CHAPTER 11 TERMINATING UNITS: CAN THE LIGHTS BE TURNED OFF?
| Jurisdiction | United States |
(Jan 1997)
TERMINATING UNITS: CAN THE LIGHTS BE TURNED OFF?
University of Oklahoma College of Law
Norman, Oklahoma
§ 11.01 Scope
§ 11.02 Introduction: Formation of Enhanced Recovery Units
§ 11.03 Termination of Enhanced Recovery Units—Especially Unsuccessful Units
§ 11.04 Cause of Action, Proper Forum, and Appropriate Relief
[1] Arguments of Unit Proponents
[2] Arguments of Unit Opponents
[a] Contract Approach
[b] Conservation Approach
[3] Reconsideration of Arguments of Unit Proponents
[4] Parkin v. State Corporation Commission
[a] Implied Covenant to Develop
[5] Summary
§ 11.05 Circumstances Under Which a Unitization Order May Be Vacated
§ 11.06 Consequences of Repealing a Unit Order
§ 11.07 What About Voluntary Unitization?
§ 11.08 Unitization Law Reform
§ 11.09 Conclusion
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§ 11.01 Scope
The involuntary termination of enhanced recovery units as a result of unsuccessful or imprudent unit operations or both is a relatively new and significant development in oil and gas law. This development originated simultaneously in Kansas2 and North Dakota3 in the early
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1980s. The paper will address some of the major concerns with this development, including the failure of conservation acts and unit agreements to contemplate unsuccessful operations, the possible causes of action, the proper forum, the proof needed to establish unsuccessful operations, the circumstances under which unit operations should be involuntarily terminated, the consequences of such termination, and the need for reform of conservation acts—especially compulsory unitization acts.4
§ 11.02 Introduction: Formation of Enhanced Recovery Units
Unitization has been defined as "the joint operation of all or some portion of a producing reservoir."5 Units may be formed for exploratory or enhanced recovery purposes and may be either voluntary or compulsory. This paper deals with the joint operation of a producing
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reservoir for the purpose of engaging in some form of enhanced recovery—either secondary or tertiary. The primary focus will be on compulsory unitization.6
Unitization for enhanced recovery is perhaps the ultimate conservation tool. Ideally, unitization should occur at an early stage so that the natural energy of the reservoir can be conserved and even enhanced to achieve a greater ultimate recovery of oil and gas. To engage in enhanced recovery efficiently, effectively, and economically and to avoid potential liability for injury to neighboring interests,7 enhanced recovery operations, except pilot projects, should be conducted over the entire producing reservoir or at least a complete block of acreage overlying a substantial portion of a reservoir. Consequently, separately owned tracts within the area targeted for those operations and the various interests in those tracts should be combined to form a unit so that enhanced recovery efforts may be conducted without regard to ownership boundaries.
Under voluntary unitization, all of the various working and nonworking interest owners in a field, or a portion thereof, agree to joint operations to enhance recovery. For a variety of reasons, however, the unanimous consent of all interest owners is difficult to achieve.8 Thus, compulsory unitization laws are often relied upon to implement an enhanced recovery plan.
Under compulsory unitization acts,9 an oil and gas conservation agency can issue an order
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compelling unitization. While in some jurisdictions a conservation agency may curtail production in an effort to "encourage" unitization or may issue a unitization order on its own motion, a unitization order is usually issued upon the application of working interest owners.
Achieving unitization is usually a lengthy and involved process. The process may begin when the working interest owners form a field-wide operating committee. This committee, or a specially formed unit committee, investigates the feasibility of enhanced recovery from both engineering and economic standpoints and determines which enhanced recovery method will obtain the maximum recovery of hydrocarbons from the field.10 Because implementing an enhanced recovery plan may be very expensive, the amount of expected increased recovery must be sufficient to recoup all costs and produce a reasonable profit.
If the committee decides that unitization is warranted, tract participation formulas must be calculated for the allocation of production from the unit and for the allocation of unit costs. In contrast to pooling, where production and costs are customarily allocated on a surface-acreage basis, unit-wide allocations are usually based on a combination of factors, such as the acreage of each tract, the net acre feet of pay and the volume of oil in place beneath each tract, the differences in porosity within the field, current production, cumulative production, the projected primary recovery from each well, and other factors.11 Reaching an agreement on a fair allocation formula is difficult,12 especially when some tracts may have no past or existing production.13
To secure the payment of each working interest owner's share of unit costs, the unit operator and each working interest owner are given a lien on each other's share of unit production. To encourage an owner to advance his share of costs, unit agreements give an owner the option of advancing his share of costs, having his share of costs taken out of his share of production, or, in some cases, selling his interest in return for a bonus or overriding royalty or both.
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Once the unit committee has reached an accord on the basics of the unit plan and allocation formulas, it will draft a unit agreement and unit operating agreement.14 The unit agreement is the basic document which identifies and combines the various tracts and interests forming the unit. The agreement outlines the basic plan for unitization and the formulas for allocating costs and production. In addition, the agreement will designate the unit operator, usually the owner of the largest share of unit production.
The unit operating agreement governs the day-to-day operation of the unit. This agreement sets forth the specific responsibilities and duties of the unit operator and working interest owners, voting procedures for working interest owners, insurance, valuation of equipment contributions, accounting procedures, winding-up provisions, and other matters.
Once the plan, unit agreement, and unit operating agreement have been formulated, the proposal is submitted to the state oil and gas conservation agency for approval.15 After notice to all interested parties, the plan and agreements are outlined at a hearing. Following the hearing, if the agency finds that the proposed unit is economically feasible and will prevent waste and protect correlative rights, it may enter an order approving the plan and agreements. In issuing its order, the agency may require modifications to the plan or amendments to the agreements, which may be proposed by interested parties or may originate with the agency itself. Often, however, the plan and agreements are approved as submitted.
Once agency approval has been obtained, the designated unit operator and other proponents of unitization will begin the task of obtaining the required ratification of working and nonworking interest owners in the proposed unit. Often, however, these ratifications are obtained prior to the time the unit plan is approved by the conservation agency. Most compulsory unitization acts require the ratification of working interest owners who collectively will be required to pay a specified percentage of the costs of unitization under the terms of the unitization agreement. In addition, the acts require the ratification of nonworking interest owners who collectively will be entitled to a specified percentage of the production (or proceeds of production) under the terms of the proposed unitization plan.16 Except for Alaska17 and
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Hawaii,18 which require no percentage of voluntary consent, among the major oil and gas producing states, the required percentage specified in these acts varies from 63% to 80% for both working and nonworking interests.
Once the necessary ratifications have been obtained and certified by order of the conservation agency, the unit is established and enhanced recovery operations may begin. Generally, the unit remains in effect for its economic life.
§11.03 Termination of Enhanced Recovery Units—Especially "Unsuccessful" Units
The termination of either a well drilling unit or an enhanced recovery unit can have profound consequences. For example, if a unit is terminated, underlying leases may terminate. Also, production sharing and cost-sharing arrangements may terminate. Consequently, conservation agencies should act to terminate units only in extreme circumstances.
One common problem encountered in several jurisdictions involves infill drilling. Sound conservation practice dictates that well drilling units be no smaller than what is needed to drain a reservoir effectively and efficiently. If well drilling units in a field are initially too large, this problem can be addressed with infill drilling. If they are initially too small, little can be done to resolve the waste of already having drilled too many wells. Thus, large well drilling units followed by infill drilling, if needed, is a proper conservation practice.
When considering a request for infill drilling, one interested party may favor the permitting of an additional well without changing the well drilling unit. Another party, however, may favor termination of the existing unit and the establishment of two separate single-well units. The creation of two separate units may not protect correlative rights, especially where the additional well is proposed long after unit...
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