Recovering Corporate Assets Through Environmental Lawsuits

Summary Over the past decade many environmentally motivated restrictions and withdrawals have been carried out at the expense of private property owners, most of whom seemed to have no effective recourse. This paper (1) summarizes a recent case in which a Michigan oil operator and several mineral owners fought back, winning a judgement worth $120 million from the State of Michigan, and (2) analyzes the essential geotechnical procedures, particularly those involving stochastic exploration risk analysis, required to determine and to justify the plaintiff's claims for monetary damages. The intent is to provide encouragement and guidance to other private property owners, especially those involved in mineral resources, who may be contemplating similar legal actions. The Fifth Amendment to the U.S. Constitution prohibits the taking of private property for public use without just compensation, and the 14th Amendment forbids the state to deprive any person of property without due process of law. Nevertheless, most knowledgeable attorneys generally concede that the law concerning "takings" of private property by state regulatory restriction has been murky and uncertain at best. Introduction Two recent key legal decisions offer strong new encouragement to private businesses that have suffered losses from environmental conflicts. In June 1992 in Lucas v South Carolina Coastal Council,1 the U.S. Supreme Court ruled that, under the 5th and 14th Amendments to the U.S. Constitution, private parties are entitled to full compensation if all economically viable use of their property is prohibited by the state for environmental purposes. In Sept. 1991, the Michigan State Court of Claims ruled that the State of Michigan owed Miller Bros. (an independent Kalamazoo operator) $50 million and the owners/lessors of the subsurface mineral rights $25 million plus legal costs and accrued interest. The award was compensation for the taking of their property in 1987 by the Michigan Dept. of Natural Resources through regulatory denial of drilling permits. Although Michigan has appealed the decision, the Supreme Court's recent ruling in the Lucas case is generally seen as highly supportive of an eventual decision upholding the original Miller ruling. As of Sept. 1992, the total award was ˜$120 million, with interest continuing to accrue. The key to establishing a sound basis for valuation of undeveloped or partly developed oil and gas properties lies in constructing an objective, documented, and convincing analysis that integrates (1) geology and method of exploration and development; (2) a production database leading to projected ultimate recoveries from analog producing fields; (3) detailed cash-flow models establishing present monetary value of reasonable production cases; (4) exploration risk analysis that forecasts numbers and sizes of expected new field discoveries plus probability of project success; and (5) determination, based on thorough knowledge of all the previous factors, of expected prudent monetary bids for acquisition of such properties as a basis for fair market value. The key to a favorable verdict regarding damages lies in assembling a competent, interactive team of technical experts, supervised by a skilled and knowledgeable managing attorney who actively seeks and uses their counsel throughout case analysis, preparation, and trial. We believe that very substantial monetary awards can be earned by companies that have been prevented from developing their properties through similar takings by other governmental agencies for environmental purposes. However, to undertake and to prosecute such a lawsuit successfully, management must be determined to stand on principle and be committed to use technical expertise fully. An important side benefit of such proceedings may be to redress, at least in part, the current imbalance in the U.S. between environmental and economic interests, by forcing governmental agencies (and taxpayers) to weigh the financial consequences of their contemplated environmental actions. Some of the issues that have complicated takings have had to do with the state's police power; with public nuisances and natural hazards; and with temporary, partial, and total takings. In that context, the June 29, 1992, U.S. Supreme Court 6 to 2 decision in Lucas v South Carolina Coastal Council provides some clarification. Associate Justice Scalia's majority opinion provided categorically that where state environmental regulation denies all economically beneficial or productive use of land, just compensation is due the landowner. Moreover, his opinion suggests that the landowner whose deprivation is something less than complete may also be entitled to compensation; the decision confirms that temporary takings are as protected by the Constitution as are permanent ones. Geologic Summary of Niagaran Pinnacle-Reef Oil and Gas Production More than 700 oil- and gas-bearing, porous, carbonate pinnacle reefs of Niagaran (Middle Silurian) age are scattered throughout a narrow subsurface fairway that trends northeast-southwest across the northern part of Michigan's lower peninsula (Fig. 1). The reef trend is consistently 6 to 10 miles wide and lies immediately basin ward (seaward) of the Niagaran shelf margin on the northwestern flank of the Michigan basin. Average depth of reef fields is ˜6,000 ft. The first recognized discovery in the trend occurred in 1968. Feverish exploration activity followed through 1975 and declined gradually thereafter. As of April 1987, estimated cumulative production from fields discovered was ˜270 million bbl of petroleum liquids and 1,470 Bcf of natural gas. Ultimate recovery from these fields is estimated to be >700 million bbl oil equivalent (BOE). (The conversion of gas to BOE is on the basis of 6 Mcf gas equals 1 bbl oil.) Even though the average field size is relatively small, the profit potential of even a moderate-sized producing reef field is exceptional. Individual reef masses appear to be roughly oval in plan view; their areas vary widely, but probably average 150 acres. Reef heights increase basin ward from <200 to >600 ft (Fig. 2). Net pay thickness ranges up to 500 ft, but probably averages ˜50 ft for all reef fields. Porosity ranges from about 5% to 15%, averaging ˜8%. Reefs near the shelf margin are pervasively dolomitized, whereas those along the basin ward edge of the reef trend are composed of limestone in which pores may be salt-occluded. Deeper reefs and those in more basin ward locations tend to be gas productive. The reefs are thought to have been charged with oil and gas generated from Niagara and Salina (Upper Silurian) petroleum source rocks within and downdip (basin ward) from the reef fairway. The reefs are sealed laterally and vertically by Salina evaporites and dense carbonates. The primary exploration tool has been the reflection seismograph with use of sophisticated data-processing methods. Exploration geophysicists commonly look for such patterns as localized absence of evaporite reflectors signaling the presence of a carbonate reef mass, velocity effects (pullups), and "drape" of Salina-age layers. Because of the large number of pinnacle-reef fields, their widespread distribution within the well-defined reef trend, and the relatively good quality of production data, the Niagaran pinnacle-reef trend of Northern Michigan is uniquely well suited to statistical analysis. Refs. 2 through 8 provide more detailed geologic information.