, that the Utica shale formation, which lies below the Marcellus formation in the State of Ohio, might prove to be an even more significant source of valuable hydrocarbons than the Marcellus formation.

What distinguishes the Utica formation is the presence of oil and so-called “wet gases,” such as propane, ethane and butane. Because of the vast amount of natural gas being produced from the Marcellus shale and similar shale formations in Texas and the Dakotas, the price of natural gas has fallen to below $2.50 per mcf, less than half of what is was in 2010. Oil, on the other hand, remains over $100 per barrel and the wet gases are significantly more valuable in today’s market than the dry gas produced out of the Marcellus formation.

Permit activity increases

Permits to drill in the Utica formation are now being issued at the rate of almost 40 permits per month in the State of Ohio. A year ago it was at the rate of three per month. To date, permits have been issued in 18 Ohio counties. The following counties are among those with the most activity:

County      Number of permits
Carroll      62 (6 producing)
Columbiana      27
Jefferson      20
Harrison      9
Monroe      8
Guernsey      6
Noble      6

The activity is beginning to move into Northeastern Ohio:

County           Number of permits
Stark           10
Mahoning           9
Portage           6
Geauga           1
Medina           1

Carroll County

To understand the impact of this new gold rush — or gathering storm, depending upon your point of view — examine Carroll County, the current center of drilling activity in the State of Ohio. Carroll County landowners are receiving bonus payments of more than $5,000 per acre to sign an oil and gas lease. In contrast to traditional royalty payments in the amount of one-eighth of the oil or gas produced from the well, landowners are receiving royalties as high as 20 percent of the oil and gas produced. Banks in the county are routinely receiving checks payable to their large landowner customers in excess of $1 million. Employment has skyrocketed in communities that previously suffered from high unemployment and the major drilling company in the county, Chesapeake Energy Corporation, donates significant sums to local schools and charities. On the downside, residents are just beginning to face the intense industrial activity that characterizes deep well oil and gas drilling in shale formations. The pads upon which the wells are drilled are generally three to five acres in size and each pad may host as many as eight or more wells, with each well taking approximately a month to drill. Drillers are likely to take several years or even decades to complete the full regiment of planned wells on any one pad. With improvements in technology, drillers will likely frack wells more than once. In other words, these are long-term, heavy impact industrial activities that will have an impact on the landowner’s property and their communities for the foreseeable future.

Winners and losers

In Carroll County, there can be strong distinctions between the winners and losers. Anyone with a significant tract of land is likely to be substantially richer, and there are many more jobs available at good hourly rates. However, many local companies are now competing with oil and gas companies for employees. For example, wages paid by oil and gas companies can be well in excess of wages paid by local manufacturing companies. The result is that local companies that do not have a direct link to the oil and gas industry may be in the difficult position of not having a large enough labor pool to keep their businesses running. Schools and local governments will be tested as the school age population explodes along with the need for government services. There are a host of issues, opportunities and risks created by this hydrocarbon revolution.

Northeast Ohio

For the residents of Northeastern Ohio, this revolution is in the early stages. Prior to the new year, Chesapeake filed more than 1,000 oil and gas leases in a single day in Stark County. In Geauga County, Chesapeake has drilled a vertical well in Parkman Township and is expected to start drilling horizontally and fracking the well in the next few months. Landmen have been seeking leases in almost every county in the area for oil and gas.

New developments

Recently, BP acquired the rights to enter into leases to drill on 84,000 acres in Trumbull County and Shell announced last month that it intends to construct a $2 billion ethane “cracker” plant just inside Pennsylvania on the Ohio River to turn the “wet gas” ethane into ethelyne, which is a key component in the production of plastics. These and other similar announcements over the past several weeks have made it clear that the shale revolution is likely to have as large an impact on Ohio manufacturing as it does on Ohio landowners. Geologists are learning more about what areas of the state may be most productive for oil and gas. The Ohio Geological Survey recently issued this map (click here to view), which identifies the better areas for oil and gas production. The map is subject to change as more information from testing is added to the mix.

As the revolution unfolds, we will report on environmental issues, impacts on local government and industry, regulatory matters, and ways that landowners can benefit from a lease while protecting their property, among other issues. Our energy team has been active in the oil and gas industry for more than 30 years. We continue to help our clients navigate the issues and opportunities in our rapidly changing energy environment.

For more information, please contact:

Jeffrey R. Huntsberger
216.348.5405
jhuntsberger@mcdonaldhopkins.com

Adam N. Saurwein
216.348.5718
asaurwein@mcdonaldhopkins.com

Click here for more information regarding oil and gas leasing.

Carl J. Grassi, President
600 Superior Avenue, East, Suite 2100, Cleveland, Ohio 44114
Chicago
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Fax: 312.280.8232
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Fax: 216.348.5474
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Fax: 614.458.0028
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Fax: 248.646.5075
Miami
1.305.704.3990
Fax: 1.305.704.3999
West Palm Beach
561.472.2121
Fax: 561.472.2122
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© 2012 McDonald Hopkins LLC All Rights Reserved. This Alert is designed to provide current information for our clients, friends and their advisors regarding important legal developments. The foregoing discussion is general information rather than specific legal advice. Because it is necessary to apply legal principles to specific facts, always consult your legal advisor before using this discussion as a basis for a specific action.