September 11, 2018
Author: Stephen R. Brown
Organization: Garlington, Lohn & Robinson, PLLP
Introduction
Pooling and unitization of oil and gas resources is the mechanism used to balance the rights of mineral owners to develop their properties with the need to ensure that development occur in a manner that most efficiently develops the resource.
Pooling also responds to the issue that ownership boundaries of tracts of land often do not match the optimum size of spacing units for well development. This issue has been exacerbated as spacing units have grown in response to recent developments in drilling technology.
Unitization is the process of optimizing the development of a field by combining a number of drilling units, often so the reservoir can be operated optimally. Unitization is common with secondary and tertiary enhanced recovery such as water flooding and other techniques.
Conservation Regulation
Historically oil and gas development was governed by the so-called “rule of capture.” This rule allowed someone who found oil to produce and recover as much as possible, regardless of whether the oil or gas was on the same property as the well, or drained from neighboring property. This led to inefficient development of oil and gas reservoirs.
Over time, states began to regulate production to protect the “correlative rights” of each owner and to prevent “waste” caused by over production. The Montana conservation statute now specifically prohibits the “waste” of oil and gas resources. Mont. Code Ann. § 82-11-121. The term “waste” has a detailed definition in the Montana conservation statute:
(a) \"Waste\" means:
(i) physical waste, as that term is generally understood in the oil and gas industry;
(ii) the inefficient, excessive, or improper use of or the unnecessary dissipation of reservoir energy;
(iii) the location, spacing, drilling, equipping, operating, or producing of any oil or gas well or wells in a manner that causes or tends to cause reduction in the quantity of oil or gas ultimately recoverable from a pool under prudent and proper operations or that causes or tends to cause unnecessary or excessive surface loss or destruction of oil or gas; and
(iv) the inefficient storing of oil or gas.
(b) (i) The production of oil or gas from any pool or by any well to the full extent that the well or pool can be produced in accordance with methods designed to result in maximum ultimate recovery, as determined by the board, is not waste within the meaning of subsection
(21)(a).
(ii) The loss of gas to the atmosphere during coal mining operations is not waste within the meaning of subsection (21)(a).
Mont. Code Ann. § 82-11-101(21).
Correlative rights is a limitation on the absolute rule of capture. Correlative rights imply that every mineral owner has reciprocal obligations to other mineral owners with ownership in the same pool. The reciprocal rights and obligations also protect the public interest in assuring a proper development of oil and gas resources.
Conservation regulations are implemented on a state by state basis. There is no comprehensive federal system of oil and gas conservation. Oil and gas conservation agencies such as the Montana Board of Oil and Gas Conservation Commission use several methods to implement conservation goals. See Chevron Oil Co. v. Oil and Gas Conservation Comm’n, 150 Mont. 351, 435 P.2d 781 (1967); Mont. Code Ann. § 82-11 124 (requirements relating to waste prevention). These include:
- Well spacing
- Allowable production
- Pooling and unitization
Well Spacing
One of the main ways that oil and gas conservation is implemented is by rules that call for well permits and the density and spacing of wells a certain distance apart. Well spacing is concerned with the location of wells and the drilling into a reservoir. Spacing rules are intended to protect correlative rights and prevent waste, especially in areas where there are multiple owners, and limiting the number of wells that can be drilled.
There basically are two types of well spacing rules:
1. Lineal spacing rules - rules that limit the proximity of wells to property lines and to other wells.
2. Density spacing rules - rules that specify the area in which a single well is allowed. For example, one well per 40 acres.
Well spacing can be done both by state-wide order or by individual field and reservoir rules. Admin. R. Mont. 36.22.702 (attached). For example, Montana, the rules limit the number of wells that can be drilled in each legal subdivision. The density of the well spacing varies with depth, and depending on whether oil or gas is being developed. The rules also require setbacks from legal subdivision boundaries.
A drilling permit specifies the location of the well, the maximum depth of the well, and the targeted formation. The Montana rules also require an operator to post a
bond to assure proper plugging and abandonment of wells.
Exceptions to well spacing rules may be granted on a well-by-well basis. Pattie v. Oil & Gas Conservation Comm'n, 145 Mont. 531, 541, 402 P.2d 596, 601 (1965) (“It would be ‘inequitable’ and ‘unjust’ not to allow one to have an exception to the drilling pattern in order to allow that driller to get his share of petroleum-provided, of course, that the exception does not cause waste”).
Units for horizontal wells typically are larger than the default rules. In areas of development with horizontal drilling such as the Bakken, 1,280 acre spacing units are typical. These 1,280-acre spacing units may be described as stand-up, laydown, and sometimes diagonal. A stand-up spacing unit is generally two full adjacent sections oriented north to south. A lay-down spacing unit is comprised of to two full adjacent sections oriented side by side, east to west.
Pooling
Pooling Background
Pooling is the process of bringing together small tracts to allow a well to be drilled within an established drilling unit, either voluntarily or by order from the Board of Oil and Gas. Pooling generally is done to comply with well spacing requirements.
Reasons for Pooling:
- Problems with the rule of capture
o Leads to drilling of wells that are not needed to efficiently develop the reservoir
o Leads to excessive rates of production, which can cause losses of reservoir pressure and other problems.
o Can cause waste as a result of improper practices by operators
- Production limits
o To attempt to achieve maximum efficient rate of recovery (MER)
o Respond to market demand
o Protect correlative rights within a reservoir and prevent net drainage
- Correlative rights – avoids necessity of drilling to protect property rights.
- Prevent waste – economic, underground, and surface waste
- Business efficiency – implement a legitimate plan of development
- Administrative necessity -- to comply with spacing and density rules
- Pooling Options
o Don’t pool and attempt to avoid well spacing requirements by requesting exception locations (which may be difficult), or
o Do not drill
- Types of pooling arrangements
o Voluntary agreement
o Quasi-Voluntary: Lessee may pool lessor’s interest if authorized to do so by a lease pooling clause
o Community lease (not common)
o Compulsory pooling
- Community lease - A single lease covering two or more separately owned tracts of land and signed by all the owners.
o Variations among states:
o Pools owners’ interests as a matter of law.
o Presumptively pools owners’ interests.
o Question of fact as to pooling
Voluntary Pooling – Lease Clauses
Voluntary pooling can occur in several different ways. Under most oil and gas leases, the mineral owner lessor grants to the mineral developer lessee the right to combine tracts to form a “pool.” A pooling clause is one of several “savings” clauses in a lease that potentially prevents an oil and gas lease from expiring at the end of its primary term even though there is no actual production on the leased premises. Pooling clauses may affect royalty because royalty may be reduced in proportion to the mineral owner’s net interest in the entire pooled unit.
Oil and gas lessees do have an implied duty to conduct pooling in good faith.
For example, this may mean that pooling that occurs on the eve of a leasing otherwise expiring could be held to be invalid as bad faith pooling, especially if there are no other rationale reason for pooling. Alexander Production Co. v. Underwood, 558 S.W.2d 509 (Tex. Civ. App. 1977).
A typical lease (edited ) pooling clause looks like this:
Lessee . . . is hereby given the right and power to voluntarily pool or combine the acreage covered by this Lease . . . with other land, lease or leases . . . . Operations for drilling on or production of oil or gas from any part of the pooled unit . . .shall be considered as operations for drilling on or production of oil or gas from the land covered by this Lease. . . . For the purpose of computing the royalties . . .there shall be allocated to the land covered by this Lease and included in said unit a pro rata portion of the oil and gas, or either of them, produced from the pooled unit. . . . Such allocation shall be on an acreage basis. . . .
Royalties hereunder shall be computed on the portion of such production . . .so allocated to the land covered by this Lease and included in the unit just as though such production were from such land.
Should a mineral owner should accept a pooling clause? Often a mineral interest owner presented with a lease will ask that a pooling clause be deleted. Factors to consider in deciding whether to accept a pooling clause include:
- Extent of pooling clause.
- Is the effect of the clause limited by a Pugh clause
- Type of development occurring in relation to size of tracts – will pooling adversely affect royalties?
- Is the tract large enough to develop without pooling?
- Is there a minimum amount of the leased premises that can be put into any pooled unit? (In other words is there a risk that the lease might be held with only a small fraction of the lease premises included in the pooled unit)?
- Risks of being force pooled if clause is not accepted.
Pugh Clause
Lessors who do not want to give lessees the power to tie up all land covered by a lease by pooling only part of the lease commonly request a “Pugh clause” (in some states referred to as a “Freestone Rider). A Pugh clause provides that if only part of the acreage under lease is pooled, the part that is not pooled will not be maintained by production and the pooled and unpooled portions are severed.
A simple example Pugh Clause states:
At the end of the primary term of this Lease, any well or operations relied upon to extend the term of this Lease shall extend the term only as to those lands described in this Lease which are within a spacing unit established by the State of Montana. No formation shall be held beyond the primary term which is greater than 100 feet above or 100 feet below the perforated zone of producing well bore(s) or horizontal leg(s) of a producing well bore.
The purpose of the Pugh clause is to prevent an oil and gas lease from extending beyond the primary term for parcels that are not actually part of a pool. Pugh clauses can take many different forms. In this particular example, there are both vertical and horizontal components to the Pugh clause. The vertical component (limiting it to specific formations) is less common than a horizontal Pugh clause.
Small Tract Problem
- Arises when spacing & density rules require a bigger tract than an owner has
o The state may not “take” without compensation by forbidding a mineral owner from exercising rights to develop
o A state has an obligation to protect correlative rights and prevent waste
- Solutions:
o “Forced” or compulsory pooling
o Exception locations
Forced Pooling
Forced pooling occurs when a conservation agency issues an order pooling tracts and interests within a spacing unit. The agency has the authority to issue the order even though some mineral interest owners within the pooling unit oppose pooling. The general theory is forced pooling furthers the goal of preventing waste of resources and protecting the correlative rights of all the interest owners. Forced pooling allows the Board of Oil and Gas to issue orders that require owners of separately owned tracts within a spaced drilling unit to pool their interests in the underlying deposit and operate as a unit.
Forced pooling statutes compel unleased mineral owners to have their minerals extracted and “pooled” with other mineral tracts. Laws vary by state, but generally drillers are allowed to extract minerals from a large area if leases have been obtained for a certain percentage of that land. Some states also allow the driller to recover an amount greater than expenses from the non-consenting mineral owners as a penalty. Also, if forced pooling is ordered, some states allow drilling to occur anywhere within the drilling unit. About 39 states have forced pooling statutes.
Several requirements must be met in Montana before the Board of Oil and
Gas will approve forced pooling:
- The interests must be contained within a permanent spacing unit.
- The applicant must have an interest.
- The applicant must have made a “good faith attempt to voluntarily pool the interests within the permanent spacing unit.”
- A hearing must occur before the Board.
- The pooling order must include “terms and conditions that are just and reasonable and that afford to the owner of each tract or interest in the permanent spacing unit the opportunity to recover or receive without unnecessary expense a just and equitable share of the oil or gas produced and saved from the spacing unit.”
Mont. Code Ann. 82-11-202(1)(b).
Unitization
- Usually involves the pooling of multiple drilling units—ideally an entire reservoir
- Usually done to facilitate enhanced recovery—secondary or tertiary
- Secondary: water flooding or gas injection (conventional enhanced recovery)
- Tertiary: unconventional
o Generally refers to combining leases and wells over a producing formation for field-wide operations.
o Almost always associated with pressure maintenance or with secondary or tertiary recovery operations.
Fieldwide Unit – Allocation
Most voluntary unitization and compulsory unitization orders provide for participation of all interest owners. These formulas are complicated because the incorporate multiple factors such as number of wells, porosity, acre feet of productive formation, and surface acreage.
Unitization Problems
- Not done early enough, e.g., exploration
- Unable to achieve unitization thresholds
o Debate over best reservoir management
o Debate over cost and production allocations
o Particular unit plan may do more harm than good
Montana Unitization Statute –
Mont. Code Ann. § 82-11-201 et seq.
- Hearing upon petition by 60% of leasehold interests
- Terms must be \"just and reasonable\"
- Plan must be approved by 70% of parties paying costs.
Unitization Obligations
- Lessee may have an implied obligation to unitize to facilitate enhanced recovery
- Lessee or Conservation Agency may have duty to terminate a unit that fails to achieve enhanced recovery
- Correlative rights and waste concerns may arise
Avoiding Liability for Unitization
- Secure participation from all owners
- Absent that:
o Secure a unitization order
o Make a fair participation offer
o Avoid obvious efforts designed to promote drainage of a nonparticipant
o Require adverse claimant to show actual damages to claimants primary recovery operations
Burlington Resources v. Lang
• Lessee may have an implied obligation to unitize to facilitate enhanced recovery
• Lessee or Conservation Agency may have duty to terminate a unit that fails to achieve enhanced recovery
– Correlative rights and waste concerns may arise
• Issues
– Who owns the pore space?
– Can the owner of the pore space stop the mineral owner from using it?
– Does it matter that this is under the unitization statute?
– What are Lang's damages?