Federal Court Holds that Fracking is not an “Ordinary Production Method” in Ohio; Liquid Hydrocarbons Produced are Gas, not Oil
By: Steven R. R. Anderson
In the recently-decided case Madzia v. SWN Prod. (Ohio) LLC[1], the U.S. District Court for the Southern District of Ohio was asked to determine whether SWN Production (Ohio) LLC (“SWN”) had properly paid oil royalties under the terms of certain oil and gas leases.
The leases at issues treated oil and gas differently for purposes of calculating royalties. The provision for oil stated that royalties were to be paid on the “oil produced”, while the provision for gas stated that royalties were to be paid on “the proceeds realized at the well from the sale of all gas marketed from the premises”. The plaintiffs alleged that SWN had instead been paying oil royalties on the amount of oil “marketed from the premises” (as it did with gas), rather than on the amount “produced”, as required. SWN argued that it had paid oil royalties properly.
In a surprising twist, however, the Court found that SWN was not responsible for paying any oil royalties at all. It noted that the Ohio Revised Code defines “oil” as “crude petroleum oil and all other hydrocarbons, regardless of gravity, that are produced in liquid form by ordinary production methods, but does not include hydrocarbons that were originally in a gaseous phase in the reservoir.”[2] It then held that
“[t]he Ohio Revised Code does not define ‘ordinary production methods’ but it seems clear to this Court that such would not include laterally drilled, hydraulically fractured ‘fracked’ wells. Fracked wells may have become common in certain parts of Ohio, but they are not in any sense ‘ordinary.’ Instead, they are highly controversial, strictly regulated, and banned in some states because of concern over their impact on the environment.”[3]
As a result, “[i]nsomuch as the liquid hydrocarbons produced by the Madzia Wells were not produced by ‘ordinary production methods’ they are not oil.”[4] All royalties for hydrocarbons produced from the Madzia Wells, therefore, should have been calculated pursuant to the gas royalty provision.
This holding raises several questions.
First, did Ohio’s legislature really intend that liquid hydrocarbons produced from hydraulically-fractured wells be classified as “gas” rather than “oil”?[5] If so, certain liquid hydrocarbons would be considered oil if produced from one type of well (vertical or conventional), but gas if produced from another. Surely the characteristics of the product itself, and not the style of well it comes from, should determine whether it is gas or oil?
Second, given the prevalence of horizontal drilling in Ohio over the past decade, what more must happen for hydraulic fracturing to become an “ordinary production method”?
Third, was the Court correct to look to the Ohio Revised Code to define the term “oil” in the leases? Ohio’s Supreme Court has held that “common words appearing in a written instrument are to be given their plain and ordinary meaning unless manifest absurdity results or unless some other meaning is clearly intended from the face or overall contents of the instrument.”[6] Specific to the case at hand, the Supreme Court has held that it
“does not find the terms ‘oil’ and ‘gas’ ambiguous. The terms are descriptive in nature and have traditionally represented a specific class of products that may be transported. The popular meaning of the word ‘oil’ appeared in Webster's New International Dictionary (1 Ed. 1927) as ‘* * * [a]ny of a large class of unctuous combustible substances which are liquid, or at least easily liquefiable on warming and soluble in ether, but not in water.’ The term ‘gas’ was defined as ‘* * * any gas or gaseous mixture, with the exception of atmospheric air; specif.: * * * b. Any combustible gaseous mixture used for illuminating or as a fuel. * * *’”[7]
Note that this definition of “oil” (its “popular meaning”, according to the Supreme Court) does not hinge upon the method by which the hydrocarbons are produced, or the physical state (liquid or gaseous) of hydrocarbons in the reservoir, pre-production. Instead, what matters in classifying a hydrocarbon as “oil” or “gas” is its physical state, full stop. (Presumably, this means the physical state under standard conditions.) The result is that the same substance could be “oil” under the Supreme Court’s definition in Alexander, but “gas” according to the Revised Code. Which set of definitions should apply to a landowner’s oil and gas lease?
At least one court believes that the Revised Code should control.
[1] S.D.Ohio No. 2:20-CV-2608, 2022 U.S. Dist. LEXIS 166502 (Sep. 14, 2022).
[2] O.R.C. § 1509.01(B), emphasis added.
[3] Madzia, S.D.Ohio No. 2:20-CV-2608, 2022 U.S. Dist. LEXIS 166502, at p. 15.
[4] Id. (Or, as the Court later reiterated, “the liquid hydrocarbons produced by the Madzia Wells are not oil.” Id. at p. 16.)
[5] O.R.C. § 1509.01(C) specifies that “gas” includes “all natural gas and all other fluid hydrocarbons that are not oil”.
[6] Alexander v. Buckeye Pipeline Co., 53 Ohio St.2d 241, 374 N.E.2d 146, 150 (1978), internal citations omitted.
[7] Id. at 151.