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The Impact of Crude Oil and Natural Gas Market Trends on Litigation

By Bob Broxson, Sonya Kwon, and Julie Carey – November 20, 2015


The continuation of the oil price slide along with the softening global market leave the industry on shaky ground. The market is flush with crude oil, in large part because of the U.S. shale revolution, with additional supply on the horizon once Iranian sanctions are lifted. Tepid demand and an uncertain outlook due to the looming economic downturn in Asia are also negatively affecting the market. The net effect for U.S. producers in unconventional oil plays is mounting financial pressures. Some producers are better positioned than others to endure because of hedging positions, strong balance sheets, and other economic factors. However, sustained lower prices around $40 will continue to have a negative impact on the entire sector.


The environment of low crude oil prices and other dynamics in the unconventional oil and gas plays have increased litigation in this industry. Some of the areas with heightened disputes are royalties, land and lease rights, labor and employment disputes, and regulation of hydraulic fracturing activities.


Navigant attempted to identify all cases filed in U.S. federal and state courts relating to unconventional oil and gas litigation. While Navigant’s list may not be exhaustive, we believe the case data present a representative picture of the nature and volume of unconventional oil and gas industry litigation filed during the first half of 2015. Navigant used Courthouse News, Law360, news articles, and other court reporting services to identify the details of relevant cases. Navigant then reviewed and evaluated these cases for inclusion in our report. For the purposes of this study, Navigant did not include cases filed in arbitrations, non-litigation agency actions, or administrative proceedings. Investigations and decisions by the Federal Energy Regulatory Commission are also not reflected in these findings.


Recent Trends
Over the past year, litigation levels for unconventional oil and gas case filings have increased dramatically. The number of new case filings across court venue, nature of suit, and geography more than tripled from 2013 to over 900 identified matters within a one-year time frame (from the second half of 2014 through the first half of 2015).



Federal case filing trends for the report time frame saw a slight increase (from 83 in the second half of 2014 to 115 in the first half of 2015). However, state court filings were the primary driver behind new litigation filings (from 246 in the second half of 2014 H2 to 472 in first half of 2015). State court filings made up 78 percent of all unconventional oil and gas litigation identified in during the time frame from the second half of 2014 through the first half of 2015. Royalty disputes and breach of contract matters were the most common type of unconventional oil and gas litigation identified during that period, followed by land and lease rights.  


Unconventional oil and gas cases filed in state courts in the first half of 2015 increased 129 percent from the first half of 2014, led in large part by new matters filed in Texas and West Virginia. Geographically, Texas, West Virginia, and Pennsylvania saw increases in case filings between the first half of 2015 and the latter half of 2014, while Oklahoma and Louisiana saw declines. Of the states with the most unconventional oil and gas litigation, only Oklahoma and Louisiana saw a decrease in cases filed between the first and second half of the time frame.


Texas continues to lead the pack with the largest number of unconventional oil and gas cases in both the latter half of 2014 and the first half of 2015. The number of cases identified during this one-year period was more than triple the number of matters identified during the previous time frame. The number of cases filed in Texas was 173 percent higher in the second half of the year than in the first half, driven in large part by multiple royalty disputes brought against Chesapeake Energy Corporation.


Royalties
Royalty matters, a longtime holder of one of the top slots in total case counts, far surpassed all other types of litigation during the first half of 2015 with a total count of 330 cases, 290 of which were filed in Texas courts.


The high number of royalty cases in Texas is primarily driven by a large swath of cases filed against Chesapeake Energy Corporation by the McDonald Law Firm. Chesapeake is in the midst of numerous royalty disputes involving its Barnett Shale wells. Within the past year, multiple suits have been filed that accuse the company of improperly charging royalty owners for production costs associated with drilling and using affiliated companies to buy gas at the wellheads to secure lower prices on which royalties are paid. Over 200 individual cases have been filed by the McDonald Firm, a firm that solicits individual clients via RoyaltyRipoff.com.


In addition, there are over 20 pending royalty suits before the Texas Supreme Court that were recently consolidated into a multidistrict litigation (MDL). See Jess Davis, “Chesapeake Faces Opposition in Barnett Shale Royalty MDL,” Law360, Mar. 5, 2015. Concurrently with the MDL, Chesapeake is also fighting the recent 5–4 ruling by the Texas Supreme Court that Chesapeake cannot require a group of Barnett Shale royalty owners to pay postproduction costs on gas produced from wells on their land. In its motion for rehearing, Chesapeake argued that the court’s decision wrongly upset long-standing Texas precedent, which sets uniform standards for interpreting royalty clauses and valuing royalties, and that the majority’s holding allows royalty owners to pick between royalties they like best—one with lower value, which they can take in kind and which “might” or “might not” bear postproduction costs, or the more valuable royalty, which is paid in cash and bears no postproduction costs. The court is currently considering the motion. See Jess Davis, “Chesapeake, Others Say Texas Justices Botched Royalty Case,” Law360, Aug. 6, 2015.


Despite the high number of royalty cases in Texas, Colorado is currently drawing considerable attention. Colorado saw marked increases in total royalty case filings with a total of 15 cases filed in the past year, compared with a single case filed in the first half of 2014. In that state, lawsuits over a ban on hydraulic fracturing in Longmont and a five-year moratorium in Fort Collins may eventually end up in front of the state supreme court. In late August, the Colorado Court of Appeals asked to bow out of both lawsuits, stating that the issues will end up before the supreme court eventually. As of publication, the supreme court has yet to say if it will take either case.


Attempts to pass legislation to protect the rights of mineral owners in Colorado have failed to make it out of the Democratic-controlled House. Senate Bill 93 offered a means for mineral-rights owners to claim compensation from a local government if that government reduced the value of the owners’ royalties by at least 60 percent. The bill passed through the Republican-controlled Senate but was later rejected in the Democratic-controlled House State, Veterans, and Military Affairs Committee.


House Bill 1119, which would also hold a local government liable for the value of lost royalties if that government enacted laws that limited natural gas and oil extraction, failed to make it past the Democratic-controlled House as well.


Land and Lease Rights
Land and lease rights experienced the sharpest decline across all case matters (from 103 in the second half of 2014 to 64 in the first half of 2015). However, in comparison with the prior yearly time frame, land and lease rights rose 26 percent. Oklahoma and Texas led the pack with a combined 57 percent of the total land and lease rights cases filed during the second half of 2014 and the first half of 2015, accounting for only 34 percent in the prior year.


In February 2015, American Natural Resources (ANR) alleged that a Chevron unit dragged its feet over returning the drilling right leases to acreage spread across Armstrong and Cambria Counties in western Pennsylvania. The original leases contained a “continuous drilling” provision, which stated that the lease holders had to drill at least one well a year to retain the leases. When no drilling occurred between May 2010 and May 2011, the leases were supposed to revert to ANR. In early 2012, ANR lined up a buyer for the leases, but Chevron didn’t return the leases until late 2012, during which time ANR lost out on the $3.2 million sale. See Michael Macagnone, “Chevron Unit Hit with $3M Suite Over Pa. Shale Leases,” Law360, Feb. 19, 2015.The case was settled with voluntary dismissal in early June 2015.


There appear to be a raft of cases similar to this one appearing in the courts. During periods of tremendous uncertainty and ever-changing market dynamics, the wide-ranging outlooks and expectations for the market provide less than perfect information in decision making, increasing the challenges of business performance and operations.


Labor and Employment
The oil and gas industry has experienced marked growth in employment to match its increased production. As employment growth continues, there is an increased risk of labor and employment litigation, especially suits claiming Fair Labor Standards Act (FLSA) violations regarding wages and hours for day-rate workers, and an increased risk of misclassifying white-collar employees for overtime exemptions.


Although other types of cases, such as discrimination suits, were much more prevalent in the past, the FLSA now dominates the litigation landscape in employment filings. There does not appear to be a direct statistical relationship between crude oil (Brent) prices and litigation trends. However, there have been two major price declines over the past 10 years, and after each price decline, there was an uptick in employment litigation or wage and hour investigations by the Department of Labor (DOL). Crude oil prices reached a high of $132.72 in 2008 and then fell to $39.95 (a 70 percent decline) by the next year. Total actions (DOL investigations and new case filings) increased the following year and continued to have peaks as prices steadily increased. In 2014, crude oil again faced a huge decline, from a high of $111.80 to a low of $47.46 (a 58 percent decline). Case filings of labor and employment cases increased dramatically into 2015 by 152 percent over the long-term trend of filings. (Note: DOL FLSA investigation data have not been published for 2015. There were no DOL investigations in oil and gas in 2014.)


The FLSA upward trend is significant. In 2008, only 10 percent of employment-related cases involved FLSA claims. By 2015, the percentage of FLSA employment-related litigation jumped to nearly 50 percent. Similarly, the number of FLSA class action cases had remained in the single digits since 2012, but the latter half of 2014 saw 11 cases filed, an 83 percent increase over the first half of 2014, and 13 cases were filed in the first half of 2015. The majority of those cases were filed in Pennsylvania, Texas, and New Mexico.


Figure 2



The first FLSA-related trend relates to day-rate workers. Employees with day-rate employment contracts earn a set base rate per day, regardless of time worked. Oil and gas employment has been steady over the past five years, but average weekly hours have been increasing. This means that day-rate employees are working longer hours, yet earning a lower average hourly wage—opening the door to litigation risk.


The second risk trend relates to overtime exemptions for white-collar workers. Under federal law, employers are allowed to classify an individual as being either exempt from overtime or eligible for overtime, based on a duties test and the individual’s annualized salary. If an employee is misclassified, the employer may be at risk for a lawsuit.


One overtime exemption case involves Weatherford International PLC, which was hit with a proposed collective action in Pennsylvania federal court in late May. The suit alleges that the company misclassified its service supervisors who worked on hydraulic fracturing sites across Ohio, Pennsylvania, and West Virginia. According to the allegations, at least 30 service supervisors working out of the Weatherford offices were misclassified as exempt when in fact they performed the duties that would be more adequately classified as nonexempt. See Jacob Batchelor, “Weatherford Hit with FLSA Suit by Fracking Supervisors” Law360, May 27, 2015. This and other similar cases present a significant risk to employers in the oil and gas industry. Overtime wages and penalties can add up quickly for these higher paid supervisors.


These types of cases are likely to become much more common in the oil and gas industries, in part because the federal government is considering changing the exemption rules to make it more difficult to classify employees as exempt from overtime and raising the threshold for the salary test. In addition, the DOL has stated that the oil and gas industry is “ripe for noncompliance” and that it will “continue reaching out to industry employers, stakeholders, and employees” to educate them about their rights.


Regulation
Regulation rights among local, state, and federal jurisdictions remain at issue in the courts. Multiple states are joining forces to block a final rule, released by U.S. Department of Interior, regulating hydraulic fracturing on public lands. The State of Wyoming, one of the first to file, claims that the finalized rule exceeds the agency’s authority and usurps existing state regulations. Specifically, the state contends that the rule exceeds the Department of Interior’s jurisdiction under the Federal Land Policy and Management Act and the Mineral Leasing Act. Since the case was filed in late March, North Dakota, Colorado, and Utah have joined forces to block the rule. See Jacob Batchelor, “Utah Joins Crowded Field in BLM Fracking Rule Suits,” Law360, June 17, 2015.


In Texas and California, legislators have greatly expanded the states’ regulation rights over their respective hydraulic fracturing industry; these laws also have the potential to instigate greater legal battles in the near future.


In May 2015, Texas Governor Greg Abbott signed House Bill 40, effectively blocking local hydraulic fracturing bans. The controversial bill preempts cities from regulating oil and gas operations and limits their ability to enforce setback rules. Rep. Sylvester Turner (D-Houston) has called HB 40 “a gold mine for lawyers.” The broadly written statute leaves plenty of room for interpretation and will likely end up being a point of major legal contention between cities looking to defend their local rules and businesses eager for more freedom to operate.


Governments at all levels are fighting to maintain their rights and authorities to deal with issues, like hydraulic fracturing, that impact their constituents. With the passage of HB 40, Texas has taken the lead in dealing with cross-governmental authority. This action stands in direct contrast to the actions in New York, for example, where hydraulic fracturing will not be allowed in the state.


In California, Senate Bill 4 is considered to be one of the toughest hydraulic fracturing guidelines in the nation. Its formal adoption by the state puts further strain on the oversight agency, the Division of Oil, Gas, and Geothermal Resources. This agency has faced increasing criticism from lawmakers over its failure to oversee oil and gas operations adequately, especially in the light of California’s ongoing drought and the generation of large volumes of oil production wastewater that have been routinely injected into protected aquifers.


This issue is likely to remain a hotly contested issues in other states, as environmental groups take action to limit perceived risk to the environment.


Keywords: energy litigation, royalties, land and lease rights, labor and employment, hydraulic fracturing regulation


Bob Broxson is a managing director in Navigant Consultant's Houston, Texas, office. Sonya Kwon is a managing director in the company's Los Angeles, California, office. Julie Carey is a director in the company's Washington, D.C., office.


Navigant Consulting is the Litigation Advisory Services Sponsor of the ABA Section of Litigation. This article should be not construed as an endorsement by the ABA or ABA Entities.


 
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