Unitization and Pooling

Unitization and Pooling

Association of Lease and Title Analysts April 22, 2013

●

“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

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”

“Unit”

► Urbandictionary.com:

“Unit”

► Urbandictionary.com:

“Unit”

► Urbandictionary.com:

*(these definitions were neither relevant nor appropriate)

► Collinsdictionary.com:

− “a complete system, apparatus, or establishment that performs a specific function”

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.”

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

● 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

● 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)

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

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

Drilling Units

Drilling Units

• Plat to be attached for

permit

• Describes unit on the

ground

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

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

Limitations on Production

● Spacing and density rules (Rules 37 and 38 in Texas) alone were not working

● They remained difficult to enforce, many exceptions

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

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

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)

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%

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.

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

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

Proration Units

unit:

● May be different land than the drilling unit

● Has zero effect on title

● Has zero effect on

Proration Units

● Contracting parties may use “proration unit” to describe land

● Even where there is no acreage allocation for allowables, and hence no proration unit

Pooled Units

●

Back to the small

tract problem

●

None of these tracts

large enough to drill

a well under 40-acre

spacing

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

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

● Baker gets his

royalty share of 100%

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

● Not enough acreage

remains

Able Lease Baker Lease

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:

● Baker has

production, so his lease is HBP

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:

● Baker has

production, so his lease is HBP

● Able, Charlie and

Dog Leases

terminate for no production

Able Lease Baker Lease

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

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

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

Pooled Units

Able Lease Baker Lease

Charlie Lease Dog Lease

● 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% 25%

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:

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

Differences between the units

Operator has four adjacent leases This field has 40-acre spacing

Field has 80-acre proration units

Differences between the units

well on the 40 acre lease

No pooling is needed

Differences between the units

larger allowable, so files an 80 acre proration unit,

using the 3 west leases

Differences between the units

Operator wants

to hold more

acreage, so

creates a

160-acre pooled unit

●

Files the P-12

●

Files in the

County

Pugh Clause

● The Pugh Clause modifies the

pooling clause

● Provides that operations or production from the pooled unit will not preserve the whole lease

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 500 acre Gas Unit (pooled) 200 acres HBP

Pugh Clause

• Severs the

unpooled acreage from the pooled acreage

• To keep the lease in force on the

unpooled acreage, the lessee must pay delay rentals or drill a well

200 acres HBP

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...”

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/Released Acreage

● The lessee should

have a reasonable time to develop the leased premises

3,000 acre lease

500 acre Gas Unit (pooled)

Continuous Development/Released Acreage

● Designate a

specified tract (a "production unit") around each well then producing on the leased premises

480 acre

Continuous Development/Released Acreage

480 acre

Production Unit

500 acre Gas Unit (pooled)

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.

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

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

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

• Fair & Reasonable Offer

• Muscle-in Provision

Lease A Lease B

Lease C Lease D

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 • Three options: Participate, Be Carried Lease A _{Lease B} Lease E

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

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

Secondary Recovery Units

●

Today, units (in Texas) are encountered in

fields for secondary recovery operations

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

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

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

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)

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

ANY QUESTIONS?

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