Marcellus Shale Update – 3.10.2018

There are two huge stories playing out in the Marcellus region right now.  Each, however, will take a little background to understand.

Story Number 1 involves the continued problems for the Mariner East pipelines.  On Wednesday the Pennsylvania Public Utility Commission shut down the Mariner East 1 pipeline after sinkholes developed in West Whiteland Township, Chester County.  That morning the PUC Board of Investigation and Enforcement petitioned the PUC Chair for an immediate halt of the shipping of highly volatile fuels through the Mariner East 1 pipeline.  In the afternoon, facing immense public pressure, the PUC Chair issued an emergency order stopping “the continued flow of hazardous liquids through the ME1 pipeline without the proper steps to ensure the integrity of the pipelines (which) could have catastrophic results impacting the public.”

In its report, the PUC Board of Investigation and Enforcement stated that without proper review, and in light of three sinkholes developing in the Mariner East 1 pipeline area right near the site of Mariner East 2 construction, the pipeline is “potentially hazardous to the life, property and/or the environment.”

On Thursday, Democratic Pennsylvania State Senator Andy Dinniman, a constant critic of the energy industry, asked that the Mariner East 2 pipeline, which has been suspended numerous times, be shut down.  Yesterday, Dinniman’s call was joined by Republican State Senator Duane Milne of Chester County (who represents my district).  Milne issued a public statement in which he said he “is outraged that further work on this route even can be contemplated, as significant sinkholes continue to erupt along the pipeline path.”

For background, Mariner East 1 was built in the 1930s to take oil products from Marcus Hook, on the Delaware River south of Philadelphia, west across the rest of the state.  It has a capacity of carrying the equivalent of approximately 70,000 barrels of gas (liquid propane and ethane) a day.  Following the shale revolution, Sunoco Logistics reversed the flow of the pipeline to allow for gas to flow from the Marcellus region of Southwestern Pennsylvania to Marcus Hook, where it can be sent to other domestic customers or exported overseas.

Mariner East 2 is a much bigger pipe with a capacity of approximately 250,000 barrels/day and is being built mostly in the same right of way parallel to Mariner East 1.  The fear is that the drilling of Mariner East 2 may have disturbed the ground, causing the sinkholes.  This is made more possible by the fact that the geology of the region includes large amounts of karst, which sits on old limestone formations and is susceptible to sinkholes.

In times like these, the affected pipeline company needs to rely on its reputation, good will and common sense to work out a proper plan with the PUC and the State as a whole.  Unfortunately, the way Sunoco Logistics has gone about this process from Day 1 indicates that all three are in short supply.  If the State believes a complete reboot of this project is not needed, let’s hope that at least a reboot of Sunoco Logistics’ modus operandi is and has taken place.

Story Number 2 comes from West Virginia, where last week the West Virginia Legislature voted overwhelmingly to prevent oil and gas producers from deducting post-production costs that have the effect of reducing the royalty amount received by a landowner below the statutory 12.5%.  To get an appreciation of public sentiment on this, the vote in the West Virginia Senate was 34-0 and in the House it was 96-2.  The bill now sits on Governor Jim Justice’s desk for signature.  Justice is a Republican but it’s hard to see how he can veto a bill that passed with such overwhelming majorities in both chambers.

This West Virginia bill comes following a decision in the West Virginia Supreme Court in the case of Leggett v. EQT Production, which was published in May 2017.  In Leggett, the Court stunningly reversed its own prior ruling by agreeing  in 2017 that EQT had acted properly in deducting post-production costs incurred by the company after the gas hit the wellhead and before it could be sold.  The action by the legislature both places West Virginia back in the “marketable product” realm of states but also is a huge repudiation of the State’s Supreme Court.

As background, nearly all energy states have laws requiring that a landowner be compensated for any oil or gas taken from his/her property in an amount not less than 12.5% of the value received for the oil or gas.  That is only the starting point, however, for the energy industry says it should have the right to deduct from that amount the storage, transportation, refining and other costs incurred by the company before the oil or gas can be sold.  Most states, like Pennsylvania, allow for this post-production deduction of any costs incurred after the gas hits the wellhead, and therefore are called “At the Wellhead” states.  A few, like West Virginia, would not allow any deductions until the oil or gas has been turned into a marketable product, and are called “Marketable Product” states.  This of course leads to a definitional problem of what constitutes a “Marketable Product” and how is it determined?

There is logic to the industry’s position on the deduction of costs post capture “at the wellhead”, but some energy companies (not all) have abused the doctrine to deduct massive amounts of questionable costs before turning any money over to the landowners in royalties.  In certain truly egregious cases in Pennsylvania, landowners actually found themselves not receiving royalty checks but bills from companies like Chesapeake Energy for their share of costs incurred by the company in transporting, storing etc. gas taken from their land!  Not surprisingly, this resulted in a class action lawsuit which has been settled pending an agreement with Pennsylvania Attorney General Josh Shapiro on an unfair trade practices suit.

In the end, Story 1 and Story 2 have one thing in common.  Here in the Northeast, the energy industry is not the 800 pound gorilla dominating each State’s economy.  States like Pennsylvania and West Virginia have held out the welcome sign for the industry.  It’s up to the industry to keep that sign standing.

Questions? Let Dan know.

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