Part 2 – Current Allocation Well Issues
It is well settled that an oil and gas lessee’s authority to pool several leases together is derived solely from the terms of the leases, or from a separate pooling agreement. The absence of appropriate pooling authority in a lease can lead to numerous problems, if not outright confrontations, between lessee and landowner.
A striking example of this is currently playing out at the Texas Railroad Commission, revolving around the concept of “allocation well” permits. Generally speaking, the term “allocation well” permit refers to a horizontal well that runs beneath two or more un-pooled tracts, where no production sharing agreement is in place to govern the participation of each tract in the well’s production (or there is a production sharing agreement, but the operator has not successfully signed up 65% of the royalty interest). The Commission has, on a number of occasions, issued drilling permits for such wells, under the reasoning that the Commission was without jurisdiction to determine whether or not the leases permitted the operator to drill without pooling. Such matters have historically been resolved by the courts, and therefore the Commission had for some time decided not to second-guess an operator’s assertion that it had the good faith claim to drill the well (failure to pool notwithstanding). No rule or regulation was ever issued to formalize this practice.
The allocation well issue has clearly been headed for a confrontation, which arrived when EOG
Resources Inc. filed an application to drill the Klotzman (Allocation) #1H well in DeWitt county, Texas. The oil well would have crossed the boundary of two separate tracts, both of which were 100% leased to EOG, and the applicable field rules required at least 80 acres to form a drilling unit for the well. EOG intended to form an 80 acre pooled unit for the well, containing 40 acres out of each tract. The leases, however, did not permit EOG to pool for oil at all. Talks to create appropriate pooling authority failed. Therefore, EOG applied to permit the well as an allocation well. Not only the affected landowners, but the Texas General Land Office and numerous observing mineral owners protested the application.
The parties raised a multitude of arguments, the most important of which is this: Klotzman (the mineral owners) and their aligned parties believe that, regardless of whether the well is called a unit well, allocation well, or anything else, the act of drilling a horizontal well across the boundary to two tracts, or the permitting of such a well (or both), is per se a pooling of these tracts. Therefore, if the leases do not permit the tracts to be pooled, then by definition the leases forbid the operator from drilling the well. If the leases prohibit the well, the Commission must deny the permit because the operator necessarily cannot in good faith claim the authority to drill the well.
EOG and its aligned parties vehemently protested that assertion. EOG cited a litany of prior commission practices, industry expectations, and avoidance of waste, and even invoked the opinion of Professor Ernie Smith. But at the end of the day, the counterargument is (i) running a lateral across two tracts does not per se pool them, and (ii) even if it does, the Railroad Commission has no authority to make that call.
The examiners sided rather dramatically with the mineral owners, stating that “[EOG’s] actions are the definition of pooling,” and further found:
Regardless of how it is denominated, combining a 40-acre tract from the Georgia Dubose-Glassell 516.569-acre lease with a 40-acre tract from the Georgia Dubose-Pierce 304.97-acre lease to form an 80-acre drilling unit for the purpose of drilling a well would be pooling the tracts.”
The examiners further characterized the authority to pool as “a property right retained by [the Klotzmans].” Because the Commission regulations may not cause the transfer of any property rights, the Commission could not grant the permit for the well because it would “strip the Klotzman’s of a property right they still own (pooling authority for oil) and transfer it to EOG.”
The Commissioners have not yet ruled on the examiners’ recommendation, but both operators and mineral owners are focused on this issue. A decision on the jurisdictional grounds rather than the underlying issue is a real possibility. But whatever the outcome at the Commission, further appeals are likely. That being said, the examiners’ recommendation raises a number of interesting issues:
- If the combination of several tracts into a drilling unit is a “pooling” of those tracts, is it pooling for all purposes, or only the limited purpose of permitting the well? The ordinary understanding of “pooling”, for purposes of an oil and gas lease, implies that royalties are shared on (usually) an acreage basis among the several tracts, and operations on one unit tract will hold the other leases in effect. The examiners probably did not mean to say that operations in a drilling unit alone will now maintain a lease as to all tracts in the drilling unit, or the issuance of a drilling permit will now require sharing of royalties within the drilling unit, but these concepts are not clearly distinguished in the proposal for decision. It is unclear what the purpose of “pooling” would be from the lessee’s perspective, absent these items.
- The examiners’ proposal for decision appears to state that a drilling unit is invalid if it assigns acreage, for spacing and/or density purposes, in excess of the pooling authority of the lease. There may be a number of cases where even vertical wells have drilling units that do not correspond exactly with the pooled unit designations filed in county courthouses. The effect of this decision on those cases is also not clear.
- The proposal for decision states that the authority to pool a lease is itself a property interest, rather than contractual right. Texas has long accepted the theory that pooling (in the “courthouse unit” sense) results in a cross-conveyance of interests among the owners of the several unit tracts, but the authority to pool a lease has not previously been described as a separate property interest. The distinction could be important in, for example, the rejection of contracts by bankruptcy trustee, who may have the power to avoid some contract obligations, but generally will not alter pre-petition property rights).
- Consider Browning v. Luecke, which is a well known case dealing with a failed unit for a horizontal well. The Browning court correctly pointed out that a lease is not pooled if the lessee attempts to form a unit but does not comply with the pooling provisions. However, the proposal for decision indicates that such lease would be pooled because it was included in the drilling unit for the horizontal well, making the result for the operator utterly confusing. To paraphrase Schrödinger, the lease would be both pooled and not pooled at the same time. What effect, if any, does this have on the operator’s continued authority to produce the well as far as the Commission is concerned?
Gaye White and Lucas LaVoy, Thompson & Knight LLP
With very limited exceptions under the Mineral Interest Pooling Act.
This could also be a well running between two separate pooled units, or certain other combinations of tracts, but for purposes of this discussion un-pooled tracts are the most relevant.
The facts of this case are recited in the Proposal for Decision issued June 25, 2013 in Oil & Gas Docket No. 02-0278952, Hearings Division, Railroad Commission of Texas.
See Southeastern Pipe Line Co. v. Tichacek, 997, S.W.2d 166, 170 (Tex. 1999) ([t]he primary legal consequence of pooling is that production and operations anywhere on the pooled unit are treated as if they have taken place on each tract within the unit”).
38 S.W.3d 625 (Tex. App.— Austin 2000, pet. denied).