CHAPTER 12 PROBLEMS CAUSED BY PRODUCER IMBALANCES
| Jurisdiction | United States |
(Sep 1991)
PROBLEMS CAUSED BY PRODUCER IMBALANCES
Clonahan, Tanner, Dauning & Knaulton, P.C.
Denver, Colorado
TABLE OF CONTENTS
Page
Causes of Producer Imbalances
Joint development situations
Operational aspects of gas marketing
Traditional contractual and regulatory marketing era
Balancing problems during the traditional marketing era
Balancing problems aggravated by the excess gas market
Balancing problems aggravated by open access
Balancing problems aggravated by development of the spot market
Summary of causes of producer imbalances
Balancing Issues
Ownership of Gas Production
The issue
Competing theories
Consequences of the contenancy theory
Consequences of the tract allocation theory
Case support for the two theories
Statutory ownership provisions
The model form joint operating agreements
The federal model onshore unit agreement
Resolving gas imbalances under the tract allocation theory
Case support for in-kind balancing
Case support for cash balancing
Statutory balancing remedies
Conclusions regarding balancing remedies
Conversion remedy
Contents of a balancing agreement
Payment of Royalties
The issues
Competing rules
The weighted average rule
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Case support for the weighted average rule
The tract allocation rule
The tract allocation rule (sales basis)
The tract allocation rule (entitlements basis)
Case support for the tract allocation rule (sales basis)
Authority for the tract allocation rule (entitlements basis)
Statutory royalty payment provisions
Choosing between sales and entitlements
The Federal tracing rule
Contractual royalty payment provisions
Unit agreement and unit operating agreement
Balancing agreements
Conclusions regarding payment of royalties
Lease Maintenance Problems
The issue
The habendum clause—production in paying quantities
The shut-in royalty clause
The implied covenant to market
The royalty clause
Recommendations
Operator Responsibility and Liability
The issue
The Model Form
Cases regarding operator rights
Market-sharing statutes
Balancing agreement requirements regarding reservoir balance
Conversion liability
Conclusions
Purchaser Liability
The issue
Cases regarding purchaser liability
Purchaser attempts to create imbalances
Severance Taxes
Income Taxes
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Conclusions
APPENDICES
A Rocky Mountain Mineral Law Foundation Form 6 Gas Balancing Agreement
B A.A.P.L. Draft Gas Balancing Agreement Form
C Oil and Gas Payor Handbook, Volume II, Form 2014, pages 1-13—1-20
D Technical Advice Memorandum 8809001 (October 23, 1987)
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The purpose of this paper is to provide an overview of the legal issues which must be addressed when the volume of natural gas taken in kind and disposed of by each owner in a jointly-developed lease or unit2 ("jointly-developed property") differs from the volume of gas which each owner is entitled to take and dispose of. This difference is known as an imbalance and, in this paper, is referred to as a "producer imbalance" or a "gas imbalance" to distinguish it from the imbalances which may occur between shippers and their transporting pipelines or purchasers in connection with the scheduling and delivery of transportation or sale gas. The legal issues which must be addressed when producer imbalances occur include those of ownership of the production, payment of royalties, maintenance of leases, operator liability, purchaser liability, payment of severance taxes, and income tax reporting.
This paper is of necessity an "issue identification" paper for several reasons. First, each of these issues could be a paper unto itself. However, space limitations do not permit a complete analysis of each of these issues in this paper. Therefore, extensive references to additional authorities will be made. Second, there are, as yet, very few published court decisions regarding these issues. In fact, one commentator has noted that there are more articles regarding producer imbalances than there are cases.3 Finally, what few cases there are involve the traditional types of producer imbalances, i.e., imbalances caused by split stream deliveries. In today's marketing environment, producer imbalances are almost unavoidable as producers struggle to cope with open access transportation and the changes it has brought to the industry. While producer imbalance disputes wind their way through the courts, producers must continue to confront the issues and attempt to minimize their risk of litigation over such issues. It is hoped that this paper will equip the reader with an awareness of the issues, the theories (and cases where there are any) for resolution of those
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issues, and practical suggestions for minimizing problems and resolving problems which have already arisen.
CAUSES OF PRODUCER IMBALANCES
Joint development situations
Producer imbalances may occur whenever there is joint development of gas-producing properties. For example, producer imbalances may occur in the following situations:
(1) Undivided leasehold ownership — When a single lease is owned by more than one party in undivided shares,
(2) Leases from mineral cotenants — When mineral cotenants lease their interests to separate lessees,
(3) Pooling — When there is voluntary or compulsory pooling4 or communitization5 of leases (hereafter "pooling"), and
(4) Unitization — When leases have been unitized.6
Operational Aspects of Gas Marketing
Producer imbalances are a function of both the operational aspects of natural gas marketing and the way natural gas is marketed from a contractual and regulatory standpoint. Unlike oil, natural gas cannot be hauled to market in trucks or railroad cars. Natural gas must be transmitted, under pressure, through pipelines from the wellhead to the burner tip. At the wellhead, natural gas is delivered into low pressure gathering lines which eventually connect with higher pressure transmission lines (interstate or intrastate). Processing of the natural gas to remove impurities (such as hydrogen sulfide or excessive carbon dioxide) and
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natural gas liquids (such as ethane, propane, butane and natural gasoline) usually, but not always, occurs before delivery of the gas into a transmission line. The transmission lines transport natural gas to distributors known as local distribution companies (or "LDCs") who, in turn, re-sell and deliver the natural gas to residential, industrial and commercial consumers. LDCs and their customers are known in the industry as "end users." Sometimes, a local distribution company is "by-passed" by an interstate or intrastate pipeline when the pipeline delivers natural gas directly to an end user such as a factory, hospital or university.
Traditional Contractual and Regulatory Marketing Era
Although the physical delivery of natural gas is a continuous process, different industry players own the various facilities and provide the various services involved in that process. Traditionally, gathering was performed by the producers themselves, by third-party gatherers, or by a wellhead purchaser such as a processor or pipeline (intrastate or interstate).
Producers almost universally sold their gas to an interstate or intrastate pipeline. The sale contracts were often long-term (such as 20 years or life of the field) and covered large blocks of relatively undeveloped acreage. If the purchaser was an interstate pipeline, these large dedications of acreage caused all of that acreage to be "committed or dedicated" to interstate commerce.7
The pipeline purchasers transported and resold the gas to intrastate pipelines, local distribution companies, or other end users. Transportation by pipelines was a service incidental to the pipelines' major role as gas merchants. In addition to transportation, pipeline purchasers often provided other services such as gathering, processing, storage and compression. All of these pipeline services were "bundled" into a single resale rate which the Federal Energy Regulatory Commission established in interstate pipeline tariffs.
Local distribution companies and other end users usually purchased their gas from interstate or intrastate pipelines. They seldom purchased their gas directly from producers. The rates charged by intrastate pipelines and local distribution companies for their resale of gas were regulated by state or local public utility commissions.
Balancing Problems During the Traditional Marketing Era
During the traditional marketing era, producers almost universally sold their gas to an interstate or intrastate pipeline. As long as there was only a single pipeline purchaser for production from a well, there were few balancing problems between producers. Occasionally, a particular working interest owner would not have a contract with the pipeline connected to the well and the operator would not elect to exercise its rights under standard
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form joint operating agreements to market that nonoperator's share of the gas. In those situations, producer imbalances would occur.8
Where a gas stream was split between two wellhead pipeline connections, balancing problems were more common. Although both pipeline connections may have been contracted for, the connections would not always be completed at the same time.9 The owners whose gas was contractually dedicated to the completed line would become overproduced while the other owners waited for their connection to be completed.
Split stream connections could lead to production imbalances for other reasons as well. For example, if the line pressure in one of the lines was too high to permit delivery, then the proper volume of gas would not flow into that line.10 Even if all the lines were in place and operating at acceptable pressures, it was impossible for the operator to perfectly split the stream and slight imbalances...
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