Unconventional Oil and Gas Litigation Trends ReportJanuary 2013

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Unconventional Oil and Gas Litigation Trends Report navigant.com/shale

Recent headlines including “Shale Fracking Makes U.S. Natural Gas Superpower – Now What?” and “U.S. Oil Output To Overtake Saudi Arabia’s by 2020” have elevated the importance of drilling for oil and natural gas to its highest level in decades.1 According to a recent study from Harvard University, in 2011, up to 95 percent of all wells drilled in the United States were hydraulically fractured, accounting for 43 percent of U.S. oil production and 67 percent of U.S. natural gas production.2 Unconventional oil and gas extraction has sparked debates about balancing energy needs, regulatory oversight and environmental management. The recent drilling boom has put many states in which shale rock formations lie at ground zero for increased litigation and a litany of policy changes at the federal, state and local levels.

The Unconventional Oil and Gas Litigation Trends Report discusses U.S. litigation trends and highlights noteworthy U.S. cases affecting the unconventional oil and gas industry. The goal of this report is to answer the following questions:

1. Are there notable trends in the overall volume of cases filed? 2. Are there any notable geographic trends for cases filed?3. Are there any notable trends in the types of cases filed?

Methodology Used For IdentIFyIng U.s. UnconventIonal oIl and gas lItIgatIon casesNavigant 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 our case data presents a comprehensive picture of the nature and volume of this specific type of litigation filed over the last five quarters (April 1, 2011 – June 30, 2012). Navigant utilized LexisNexis Courtlink, Law360, news articles and other court reporting services to identify relevant cases. We 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.3

Increased regulatory oversight and investigations (e.g., FERC analysis of market manipulation) is not reflected in the findings but is expected to increase and could lead to an increase in litigation. See the included “Spot-light on Regulatory Developments” for an example of increased regulatory oversight.

1. are there notable trends In the overall volUMe oF cases FIled?Prior to Q2 2012, the average number of unconventional oil and gas litigation cases filed per quarter approximated 60, with the highest quarter seeing 66 cases filed (Q1 2012) and the lowest quarter seeing 49 cases filed (Q4 2011). That consistency ended in Q2 2012 when the total number of uncon-ventional oil and gas cases increased to 89 – a nearly 50 percent increase over the average number of cases for the prior four quarters (see Figure 1).

Despite the overall increase in the volume of the cases filed in Q2 2012, the jurisdiction of the cases identified remains predominantly in state courts. Throughout the period studied, two-thirds (66 percent) of all cases filed were in state court.

hIghlIghts oF lItIgatIon trends report

» Q2 2012 witnessed a near-50 percent increase in the volume of cases filed, in comparison to the average volume of cases filed in the previous four quarters. During the relevant period, 66 percent of all cases identified were filed in state court.

» While Texas consistently reports the highest number of cases filed (44 percent of all cases filed throughout the relevant period), Pennsylvania and Oklahoma had notable increases in the number of cases filed during Q2 2012.

» Royalty disputes consistently make up the largest portion of unconventional oil and gas litigation throughout the relevant period. Land and lease rights disputes, however, had a notable volume increase in Q2 2012.

On February 9, 2012, an individual shareholder of a publicly-traded proppant manufacturer (a material used in hydraulic fracturing) filed a securities class action matter alleging that the Company and its officers intentionally misled investors by omitting material adverse information about lower demand for its product during its third-quarter 2011 earnings release investor call. Soon after the investor conference call, the Company’s stock price rose 17 percent. The Company later disclosed that it underestimated the logistical complications that arose when oil and gas companies migrated from dry natural gas regions to liq-uid rich regions. In response to the Company’s announcement of these logistics issues and lower demand, the stock price dropped more than 20 percent. The Company filed a Motion to Dismiss and the matter is ongoing.

FIgUre 1: UnconventIonal oIl and gas lItIgatIon cases by qUarter

23 24

13

2429

38 4036

42

60

2011Q2 2011Q3 2011Q4 2012Q1 2012Q2

Federal State

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January 2013navigant.com/shale

2. are there any notable geographIc trends For cases FIled?Figure 2 shows that Texas consistently outperformed other geographies in terms of unconventional oil and gas cases filed during the relevant period. With 44 percent of all cases filed, Texas had four times as many cases as the next closest state. Pennsylvania, Louisiana, Ohio, and Oklahoma round-out the top five states in terms of the number of unconventional oil and gas cases filed. Included in “other” states are West Virginia, Arkansas and New York, in which Marcellus, Fayetteville and Utica shale formations lie. A recent trend, however, is the notable increase in the number of cases filed in Q2 2012 in Pennsylvania (100 percent increase over Q1 2012) and Oklahoma (a three-fold increase over Q1 2012). This increase is primarily attributable to a growth in oil and gas royalty disputes and disputes involving land and lease rights (see next section for a description of each).

3. are there any notable trends In the types oF cases FIled?Figure 3 shows that royalty disputes have dominated the unconventional oil and gas litigation landscape for the past five quarters (39 percent of all cases filed during the relevant period). Generally involving allegations of underpayment of oil, gas or liquid natural gas royalties, these matters accuse well operators of improperly deducting costs from the royalty base or of using aggregation or accounting techniques to understate volumes.

Butler v. Charles Powers Estate is a Pennsylvania land and lease rights case that is seeking an answer to: “Is natural gas a mineral?” The Pennsylvania surface property of Charles Powers was sold in 1881, but the deed retained “half the minerals and petroleum oils” found on the property for his estate. The surface property is currently owned by John and Mary Butler, who are at odds with the Charles Powers estate over whether the estate’s right to half the minerals on the property includes half the Marcellus Shale gas. In 2010 the Court ruled in favor of the Butlers, concluding that use of the word “minerals” in the deed did not specifi-cally reserve ownership of the natural gas found in the Marcellus Shale formation. The case was appealed to the Superior Court which overturned the original decision and sent it back to the Court of Common Pleas for additional review. The case was appealed to the Supreme Court of Pennsylvania and arguments were held in October 2012. A final decision in this matter is pending.

FIgUre 2: cases by geography by qUarter

FIgUre 3: cases by type oF Matter by qUarter

Q2 2012 saw a notable increase in the volume of disputes related to land and lease rights and environmental/product liability issues. Land and lease rights disputes generally entail plaintiffs seeking a declaratory judgment to (1) stop defendants from drilling for oil and gas on land for which plaintiffs have a valid lease, and/or (2) disallow defendants from asserting ownership of mineral rights for certain lands located on various shale formations in the U.S. (see included Butler v. Charles Power Estate case example).

The most common allegations in environmental/product liability cases involve negligence, nuisance, personal injury, property diminution, or damage to property during drilling. One interesting item of relief sought by the plaintiffs in certain environmental/product liability matters involves medical monitor-ing. The stated intent of medical monitoring is to detect diseases or other ailments, and offer early detection to ameliorate the severity of any exposure.

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Unconventional Oil and Gas Litigation Trends Report navigant.com/shale

aboUt navIgant’s UnconventIonal oIl and gas servIcesNavigant’s unconventional oil and gas offerings include advisory services for strategic business decision analysis, construction risk management, economic and antitrust analyses, investment banking and restructuring advi-sory services, and expert services for disputes and investigations. For more information, go to www.navigant.com/shale.

aboUt navIgantNavigant (NYSE: NCI) is a specialized, global expert services firm dedicated to assisting clients in creating and protecting value in the face of critical business risks and opportunities.Through senior level engagement with clients, Navigant professionals combine technical expertise in Disputes and Investigations, Economics, Financial Advisory and Management Consult-ing, with business pragmatism in the highly regulated Construction, Energy, Financial Services and Healthcare industries to support clients in addressing their most critical business needs. More information about Navigant can be found at www.navigant.com.

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rob Wentland +1.312.583.2644 rob.wentland@navigant.com

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rick smead +1.713.646.5029 rsmead@navigant.com

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spotlIght on regUlatory developMents

On November 15, 2012, the Federal Energy Regulatory Commission (FERC) issued its “Enhanced Natural Gas Market Transparency” Notice of Inquiry (NOI) in which it is “considering proposing to require all market participants engaged in sales and wholesale of physical natural gas in interstate commerce to report quarterly to the Commission every natural gas transaction within the Commis-sion’s NGA jurisdiction that entails physical delivery for the next day… or for the next month…”4 The stated purpose for the proposal is:

“…obtaining such information would significantly increase the information available to the Commission concerning transactions in the natural gas markets thereby enhancing its ability to identify the potential for market manipulation in the natural gas markets, to examine more efficiently the manipulative behavior, and to assess the effects of manipulation.”

Whereas the FERC has in the past collected a great deal of pipeline capacity information, transportation rate and capacity release information, and total-volume sales information, this NOI proposes more details of every transaction – including the price charged for the gas commodity. Industry experts suggest that this proposal by the Commission will likely be seen by the commercial elements of the industry to be an intrusive progression of the market-enforcement function FERC has been building ever since the Energy Policy Act of 2005 (EPAct 2005) was implemented. While it is uncertain that the FERC’s NOI may or may not lead to a notice of proposed rulemaking (NOPR) and that an issued NOPR may never become a final rule, these types of regulatory initiatives could continue through 2012-2013 across a broad spectrum of agencies.

1 Eric Roston, “Shale Fracking Makes U.S. Natural Gas Superpower – Now What?,” Bloomberg September 25, 2012. Lananh Nguyen, “U.S. Oil Output To Overtake Saudi Arabia’s by 2020,” Bloomberg November 12, 2012.

2 Maugeri, Leonardo. “Oil: The Next Revolution” Discussion Paper 2012-10, Belfer Center for Science and International Affairs, Harvard Kennedy School, June 2012.

3 Case data reported in prior studies may change when information regarding ongoing litigation is identified or amended.

4 141 FERC ¶ 61,124 United States of America Federal Energy Regulatory Commission [Docket No. RM13-1-000]; Notice of Inquiry, Enhanced Natural Gas Market Transparency; Issued November 15, 2012.