Pennsylvania Trial Court Confirms Non-Severable Nature of “Dual-Purpose” Oil and Gas Production and Storage Leases

April 30, 2014

With the boom in shale gas production in the Appalachian Basin, there has been an accompanying boom in lease litigation, as landowners whose oil and gas rights are encumbered by existing leases have tried to get out of leases that they now perceive (with the benefit of hindsight) to be unfavorable. One such type of lease – and lease litigation – involves so–called “dual purpose” leases, which allow the lessee to conduct both oil and gas production and natural gas storage, and which provide that either activity will hold the lease in effect for all purposes. Because of the prevalence of natural gas storage in Southwestern Pennsylvania and Eastern Ohio (an activity necessary to ensure sufficient gas supplies during the winter months), large tracts of promising Marcellus and Utica Shale production horizons are encumbered by such leases. While some courts have voiced sympathy for landowners whose predecessors–in–title have deprived them of the ability to “cash in” on the shale gas bonanza, almost all courts have ultimately held that the leases must be construed as written. A recent decision from a Pennsylvania trial court is emblematic of this trend, confirming that a lessee’s use of the leased premises for storage, under a “dual purpose” lease, keeps the lease fully in effect for all purposes, including production.

In Warren v. Equitable Gas Company, LLC, No. 262–1991 (Apr. 22, 2014), Judge William Nalitz of the Court of Common Pleas of Greene County recently decided that the lessee’s use of the leased premises for storage, under the “dual purpose” oil and gas lease at issue, held production rights under the lease. In so ruling, the court held that the lease’s storage and production rights were not severable, and that the lease could not be construed as two separate contracts (one for storage, and one for production). Warren is the latest in a string of recent decisions construing “dual purpose” oil and gas leases in accordance with their express terms, and refusing to construe the habendum clause as severable.

The decision’s opening remarks cautioned that “[p]laintiffs are among those unfortunate persons whose interests in oil and gas lands are subject to a storage lease,” a telling preview of what would follow.

The plaintiff–landowners brought their initial claims in 1991, and after an extended period of procedural dormancy, counsel filed an amended complaint in June 2011, alleging that the lease expired because the lessee took no steps to produce native gas from the property since the lease’s execution in 1966. There was no dispute that the property had been used for the storage of natural gas. The parties eventually filed cross motions for summary judgment.

The habendum clause stated that the lease would extend beyond its 10–year primary term “so long as said land is operated for the exploration or production of gas or oil … or as long as said land is used for the storage of gas or the protection of gas storage on lands in the general vicinity of said land.” The plaintiffs argued that this language required a commencement of production operations during the primary term in order to extend the lease into its secondary term, but the court disagreed. The plaintiffs also contended that the introductory clause, which mentioned only production as the lease purpose, elevated the importance of production in the contracting parties’ eyes. The court, again, refused to adopt the plaintiffs’ theory.

In so ruling, the court – consistent with all other Pennsylvania cases to consider the issue – held that the lease was not severable, rejecting plaintiffs’ alternative argument that (even if the lease was “dual purpose”) the storage and production aspects of the lease were severable from each other. In effect, the court held that the lease could not be construed as a lease for production and a separate lease for storage.

This case is also evidence that Jacobs v. CNG Transmission Corp., 332 F. Supp. 2d 759 (W.D. Pa. 2004), is increasingly viewed by courts as an outlier. The 2004 decision in Jacobs, which involved similar circumstances, agreed that a “dual purpose” lease was not severable, but went on (confusingly) to hold that the lessee had lost or abandoned its production rights by failing to exercise them. The court in Warren refused to adopt Jacobs’ holding on the “abandonment” issue. Rather, the Warren court looked to the controlling intent of the parties and the plain language of the lease, which referenced storage several times throughout, indicating that either storage or production use were intended to bind the other. (In so holding, the court in Warren – without citing the case – reached the same conclusion as the court in Penneco Pipeline Corp. v. Dominion Transmission, Inc., No. 05–49, 2007 WL 1847391, at *13 (W.D. Pa. June 25, 2007), aff’d, 300 Fed. Appx. 186 (3d Cir. 2008)).

It is unclear whether the landowners in Warren plan to appeal to the Pennsylvania Superior Court. Any such appeal would present considerable obstacles: while Pennsylvania’s appellate courts have not construed “dual purpose” leases, Pennsylvania Supreme Court and Superior Court precedents have consistently made clear that oil and gas leases are to be construed according to their plain terms. Further, the emerging groundswell of precedent, in Pennsylvania and elsewhere, is consistent with Judge Nalitz’s ruling.

This decision should bring additional certainty to those companies claiming rights through historical “dual purpose” leases, confirming that storage of natural gas pursuant to these “dual purpose” oil and gas leases holds the lessee’s production rights.