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Quackenbush Hill Field - Interim Decision, October 28, 2002

Interim Decision, October 28, 2002

STATE OF NEW YORK : DEPARTMENT OF ENVIRONMENTAL CONSERVATION

In the Matter of the Application of Pennsylvania General Energy, Inc. to construct and operate natural gas wells in an area designated as the Quackenbush Hill Field and an order establishing field wide spacing pursuant to the New York State Environmental Conservation Law ("ECL"), Article 23, and 6 NYCRR Parts 550 through 559.

INTERIM DECISION

DEC Case No. DMN-01-2

October 28, 2002

Introduction and Background

This Interim Decision relates to the proposal of the New York State Department of Environmental Conservation Staff ("Department"or "Staff") to establish well spacing and compulsory integration in the Quackenbush Hill Field, a discovery of natural gas in portions of Steuben and Chemung Counties. The well spacing and compulsory integration proposals are made pursuant to ECL Article 23, Titles 5 and 9. Pennsylvania General Energy ("PGE") is conducting an exploration and development program on portions of leasehold acreage in the Quackenbush Hill Field located in the Town of Corning, Steuben County and in the Towns of Big Flats and Catlin, Chemung County and has applied for the permits to drill for natural gas necessitated by 6 NYCRR 552.1. On November 1, 2001 PGE and Staff agreed in the form of a written stipulation ("Stipulation") on terms dealing with field-wide well spacing and the integration of interests at the Quackenbush Hill Field.

The Department, as lead agency under the State Environmental Quality Review Act ("SEQRA"), determined that the establishment of the field-wide spacing and integration rules within the units of the Quackenbush Hill Field would not have any significant adverse impact on the environment and issued a negative declaration on November 5, 2001.

A Notice of Public Hearing was sent on November 28, 2001 to governmental officials and to those persons who had contacted the Department regarding the proposal and was published in the Environmental Notice Bulletin and two local newspapers on December 5, 2001. Pursuant to such notice, a public hearing was held before Administrative Law Judge ("ALJ") Susan J. DuBois on January 3 and January 4, 2002 at the Holiday Inn in Painted Post, New York. An issues conference was conducted by ALJ DuBois in the same location on January 4, 2002 following the hearing. On January 8, 2002 ALJ DuBois ruled that no issues had been proposed regarding four of the five units within the proposed Quackenbush Hill Field and authorized the Department to prepare and complete a Commissioner's Decision and Report establishing the four units not in dispute. The units which were determined by the ALJ to not be in dispute were Lovell (Well No. 1323), Rhodes (Well No. 1322), Henkel (Well No. 1359) and Hartman (Well No. 24546). The remaining unit, Gregory (Well No. 1446), is the only one about which there is a dispute and which, according to ALJ DuBois, would be the subject of a separate ruling.

By my Decision and Order dated January 23, 2002, I determined that the Stipulation would result in the efficient and economical development of the gas pool as a whole, and that no dispute exists regarding four of five spacing units the Stipulation seeks to establish for the existing wells in the Quackenbush Hill Field. By such Decision, future spacing and integration rules for the four undisputed units were thereby established, and I directed, inter alia, that royalties for such units be released by PGE and that the Stipulation be incorporated by reference.

Standards for Adjudication

Under the Department's permit hearing procedures, an issue is adjudicable if "it is raised by a potential party and is both substantive and significant." 6 NYCRR 624.4(c)(1)(iii). An issue is "substantive" if there is sufficient doubt about the applicant's ability to meet statutory or regulatory criteria applicable to the project, such that a reasonable person would require further inquiry. In determining whether such a demonstration has been made, the ALJ must consider the proposed issue in light of the application and related documents, the draft permit, the content of any petitions filed for party status, the record of the issues conference and any subsequent written arguments authorized by the ALJ. An issue is "significant" if it has the potential to result in the denial of a permit, a major modification to the proposed project or the imposition of significant permit conditions in addition to those proposed in the draft permit. 6 NYCRR 624.4(c)(2) and (3).

In situations where Department Staff has reviewed an application and finds that a component of the applicant's project, as proposed or as conditioned by the draft permit, conforms to all applicable requirements of statute and regulation, the burden of persuasion is on the potential party proposing the issue related to such component to demonstrate that the issue is both substantive and significant. 6 NYCRR 624.4(c)(4).

The ALJ's Ruling

On February 13, 2002, ALJ DuBois issued her Ruling on Issues and Party Status ("Ruling") dealing with the disputed Gregory Unit. In the Ruling, the ALJ found that no issues were raised at the issues conference requiring adjudication. Petitions for party status were filed by Columbia Natural Resources ("CNR"), which is a joint venture working interest partner of PGE with respect to this field; Richard M. Roper ("Roper"), the fee owner of an approximately 1.9 acre parcel located within the Gregory Unit; and James E. Caflisch ("Caflisch"), the assignee of an oil and gas lease affecting the Roper parcel. The ALJ ruled that none of the petitions for party status would be granted since none of the proposed issues were found to be substantive and significant.

The Ruling also dealt with issues proposed by prospective parties other than James E. Caflisch. As none of these other prospective parties appealed any part of the ALJ's Ruling, the issues proposed by them will not be discussed in this decision. The Ruling was appealed by James E. Caflisch ("Caflisch") by the filing by his attorney, Charles Edward Fagan, Esq., of an "Appeal" and a "Memorandum of Law," each dated February 28, 2002 and collectively referred to herein as the "Appeal." On March 14, 2002 the Department and PGE each filed Reply briefs in opposition to the Appeal.

Caflisch had proposed three issues in his petition and at the issues conference. His first issue dealt with the content of the notice of hearing and the method of its service. The second issue was whether an operator's lease interest is subject to compulsory integration. Caflisch's third and final issue was whether the interest he claims in the production revenue from the well should be escrowed along with the landowner's royalties. PGE and the Department argued that the notice of hearing was properly prepared, served and published. With respect to the second and third issues, PGE and the Department maintained that PGE was the sole "operator" in the Gregory Unit and that Caflisch was not an "operator" as that term is defined in the appropriate DEC regulation (6 NYCRR 550.3(ab)) or by the Stipulation (Stipulation I.B., page 2). According to PGE and the Department, Caflisch's interest is limited to the royalty interest provided in paragraph III (G.) of the Stipulation as Roper's lessee and that he had no entitlements beyond that which would have been made available to Roper had he not leased his mineral rights to Buck Mountain, the holder of the Roper lease at the time of the issues hearings.

By her February 13, 2002 Ruling, the ALJ found that there was no adjudicable issue regarding the adequacy of PGE's notification to landowners. She stated that PGE's affidavit of notice is dated September 26, 2001 and that the stipulation is dated November 1, 2001. She indicated that the notice of hearing was published in two local newspapers in the area of the Quackenbush Hill Field and in the DEC Environmental Notice Bulletin on December 5, 2001, which date preceded Caflisch's lease assignment of December 14, 2001. Caflisch, therefore, had no interest whatsoever in the 1.9 acre parcel as of the date of service of PGE's notice and accordingly there was no obligation on the part of PGE to provide notice to Caflisch.

The ALJ also dealt with the non-procedural issues raised by Caflisch concerning his position that he was an "operator" and entitled to a 7/8 share in the production revenue of the well allocated to Roper's parcel. Caflisch had argued that as an "operator" he was entitled to revenue above and beyond the royalty share provided for in the Stipulation and that some means should be devised to escrow his share of the production revenue. He also raised the question of whether the operator's lease is subject to compulsory integration. The ALJ concluded that Caflisch did not have the 7/8 interest which his proposed issue assumed and therefore there was no basis for the escrow provisions he was proposing.

It should be noted at this point that Staff has objected to the Appeal on the grounds that it was not timely served. Staff states in its Reply Brief that Caflisch failed to comply with the direction of the ALJ contained in her Ruling that "Any appeals must be received at the office of the Commissioner no later than 4:00 P.M. on March 1, 2002...." However, I find that my office received and "stamped in" the Appeal at 12:56 P.M. on March 1, 2002 and therefore Staff's objections on this procedural basis are not credited. Accordingly, the appeal will be decided on the merits.

The Appeal

Caflisch raised a total of four issues between his Appeal and Memorandum of Law. The three issues stated in the Memorandum of Law were also argued in the Appeal in which a fourth issue is stated, dealing with whether Caflisch is entitled to party status. The first issue raised on the Appeal by Caflisch in both the "Appeal" and the Memorandum of Law concerned the adequacy of the content of a "Notice" sent to Roper in September, 2001 by PGE and the adequacy of the service of the Notice of Public Hearing in this proceeding. In September, 2001 PGE sent a notice to Roper and other landowners in the unit not under lease to PGE that their interest in natural gas relating to their parcels may be subject to compulsory integration. In point I of the "Appeal" Caflisch argues that the content of the PGE notice was deficient in that it did not, inter alia, indicate what lands of Roper were subject to the notice and referred to Roper's property as being "unleased." Point I of the Memorandum of Law dealt with the timeliness of the service of the Notice of Hearing. Although the discussion of Point I set forth in each of the "Appeal" and the Memorandum of Law strays in a confusing manner between the two separate notices, I interpret Point I of the "Appeal" as dealing with the PGE notice and Point I of the Memorandum of Law as dealing with the Notice of Hearing.

With respect to Point I of the "Appeal," it is noted that while Caflisch voices his general objection to the content of the PGE notice, he does not set forth any statutory or regulatory criteria upon which to ground his objection. Accordingly, the ALJ's ruling that the adequacy of the PGE notice was not an adjudicable issue will not be disturbed. With respect to the adequacy of the service of the Notice of Hearing, Caflisch correctly cites 6 NYCRR 624.3(d) as the regulation governing the service of the Notice of Hearing in these proceedings but incorrectly references 6 NYCRR 621.6(d) which deals with notices of complete application for permits governed by the Uniform Procedures Act (ECL Article 70). 6 NYCRR 624.3(d) requires that notices of hearing be "sent" not less than twenty-one calendar days prior to the hearing date. Caflisch objects to the notice provided for two reasons. The first reason, as stated in the Memorandum of Law, is that Caflisch never received actual notice of the hearing. Caflisch argues that the Hearing Notice was dated and, impliedly, served by mail on November 28, 2001 upon Buck Mountain, the holder of the Roper lease at the time of such service. He argues that Buck Mountain never received the Notice of Hearing until December 10, 2001. However, it is clear that 6 NYCRR 624.3(d) requires that the Notice of Hearing be "sent" or mailed twenty-one days prior to the hearing and the date of receipt by Buck Mountain is irrelevant. Irrespective of any other consideration, the Department would be in compliance with the twenty-one day requirement even if the Notice of Hearing had been mailed by the Department as late as December 10, 2001. Accordingly, the arguments of Caflisch regarding the timeliness of service of the Notice of Hearing are defeated by his acknowledgment of receipt of the Notice of Hearing by such date.

Caflisch's second issue deals with his status as lessee of the Roper parcel following compulsory integration or, more precisely, his entitlement, if any, to share in production revenue from the well drilling in the Quackenbush Hill Field. In this case the actual owner of the parcel, Roper, like many other owners, has leased natural gas rights to a third party. Such leases are commonly referred to as "oil and gas" leases and provide for royalty payments to the owner of the production revenue (usually 1/8th) allocated to the particular parcel based on the percentage such parcel is of the entire field. The holder of such lease, in this case Caflisch, assumes the position of the owner and is thereby entitled to receive whatever royalty his landlord would have been entitled to. Under compulsory integration, the remaining 7/8's interest in the production revenue allocated to a particular parcel vests in the "operator" who is the actual driller and manager of the well and its production. In situations where the actual "operator" is an entity other than the landowner or lessee, as is the case here, the 7/8 interest does not inure to the benefit of either the landowner or his lessee.

Integration, moreover, does not relieve the holder of such lease of his contractual duties to the landowner. In the instant case, Caflisch has argued that the compulsory integration of the Roper parcel is confiscatory and will frustrate him in the performance of some of his obligations to Roper such as providing access for Roper to books and records pertaining to the costs and operating expenses of drilling and production. In addition, Caflisch suggests that his lease requires a royalty payment to Roper which exceeds the amount he would receive from PGE, thereby forcing him to suffer financial loss. Caflisch maintains that ECL 23-0901(3), the statute providing for compulsory integration, impairs the "obligation of contracts"and is, at least as applied, in violation of the United States Constitution, Article I, §10, cl. 1.

The arguments of Caflisch in Points II and III of his Appeal and his Memorandum are entirely predicated on his assumption he is an "operator" in the Gregory Unit of the Quackenbush Hill Field and beg the question of his status. He seeks to include himself within that part of ECL 23-0901(3) which provides in part:

If one or more of the owners shall drill, equip and operate, or operate, or pay the expenses of drilling, equipping and operating, or operating, a well for the benefit of another person as provided for in an order of integration, then such owner or owners shall be entitled to the share of production from the spacing unit accruing to the interest of such other person, exclusive of a royalty not to exceed one-eighth of the production, until the market value of such other person's share of the production, exclusive of such royalty, equals twice such other person's share of the reasonable actual cost of drilling, equipping and operating, or operating the well, including a reasonable charge for supervision and interest.

Staff maintains that Caflisch's reliance on this statute is misplaced. The statutory provision quoted above refers to a situation where an order of integration provides for one "owner" to pay another "owner's" share of the costs. Here there is no order of integration in effect and Caflisch's leasehold interest does not qualify for the benefits afforded by the statute.

Although Caflisch's Appeal and Memorandum of Law assume that he is an operator, neither of these submissions on appeal provide any argument in support of such conclusion. At the Issues Conference Caflisch had argued he was an operator for several reasons. Firstly, Caflisch suggested that he operated four natural gas wells in Chatauqua County and, secondly, that claimed he was designated as an "operator" by DEC on its public website. Finally, he states that by virtue of his acquisition of the Roper-Buck Mountain lease, he acquired an "operator interest" in the Roper parcel.

The basis of Staff's opposition to Caflisch's claim to be an operator and therefore entitled to share in the production revenue of the well is set forth in the January 2, 2002 letter from John K. Dahl, Director, the Department's Bureau of Oil & Gas Regulation and in the February 5, 2002 letter from Arlene J. Lotters, the Department's Program Attorney, each of which letter was addressed to ALJ DuBois. Staff maintains that whether Caflisch is an "owner" or "operator" of wells in Chatauqua County does not make him an operator in the Quackenbush Hill Field. Moreover, the reference in DEC's website to Caflisch under the category "OWNR" is not dispositive of the issue and there is no distinction in the downloadable file among landowners or others who produce for self-use and operators who produce gas for sale.

Staff points out other reasons why Caflisch cannot qualify as an operator in the Quackenbush Hill Field. Caflisch, Staff maintains, has not demonstrated any intention to drill or operate wells in the Quackenbush Hill Field, has not shared in the expense of exploration or drilling and has not engaged in any exploration activities itself. Also, he has not demonstrated an adequate acreage position to be granted a drilling permit, controlling as he does only 0.06% of the Quackenbush Hill Field and 0.30% of the Gregory Unit. Moreover, as ALJ DuBois observes in her Ruling, Caflisch's lease with Roper expressly provides that the lessee obtains no right to enter onto, or conduct operations on the surface of the property.

For all of these reasons, I conclude that the ALJ was correct in determining that irrespective of Caflisch's experiences elsewhere, he cannot be considered an operator in the Quackenbush Hill Field and is therefore not entitled to a share of the production revenue from the well beyond the royalty provided for in the stipulation. Caflisch's third point regarding an escrowing of what describes as his operator's interest is rendered moot by my determination that he enjoys no such interest. Similarly his claim to party status set forth in Point IV of his Appeal is moot. In deciding these issues, I am aware of Caflisch's argument that compulsory integration is unconstitutional as applied to the extent to which it results in PGE acquiring the entire operator's interest in the revenue produced by the well. However, the Court of Appeals in In the Matter of Sylvannia Corporation v. R. Stewart Kilbourne, as Commissioner of the Conservation Department of the State of New York et al, 28 N.Y.2d 427, 322 N.Y.S.2d 678 held that compulsory integration under §79 of the Conservation Law of 1911, the predecessor statute to ECL 23-0901, did not violate constitutional provisions dealing with impairment of contracts and the taking of private property without just compensation. Also, an administrative tribunal is not the appropriate forum in which to challenge the constitutionality of a statute. See, Matter of Finn's Liquor Shop, Inc. v. State Liquor Authority, 24 NY2d 647 (1969), cert den, 396 US 840 (1969).

Finally, it is to be noted that the arguments concerning operator status and compulsory integration which were made by Caflisch in this matter by his attorney, Charles Edward Fagan, Esq., were raised in the Matter of Pennsylvania General Energy, Inc. (Wilson Hollow Field), Interim Decision, August 8, 2001 by Mr. Fagan who was also the attorney for Buck Mountain Associates, the intervening party in that case. There is a similarity between the facts in Wilson Hollow Field and the facts herein including the fact that Buck Mountain was, like Caflisch, a lessee of an oil and gas lease claiming "operator" status and financial entitlements beyond a royalty interest. Buck Mountain also claimed that compulsory integration was unconstitutional in that it resulted in derogation of privately negotiated and existing contract rights and was confiscatory, resulting in a taking without compensation. I rejected these arguments in Wilson Hollow Field and held that the interest of a lessee of an oil and gas lease was subject to compulsory integration.

Conclusion

The Ruling of the ALJ is affirmed and Staff is directed to proceed with a Decision and Order regarding the Gregory Unit consistent with this Interim Decision.

_____________/s/_____________
Erin M. Crotty,
Commissioner
Albany, New York

Dated: October 28, 2002

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