Pooling and Unitization

dylanIf you’ve ever tried to escape penalties for the operator/producer’s failure to comply with La. R.S §30:103.1 and §103.2, take comfort in XXI Oil & Gas, LLC v. Hilcorp Energy Company.  You are not alone. No excuse has satisfied the courts, and there is none here.

The statutes (links above) require information and certain procedures to be followed by an operator before it can recoup costs of unit drilling operations from an unleased mineral owner. Of particular importance is a detailed sworn statement of costs of the operation and a statement of revenues.

The events unfold

XXI was the lessee of leases comprising 20% of a drilling unit; Hilcorp was the operator.

  • 1/11/11-Hilcorp recompletes a well in the drilling unit and begins producing.
  • 2/11/11-XXI acquires the leases.
  • 4/21/11-XXI sends a letter by certified mail requesting the information required by Section 103.1.
  • 4/21/11-Hilcorp sends XXI an AFE itemizing estimated costs to recomplete the well but including no revenue information.The accompanying letter explains that the unit well had been shut-in and would be returned to production shortly.
  • 5/20/11-XXI elects to participate in the recompletion and signs the AFE as “participant”. .
  • 6/13/11-XXI sends Hilcorp a second letter stating that because Hilcorp failed to provide the statement required by the statute, it could not deduct the cost of recompleting or operating the well from XXI’s revenues.
  • 9/9/11-XXI sues, seeking penalties for failure to comply with the statutory reporting requirements.

Summary judgment was granted for XXI on the basis that Hilcorp did not comply with the statutes.  The statement of costs was neither sworn nor detailed.

Hilcorp appealed, admitting it did not comply with the technical requirements of the statute but asserting that it achieved the intent and purpose the statute by submitting a statement of cost with the AFE. Hilcorp argued that XXI’s position was weakened because it elected to participate in the well after receiving the AFE.

Judgment affirmed

The court of appeal upheld the trial court’s judgment against Hilcorp. Here is the reasoning:

  • Whether the leases had been validly executed by owners of each tract was not relevant to issue of whether operator forfeited its right to demand contribution. Hilcorp offered no authority supporting the proposition that validity of the underlying leases is a required element for the statute to apply.
  • The producer forfeited its rights to demand reimbursement by submitting an unsworn statement of costs.
  • The statutory provisions were subject to strict construction.
  • Where the statute is unambiguous it is not the court’s role to determine the purpose of the statute. “Detailed” is unambiguous.  The text of the statute does not invite an inquiry about its purpose.

REVISION: What’s new about this opinion?

An observation that didn’t make its way into the original post is the court’s application of the statute to a lessee of a mineral owner who did not have a lease with the offending operator.  Prior to this case that was an unanswered question.

Obvious musical interlude

Hey, you of a certain age, sitting in your 60’s and 70’s dorm room you thought “literature” wasn’t what you were doing. Think again. Here are a few good ones from our Nobel Prize winner (from Youtube’s slim pickins):

the acoustic love song Bob

the acoustic protest song Bob

the electric-for-the-first-time song Bob

 

With Travis Booher

Texas’s proposed Oil and Gas Majority Rights Protection Act(House Bill 100) has many detractors whose reasons are intense and varied. Here are some of them:

It’s About Liberty

It’s my property that I’ve worked for years to develop (or not, but that’s my concern and not yours). I should be able to do business with those I choose and to avoid those I don’t. Your bill deprives me of that freedom. Let’s say I make a good living off my six or seven 20 BOD wells, and there’s room for more, and I can drill ‘em cheap. The decline curves suggest that with my lean operation, these wells will be around for as close to forever as I need them to be. I’m going to educate my kids off the revenues; then I’m going to sell them and retire. But your $30MM CO2 flood will impose huge costs that will take more years to recoup than I have left in this world, made wretched by people trying to steal my leases. And if I don’t have the money? See next.

Severe Penalties

The bill allows bullies to confiscate my leases. There is a 300% “sit out” penalty on those owners who don’t participate in (that is, pay for) operations, and a lien is allowed to secure the operator’s expenses. (§104.108, 203). Small operators who can’t afford the expenditure and long payout necessary for a huge CO2 flood should oppose the bill on this basis alone.

Abrogation of Private Contracts

The Railroad Commission may amend or abrogate surface use protections in pre-existing oil and gas leases that conflict with unit operations so as to prevent or render operations uneconomical. (§104.204) There goes my blueberry patch, for the good of the collective!

The Big Get Bigger at the Expense of the Small

It allows “big oil” to run over the “little guy”. Again, we refer to working interest owners with the small leases who are happy with their current situation and can’t afford to plan tens of millions of dollars down the road. “Big Oil” proposes a $20-$30MM CO2 flood that will not only wipe out the revenue from their small wells but impose huge costs with a long pay-out, or worse – a 300% penalty.

And speaking of the big guys, it will be expensive and time-consuming for small working interest and royalty owners to fight the proponent at the Railroad Commission proceeding, with all the engineers and lawyers that will be required.

The Share of Production is Uncertain

Sharing of proceeds is not on an acreage basis, but on each tract’s “fair share” of unit production (§104.103). When and how will a royalty owner determine if her interests are likely to benefit from the unitization?

Voting Favors Those with the Most Resources

Approval must be of 70% of the royalty owners who actually cast a ballot (§104.056(a)(2)). This doesn’t say 70% of all royalty owners. It means 70% of those who care enough to vote. In the face of a concentrated effort by the proponent with its hoards of landmen and public affairs personnel to woo the undecideds, royalty owner indifference will benefit the proponent.

If you’ve read this far, you probably know that we’ve had several posts on this topic.  We are neither for nor against. We give you the information so that you can decide for yourself. Here’s a little swamp pop to inspire.

Co-author Travis Booher

There are plenty of reasons why compulsory unitization is good for Texas, say the proponents of Texas House Bill 100, the Oil and Gas Majority Rights Protection Act.

More production = more money

The foremost benefit of fieldwide unitization is enhanced production.  Oil and or gas that would otherwise be left behind would be produced. For example Mississippi, which has had production since 1939, has seen a substantial increase since C02-enhanced oil recovery projects were initiated. C02 oil now accounts for 49% of total Mississippi production. This increase is oil that presumably would have been left in the ground.  Projections are similar for selected fields in Southeast Texas: Up to 25,000 bopd of production, resulting in $2.2 billion in addtional tax revenues.

This would, of course, mean more money to royalty owners. Oil left in the ground forever never ends up in a royalty check.

Economic prosperity a/k/a JOBS

The community in which fieldwide units are formed see more oil field jobs. The drilling and operation of injection wells, capture wells and other infrastructure in fields that are otherwise depleted create new jobs in areas that probably need them. That leads to more money circulating among local businesses and households.

More efficient production

Unitization in most cases means more production with fewer wells, which prevents waste. More oil will be produced, which leads to a higher utilization of our natural resources. This allows the most efficient development of resources with less environmental impact.

Protection of surface owners

Surface owners, who always like to see fewer tank batteries and other facilities, would benefit. In a typical secondary or tertiary recovery operation, fewer surface facilities are necessary because the owner of each tract is not required to a drill his own well and locate facilities on his tract. Although production will increase, the number of facilities should not increase, thereby resulting in higher utilization of natural resources with less environmental impact.

Defeats the “tyranny of the myopic minority”

Fieldwide units can be established by agreement, but owners who do not agree cannot be forced to join, leaving large swaths of acreage, often in the middle of operations, un-unitized. Without a mechanism for compulsory unitization, a few small owners situated in the wrong place have the power frustrate opportunities the majority would like to pursue. The bill would provide willing lessees and mineral owners an opportunity to obtain their “fair share” without hindrance from the neighbors.

These points demonstrate the purpose of unitization: Conservation of oil and gas, prevention of waste and protection of correlative rights: This is a favorite of law professors and policy wonks (but we repeat ourselves).

We could be more like Louisiana!

Seriously, our neighbor to the east and 38 other producing states have some form of compulsory unitization. Set aside your Texas pride for a moment: Can everybody else be so wrong? Is Texas that much smarter than they are? Given our great state’s inglorious national ranking in elementary and secondary education, I doubt it.

Coming soon: Compulsory Unitization is a Terrible Idea (Rhetorically Speaking)

Co-author Travis Booher

“What’s in a name? That which we call a rose by any other name would smell as sweet”. (This situation is more like the star-crossed lovers of this famous passage than you might think; let’s hope this session’s Act III doesn’t end the same way.)

We’ve been called to task because of last week’s reference to HB 100 as a “forced pooling” bill; that it is really about ”fieldwide unitization”. Is there a difference, and does the nomenclature matter? As a matter of oil and gas law, there is a difference. In the eyes of some participants in the business, we aren’t so sure. Let’s discuss.

“Pooling” and “unitization” are analogous and often used interchangeably, but each has a specific meaning. “Pooling” is the joining together of small tracts sufficient for the granting of a drilling permit under applicable well spacing rules.  “Unitization” refers to the joint operation of all or some portion of a producing reservoir. Said another way, unitization is the joining together of tracts in order to cooperatively develop all of a part of a reservoir containing hydrocarbons.

Texas already has a forced pooling law of sorts, the Mineral Interest Pooling Act. However, it is infrequently used and has proven to be of relatively little value in everyday practice. The MIPA has also been limited in function to protection of small-tract lessees.

Examples of true forced-pooling regimes are statutes in Louisiana, Oklahoma and other producing states, in which the regulatory power of the state is invoked to establish drilling units for primary production. Texas has no such statute.

HB 100 is essentially a proposal for compulsory unitization to promote and enable secondary and tertiary operations from fields that have been depleted by primary production. This can be seen from the bill itself: “A plan of unitization may be proposed under this chapter only to establish units . . . for unit operations that are reasonably anticipated to substantially increase the ultimate recovery of oil, gas, or oil and gas to greater volumes than would be recovered by primary recovery alone”. § 104.101(a). Moreover, throughout the bill the scheme is referred to as “unitization” which, as we have said, has a particular definition under the law. Pooling is not mentioned.

On the other hand, there are many who will deem participation in a unit under this legislation to be “forced” in the sense that the interests of a working interest owner or unleased mineral owner would be joined together with other tracts without his permission. Whether pooling or unitization, the result is the same: a collective effort by the owner and others to produce hydrocarbons in an arrangement in which he is no longer the “boss” of his property or his operations.

In the end, we agree that HB 100 should be referred to as a bill for compulsory unitization, and not pooling. For some, “compulsory unitization” and “forced pooling” may be a distinction without a difference.

And another musical interlude.

Next week: How many gas molecules can dance on the head of a drill bit?