At the intersection of Wall Street and Main: impacts of hydraulic fracturing on residential property interests, risk allocation, and implications for the secondary mortgage market.

• Author: Radow, Elisabeth N.
• Position: Fractured Communities: Hydraulic Fracturing and the Law in New York State

1. AT THE INTERSECTION OF WALL STREET AND MAIN

   Unconventional gas drilling--that combination of high volume hydraulic fracturing and horizontal drilling for shale (methane) gas (a.k.a. "fracking") affects Americans in ways which are not immediately obvious. Ways involving repercussions from residential fracking and lacking regulatory oversight which go beyond the Halliburton Loophole. (1) Homeowners with unconventional gas drilling operations host two Wall Street investments courtesy of their residential property: one derived from a gas lease, the other from a home mortgage. (2) The mere existence of a signed gas lease enables the gas company to leverage it to obtain investors and financing. (3) The mere existence of a signed gas lease can affect the home's appraised value and the homeowner's ability to obtain a mortgage loan, homeowner's insurance, and sell the residence. (4) The cumulative effect of unconventional gas drilling on residences in the thirty to thirty-five states where operations occur, or are planned, poses a potential threat to the nation's $6.7 trillion secondary mortgage market, since the secondary mortgage market is supported by an unknown number of mortgages affected by residential fracking. (5)

   Projections for recovery of shale gas change from year to year with estimates increasing in certain shale plays and decreasing in others. (6) Furthermore, there is data indicating that "[t]he true extent of unconventional oil and natural gas reserves in the United States is uncertain ... because assessments of technically recoverable reserves are far more predictive than they are factual." (7) Homeowners with a gas lease seek to reap significant royalties during the gas boom while maintaining the long-term value of the family residence. According to a Penn State report, 60 percent or more of the gas could be extracted in the first year with a steadily declining curve thereafter. (8)

   Shale gas investors, including New York State's pension fund, hope to cash in on the shale gas boom. (9) Unconventional gas drilling requires access to substantial cash flow. During the past several years Wall Street private equity investment firms, such as KKR, have raised billions of dollars from investors who seek high returns and must accept the risk and volatility that goes along with it. (10) KKR's website indicates an affinity for investing in energy--yet KKR also handles mortgaged backed securities. (11) Goldman Sachs is another Wall Street firm which describes itself "[a]s a major player in the Energy Sector" with expertise spanning "from unconventional oil and gas" to renewable energy sources. (12) Goldman Sachs also handles residential loan trading and secondary mortgage market investments. (13) Traditionally, investors in mortgaged backed securities include pension managers for municipal governments, credit unions, colleges, and other institutions focused on more stable investments even though they typically yield lower returns. (14)

   The mortgage market is showing signs of a rebound following the mortgage crisis of 2007; yet, Wall Street's robust embrace of unconventional gas drilling raises questions about whether people's Main Street homes and Wall Street's alternate support of the secondary mortgage market can remain intact in the presence of this drilling rush. While this article does not purport to resolve this critical question, it does attempt to identify conflicts between gas leases and mortgage loans, potential repercussions resulting from the conflicts, and it proposes solutions: preventative actions intended to preserve residential and farm properties and fortify the mortgage market in the presence of unconventional gas drilling.

   The approximately decade old combination of high volume hydraulic fracturing with its millions of gallons of chemically treated frackwater and resulting volumes of toxic, radioactive waste, combined with multi-directional mile-long horizontal pipelines which enable high volume drilling across various properties, is responsible for revolutionizing homeownership across America. (15) According to former Mobil Oil executive Louis W. Allstadt, who oversaw Mobil's side of its merger with Exxon, the difference in using these combined technologies

   is the volume of fracking fluids and the volume of flow-back that occurs in these wells. It is 50 to 100 times more than what was used in the conventional wells. The other [difference] is that the rock above the target zone is not necessarily impervious the way it was in the conventional wells. And to me that last point is at least as big as the volume. The industry will tell you that the mile or two between the zone that's being tracked is not going to let anything come up. But there are already cases where the methane gas has made it up into the aquifers and atmosphere. Sometimes through old well bores, sometimes through natural fissures in the rock. What we don't know is just how much gas is going to come up over time. It's a point most people haven't gotten. It's not just what's happening today. We're opening up channels for the gas to creep up to the surface and into the atmosphere. And methane is a much more potent greenhouse gas in the short term--less than 100 years--than carbon dioxide. (16) And with respect to reliability and resilience of the infrastructure:

   What you [also] don't know [is that] when you plug that well, how much is going to find its way to the surface without going up the well bore. And there are lots of good indications that plugging the well doesn't really work long-term. There's still some pressure down there even though it's not enough pressure to be commercially produced. And sooner or later the steel casing there is going to rust out, and the cement sooner or later is going to crumble. We may have better cements now, we may have slightly better techniques of packing the cement and mud into the well bore to close it up, but even if nothing comes up through the fissures in the rock layers above, where it was tracked, those well bores will deteriorate over time. And there is at least one study showing that 100 percent of plugs installed in abandoned wells fail within 100 years and many of them much sooner. (17) Currently, the gas industry dominates control of what happens on and under the contiguous tracts of residential land which collectively comprises each 640 plus acre spacing unit on and under which drilling and fracking occurs. Homeowners beware.

   1. Attributes of Home Ownership

      "A home represents a family's most valuable asset": financially, spiritually, and otherwise. (18) The property's value is derived from a bundle of rights: the right to construct, obtain a mortgage loan, lease and sell the property, the expectation of clean running water, electricity, a "roof over one's head," "peaceful sanctuary," and a safe place to raise children and grow our food. (19) We Americans pay for these rights when we purchase our homes. We expect these rights to continue until we sell our homes. Homeowners on Main Street across the United States expect the property value to increase over time, or at least not to diminish. So does the mortgage market-- Wall Street's investors depend upon it. So does local and state government; our tax base depends upon it.

   2. The Gas Lease

      Up to now, home has represented one place people have control. Gas leases take away homeowner control in several ways. Standard gas leases grant to the gas company the right to use "undesignated portions of the surface" for operations. (20) This includes the right to install easements for roads, utilities and underground storage for gas and other "'reasonable and convenient easements' for the existing wells, pipelines, pole-lines, roadways and other facilities." (21) These other facilities can include compressor stations and pipelines. The standard gas leases are silent regarding funding or maintenance of the potentially perpetual easements. A standard gas drilling lease does not obligate the company to maintain or repair the infrastructure it constructs or fully restore the property to its predrilling condition. (22) Gas leases are often silent on allocation of risk and liability. (23) To the extent the gas lease delegates rights of property use to the gas company, this corresponds to a diminution of the homeowner's use and enjoyment of those attributes of the residence and by extension, its market value. (24)

   3. The Risks

      The gas companies' 10-Ks, filed with the Securities and Exchange Commission ("SEC"), characterize unconventional gas drilling as subject to many risks. (25) They include in the list of hazards: blowouts, fires, explosions, cement and pipe failure, casing collapse, pipeline ruptures or spills, chemical spills, mechanical failure, craterings, pressure or irregularities in formations, accidental, uncontrollable flows of oil, natural gas or well fluids, pollution, releases of toxic natural gas and other environmental hazards and risks. (26) If any of these hazards occur, they can result in substantial losses as a result of: injury or loss of life, severe damage or destruction of property, equipment and natural resources, including water. (27)

      Contaminated water affects property use and property value. (28) Currently, the public is focused on whether there exists a link between the hydraulic fracturing phase of the multi-step shale gas extraction process and water contamination. (29) A recently released EPA power point presentation regarding its Dimock, Pennsylvania water analysis reflects an apparent nexus between gas drilling operations and contaminated water. (30)

      Exclusive focus on the hydraulic fracturing phase obscures the fact that adverse impacts to water occur at various phases in the multi-step gas extraction process, not just the fracturing phase. (31) Water contamination can also occur from cracked well casings, pipeline ruptures or surface spills, over-turned trucks, inappropriate waste disposal into rivers...