compulsory unitization

Co-author Brooke Sizer

Prevails over what, you ask? In Gladney v. Anglo-Dutch Energy, LLC, a conditional allowable from the Office of Conservation didn’t supersede lease royalty obligations.

How did we get here?

Anglo-Dutch completed a gas well on the Gladneys’ lease and then filed a pre-application notice for a compulsory drilling and production unit and applied for a conditional allowable. On May 17, 2012, the application was granted:

All monies generated from the date of first production, the disbursement of which is contingent upon the outcome of the current proceedings before the Office of Conservation for the Frio Zone will be disbursed based upon results of those proceedings.

The next day Anglo-Dutch began sales of production from the well and later submitted a formal unit application. Order No. 124-Y established the unit, effective on and after October 30, 2012.

Perhaps to the surprise of Anglo Dutch, but certainly to its chagrin, the Gladneys demanded payment of the full one-fifth royalty for production from the well prior to October 30th, rather than settle for their share of production on a unit basis.

Anglo-Dutch refused, relying on the conditional allowable which, it said, superseded its lease obligations.

The trial court ruled for Anglo-Dutch, holding that the “allowable covers the royalty payments” because the allowable dated back to first production. The court found no provision in the lease which would require that the Gladneys be paid more than that provided by the commissioner under the allowable and the unitization order.

Reversal from the court of appeal

The court of appeal reversed. “The Mineral Lease … clearly provided Plaintiffs were to get lease-basis royalties on all production from the well and that lease governed the parties’ relationship prior to the unitization order, which was not effective until October 30, 2012.”

Under the Order, the effective date of the unit was October 30, 2012, not the first date of production. The Gladneys were entitled to a full one-fifth royalty from first production until the effective date of the Commission’s Order.

The Gladneys argued, and the court agreed, that the Office of Conservation can’t impede private contract rights. According to an affidavit from a long-time Office of Conservation representative, the conditional allowable was not meant to abridge privately negotiated contract rights. That is consistent with settled Louisiana jurisprudence that meddling in private contracts is beyond the Office of Conservation’s authority.

The court helps those who help themselves

 The court was unpersuaded by Anglo-Dutch’s plea that it had no choice other than to pay royalty on a unit basis because otherwise it would have had to pay double royalties. Anglo-Dutch could have amended its lease obligations through a royalty escrow agreement. The Gladneys noted that they suggested this alternative and it was rejected, and that such an arrangement is a common practice in these situations. The court also rejected the argument that the Gladneys were improperly attacking the Commission’s actions.

Anglo-Dutch should have listened to Alabama Shakes.

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)