Ever wonder whether storage can hold a lease's production rights? Recently the U.S. Court of Appeals for the Third Circuit confirmed that it could. In Penneco Pipeline Co. v. Dominion Transmission, Inc., the court upheld a lower court determination preserving numerous "dual-purpose" oil and gas leases held by Dominion in the South Bend and Oakford Storage Fields, including the production rights set forth in the leases.
The facts were straightforward: Dominion had acquired numerous oil and gas leases in Armstrong and Indiana Counties, Pennsylvania, and relied on those leases to develop and operate its South Bend and Oakford Storage Fields. While the original leases did not provide for the underground storage of gas, that right was added in the 1940s through the 1960s through either lease modifications or the execution of new leases. This resulted in combined production and storage leases, commonly referred to as "dual purposes" leases.
The related landowners and Penneco Pipeline, which had been given top leases on the properties, sued for a declaration that the oil and gas production rights contained in the leases had terminated. The reason: Lack of production during Dominion's tenure on the property.
The plaintiffs made two arguments of interest to producers. First, that the production rights terminated under the terms of the habendum clause. Second, that the production rights should be deemed to have been forfeited because Dominion had failed to comply with its implied covenant to develop and produce oil and gas from the properties. The district court (when it adopted the Magistrate's Report and Recommendation) rejected both.
Habendum Argument. Examining the leases themselves, the court found that each of the leases granted two rights to Dominion - the right to drill, operate and produce the property; and the right to store natural gas in the property's substrata. This, said the court, was:
[C]onsistent with the habendum clause in each of those leases, which provides, in essence, that the lease term can be extended indefinitely so long as the land is being operated by the lessee in the search for or production of oil or gas or used for the storage of gas. The use of the disjunctive conjunction “or” in the habendum clause clearly indicates that the term of the lease can be extended by the occurrence of either event: the production of gas or the storage of gas on the property subject to the lease. (Emphasis added.)
To overcome the express terms of the habendum clause, the plaintiffs argued that the leases expired with respect to the production rights - i.e., that they were severable from the storage rights. The court disagreed:
The DTI leases here, like the lease agreement in federal Jacobs, are all dual-purpose leases, and contain habendum clauses that extend the term of the leases indefinitely so long as the land is used to produce or store gas. Like the Jacobs lease, the compensation provisions under the DTI leases, i.e., delay rentals, royalties, and storage rentals, are not distinctly allocated to production or storage rights, but rather, are written in such a way that payment for one purpose interrelates and impacts on the payment for the other.
Because the production and storage rights were not severable, and because the properties had been continually utilized for storage purposes, the court found that the leases remained in full force and effect for both production and storage operations.
Implied Covenant to Develop. Plaintiffs argued that the Dominion leases were silent regarding whether oil and gas must ever be produced when the properties were used to store gas, and thus there was an implied duty to develop the properties under Pennsylvania law that had been violated when Dominion failed to exercise its production rights for over 40 years. Again, the court disagreed. Looking at the lease language, the court stated:
Given that the compensation paid under the DTI leases is not limited to royalties and is not specifically apportioned to either production or storage rights, but rather is applied to the lease agreement as a whole to extend the term of the lease indefinitely, payment of compensation under the alternative gas storage provisions of the DTI leases precludes the application of an implied covenant to develop and produce oil and gas under the Pennsylvania Supreme Court's decision in Jacobs. *** This conclusion is consistent with, if not mandated by, the Court's earlier finding that production and storage rights under the DTI leases are not severable. (Emphasis added.)
Accordingly, the court denied plaintiffs' motion for summary judgment and granted the defendants'.