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Contacted at his seaside villa, Captain Renault exclaimed his shock that Elsie and Adrian Opiela are asking the Texas Supreme Court to review questions surrounding the Railroad Commission’s approval of a drilling permit for a Production Sharing Agreement well.

The Commission’s “65% Rule” for multi-tract horizontal wells is invalid because the Commission does not have the authority to make such a rule. There must be either valid pooling authority or compliance with the Mineral Interest Pooling Act, neither of which were present here. The Commission adopted the ad hoc 65% Rule for issuing horizontal well permits without following formal rulemaking procedures required by the Administrative Procedure Act.  

You might recall that the Austin Court of Appeals confirmed the Commission’s decision to approve a permit without considering the anti-pooling provision in the Opiela’s oil and gas lease. The court also found that the Commission was wrong in concluding that the permit applicant Magnolia Oil & Gas Operating had shown a good faith claim of right to drill the well. We discussed the court of appeals opinion here and the district court ruling here.

The Opielas challenge the court of appeals ruling on several grounds. Here is our (oversimplified?) summary of Opiela’s assertions in their petition for review:

The 65% Rule

In permit applications for horizontal wells across multiple tracts, the operator represents that it will allocate production according to a formula that the mineral interest owners have not agreed to. The Commission may not issue such permits when the mineral and royalty owners have not consented to pooling or how to allocate production.

The Commission routinely approves permits for wells across tracts without determining whether it has authority to develop its approval policies and without notice to the mineral and royalty owners of property rights that are affected by the Commission’s actions.

The anti-pooling clause

The Court of Appeals incorrectly held that pooling authority was not necessary to drill the PSA well because pooling of tracts is not expressly required by Texas statutes or regulations for horizontal drilling for a wellbore that crosses property lines.

The Court of Appeals incorrectly held that even if the Commission did consider the anti-pooling clause, the clause was not implicated because a permit for horizontal drilling under a PSA is not pooling under Texas law. There is no functional distinction between pooling and PSA/allocation wells.

In determining whether Magnolia had a good-faith claim to drill a horizontal well across Opiela’s tract the Commission ignored a clause in Opiela’s lease that prohibits pooling “in any manner whatsoever”. With this clause in place, Magnolia cannot have a good-faith claim to drill a well.

Determination of parties’ property and contract rights

The Court of Appeals incorrectly concluded that the Commission was not required to consider the anti-pooling clause because the Commission has no power to adjudicate parties’ rights under a lease or other title documents.

The anti-pooling clause in the lease is relevant because, while the Commission lacks authority to make the binding determination of property rights it does have the authority and duty to examine property rights in the performance of its regulatory responsibilities to determine whether an applicant has a good-faith claim.

The Commission’s APA-compliant rules recognize that a good-faith claim for creating a pooled unit requires appropriate contractual authority and such authority is not present here.

There’s more to come on this.

Your musical interlude

The Austin Court of Appeals has ruled in Texas Railroad Commission et al v. Opiela, the dispute over a permit for a horizontal well under a Production Sharing Agreement.  We reported on the result in the trial court. Here are some highlights of the appeal.

Where did the 65% rule come from?

The court traced the Commission’s authority to a 2008 minute entry in which two of the three commissioners approved a permit while directing staff that wells that are permitted based on PSA’s should be approved when the operator certifies that at least 65% of the working and mineral interest owners in each component tract have signed a PSA.  That announcement did not say that multiple different PSA’s could be signed or that other documents, such as a lease pooling clause, could be the equivalent of a PSA for purposes of the 65% threshold.

Pooling and PSA’s

The court examined the relationship between pooling and PSA’s and determined that Magnolia’s assertion of right to drill under a PSA did not infringe on the anti-pooling clause in the Opiela lease. The Commission ignored the anti-pooling clause as irrelevant to the well permit.  The court concluded that a permit for horizontal drilling under a PSA is not pooling under Texas law and thus the Opiela lease’s anti-pooling clause was not implicated.

RRC authority over title questions

The court affirmed that Commission does not have the authority to adjudicate questions of title or rights of possession when it grants a drilling permit. The Commission’s conclusion that Magnolia made the requisite showing of a good-faith claim of right to operate the well rested on satisfaction of the 65% threshold that is not found in the Texas Administrative Code.

Is a PSA required?

The evidence showed that only 15.625% of the interest owners signed a PSA. The other written agreements Magnolia relied on included consents to pool and pooling ratifications. Substantial evidence did not support a finding that 65% of the interest owners signed a PSA.

Even while granting deference to the Commission’s expertise in regulating the industry, the court was not persuaded that a consent to pool can substitute for a PSA absent a good-faith showing that consents and the PSA’s call for the same sharing of production for a well across tracts that are not pooled. Magnolia did not so certify and the Commission did not make such a finding.

The definition of a PSA from the Commission’s 2019 Form P-16 allows proof of a PSA to include certification that 65% of interest owners have signed an agreement as to how proceeds will be divided. But Magnolia’s permit was based on applications predating that definition. Neither the form nor the instructions used to complete the application contained the expanded definition of the agreements that would make a 65% threshold.

The rulings

The court:

  • reversed the trial court judgment that the Commission erred in concluding that it had no authority to review whether an applicant seeking a permit has authority under a lease or other relevant title documents
  • reversed the trial court judgment that the Commission erred in failing to consider the pooling clause of the lease in deciding that Magnolia had a good-faith claim to operate the well.
  • affirmed the trial court judgment that the Commission erred in finding that Magnolia showed a good-faith claim of right to drill the well.
  • remanded the case to the Commission for further proceedings.

The dissent

Justice Kelly would conclude that an operator’s certification that the requisite owners from each tract have agreed on how production would be shared, when supported by signed agreements, is sufficient to show a good-faith claim to operate. Because royalty calculations are specific as to each lease, the exact share or method for dividing proceeds under any particular agreement is immaterial. He would resolve whether the 65% threshold standard complies with the APA.

Your musical interlude

In Opiela v. Railroad Commission of Texas and Magnolia Oil and Gas Operating, LLC, an Austin district court determined that the Commission’s Final Order granting a permit for a Production Sharing Agreement well in Karnes County did not comply with the Administrative Procedure Act. Here is the Commission’s hearing examiners’ recommendation. It is 18 pages, but we won’t venture into the weeds. In particular, the court said that the Commission erred in:

  • Approving the initial unit well permit for the Audioslave A 102H well in Karnes County;
  • Determining it had no authority to review whether an applicant seeking a well permit has authority under a lease or other relevant title documents to drill a well;
  • Failing to consider the pooling clause of a lease in deciding an operator’s good-faith claim to operate a well; and
  • Finding that the operator showed a good-faith claim of right to drill the well.

Plaintiffs asserted:

  • Because the Commission has no formal rules that mention PSA or allocation wells, there is no statutory or administrative authority to issue PSA permits or allocation well permits.
  • Allocation wells violate Statewide Rule 26, which requires that all liquid hydrocarbons be measured before leaving the lease, and Statewide Rule 40, which requires that operators establish a pooled unit if they want to combine acreage from separate leases to form a drilling unit.

The well was designated as a PSA wellbore (the previous operator had designated it as a allocation well). The plaintiffs’ arguments were based on the fact that they did not consent to pool their lease or sign a PSA or ratify a pooled unit. Magnolia responded by relying on the Commission’s requirements for additional documentation that is required for allocation wells in the form of underlying written agreements for all tracts from which hydrocarbons will produce.

The examiners recommended that the Commission find that it had authority to grant drilling permits for wells on tracts covered by PSA’s. The Commission agreed and lessors sued.

“Maybe”, you say?

The case, and its ramifications, is far from over. The district court judgment is sure to be appealed, but first the dispute must return to the Commission for proceedings consistent with the judgment. For its part, the Commission has not altered its practices and processes for the issuance of PSA and allocation well permits.

And a musical interlude.