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Allocation Wells: Another Take[point]

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Allocation Wells: Another Take[point]

For over one hundred years, traditional vertical wells have been producing oil and gas across the country. However, as technology has advanced, horizontal wells have become a more profitable way to produce oil and gas from the maximum acreage allowed. What happens when an operator wants to drill a modern, horizontal well, thousands of feet long, under lands covered by old leases, without a pooling provision, without a separate pooling agreement, or when the lease expressly prohibits pooling under certain conditions? In this introduction to allocation wells, we breakdown the different types of horizontal wells, and the current guidance regarding to process of drilling an allocation well, and the related underlying production sharing agreements.

Transcript

- In 1866 Lynn T. Barrett completed the first Texas oil well, after drilling down 106 feet in an east Texas area, appropriately known as Oil Springs. Production came in at a measly 10 barrels per day, but the discovery had been made. Nearly 50 years later, Spindletop would come in and announce the arrival of the first Texas oil boom. Production took off in the early 20th century. An ambitious oil and gas companies would drill a well anywhere they could fit a rig. At one point, a city block in Kilgore, Texas was home to 24 wells, coming to be known as a world's richest acre. In response, the Texas Railroad Commission passed rules 37 and 38, establishing well spacing and density requirements, to protect natural resources, correlative rights of landowners, and primarily to reduce fire hazards and to minimize the danger of water percolation into oil stratum from wells drilled into great a number or in too close proximity. As a result of the new rules, operators turn to pooling to meet well spacing requirements and allow for drilling on tracts, not previously developed due to space constraints. The Texas Supreme Court stated in Wagner and Brown v. Sheppard, the pooling benefits mineral owners, operators, the state and the environment by reducing the number of wells needed to maintain efficient production while protecting correlative rights. It also allows operators to hold a larger number of tracts based on drilling of fewer wells. Pooling can be accomplished in many ways, with the most common being inclusion of a lease pooling clause and an oil and gas lease, or the execution of a pooling agreement. The key to pooling is that operations and production anywhere within the unit will be considered to have occurred upon all lands in the unit. Therefore, individual ownership ceases to exist under individual tracts, but rather becomes undivided interest in the production obtained from the entire pooled unit. The Texas Supreme Court held that pooling creates a cross conveyance among the owners of minerals under the various tracts and royalty or minerals in a pool so that they all own undivided interest under the unitized tract. And the proportion their contribution bears to the unitized tract. Royalty is then distributed based on the ratio of each less source surface acreage, it's the acreage of the entire pooled unit. What to do then when an operator wants to drill a modern horizontal well, thousands of feet long, under lands covered by old leases, without a pooling provision, without a separate pooling agreement, or when the lease expressly prohibits pooling under certain conditions. This is the problem faced by many operators today. Horizontal wells are drilled today across the country. Allocation wells are drilled not only in Texas, but also Oklahoma and other states. However Oklahoma's process is statutorily based with all matters running through the Oklahoma Corporate Commission. Today, we are focusing on allocation well issues unique to Texas as it is a highly utilized process that is still quite risky as we've yet to see a court, a competent jurisdiction, determine its legality. While the ability to drill horizontal wells is not new, the rapid increase in the number of permits is astounding. And the year 2000, according to the Texas Railroad Commission records, almost 4,000 permits were filed for vertical wells in districts, 7C, 8 and 8A, which is the Permian basin. While only 199 horizontal permits were filed over the same period in the same areas. In 2013, the first year allocation wells were permitted, only 176 wells out of a total of 26,356 total permits were allocation wells. In 2018, in the same districts, 2,397 vertical well permits were filed, but horizontal permits had skyrocketed to 8,022. That is a swing from less than 5% to 77%. As technology developed and drillers honed their craft, well boars grew from one mile in horizontal length, then to a mile and a half, then to two miles. Recently operators have been drilling as far as three mile horizontal well boars. Chesapeake Energy drilled an Eagleford well with a 17,000 foot lateral. In 2019, permits for allocation wells had risen to 4,409 out out of a total of 15,910 permits. 605 of the permits were for production sharing agreement wells. Since January of 2020, 9,375 horizontal allocation permits were approved by the Texas Railroad Commission. Clearly there's a trend across the country to horizontal wells. While they tend to be more expensive per well, fewer may be drilled to achieve greater production with fewer service locations and expenses. Many operators, however, have not drilled allocation wells out of concern that it may be considered bad faith pooling. However, it appears that Ford Oil and Gas attorney in Texas dealing with an allocation well is not a matter and if, but when. As a number of horizontal wells has grown and production has increased, new issues have popped up in areas where old vertical wells are still holding leases and units based on antiquated lease language and drilling practices. Our current legal and regulatory framework has yet to fully catch up with the rapid changes and has left many operators without a clear answer as to maximize recovery in the field, minimize surface use, and realize the most economic benefit for their investments. There are different types of horizontal wells, with the first type being a horizontal well drilled on a pooled acreage basis. These are developed to meet well spacing requirements and allow for drilling on tracts, not previously developed due to space constraints. This benefits the mineral owners, operators, state, and the environment by reducing the number of wells needed to maintain efficient production while protecting correlative rights. This allows operators to hold a larger number of tracts based on drilling fewer wells. As mentioned before, operations and production, anywhere within the unit will be considered to have occurred upon all lands in the unit, which creates a cross conveyance among the owners of the minerals under the various tracts of royalty or minerals in a pool so that they all own undivided interest under the unitized tract in the proportion their contribution bears to the unitized tract. There is significant history and case law supporting pooling and horizontal wells drilled on a pooled acreage basis. There are multiple ways to achieve pooling. A pooling provision is one of the most popular ways. The provision serves as a grant of authority to pool within certain parameters created by the lessor. Pooling agreements are also used when a lease prohibits pooling or for the ratification by non-executive interest owners. Community leases are another way to achieve pooling, but have fallen to the wayside due to potential problems with non participating royalty interest owners. The second type of horizontal well is a production sharing agreement well. In this situation, interest owners of land to be crossed by a horizontal well agree to the sharing of production from said well, via contractual agreement. The operator must file a PSA-12 form with the Texas Railroad Commission stating that they have obtained agreements from at least 65% of the mineral owners. The PSA-12 is a production sharing agreement code sheet, which describes each tract contained within the production sharing agreement. Currently, there is no case law regarding production sharing agreement wells, other than what we have which governs contractual agreements. The Railroad Commission website contains extensive information regarding production sharing agreement wells, the permitting process, and the supporting documentation required for a proposed well. An easy way to locate these resources is to Google search production sharing agreement or allocation wells along with the Texas Railroad Commission. The search results will bring up the presentations on the Texas Railroad Commission website. The third type of horizontal well is an allocation well. Allocation wells are drilled across several tracts without the formation of a pooled unit and without a production sharing formula between the owners. Operators are not allowed to include tracts of land, which the wellbore does not cross. Well permits for allocation wells have been issued since 2010. However, there is no controlling law, whether judicial, statutory or regulatory on the legality of allocation wells in the state of Texas. Typically production is allocated on the proportion of productive length of the lateral traversing a tract from first take point to last take point and how that bears to the entire length of producing lateral from first take point to last take point. We will discuss case law that has established possible formulas which may be used to determine how to allocate production in such a situation. Currently, Texas has administrative code provisions, which address horizontal wells. Under 16 section 3.86, the Texas Administrative Code defines a horizontal well as any well that is developed with one or more horizontal drain holes, having a horizontal drain hole displacement of at least 100 feet. It also defines many other terms such as first and last take point, non perforation zones and stacked lateral wells. Section three 3.10 outlines the production of oil and gas from different strata, which means two or more different commission designated fields or one or more commissioned designated fields and any other hydrocarbon reservoir. Section three 3.37 A1 states that no well for oil, gas, or geothermal resource shall hereafter be drilled nearer than 1,200 feet to any well completed in or drilling to the same horizon on the same tractor farm. And no well should be drilled nearer than 467 feet to any property line, lease line or subdivision line, provided the Commission in order to prevent waste or to prevent the confiscation of property may grant exceptions to permit drilling within shorter distances than described in this paragraph. When the Commission shall determine that such exceptions are necessary either to prevent waste or to prevent the confiscation of property. The first case that we will examine is Browning Oil Company versus Luecke. This is what really started the idea of an allocation well. Humble Oil purchased three leases from the Luecke's in 1979, which were subsequently assigned to Browning in 1994. Each lease contained a pooling provision and an anti-dilution provision restricting the amount of acreage that could be pooled with each lease. As it had insufficient pooling authority, it could be pooled, but had restrictions that made the proposal impossible. The lease is required that 60% of any pooled unit contained lease acreage. Browning and Marathon, Browning's GWA partner approach the Luecke's to amend the leases to allow for horizontal wells, which were not possible considering the anti-dilution provisions. The Luecke's refused to sign. Browning and Marathon, nevertheless, drilled two horizontal wells crossing multiple tracts, including the Luecke land. Browning and Marathon filed certificates of pooling authority for two purported units, one being 839.18 acres, which included 268.68 acres owned by the Luecke's, and the second being 346.625 acres, which included 114.86 acres of the Luecke land. The Luecke's filed suit claiming that the units violated the pooling and anti-dilution provisions of the lease as one of the wells crossed two separate lease tracts. In this well, the last source claimed a double royalty, 100% production from each tract. Luecke argued co-mingling based on Humble oil v. West, and that they should be entitled to a royalty based on all production from the well. The trial court found for the Luecke's and Browning and Marathon appealed. The court of appeals held that while pooling provisions had been violated, Luecke was not entitled to all production from the well. The better remedy is to pay based on production from each tract, as determined with reasonable probability. "We decline to accept legal principles appropriate to vertical wells that are so blatantly inappropriate to horizontal wells, and we discourage the use of this promising technology," the court stated. Another case regarding allocation wells is a Texas Railroad Commission matter and Ray Klotzman. In this case, EOG filed an application to drill the Klotzman 1H across two tracts of land in DeWitt County, Texas covered by two different oil and gas leases, neither of which contain pooling provisions. The mineral owners under the two leases filed a protest and sought a hearing with the Texas Railroad Commission. Klotzman argued that EOG was effectively pooling without authority, no established law allowed this type of production and with no means to measure production from each tract. EOG argued that it owned 100% of leases on both tracts, Therefore, it had the right to drill on each tract and that the Railroad Commission was not empowered to determine contractual rights, but the Railroad Commission had a duty to revoke development. At the hearing, the Texas Railroad Commission examiner recommended that the EOG permit be denied because EOG did not have pooling authority, and EOG's premise was essentially forced pooling. The Railroad Commission overruled the examiner's decision and unanimously approved the EOG permit, stating that deciding whether or not the lease permitted the operator to drill without pooling was not within the jurisdiction of the Railroad Commission. Klotzman appealed to the county, Travis County District Court seeking judicial review and declaratory relief. However, this case was settled before the courts were able to weigh in. Springer Ranch v. Jones is another Texas appellate case that addresses the issue of allocation wells. The issue wasn't with the validity of an allocation well, but, however, it provides guidance as to royalty payments based on the location of the well. In this case, there was an 8,545 acre ranch in Webb and La Salle counties that had been held by production under one oil and gas lease since 1956. The lessor, Burkholder, died leaving a life estate to her husband and splitting the original acreage into three tracts. After the death of her husband, the remainder man contractually agreed to split production from existing vertical wells, according to the service location of the well, without reference to production units. In 1993, a horizontal well was drilled from a surface location on a Springer Ranch tract with the bottom hole located on an adjoining Sullivan ranch tract. This is when a question arose as to who gets paid what. Springer Ranch argued since the well was located on a Springer Ranch tract, all royalties from production should go to Springer Ranch. Sullivan argued that production should be allocated based on length of productive lateral of the well within each tract. The trial court agreed with this idea and the court of appeals affirmed it. In the appeal Springer Ranch further argued that allocation should be based on the entire length of lateral, not just the productive length, but the courts disagreed with this premise. Another matter which we can look to is the Texas Railroad Commission and Monroe Properties, Inc. In this case, Devin applied for a permit to drill an allocation well, which would cross multiple tracts, all of which Devin held leases on. On March 7th, 2017, Devin applied for the permit to drill the well. On March 10th, only three days later, Monroe Properties, Inc. filed its complaint. Monroe Properties, Inc., SRO Land & Minerals, LP and the Lee M. Stratton Living Trust all stated that Devin did not have a good faith claim to drill a well because they did not have pooling authority in the oil and gas lease and they did not have a production sharing agreement. The unit was to cover 1587.19 acres in Ward county, Texas. It traversed the Monroe unit number one, the Burkholder unit number A1, and the Burkholder lease. The surface location was to be located on the Burkholder lease land. And the bottom hole was to be located on the Monroe unit number one. The Texas Railroad Commission issued an order of dismissal on November 9th, 2017. Wherein the Commission made the following facts, findings and facts and conclusions of law. Facts number one through 12 discussed the history of the matter. The heavily relied on the final order issued in the Klotzman case, which we previously discussed, wherein the Commissioner rejected the argument that the applicant must show it has pooling authority or a production sharing agreement to establish it has a good faith claim to drill an allocation well. In fact, the manager of drilling permits of the Railroad Commission sent an email to the complainants discussing the Klotzman case and how they were going to allow the permit. The order then discussed the statistics on allocation well permits and laid out the aftermath of Klotzman. It also sided the number of allocation wells, which have been permitted since the Klotzman decision was made. Fewer than 100 permits were granted before the December 3rd, 2012 Klotzman hearing. From the hearing date until November 9th, 2017, the date of this dismissal, 3,324 wells have been permitted as allocation wells. Finding a fact number 13 in the order states that it has been commission practice to allow the drilling of allocation wells. Essentially, the Texas Railroad Commission decided that if it isn't broken, don't fix it, they have been allowing this to happen, and there have been no changes to case law or statutes to make them consider otherwise. The order also addresses all of the forms created by the Railroad Commission since Klotzman for the permitting of an allocation well. There is the W1 application for permit to drill, recomplete or reenter, which specifically addresses allocation wells as a type of horizontal well, eligible for drilling permit. It also asks whether the completion type is allocation, production sharing agreement, or stacked lateral. There's also drilling permit seminars and online publications, which instruct operators under how to file all of the necessary permits. And there are two separate publications which operators can also follow. The Railroad Commission created a electronic notices service, which issued to the public regarding allocation wells and other type of horizontal wells. On the day prior to a hearing to dismiss in the railroad commission docket, the Commission issues emails to the public advising of the enhancements and its electronic completion screen. The day of the hearing, they issue another email about the file format for the online completions data subscription. This is the front of a P-16 data sheet. A P-16 is an acreage designation form. On page two, the operator must list all the tracts contributing to the acreage to a Railroad Commission drilled site that is not a single lease pooled unit or a group tracts utilized by contract for purposes of secondary recovery. They must also lease, they must also list the lease number, well number, whether it's horizontal, directional, or vertical, the lease name, API number, acreages and other information. The filer is the owner or lessee of all or undivided portion of the minerals under each tract listed below and has a legal right to drill on each tract traversed by the well, that will have perforations or other take points open in the interval of the applied four fields. All tracts listed will be actually traversed by the wellbore, or the filer has pooling authority or other contractual authority such as production sharing agreement. Authorizing inclusion of the non drill site tract in the acreage assigned to the well. This is a W1 application for permit to drill, recomplete or reenter, which specifically addresses allocation wells as a type of horizontal well eligible for a drilling permit. It asks whether the completion type is an allocation well, production sharing agreement well, or stacked lateral. If it is a horizontal well, a W-1H must be filed as well, which contains supplemental well information such as lateral drain hole information location. This slide shows that the two presentations that the Texas Railroad Commission has saved on their website. The first one is titled PSA Wells, Allocation Wells and Stacked Laterals Permitting and Completing. This will help a user know how to qualify for stacked lateral status, the requirements for a PSA well and allocation wells, how to use a P-16 data sheet and the filing completions for these types of applications. The second is PSA Wells, Allocation Wells, Stacked Laterals, and the Use of Form 16 Data Sheet. Further in Monroe Properties, Inc. matter, the Texas Railroad Commission relied on Klotzman being previously decided, and that there had been no change to law since that decision. They stated that to re-litigate this issue, would be an unnecessary duplication of proceedings. Essentially, in the Railroad Commission's mind, it had been three and a half years since the Klotzman decision and nothing had changed. They also stated that the Monroe group's reliance on Browning v. Luecke is misplaced and they cite the Ernest E. Smith's paper, "Applying Familiar Concepts to New Technology." Under the traditional oil and gas lease, a lessee does not need pooling authority to drill a horizontal well that crosses lease lines. This paper was published in the Texas Journal of Oil and Gas. In it Smith states, Browning does not hold that where a lease is silent on pooling, a lessee is required to obtain pooling authority before the lessee can drill a horizontal well that crosses lease lines. The result that Browning dictates that each lesser whose tract is traversed by the horizontal well should be paid the royalties due under his or her lease is exactly the result that should be obtained for the horizontal allocation well. Smith reiterates that neither pooling authority nor a production sharing agreement is required to establish a good faith claim for permit to drilling an allocation well, which Monroe relies on. After the dismissal of Monroe Properties in the Texas Railroad Commission, Monroe sued the Railroad Commission in Travis county, Texas. However, Devin ended up withdrawing the permit to drill the well in question and Monroe filed a non-suit. Another matter which was litigated is Casey et al. versus MD America Energy, LLC. This case was filed in Madison county, Texas. It was regarding four units from the Ned Kelly allocation 1H H well that covered over 1,200 acres of land. It was filed by the same law firm as both the Klotzman and Monroe Property matters. However, this case was settled. So we do not know what a court would hold. This is a copy of the well location plat for the Ned Kelly 1H well. And as you can see, there's a very unorthodox way the wellbore crosses through the four units. Currently there's litigation in Karnes county, Texas in the LC Ophelia versus EnerVest Operating LLC matter. EnerVest Operating, Compass Oil and Gas, and other EnerVest entities were the owners of the leasehold. Around May 1st, 2018 EnerVest filed for an application for an allocation loan. The plaintiffs filed a protest letter with the Railroad Commission on May 2nd, 2018. The Railroad Commission granted the permit on May 3rd, 2018, the next day. The well was then spotted on May 7th, 2018. This is a copy of the Audioslave A 102H unit plat. It consisted of two leases, the Pavelic lease and the Ophelia lease. The Pavelic lease was 182.99 acres, but had over 2,600 feet of the length in lateral, the Ophelia lease was 637 acres, but it only had 1,700 feet of the length in lateral. The causes of action alleged in this matter by the plaintiff were breach of lease. There was no provision of the lease that allowed for payment of royalties based on estimated volume of oil or gas produced from the lease premises or other lands. Also, the lease does not allow for co-mingling and expressly prohibits pooling. They also alleged trespass, physical and intentional entry onto the land in the mineral interest. The plaintiffs sought three different types of damages, actual and exemplary damages, actual damages based on the fact that the defendants were bad faith trespassers, and that they knew that they should not be drilling on this tract and exemplary damages because they acted with a conscious indifference. The plaintiffs sought a permanent injunction against the defendants, barring production from the property through the well in question. This is the most expensive form of damages sought by the plaintiff. Additionally, they sought attorney's fees and interest. This case, however, has moved quite slowly. My last review of the record showed a motion for summary judgment on file, but we are unsure whether it has been heard. Due to this, we are still waiting to see how a court of competent jurisdiction would decide this issue. Now, what are some claims being made by landowners against allocation wells in Texas? Well, recent ones that we have seen are breach of lease terms, unauthorized pooling, trespass, co-mingling, and request for injunctive relief. When looking for a breach of lease terms, you must examine the lease language to determine whether pooling language is or is not included. Your client may not have taken the lease in question, they may have received an assignment of the lease and are not aware of all the lease provisions. Remember, that typically oil and gas leases are construed against the lessee due to typically being lessee promulgated. We have seen language in leases, such as no pooling or allocation wells without the consent of lessor, often, it may include the phrase not to be unreasonably withheld. Now what unreasonably withheld means is yet to be determined and can vary from person to person. As allocation wells have increased, lessors have become more sophisticated, including provisions that state that the lessor will be entitled to royalty on 100% of production of a well that is drilled with take points on and off lease premises, unless the lessor previously agreed in writing to a pooled unit or production allocation. Another situation in where there may be a breach of lease terms is if it is a GLO or general land office lease. Here on this slide is paragraph 10 of a typical GLO lease, which includes pooling and allocation. This language states, lessee is hereby expressly prohibited from pooling or utilizing the lease premises or any interest they're in with any other leasehold or mineral interest for the exploration, development and production of oil and gas, or either of them without the express consent of the school land board and the Commissioner. A well, whether or not classified as an allocation well, that traverses multiple leases or units, including the lease premises here under one or more of which which leases or units contains oil and gas owned by the state and which well is not associated with an agreement approved by the GLO and owner of the soil specifying the allocation of the production of state owned oil and gas is here expressly not permitted and may not operate on or under this lease, or a unit containing state owned oil and gas without the prior written consent of the Commissioner or his authorized designee, which consent may be granted or withheld in the commissioner's sole discretion. Therefore, the GLO must give express consent for pooling or unitization of state land. However, we all know that the GLO enjoys accepting money in cashing checks. However, by changing the rules of allocation wells, commissioner Bush has assured oil and gas leases won't sit underutilized during market corrections. While those holding them hurt the permanent school fund by postponing operation and abusing the state's mineral rights. We have seen private lessors take this language from the GLO lease and adapt it for their leases to require consent to cross lease lines, regardless of any rule 37 exception obtained. Another claim made by landowners is unauthorized pooling. Lessors have brought causes of action, claiming that by drilling a horizontal well, the operator has committed unauthorized pooling. Both sides of this argument have appeared in recent law review journal articles with the most recent one written by Ernest E. Smith. As we know, pooling involves a cross conveyance of interest in various tracts. However, Smith argues that by drilling an allocation well, there is no cross conveyance of royalties. He finds that the inquiry, whether the lessee is violating the lease should begin and end with recognizing that the lease authorizes the lessee to drill a horizontal well, that begins at one side of the less horse tract and ends on the other side of that tract. The fact that the horizontal well may also extend into an adjacent tract is irrelevant under the traditional oil and gas lease. That this does not specify whether the lessee may drill vertically or horizontally. And as the court noted in Browning, each tract traversed by the horizontal well is a drill site tract. And each production point on the wellbore is a drill site. Another claim made by landowners is trespass. We've seen specific arguments made regarding this in the Ophelia v. EnerVest case. Trespassed real property is an unauthorized entry upon the land of another. It may occur when one enters or causes something to enter another's property. The Texas Supreme Court found in Barnes v. Mathis in 2011. The Supreme Court also found that every unauthorized entry upon land of another is a trespass even if no damage is done, or the injury is slight and gives a cause of action to the injured party. This is in the coastal oil and gas corporation, the Garza Energy trust case, which my colleague and partner Michael Jones litigated. Additionally, appellant claims that the trespass was in bad faith because unless he did not have authority to enter the lease and therefore lacks a good faith basis for its actions. However, these arguments, as they relate to trespass, fail to recognize that when a lessor grants an oil and gas lease to a lessee, an implied easement across the land covered by the oil and gas lease is granted. Said, easement is granted to the lessee to use the surface estate of the tract as reasonably necessary to develop the mineral state. Now, what are the factors for determining what is considered reasonably necessary? Well, you can look at the size of the well pad, the number of battery tanks, and other factors that go into how much of the surface is taken for the development of the mineral estate. Now, an argument has been made that by using the surface of one tract to benefit the development of minerals from another tract the lessee's excessively burdening the surface of state and exceeding the scope of the easement granted by the oil and gas lease. However, this is very fact intensive. If you determined that there was an excessive burden on the surface, how would you determine the measure of damages? In this case, we have three different wells that were drilled. One has a 5,000 foot lateral and has a three acre pad site. The second is a 7,500 foot lateral and has a five acre pad site. The third is a 10,000 foot lateral with a seven acre pad site. Looking at these three different lateral lengths and the three different pad sizes, it's easy to tell what the burden is. This could be determined by expert testimony on standard use and can be quantified by the size of the pad, the length of the lateral and the amount of additional damages. However, what do you do if all the pads for the laterals are the same size, no matter what the length of the lateral is? Some operators have streamlined their process and every pad side is exactly the same size, regardless of how long the well is. This is a much harder case to make. It would be very hard to show an excessive burden on any of the properties. At most, you may have the equivalent of a pipeline moving oil from one tract of land, through your land, without proper compensation. Then perhaps you could look at the price per rod for a pipeline for damages. Then each horizontal well would be considered a pipeline. Another claim made by land owners against operators in the drilling of allocation well is the co-mingling argument. This is brought to us by the case Humble Oil and Refining Company v. West Texas Supreme Court decided this in 1974. In this case, they established the rule that the one who was responsible for the intermingling and confusion of the property, so as to render it impossible to identify the goods of each party is under the burden of establishing with a reasonable certainty what each party is entitled to. The court held in this case that Humble was not under the obligation to pay West for all gas produced from the reservoir, so long as Humble could establish with reasonable certainty the volume of gas that the West were entitled to. Now, when you're looking at methods and determining with reasonable certainty, this was later established by Brownining v. Luecke to be determined as a reasonable probability. When looking at reasonable probability, you look at metering oil or gas produced from each portion of the wellbore and expert testimony to establish these facts. Another claim made by land owners against operators is injunctive relief. The plaintiffs in the Ophilia v. EnerVest case requested an injunction to cease production from the well in dispute. This is by far the most damaging of all relief sought. We have seen both applications for temporary injections, which would enjoin the operator from using their land to reduce from another tract during the pendency of a litigation in conjunction with the request for a permanent injunction after trial enjoin the operator from using the wellbore to produce from other lands. This would essentially flush all of the money that the operator spent in drilling said well down the drain and not allow for them to recover and recoup their losses. Now, there are some practical considerations when you are looking at allocation wells and how you are going to pay lessors in different circumstances. In this first picture, I have attempted to show an equal length of productive lateral, which crosses two tracts. And it has an equal distribution of take points. In this case, each tract is roughly the same size and has the same amount of take points. If this is your situation, it's very easy to determine how to pay each owner. You could merely split the production in half. In the second slide, you see a productive lateral that is roughly an equal length on each tract. However, there is an unequal distribution of take points with three take points on the west tract and only two take points on the east tract. In this situation, it would be a little bit trickier to pay each set of owners, but paying based on the length of lateral would be the safest way to allocate production to each lessor. Now, in the third situation, you have an offsite tract surface location. You have unequal, productive lateral lengths, and you have unequal distribution of take points. Essentially, your client has set up the worst circumstances for you. This is the trickiest situation. Here there's an off tract surface location, so how do you allocate production to that tract if there are no take points within that tract? There's also an unequal, productive length of lateral amongst the other two tracts and an uneven distribution of take points. This is a situation in which a production sharing agreement would be key to prevent litigation of this matter. Other practical considerations involve if you are drilling a horizontal well, whether an allocation well, production sharing agreement well, or pooled unit that traverses an existing unit. So in this picture, we have laid out an existing unit at the north of the tract, which is composed of 10 tracts, totally in 80 acres, 40 of which lay within the proposed horizontal unit and 40 outside the unit. So as you could see, the wellbore of this unit crosses 40 of the acres. Now, the proposed horizontal unit outlined in green is 320 acres, includes 40 acres in the existing unit, the total productive interval length is 9,900 feet. And it has 1,320 feet, which traverse the existing unit. Now, earlier, we talked about how pooled units create a cross conveyance of minerals. Now, due to this existing unit and the cross conveyance created by the pooling of tracts in the vertical unit, the division of interest for this new horizontal well and horizontal unit must account for off unit owners line within the vertical unit, but outside of the proposed horizontal unit. Because of the cross conveyance, the off unit owners are owed an interest in the horizontal unit. So to look at this more specifically, you can see that tract one is 2.58 acres, which lies outside of the new unit, but within the existing unit. The owner of this tract is entitled to 2.5 acres over 80 acres of the royalty for its proportionate share of production from within the vertical unit. However, under Browning and Springer Ranch cases, this interest is entitled to royalty from production from the new unit as well. So you would take the 2.5 acres over the 80 acres and further reduce it by 1,320 feet, which is the length existing unit is on the wellbore by 9,900 feet, which is a total length of the wellbore for its proportionate share of the productive interval of the horizontal well. So to get a little complicated with math, if you assumed it was a one fifth royalty, the owner attracted one, even though it is outside the new unit would receive two and a half over 80 of 1,320 over 9,900 of a one fifth royalty, which would equal 0.00083333. So after examining all of the different claims that landowners can make and issues that operators have seen, how can you protect an operator if you represent them as one of your clients? The first way to protect an operator is to pool or get a production sharing agreement. This avoids the creation of an allocation well all together and makes all parties subject to the contractual obligations of either the pooling agreement or the production sharing agreement. Another way to protect the operator is to obtain statutorily based division orders from all parties prior to placing any of the parties in pay. If an owner does not execute a division order, you should place them in suspense, pursuant to the division order statute and your title of opinion. Now, if you want to feel better about the situation as a whole, while the Railroad Commission has now been issuing allocation well permits since the Klotsman, on every permit that is issued, the Railroad Commission includes this following disclaimer language. The language states, "The Commission staff expresses no opinion as to whether 100% ownership interest in each of the leases alone, or in a combination with a production sharing agreement, confers the right to drill across lease unit lines or whether a pooling agreement is also required." However, until the issue is directly addressed and ruled upon by a court of competent jurisdiction, it appears that 100% interest in each of the leases and a production sharing agreement constitute a sufficient colorable claim to the right to drill a horizontal well as proposed to authorize the removal of the regulatory bar and the issuance of a drilling permit by the Commission. Assuming the proposed well is in compliance with all other relevant Commission requirements. The issuing of a permit is not an endorsement or approval of the applicant stated method of allocating production proceeds among component leases or units. All production must be reported to the Commission as production from the lease or pooled unit on which the wellhead is located and reported production volume must be determined by actual measurement of hydrocarbon volumes prior to leaving that tract and may not be based on allocation or estimation. Payment of royalties is a contractual matter between the lessor and the lessee, interpreting the leases and determining whether their proposed proceeds allocation comports with the relevant leases is not a matter within Commission jurisdiction, but a matter for the parties to the lease, and if necessary a Texas court, a competent jurisdiction. The forgoing statements are not, and should not be construed as final opinion or decision of the Railroad Commission. Therefore, as everything stands, the Railroad Commission continues to issue permits for allocation wells with little guidance and possibly little confidence at said permits. Although the Railroad Commission does not provoke confidence in outcome of litigation related to this matter, others in the industry believe that case law will catch up to current technology. As we've seen with Browning and Springer Ranch, the courts appear to acknowledge the industry movement to horizontal drilling and how advances in technology are benefiting both landowners and operators nationwide. Therefore, while Texas courts have not provided us with case law directly dealing with the legality of allocation wells, we have been provided with the several cases that suggest how a court may handle these wells in future. While we have seen numerous cases pop up in recent years, we have not seen a case make it past settlement. Until we see this, we do not know how a Texas court, a competent jurisdiction, will rule on the legality of allocation wells. So in the meantime, we are all sitting here just waiting. Thank you.

Presenter(s)

JCJ
Jessica Crawford, JD
Partner
Jones, Gill, Porter & Crawford LLP

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