CHAPTER 1 BASIC CONSERVATION PRINCIPLES AND PRACTICES: HISTORICAL PERSPECTIVES AND BASIC DEFINITIONS

• Jurisdiction: United States

Federal Onshore Oil and Gas Pooling and Unitization
(Nov 2006)
CHAPTER 1
BASIC CONSERVATION PRINCIPLES AND PRACTICES: HISTORICAL PERSPECTIVES AND BASIC DEFINITIONS
Bruce M. Kramer
Maddox Professor of Law
Texas Tech University School of Law
Lubbock, Texas

BRUCE M. KRAMER

Bruce M. Kramer received a B.A. in International Relations from UCLA, a J.D. from the UCLA School of Law, and an L.L.M. in Environmental and Natural Resources Law from the University of Illinois College of Law.

He has been teaching at Texas Tech University School of Law since 1974 and has been the Maddox Professor since 1992.

Professor Kramer is the co-author of The Law and Pooling and Unitization (3d ed.), Williams and Meyers Oil and Gas Law (since 1996, Cases and Materials on Oil and Gas Law (6th and 7th eds.) and International Petroleum Transactions. He is the author of numerous law review articles on oil and gas law including "The Sisyphean Task of Interpreting Mineral Deeds and Leases: An Encyclopedia of Canons of Construction" and "Royalty Interests in the United States: Not Cut From the Same Cloth." He has been an editor of the Oil and Gas Reporter and was recently named the Administrative Editor of that publication.

I - INTRODUCTION

As both the oil and gas industry and governmental regulation of the industry pass the 150-year sesquicentennial mark, it is appropriate to review the history of conservation regulation in general and the basic and related conservation concepts of pooling and unitization specifically.¹ This paper will present the historical context of modern conservation regulation, including pooling and unitization as it applies to federal, Indian and fee land mineral interests. It will serve as a primer for the papers that follow which will discuss in depth the modern application of pooling and unitization principles on both federal and private lands predominantly in the western United States.²

Today it is widely accepted that the public regulation of the oil and gas industry is based on three bedrock principles: the prevention of waste, the conservation of natural resources and the protection of correlative rights.³ Early conservation regulation, however, was principally concerned with the prevention of waste in the physical sense of the term waste. For example, as early as 1879 states were regulating the plugging and casing of wells

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to avoid groundwater pollution.⁴ Such regulation was designed to prevent the physical loss of hydrocarbons as well as the prevention of the pollution of surface water and groundwater supplies that were often critical to the population in the semi-arid mid-continent area.⁵ The focus on physical waste which is apparent at the surface is reflected in a series of Indiana statutes that laid the groundwork for the upholding of such regulations against federal and state constitutional challenges.

It was an 1893 Indiana statute that prohibited natural gas to escape into the open air for more than two days after discovery that led to landmark Supreme Court of the United States opinion in Ohio Oil Co. v. Indiana.⁶ The stated statutory purpose in prohibiting the dissipation of natural gas was that it would cause injury to others with interests in the common source of supply. At this stage in American constitutional jurisprudence, there was only a limited "regulatory takings" doctrine because substantive due process principles dominated attacks on state police power exercises. The Supreme Court rejected the substantive due process challenge because it found that the prevention of underground waste to the common source of supply is a valid police power objective.⁷ It also found that the states were the source of property rules relating to the ownership of oil and gas and as such they could define or refine their ownership definitions to deal with the somewhat unique circumstances of a common source of supply owned by different parties.⁸ Similar findings were made by the Indiana Supreme Court when it came to statute forbidding the burning of gas in flambeau lights,⁹ and a statute prohibiting the use of vacuum pumps to induce a greater flow of oil.¹⁰ These early attempts at regulating not only the production of oil and gas but what the owner could do with the oil and gas once produced laid the foundation for the much more invasive regulation that took place during the middle of the twentieth century that will be discussed later in this paper.

There are some basic terms that need to be defined when one speaks about conservation regulation. To be consistent as used in this paper the terms "unitization" or "unit operations" refer to the consolidation of mineral, leasehold or royalty interests covering all or

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a portion of a common source of supply.¹¹ On the other hand "pooling" or a "pooled unit" refers to the joining together of small tracts or portions of tracts for the purpose of having sufficient acreage to receive a well drilling permit under the relevant state or local spacing or drilling laws and regulations.¹² The federal government has chosen to use the term "communitization" to describe what would be a pooling if only fee lands were involved.¹³ Pooling, as distinct from unitization, developed in large part due to the longstanding existence of state well spacing regulation. Well spacing regulation is implemented through either or both a lineal spacing rule or statute and a density spacing rule or statute.¹⁴ The lineal spacing system regulates well location based on distances from property lines or other wells. Louisiana, Statewide Order 29-E is a good example of a lineal spacing regulation which prohibits wells from being closer than 330 feet from any property line nor closer than 900 feet from any well completed in the same common source of supply. Wyoming utilizes a density spacing rule requiring no more than 1 oil well on a 40 acre tract.

Compulsory or statutory pooling involves the use of the state government's police power to "force" or "compel" non-consenting mineral owners, royalty owners and/or working interest owners to pool their interests with others.¹⁵ Today all major producing states except for Kansas have a compulsory pooling statute. Compulsory or statutory unitization involves the use of the state government's police power to "force" or "compel" the unitary development of all or a portion of a common source of supply. In addition to compulsory unitization many states provide for the approval of voluntary fieldwide units where non-consenting parties remain outside the parameters of the unit agreement and unit operating agreement. The development of these types of conservation regulation was in response to the perceived evils of the "rule of capture" ownership regime that had been adopted by most states.

II - CONSERVATION TECHNIQUES OTHER THAN POOLING AND UNITIZATION

A -- Definitions

As used in this paper, the term "prorationing" means the: "restriction of production by state regulatory commission, usually on the basis of market demand. The commission determines what amount shall be produced in a state during a given period of time and then allocates this total amount among the producing fields in the state (field allowables) and then allocates the field allowable to the various leaseholds and wells within the field (lease and well allowables).¹⁶ An "allowable" is "The amount of oil or gas which a well, leasehold, field, pipeline system or state is permitted to produce under proration orders of a state conservation commission. The allowable may be stated in terms of number of barrels of oil or MCF of gas per day for a state number of days per month... In such instances, operators

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may produce daily during the entire calendar month but must limit gross monthly production to the amount allowed by the conservation commission, determined by multiplying the daily allowance by the number of producing days allowed per month."¹⁷ A "proration unit" is "The acreage assigned to an individual well for the purpose of allocating allowable production thereto."¹⁸ Market demand prorationing is a term that describes the type of prorationing dependent upon the governmental agency attempting to determine at some level what the equilibrium point is for demand and supply of oil or gas. Maximum efficient rate or MER is defined as "The maximum rate at which oil can be produced without excessive decline or loss of reservoir energy."¹⁹ Ratable taking involves regulation of transporters or purchasers of oil or natural gas which prohibits discrimination in favor of one producer against another, on in favor of any one source of supply as against another.²⁰

B -- The Historical Antecedents

OPEC was not the first organization that decided to limit production of oil for the purposes of maintaining a higher price than the market would otherwise bear. The notion of limiting production to market demand first appears in a 1915 Oklahoma conservation statute within the definition of economic waste.²¹ The stimulus to the enactment of this conservation statute appears to be the discovery and subsequent development of the Healdton and Cushing Pools that overwhelmed the transportation system as well as the market for crude oil. This led to a series of Corporation Commission orders dealing with ratable take requirements as well as limits on production. The constitutionality of regulating the ability of an oil and gas lessee to produce oil was upheld against arguments that proration regulation was a taking of private property without just compensation and a violation of the substantive due process clause.²² The Texas Railroad Commission also attempted to impose a proration system as a result of the discovery of the huge East Texas Field in 1930.²³ The Commission's efforts went for naught, however, as a federal district court found that the Commission lacked the authority to impose prorationing.²⁴ This was followed by a legislative act specifically...