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January 30, 2015

Natural Gas Drilling and Its Effect on Property Values: A Municipal Perspective

For years, natural gas drilling was an industrial activity that was commonplace in many parts of rural Texas; however, with the advent of natural gas drilling in the Barnett Shale in the Dallas-Fort Worth region of North Texas, gas wells and associated facilities have steadily encroached on both urban and suburban areas, often leading to vocal demands by residents that local government protect them from the sometimes hazardous effects of natural gas drilling. Indeed, in the last several years, serious concerns have been raised by residents that gas drilling is unsafe, with benzene and carbon disulfide being poured into the air, cancer clusters appearing in residential subdivisions located nearby gas well pad sites, and unhealthy air quality resulting from such drilling. These concerns have been compounded by fears that the State of Texas is doing little or nothing to address these issues, citing a lack of manpower to monitor thousands of well sites around the state. Cities around the state have recently completed or are in the process of reviewing existing natural gas drilling regulations, including Dallas, Fort Worth, Denton, Flower Mound, Southlake, and Arlington. Further, at the November 4, 2014, election, the residents of Denton overwhelmingly adopted a ban on hydraulic fracturing in the city. On the morning of November 5, two lawsuits were filed against the city, even though the tracking ban will not become effective until early December. The purpose of this article is to provide a brief overview of federal and Texas takings law and, in light of such, discuss how municipalities can use property valuation as a means of supporting municipal drilling regulations, specifically focusing on the experience of Flower Mound, Texas, and its determination of drilling setbacks.

Basic Principles of Texas and Federal Takings Law

While a takings analysis of any proposed land use regulation affecting oil and gas interests will turn on the particular facts presented, it is helpful to briefly review the basic concepts underlying current takings jurisprudence under both the federal and Texas Constitutions.

Article I, Section 17 of the Texas Constitution provides that “[n]o person’s property shall be taken, damaged or destroyed for or applied to public use without adequate compensation being made, unless by the consent of such person . . . .” Tex. Const. art. I, § 17. The federal Takings Clause is substantially similar. See U.S. Const. amend. V (“[N]or shall private property be taken for public use, without just compensation”). As a result, the Texas Supreme Court relies on interpretations of the federal Takings Clause in construing the Texas takings provision and analyzes Texas takings claims under the more familiar federal standards. See, e.g., City of Austin v. Travis County Landfill Co., L.L.C., 73 S.W.3d 234, 239 (Tex. 2002) (considering aircraft overflights takings claim, asserted under the Texas Constitution, by reference to federal standard established in United States v. Causby, 328 U.S. 256 (1946)); City of Corpus Christi v. Pub. Util. Comm’n of Texas, 51 S.W.3d 231, 242 (Tex. 2001) (examining federal precedent to decide the framework for determining whether utility charges constitute a taking); Mayhew v. Town of Sunnyvale, 964 S.W.2d 922, 932 (Tex. 1998) (“[W]e assume, without deciding, that the state and federal guarantees in respect to land-use constitutional claims are coextensive, and we will analyze the Mayhews’ claims under the more familiar federal standards.”). Consequently, while this article will use Texas takings cases when available, because of the dearth of modern takings cases that address mining regulations, including oil and gas regulations, substantial reliance on non-Texas cases from federal courts and from other states will be necessary for a full discussion of the issues.

Both the federal and Texas Constitutions recognize a claim for a taking of property. Mayhew, 964 S.W.2d at 933; Agins v. City of Tiburon, 447 U.S. 255, 260 (1980). There are three categories of takings claims: (1) physical occupation, (2) compelled dedications, and (3) regulatory takings. Mayhew, 964 S.W.2d at 933. The United States Supreme Court has determined that the first category, a physical invasion or a regulatory activity that produces a physical invasion, will support a takings claim without regard to the public interest advanced by the regulation or the economic impact on the landowner. See Tahoe-Sierra Preservation Council, Inc. v. Tahoe Regional Planning Agency, 535 U.S. 302, 321–23 (2002); Lucas v. South Carolina Coastal Council, 505 U.S. 1003, 1015 (1992); Loretto v. Teleprompter Manhattan CATV Corp., 458 U.S. 419, 435–40 (1982). See also Mayhew, 964 S.W.2d at 933 (recognizing physical takings as a takings category).

The second category of takings claims is found when a required dedication of land is made a condition of development approval. See City of Monterey v. Del Monte Dunes at Monterey, Ltd., 526 U.S. 687, 704 (1999); Dolan v. City of Tigard, 512 U.S. 374, 391 (1994); Nollan v. California Coastal Comm’n, 483 U.S. 825, 836 (1987).

The third category of takings claims—regulatory takings—encompasses the majority of takings cases and involves the most complex analysis. See Mayhew, 964 S.W.2d at 933 (recognizing regulatory takings as a category of takings claim). Within the context of regulatory takings, the United States Supreme Court has recognized a categorical rule in which a regulation itself “denies all economically beneficial or productive use of land,” finding that such regulation requires compensation without “case-specific inquiry into the public interest advanced in support of the restraint.” Lucas, 505 U.S. at 1015–16. The Texas Supreme Court also recognized this rule in Mayhew, when it held that a compensable taking occurs when a governmental restriction “denies the landowner all economically viable use of the property or totally destroys the value of the property. . . .” 964 S.W.2d at 935.

When a regulatory takings claim does not render property valueless, however, a taking may still result after evaluation of the three factors promulgated in Penn Central Transp. Co. v. City of New York, 438 U.S. 104 (1978). Those factors are (1) the character of the governmental action, (2) the economic impact of the regulation on the claimant, and (3) the extent to which the regulation has interfered with distinct investment-backed expectations. Lucas, 505 U.S. at 1016–20; Penn Central, 438 U.S. at 122. The United States Supreme Court consistently has reaffirmed the viability of the Penn Central standards. See Tahoe-Sierra, 535 U.S. at 321 (“[W]e conclude that the circumstances in this case [determining whether a 32-month moratorium is a taking] are best analyzed within the Penn Central framework.”); Palazzolo v. Rhode Island, 533 U.S. 606, 617 (2001) (“Where a regulation places limitations on land that fall short of eliminating all economically beneficial use, a taking nonetheless may have occurred, depending on a complex of factors including the regulation’s economic effect on the landowner, the extent to which the regulation interferes with reasonable investment-backed expectations, and the character of the government action.”).

Texas courts have adopted the Penn Central analytical framework. See City of Houston v. Trail Enterprises, Inc., 377 S.W.3d 873 (Tex. App. 2012) (pet. denied). In the latest chapter of this long-running battle between the City of Houston and landowners who were prohibited from drilling additional oil and gas wells on land in the area of Lake Houston, the court of appeals reversed and rendered in favor of the city, negating a $17 million takings verdict. After four appellate opinions (Trail Enters., Inc. v. City of Houston, 957 S.W.2d 625, 633 (Tex. App. 1997), writ denied; Trail Enters., Inc. v. City of Houston, No 14-01-00441-CV, 2002 WL 389448 (Tex. App. Mar. 14, 2002), no pet. (not designated for publication); Trail Enters., Inc. v. City of Houston, 255 S.W.3d 105 (Tex. App. 2007); City of Houston v. Trail Enters., Inc., 300 S.W.3d 736 (Tex. 2009)), the trial court was finally able to try the case on the merits, finding that a taking valued at $17 million had occurred.

In reversing the trial court judgment, the court of appeals used Sheffield Development Co., Inc. v. City of Glenn Heights, Texas, 140 S.W.3d 660 (Tex. 2004), as its guide, calling it the “seminal case in Texas on” whether a taking has occurred. Trail Enterprises, 377 S.W.3d at 878. After noting that all economic value had not been taken, given that there were existing wells on the land that were still allowed to operate, the court turned to the three Sheffield/Penn Central factors. Id. at 878–79. The court first reviewed the character of the governmental action involved, finding that the protection of drinking water was an important goal that was furthered by the drilling ban and that this factor favored the ban. Id. at 880 (“Given the importance of protecting the community’s drinking water and possible pollution from new drilling near Lake Houston, we conclude that the first factor weighs heavily in favor of the City and against a finding of a compensable taking.”).

In reviewing the reasonable investment-backed expectations, the court noted that the landowners invested in the land after the drilling ban went into effect and with full knowledge of the ban. Id. at 881–82. The landowners argued that mineral interests are different because the only use that can be made of a mineral estate is extraction of the minerals. Id. at 882–83. The court held that the landowners misunderstood the nature of protected investment-backed expectations and that mineral interests were entitled to no special protection under takings law.

If appellees’ argument were correct, a person could entitle him or herself to compensation by obtaining a mineral interest in any property, even for a nominal sum, where extraction of the minerals was prohibited. This is not the case. By definition, the purpose of the investment-backed expectation requirement is to assess whether the landowner has taken legitimate risks with the reasonable expectation of being able to use the property, which, in fairness and justice, would entitled him or her to compensation. . . . This is true regardless of the nature of the property interest owned.

Where, as here, landowners have failed to demonstrate that investments were made (i.e., put at risk) in the property with the reasonable expectation that new wells could be drilled, concepts of fairness and justice do not militate in favor of compensation. Most, if not all, of appellees’ evidence of investment pertains to periods of time during which new drilling was prohibited by ordinance. Under Sheffield, Mayhew, and the similar cases discussed above, such investment does not relate to reasonable expectations of a recovery beyond that from the existing wells. The second factor heavily favors the City.

Id. at 883 (citations omitted).

Finally, the court looked at the economic impact factor. The court noted that a diminution in value of $17 million was a significant economic impact and assumed this finding was correct even though the city contended that the impact was not that great. Id. at 883–84. The reason the court assumed this factor to be correct, and found that “this factor necessarily favors the [landowners],” is because when weighed against the other two factors, the court found a taking was lacking. As concluded by the court:

Of the three Penn Central factors, the first two, concerning the nature of the governmental action and the investment-backed expectations of the property owners, weigh quite heavily in favor of the City. As discussed, protection of a water source from pollution is a primary governmental function, and appellees demonstrated minimal, if any, reasonable and distinct investment-backed expectations. The third factor, concerning the economic impact of the regulation on the property owner, weighs in favor of appellees. Even if the City is correct that appellees were not completely restricted from drilling new wells to access the minerals, appellees established a significant economic impact. However, given the degree to which the first two factors favor the City, we do not find the weight of the third factor sufficient to demonstrate that a compensable taking has occurred under Penn Central and Sheffield. . . . With substantial government interests at stake and minimal-to-no investment-backed expectations, justice and fairness do not require compensation in this case.

Id. at 884–85 (citations omitted). What is the significance of the Penn Central factors and property values? While property values for landowners adjacent to drilling pad sites are usually not the only reason underlying drilling setbacks, they may be one more arrow in the municipal quiver justifying the drilling setback.

Gas Drilling Setbacks for Natural Gas Wells and Property Values

Although most, if not all, North Texas municipal gas drilling ordinances contain detailed provisions about insurance coverage, application requirements and fees, emergency notification procedures, landscape screening and buffering requirements, and on-site signage and fencing, among other technical requirements, several issues are far more controversial and vary greatly from city-to-city. Without a doubt, though, distance setbacks are the most controversial aspect of natural gas drilling in urban and suburban areas. Drilling setbacks, like zoning setbacks, are the distance from which drilling activity is set back from a place that is deemed to need protection, such as a residential dwelling, a school, a hospital, or a park. The primary goal of setbacks is to protect adjacent property from potential injury and property damage.

In the Barnett Shale, early municipal gas drilling ordinances generally contained setbacks in the 300–600 foot range.1 For example, several cities adopted 600 foot setbacks from a wellhead to a residence or other habitable structure, with distance setback variances down to 300 or 400 feet. With greater public concern about the potential health effects of natural gas drilling, many municipal ordinances across the region underwent substantial revisions during the last several years, for example, with distance setback measurements being made not from the wellhead but from the edge of the pad site, and not from the pad site edge to a residence or other habitable structure, but to the property line of the residence or habitable structure. Moreover, in many instances, distance setbacks simply were increased. In one North Texas city, Flower Mound, the setback from the edge of a pad site to a habitable structure was increased to 1,500 feet, with a variance only down to 25% of the setback distance (or 1,125 feet).2 Public concern about setbacks often has been critical, with allegations that setbacks are either too close (resulting in concerns about the public health aspects of nearby natural gas drilling) or too far (resulting in concerns whether such setbacks deprive mineral estate owners of the ability to realize their investments in their property). Besides unconstitutional takings concerns, scientific studies about the effects of natural gas drilling—studies related to air quality concerns, toxins, and groundwater and surface water pollution, among others—enter into the picture and often are the subject of intense public debate about the perceived validity (or invalidity) of the scientific studies.3 The general trend in the Barnett Shale over the last few years has been to increase setbacks rather than reduce setbacks; nonetheless, perhaps no single issue is more controversial.

Another key issue associated with setbacks is the legally permitted variance distance. The experience of at least one Barnett Shale municipality is that whatever the designated well setback distance may be, the overwhelming majority of gas drilling applications request distance setback (and occasionally other) variances. In Flower Mound, Texas, for example, the historical data is as follows:

Total Number of Pad Sites Applied for:22

Total Number of Pad Sites Approved:19

Pad Sites Requiring Variances:154

Thus, almost 80% of the pad sites approved in Flower Mound, Texas, since the inception of its gas drilling ordinance in 2003, obtained some sort of variance, the overwhelming majority of which were distance setback variances. Therefore, based on observations of many Dallas/Fort Worth metroplex cities, it is reasonable to anticipate that practically every application to drill for natural gas will contain a distance setback variance request. As the foregoing reflects, the minimum permitted setback variance that is allowed by ordinance in all likelihood will become the standard for operators, thereby ensuring that almost every operator will request a distance setback variance down to (or close to) the minimum distance allowed.

In fighting a potential takings claim—particularly where drilling setbacks are challenged as constituting an unconstitutional taking—using land value information may buttress a local government’s defense. As noted previously, while many factors can be considered by a local government in adopting a gas drilling ordinance (effect of drilling on public health and safety, blast zones, toxic spills, air pollution and emissions, and so on),5 the impact of natural gas drilling on residential property values also should be considered in determining appropriate distance setbacks. Although the data on this issue is scant, two studies in the Barnett Shale have reached opposite conclusions about the residential property value impact, if any, as a result of proximity of residential structures to natural gas well sites.

In August 2009 Integra Realty Resources (“Integra”) prepared for the Town of Flower Mound a Well Site Impact Study (“Study”). The objective of the Study was “to develop an opinion of the impact, if any, of the proximity of improved residential properties as a result of their proximity to natural gas well sites.” The Study concluded, in general, “that in the Flower Mound area, when houses are immediately adjacent to well sites there is a measurable impact of value. As distance from the well site increases, this affect quickly diminishes.” (Emphasis in original.) The 2009 Integra Study further concluded that residential property with price points over $250,000 and immediately adjacent to well sites can experience an impact from -3% to -14% in value based on the sales comparison method. Any influence on property values on a linear basis was found to dissipate at around 1,000 feet from the wellhead. The range in property value decline found in price-distance relationships was observed to be about -2% to -7%. Impact on housing prices by the price­-distance method generally dissipated between 1,000 and 1,500 feet. This data suggests that gas drilling has an impact on nearby residential property values, and consequently, if through the variance process gas drilling is permitted closer to residential properties, the greater the potential for the reduction of property values. A copy of the Integra Study Summary can found at http://www.americanbar.org/publications/state_local_law_news/2014-15/winter/integra_summary.html.

A study by Integra conducted for the City of Arlington, Texas, in 2009–10 concluded, however, that

[t]he preponderance of evidence suggests that there is little or no impact on residential property as a result of near proximity to well sites. Minimal measurable impact was found to residential properties that adjoin well sites. Anecdotal evidence also suggests that high-end housing also may be impacted by the proximity to well sites but insufficient data was available to extract quantifiable affects. Lastly, any damages that may accrue to residential property appear to dissipate over time as drilling activity subsides at a well site.6

It should be noted, however, that there certainly may be a correlation between natural gas drilling and the impact on nearby residential property values. In addition, as residential sales data becomes more mature, the effect of natural gas drilling operations on residential property values may become more reliable. Thus, if through the setback variance process gas drilling is permitted closer to residential properties, it appears that there may be greater potential for the reduction of nearby residential property values. A reduction of nearby or neighboring property values clearly is emotionally charged.

Conclusion

The key issue in municipal regulation of natural gas drilling usually revolves around drilling setbacks—is the drilling setback distance too large, perhaps resulting in an unconstitutional taking of property? Should a gas well pad site be authorized to locate within 500 feet of a single family residence, 1,000 feet, 1,500 feet, or more? While the answer may not be the same in every locality, using property value data in determining the appropriate drilling setback will assist a local government in defending any takings litigation that may ensue.

Endnotes

1. Prior to December 2013, the City of Dallas only required a 300-foot setback from a well bore to any institutional or community service use, recreation use (except when the operation site is in a public park), or residential use, with lower setbacks for freshwater wells (200 feet from well bore), right-of-way (75 feet from well bore), and property lines, storage tanks, or any source of ignition (25 feet from well bore). See Dallas, Texas, Code of Ordinances § 51A-4.203(b)(3.2)(E)(iv)(aa)–(ee)(now repealed).

2. See Flower Mound, Texas, Code of Ordinances § 34-422(d).

3. For example, in March 2012 the University of Colorado Denver School of Public Health issued a report that air pollution caused by hydraulic fracturing may contribute to acute and chronic health problems for those individuals who live near gas drilling sites. “Our results show that the non-cancer health impacts from air emissions due to natural gas development is greater for residents living closer to wells,” the report said. “The greatest health impact corresponds to the relatively short-term, but high emission, well completion period. . . . We also calculated higher cancer risks for residents living nearer to the wells as compared to those residing further [away],” according to the report. “Benzene is the major contributor to lifetime excess cancer risk from both scenarios.” See University of Colorado Denver News Release, “Study Shows Air Emissions Near Fracking Sites May Pose Health Risk,” dated March 19, 2012, quoting Lisa McKenzie, lead author. The news release may be found on-line at http://www.ucdenver.edu/about/newsroom/newsreleases/Pages/health-impacts-of-fracking-emissions.aspx. While it was not my purpose to review and critique scientific studies on the topic, at an absolute minimum it is clear and undisputed that scholars and scientists in this area of study often strongly disagree about the human health effects of natural gas drilling and hydraulic fracturing.

4. Information provided by the Town of Flower Mound, Texas, Environmental Services Division.

5. For example, the 2011 oil and natural gas drilling ordinance adopted by Flower Mound, Texas, listed in great detail the bases for selecting a 1,500-foot residential setback. Those bases included property values, air quality issues, the EPA’s concerns about hydraulic fracturing activities and drinking water, soil contamination, federal government infrastructure concerns, insurance issues, and the impacts of drilling relative to the municipal comprehensive plan. A copy of the 2011 Flower Mound oil and natural gas well drilling and operations ordinance may be viewed at http://www.flower-mound.com/DocumentCenter/View/7148.

6. I would note, however, that in my “off line” conversations with Arlington officials, because of the proliferation of well sites and compression facilities in Arlington, several believe that a current study of property values indeed would reflect that gas drilling activities impact adjacent property values.