Pennsylvania Superior Court: Storage Activities Hold Production Rights Under “Dual Purpose” Lease

February 23, 2015

The explosion of natural gas production in the Appalachian Basin in recent years has led to litigation involving landowners trying to get out of existing oil and gas leases to take advantage of the fierce competition among production companies. Due to the prevalence of natural gas storage in Pennsylvania and Ohio, large tracts of promising production horizons are encumbered by “dual purpose” leases, which allow a lessee to conduct both oil and gas production and natural gas storage, with the election of either activity holding the lease in effect for all purposes.

While there are two federal court decisions analyzing dual purpose leases under Pennsylvania law that have been “on the books” for several years, their contrasting results have led to confusion and uncertainty. See 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); Jacobs v. CNG Transmission Corp., 332 F. Supp. 2d 759 (W.D. Pa. 2004). However, the Pennsylvania Superior Court’s recent decision in Warren v. Equitable Gas Company, LLC, No. 697 WDA 2014 (Pa. Super Ct. Feb. 4, 2015), confirms that a lessee’s use of leased premises for storage, under a “dual purpose” lease, keeps the lease fully in effect for all purposes, including production. Warren is the latest decision construing “dual purpose” oil and gas leases in accordance with their express terms, and refusing to construe the two rights under the lease as severable. The case confirms that the result in Jacobs is an outlier and that the reasoning in Penneco more aptly captures the construction of dual purpose leases in Pennsylvania.

In Warren, 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. 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.” There was no dispute that the property had been used for the storage of natural gas, and the trial court held that this was dispositive, based upon the plain language of the lease; in so ruling, the trial court held the production and storage rights conferred by the dual purpose lease were not severable from each other. See Warren v. Equitable Gas Company, LLC, No. 262–1991 (Comm’n Pleas Greene County Apr. 22, 2014). The plaintiff-landowners appealed this decision to the Superior Court of Pennsylvania, which issued its opinion affirming the trial court decision on February 4, 2015.

The landowners raised several arguments on appeal, generally relying on the proposition that the production of gas was the primary purpose of the lease, whereas the storage of gas was a secondary purpose, and that the lease should be construed with the aim of furthering production. The Superior Court rejected this argument, finding that the trial court “correctly determined that the lease allowed for gas to be stored on the property, as well as produced, such that Equitable’s continued gas storage without gas production activities allowed for the lease’s term to continue.” The Superior Court explained that while a traditional oil and gas lease does not permit the use of the land for the storage of gas absent an express agreement, see Pomposini v. T.W. Phillips Gas and Oil Co., 580 A.2d 776, 778-779 (Pa. Super 1990), the Warren lease did have an express agreement for the storage of gas.

With respect to the landowners’ severance argument, which attempted to divide the lease into two contracts one for storage, one for production – the Superior Court held that the trial court “aptly determined” that the lease was not severable. The Superior Court explained that the trial court’s rationale properly examined the lease’s language (the multiple gas storage provisions), the circumstances surrounding the lease’s execution, and the discernible intent of the original contracting parties, all factors that the Pennsylvania Supreme Court has endorsed. Jacobs v. CNG Transmission Corp., 772 A.2d 445, 452 (Pa. 2001).

Next, the Superior Court held that the lessee did not breach any implied covenant of production by electing to store gas on the property. Looking to the Pennsylvania Supreme Court’s decision in Jacobs once again, the Superior Court explained that no implied covenant to develop exists where the parties have expressly agreed that the landowner shall be compensated even where the lessee does not actively extract the resource. Jacobs, 772 A.2d at 455. The Superior Court held that, because the lease expressly provides for separate rates to be paid for production and for storage, the lease did not obligate the lessee to produce gas and thus, under the plain language of the lease, the lessee’s ongoing storage activities extended the lease term to the present day. Accordingly, because the production and storage rights were not severable, and the land had been used for storage or the protection of storage since its primary term, the lease was held to remain in full force as to both production and storage rights.

This decision is the first time a Pennsylvania state appellate court has construed a “dual purpose” oil and gas lease. While the opinion is designated as non-precedential, and thus cannot be cited in Pennsylvania state court proceedings, it will certainly influence federal courts that are currently grappling with these lease disputes. (There is at least one such case presently awaiting decision, in which the Superior Court’s decision has been prominently cited.) This decision thus should help to bring additional certainty to companies claiming rights through historical “dual purpose” leases, confirming that storage of natural gas pursuant to “dual purpose” oil and gas leases holds a lessee’s production rights.