Unitization and Pooling

Association of Lease and Title Analysts
April 22, 2013
Houston, Texas
Unitization and Pooling
Lucas LaVoy
Rebecca Seidl
● “Unit” is one of the most confusing terms in oil
& gas
● Can mean many different things
● Used interchangeably without explanation
● We will try to cover as many types of units as
we can, explain where they came from, and how
they differ
● Why do we care?
2
What is a “Unit”?
3
What is a “Unit”?
►
Merriam-Webster:
− “a single thing, person, or group that is a
constituent of a whole”
− “an amount of a biologically active agent (as a
drug or antigen) required to produce a specific
result”
4
“Unit”
►
Urbandictionary.com:
5
“Unit”
►
Urbandictionary.com:
*(these definitions were neither relevant nor appropriate)
6
“Unit”
►
Urbandictionary.com:
*(these definitions were neither relevant nor appropriate)
►
Collinsdictionary.com:
− “a complete system, apparatus, or establishment
that performs a specific function”
7
The Rule of Capture
Westmoreland & Cambria Natural Gas Co. v.
Dewitt, 18 A. 724
“[O]il, and still more strongly gas, may be
classed by themselves, if the analogy be not too
fanciful, as minerals ferae naturae. In common
with animals, and unlike other minerals, they
have the power and the tendency to escape
without the volition of the owner. Their fugitive
and wandering existence within the limits of a
particular tract is uncertain.… They belong to
the owner of the land, and are part of it, so long
as they are on or in it, and are subject to his
control; but when they escape, and go into
other land, or come under another's control, the
title of the former owner is gone.… If an
adjoining, or even a distant, owner, drills his
own land, and taps your gas, so that it comes
into his well and under his control, it is no
longer yours, but his.”
-Justice Mitchell, Pennsylvania Supreme Court, 1889
8
The Rule of Capture
• Actually developed from the
English law relating to ownership
of wild animals
• Rule of capture states you may
extract as much as you want
(except for waste)
• You may drain your neighbor
without liability
• Creates the incentive to drill as
much and as quickly as possible
• Each party will seek to extract
maximum production quickly for
fear of drainage
9
…and predictable results ensue
10
…and predictable results ensue
11
Boiler Avenue, Spindletop 1903
12
The Rule of Capture
13
…and predictable results ensue
● Rampant wasteful drilling led to damage to reservoirs
and precipitous price drops
● Particularly prominent in the East Texas Field, where
production reached 1.1 million barrels in 24 hours on
May 1, 1933.
● Prices hit $0.10/bbl.
● Railroad Commission attempted to limit production, but
had limited power at the time
● Operators ignored the limits and filed numerous
lawsuits against the RRC, tying its hands
14
● This led to significant public and political pressure to
effectively regulate waste.
● In April of that year, the Texas House passed a bill to
create a stronger commission to regulate oil and gas
● Independent operators and their allies fiercly opposed
this, even leading to fistfight in the Capitol building
between representatives Burns (opposing) and Roeser
(supporting)
● Burns lost the fistfight but won the debate; the bill
failed in the Texas Senate.
15
Conservation Regulation
● Two main regulatory concepts emerged from this
period:
►
Density
►
Proration
● RRC gained jurisdiction over oil & gas in 1919,
and promulgated 38 original rules
● To address the crowding of wells and waste due to
close spacing, RRC promulgated Rule 37:
►
The very first spacing rule required only 150 feet to a lease line,
and only 300 feet to the nearest well
16
Drilling Units
● This spacing limitation led to what we now know as
Drilling Units
● Also known as the spacing unit
● Shows the RRC that there is sufficient unassigned
acreage to satisfy the density rule for the field
● Could be special field rules for density, or statewide
rules for density
17
Drilling Units
● Filed with the W-1 application for permit to drill
18
Drilling Units
• Plat to be attached for
permit
• Describes unit on the
ground
• But…
19
Drilling Units
• In Texas this 40 acre
Drilling Unit has:
• Zero effect on title
• Zero effect on royalty
allocation
• Zero effect on well
participation
• Zero effect on lease
maintenance
• Purely regulatory
concept
20
Drilling Units
To re-cap:
• Drilling Unit is the result
of the density
regulations
• Avoids packed wells
• Does not, by itself, affect
the quantity of oil that
may be produced from
any given well
21
Meanwhile, back in 1933 …
22
Limitations on Production
● Spacing and density rules (Rules 37 and 38 in Texas)
alone were not working
● They remained difficult to enforce, many exceptions
● Many tracts were so small they would be un-drillable
23
Limitations on Production
● Small Operators
objected, in court &
in the legislature
● Wanted equal
access to the
reservoir,
regardless of
acreage
● Commission
granted thousands
of exceptions,
hoping to avoid a
showdown
24
Limitations on Production
● One Texas example was the Hendrick field in Winkler
County
● So many spacing exceptions granted that the field
began to water out and price plummeted
● 17,000 of the 24,269 wells in the East Texas Field drilled
before 1938 were exception wells
● $100,000,000 per year wasted on drilling unnecessary
wells
● Needed a second component to regulation
25
Limitations on Production
● Texas has used different systems for limiting overall
production of oil and gas
● One concept is Maximum Efficient Rate of production.
►
MER is the maximum rate a particular oilfield will produce that
will not damage the field
►
Used where there is high demand for certain field production.
►
E.g., during WWII, or the 1970’s energy crisis
►
Under MER, a field receives a maximum field-wide allowable,
which is then distributed to the wells based on various formulae
(i.e., it is “prorated” among the wells)
26
Limitations on Production
● The second production limitation concept is “Market
Demand” prorationing
● This is used when there is not a supply crisis
● Looks at the market demand for oil & gas and attempts
to provide price stability
● Since 1973, market demand factor has been set at 100%
● This means that most fields may produce at 100% of
their maximum allowable
27
Proration Rules
● Wells within a field have a limit on how much they may
produce (their “allowable”)
● The “proration unit” is the acreage assigned to a well
for determining the well’s production allowable (Rule
38(a)(3)).
● Some field rules allocate production based on
productive surface acres
● Some fields allocable allowables based only on well
deliverability and/or well count. There are less-common
variants as well.
28
Proration Rules
● Interestingly, for virtually all fields in Texas, gas
allowables are all suspended. Therefore, no proration
units for gas
● If there are no applicable field rules, and Statewide
Rules apply, proration units are unnecessary
►
Instead, Rule 45 allocates production based on a “yardstick” according
to the depth of the reservoir
● Furthermore, if the field rules use deliverability, well
count, or something other than acreage for the oil
allowable, proration units are unnecessary
29
Proration Units
● IF the field uses
productive acreage
allocation, then
acreage is assigned to
a well’s proration unit
on the form P-15
● Accompanied by a
certification that the
acreage claimed is
productive
30
Proration Units
This 40-acre proration
unit:
● May be different land
than the drilling unit
● Has zero effect on title
● Has zero effect on
allocation of royalties
31
Proration Units
Potential for confusion:
● Contracting parties
may use “proration
unit” to describe land
● Even where there is no
acreage allocation for
allowables, and hence
no proration unit
32
Pooled Units
● Back to the small
tract problem
● None of these tracts
large enough to drill
a well under 40-acre
spacing
33
Pooled Units
● Operator files a P-12
with RRC, designating
all 4 lease tracts as a
pooled unit
● Now the Operator has
40 acres on which to
drill the well
● Operator can also
assign 40 acres to the
well to get the allowable
34
Pooled Units
If operator does nothing
more than file this P-12:
● Operator has enough
acreage to drill on
the 40-acre “pooled
unit”
● The well is on
Baker’s tract
Able Lease
Baker Lease
● Baker gets his
royalty share of 100%
of production
Charlie Lease
Dog Lease
35
Pooled Units
If operator does nothing
more than file this P-12:
● Able, Charlie and
Dog get nothing
● No well can be drilled
on Able, Charlie or
Dog tracts
Able Lease
Baker Lease
● Not enough acreage
remains
Charlie Lease
Dog Lease
36
Pooled Units
If operator does nothing
more than file this P-12:
● But, assume all 4
primary terms end on
the same day
At end of primary terms:
Able Lease
Baker Lease
● Baker has
production, so his
lease is HBP
Charlie Lease
Dog Lease
37
Pooled Units
If operator does nothing
more than file this P-12:
● But, assume all 4
primary terms end on
the same day
At end of primary terms:
Able Lease
Baker Lease
● Baker has
production, so his
lease is HBP
● Able, Charlie and
Dog Leases
terminate for no
production
Charlie Lease
Dog Lease
38
Pooled Units
● Filing the P-12 does not, by itself, affect title
● RRC normally has no jurisdiction over title or
property rights
● Filing the P-12 does not allocate royalties
among the separate tracts
39
Pooled Units
● The “Pooled Units” we all know and love are
created by contract
►
(i.e., by the oil & gas lease)
● The pooling clause in the Leases would have
allowed:
►
Able, Charlie and Dog to share in production, and
►
That production would have been “deemed” to
have occurred on all their tracts, making them HBP
40
Pooled Units
● Example:
►
…Lessee, at its option, is hereby given the right and power to pool
or combine the acreage covered by this lease or any portion thereof
as to oil and gas, or either of them, with … any other land, lease or
leases in the immediate vicinity.…
►
…Lessee shall file for record in the appropriate records of the
county in which the leased premises are situated an instrument
describing and designating the pooled acreage as a pooled unit…
►
…In the event of operations for drilling on or production of oil or
gas from any part of a pooled unit which includes all or a portion of
the land covered by this lease …. such operations shall be
considered as operations for drilling on or production of oil or gas
from land covered by this lease whether or not the well or wells be
located on the premises covered by this lease…
41
Pooled Units
● Traditionally, the tracts
participate in
production from the
well proportionate to
their acreage
● Royalty owners get
paid on the basis of
their tract participation
in the pooled unit
● Production from Baker
now holds Able,
Charlie and Dog
Leases
25%
Able Lease
25%
Baker Lease
25%
Charlie Lease
25%
Dog Lease
42
Pooled Units
● Alternative tract participation formulas now
becoming common
● Particularly for horizontal development and
in leases with sophisticated landowners
● Often there are restrictions on the ability to
pool:
►
Example: If my tract is pooled with other tracts, at
least 50% of the resulting pooled unit must be my
lands.
43
The Same Unit
• A pooled unit
may also be the
same land as a
drilling unit and
a proration unit
• The plat looks
identical for each
• They do not have
to be the same
land
44
Differences between the units
For example:
Operator has four
adjacent leases
This field has 40acre spacing
Field has 80-acre
proration units
45
Differences between the units
Operator drills a
well on the 40 acre
lease
40 acre drilling unit
No pooling is
needed
46
Differences between the units
Operator wants the
larger allowable,
so files an 80 acre
proration unit,
using the 3 west
leases
47
Differences between the units
Operator wants
to hold more
acreage, so
creates a 160acre pooled unit
● Files the P-12
● Files in the
County
Courthouse
48
Pugh Clause
● The Pugh Clause
modifies the
pooling clause
3,000 acre lease
● Provides that
operations or
production from
the pooled unit will
not preserve the
whole lease
500 acre Gas
Unit (pooled)
49
Pugh Clause
● In other words,
such operations or
production will
only preserve that
portion of the
lease which
covers land in the
pooled unit
3,000 acre lease
200 acres
HBP
500 acre Gas
Unit (pooled)
50
Pugh Clause
• Severs the
unpooled acreage
from the pooled
acreage
200 acres
HBP
• To keep the lease
in force on the
unpooled acreage,
the lessee must
pay delay rentals
or drill a well
• Can be vertical or
horizontal
500 acre Gas
Unit (pooled)
51
Quiz:
● Which of these is the Pugh Clause?
►
A: “…if, after the expiration of the primary term, Lessee fails to
conduct drilling operations for more than 180 days between the
completion of one well and the spudding of the next well … this
Lease shall terminate except as to a Unit being the number of
acres surrounding each producing well required to obtain the
full monthly production allowable…”
►
B: “…each horizontal well producing on the leased premises, or
on lands pooled or unitized therewith, shall hold only the acres
out of this lease (or such pooled or unitized acreage) … as is
located within a rectangle measured 500 feet on each side of the
horizontal wellbore within the correlative interval and 500 feet
from the penetration point and terminus of such wellbore in a
direction perpendicular to the path of the well...”
52
Answer:
● None of the above
● These are “Continuous Development / Released
Acreage” Clauses.
● These clauses require sequential drilling operations to
keep the lease alive after the primary term (“Continuous
Development”)
● The units around the producing wells, that survive the
expiration of the primary term and the end of
Continuous Development, are the “Production Units”
53
Continuous Development/Released Acreage
● The lessee should
have a reasonable
time to develop the
leased premises
3,000 acre lease
500 acre Gas
Unit (pooled)
54
Continuous Development/Released Acreage
● Designate a
specified tract (a
"production unit")
around each well
then producing on
the leased premises
480 acre
Production Unit
500 acre Gas
Unit (pooled)
55
Continuous Development/Released Acreage
• One 480 acre
Production Unit HBP
480 acre
Production Unit
• A Second Unit
consisting of
Acreage HBP from
the Pooled Unit
Acreage HBP
500 acre Gas
Unit (pooled)
56
Continuous Development Continued
● After the designation of production units,
production from each production unit will maintain
the lease in effect only as to the lands included
within that production unit.
● In effect, each production unit becomes a separate
lease for lease maintenance purposes.
57
Possible Problems
● Take care to be clear when referring to any unit:
what type of unit are you really talking about?
● For example: Oil & Gas Lease
►
“At the expiration of the primary term this lease shall
terminate except for the acreage within the proration
unit for each well then producing oil or gas”
►
If these are oil wells, and there is no acreage
allocation in the field rules for oil, arguably the lease
is terminated except for the producing wellbores
58
Possible Problems
● Net Profits Interest Conveyance:
►
“The Net Profits Interest shall cover and apply to the
Subject Wells, and also to the acreage within the unit
for each such Subject Well.”
● Farmout Agreement:
►
“…If Farmee should drill and complete a producing
well … Farmee shall earn the acreage out of the lease
associated with such well in the records of the
Railroad Commission of Texas…”
59
Forced Pooled Unit-Texas
• Mineral Interest
Pooling Act
• Precluded in most
major fields (i.e.,
Permian Basin, the
East Texas Field)
• RRC cannot compel
based on its own
motion
Lease A
Lease B
Lease E
• Fair & Reasonable
Offer
• Muscle-in Provision
Lease C
Lease D
60
In Oklahoma…
• Favors forced pooling
• Represents the
Majority View
• Pool all of the interests
in the drilling unit
• Name one of the
interest owners as
operator
Lease A
• Three options:
Participate, Be Carried
with Penalty or Lease
Lease B
Lease E
Lease C
Lease D
61
Unitization
● “Unitization” refers to a slightly different
concept than pooling
● Both involve combined multiple tracts to be
operated together
● Pooling is about complying with density
regulations and assigning acreage for
allowables
● Unitization is about operating a common
source of supply, for maximum efficiency
62
Unitization
● Here, the entire field can become the Unit,
sometimes thousands of acres
● Many states allow parties seek compulsory
unitization where they can show it will benefit
the field
● Texas is the only major producing state that
does not allow this. Texas Units are voluntary
63
Secondary Recovery Units
● Today, units (in Texas) are encountered in
fields for secondary recovery operations
64
Secondary Recovery Units
● Generally the parties will enter into a Unit
Agreement (including the royalty owners)
● Provides for the sharing of costs and allocating
production to various unit tracts
● May designate one party to operate the new
Unit, or may provide for coordinated operations
● Approval of the Unit provides for immunity to
some tort actions
65
Secondary Recovery Units
● There will be an approval process at the RRC, usually
not contested (normally a large majority of
stakeholders sign the agreement)
● An approved Unit provides for limited immunity to
antitrust actions
66
Secondary Recovery Units
● Usually the Unit Agreement will provide that all leases in the unit
will be HBP from production anywhere in the Unit.
● Usually provides for specified participation factors for the
individual tracts in the unit
● These may be acreage based, but likely will take into account
geological advantages as well
● RRC approval of the Unit does NOT bind stakeholders (WI owners
or royalty owners) that have not signed it
►
Those parties may still sue for tort damages, although their burden of
proof will be more difficult
►
These parties’ leases are not kept alive by Unit production
67
Federal Units
● Where a large portion of the lands for a reservoir are
federally owned lands, a federal unit is often used
● Most important type of federal unit is the Exploratory
Unit
● Can be huge (20,000+ acres)
● Administered by various federal agencies (often the
BLM)
68
Federal Units
● A federal exploratory unit is a contract between the United States
and participating parties for joint exploration and development
● There is a statutory form of unit agreement
● The federal agency (varies by jurisdiction) will generally require
some large majority of interest owners agree to the proposal,
before the agency will approve it
● Provides for lease maintenance by unit operations/production,
although terms are considerably more complex than private unit
agreements
● Usually there will be a Unit Operating Agreement as well,
negotiated separately
69
ANY QUESTIONS?
70
ANY QUESTIONS?
[email protected]
[email protected]
www.tklaw.com
71