House Bill 152 is Unconstitutional and Bad for Ohio’s Landowners

By: Steven R. R. Anderson

Under both the U.S. and Ohio constitutions, private property may only be taken against the owner’s will if two conditions are met. First, the property must be taken for a public use. Second, the owner must be paid the property’s fair market value.

Ohio House Bill 152, sponsored by Representatives Brian Stewart (R-District 78) and Timothy E. Ginter (R-District 5) and currently pending before the House Energy and Natural Resources Committee, seeks to amend the “force pooling” process in Ohio by compelling landowners to give their property to oil companies for less than fair market value. It is, therefore, facially unconstitutional. It is also bad policy.

What is force pooling?

A hydraulically fractured oil and gas well unit will often encompass more than a thousand acres. To stop a single holdout from preventing the development of the entire unit, Ohio allows oil companies to “force pool” unleased acreage into the unit, once a company has at least 65% of the unit acreage under lease. The owner of the force-pooled acreage then becomes a part-owner of the unit, bearing her proportionate share of the drilling costs and receiving her proportionate share of the unit’s profits.

The average landowner, however, does not have the money to cover her share of the massive costs of drilling oil and gas wells. Such a “non-participating” landowner must be “carried”. This means the oil company will pay the entire cost of drilling up front, but then will deduct the landowner’s share of costs from the landowner’s share of profits once the unit starts producing, until the landowner’s costs are fully repaid. In this way, the landowner receives full value for her minerals, minus the cost of extracting them from the ground.

What changes does House Bill 152 make?

Under House Bill 152, however, a non-participating owner may no longer be carried by simply repaying her share of the unit’s production costs out of her share of the unit’s profits. Instead, she will be forced to pay the oil company an additional, punitive “non-participation charge” equal to 300% of the amount carried. In practice, this huge penalty will often mean the non-participating landowner never sees any of her share of the unit’s profits. Her minerals will be taken against her will, and the oil company will keep every dollar.

If a non-participating landowner wants to avoid this penalty for being carried, House Bill 152 gives her one alternative. She may elect instead to enter into a lease with the oil company under terms that House Bill 152 mandates – terms that are hugely favorable to the oil company, far below market value for the property being taken, and much worse than those the landowner could get if she negotiated with the oil company on an even playing field.

Whereas landowners in Ohio are regularly able to negotiate oil and gas leases with gross royalties in the range of 15% to 20%, House Bill 152 dictates that force-pooled landowners will get 12.5% net royalties. It also requires landowners to accept a lease bonus payment that is only 75% of the market value for lease bonuses in the area. In short, the financial terms mandated by House Bill 152 are a windfall for oil companies.

As for other lease provisions, House Bill 152 simply directs that they will be “just and reasonable”. The vagueness of that phrase bears little relation to the reality of oil and gas leases in Ohio, which are complex and varied. Almost immediately, lawsuits will fill Ohio’s courts to determine what the phrase “just and reasonable” means in practice.

House Bill 152 also creates perverse incentives.

Moreover, House Bill 152 will create a system of perverse incentives that undermines Ohioans’ ability to get fair market value for their oil and gas rights.

Oil companies will no longer have an incentive to negotiate leases with every landowner. Instead, they will only ink deals covering the minimum 65% of a unit’s acreage necessary to invoke the force pooling process. The owners of the remaining 35% will then be stuck choosing between the punitive non-participation charge or the below-market lease mandated by House Bill 152.

The incentive for landowners under such a regime, therefore, will be to ensure that they sign leases before the oil company reaches its 65% acreage threshold. But once landowners understand this, they will begin to bid against one another, and the going rate for lease bonuses and royalty payments will plummet as landowners race each other to the bottom to avoid being in the 35%. In short order, the market for oil and gas leases in Ohio will crater, as oil companies will be collecting leases at bargain prices while Ohio’s landowners have their mineral wealth taken out from under them at prices far below market value.

Conclusion.

House Bill 152 raises numerous, major concerns.

First, both the non-participation charge and the statutorily-mandated lease essentially leave the landowner in the same place – forced to give up her property while getting far less than its full value in return. Neither the U.S. Constitution nor the Ohio Constitution permits this.

Beyond that, the perverse incentives the bill creates will severely disadvantage Ohioans in their negotiations with oil companies. This massive shift in bargaining power will result in far less money paid to Ohio’s landowners, and much larger profits for oil companies.

Moreover, the bill’s requirement that the leases imposed on non-participating landowners contain “just and reasonable” terms is vague and will be the subject of endless litigation. Ohio’s courts will be tied up for years to come, and the state’s oil and gas development will slow as the industry waits for legal challenges to be resolved.

In the end, House Bill 152 is a short-sighted money-grab by oil companies. It is unconstitutional, exploitative of Ohio’s landowners, and bad policy for Ohio’s oil and gas industry. It should be defeated soundly in the statehouse and never see the light of day again.