CHAPTER 17 FUNDAMENTALS OF DRILLING AND SPACING UNITS AND STATUTORY POOLING

• Jurisdiction: United States

Mineral Title Examination
(Feb 2012)
CHAPTER 17
FUNDAMENTALS OF DRILLING AND SPACING UNITS AND STATUTORY POOLING
Michael J. Wozniak
Matthew J. Lepore
Beatty & Wozniak, PC
Denver, Colorado

MICHAEL J. WOZNIAK is the managing partner in the Denver office of the natural resources firm of Beatty & Wozniak, P.C. where the firm's practice focuses on representation of natural resource development companies throughout the Rockies. He received his B.A. degree with distinction from Indiana University in 1976 (Phi Beta Kappa) and his J.D. from the University of Colorado School of Law in 1980. Mike represents oil and gas clients in regulatory and environmental compliance matters, Public Lands appeals, and natural resources litigation in both state and federal courts. Mike's primary practice focuses on oil and gas conservation commission matters in both Colorado and Wyoming. He is also involved in merger, divestiture and acquisitions, involving oil and gas producing properties, midstream assets, gas processing plants and pipelines throughout the United States. He is licensed to practice in the states of Colorado and Wyoming, is a member of the Colorado, Wyoming, Southern Ute Tribe and Federal Energy Bar Associations and is a frequent lecturer on natural resources matters, including the Annual Institutes of the Rocky Mountain Mineral Law Foundation in 2002, 2005 and 2011 and was the Chair of the Foundation's the Federal Oil & Gas Leasing Short Course in 2005, 2007 and 2009. Mike is active in community and governmental affairs. He is a member of the Board of Directors of the Western Energy Alliance and serves as a Trustee-at-Large of the Foundation. Mike previously served on the City Council and as chair of the Board of Adjustment and Appeals and two terms on a Planning and Zoning Commission. In his spare time, Mike is in his third term as the Mayor of Cherry Hills Village, Colorado.

MATTHEW J. LEPORE joined Beatty & Wozniak as a Member of the firm on July 1, 2011. Mr. Lepore brings 18 years of experience in natural resources and environmental litigation and compliance counseling to the firm. Immediately prior to joining the firm, Mr. Lepore was an Assistant Attorney General and counsel to the Colorado Oil and Gas Conservation Commission. Mr. Lepore represented the Commission before all Colorado state courts, and counseled the Commission on enforcement matters and rule making proceedings. Prior to his tenure with the AG's Office, Mr. Lepore was a partner in a large private firm where he represented a variety of energy companies and other businesses in toxic tort litigation, environmental compliance, and regulatory enforcement proceedings before both federal and state regulators.

I. Introduction

Well spacing requirements are one of the primary means by which state conservation agencies promote efficient production of oil and gas resources, limit unnecessary drilling, and protect the property interests of multiple owners within a common pool of oil and gas. Imposing limits on the number and location of wells within a common pool: 1) avoids premature dissipation of reservoir energy, thereby maximizing ultimate recovery of the resources; and 2) avoids drilling more wells than are needed to efficiently drain the pool, thereby minimizing physical and economic waste. The importance of regulating drilling within a pool was recognized early in the history of domestic oil production: municipalities in Kansas and Oklahoma adopted well spacing regulations in the late 1920s.¹ Today, well spacing is typically regulated at the state level through oil and gas conservation agencies. Such agencies are authorized by statute to establish a "drilling unit," defined as the area in which only one well may be completed.² Theoretically, a drilling unit should be equal to the area a single well can efficiently drain within a given pool. Therefore, the geology of the pool and engineering considerations should be the principal determinants of spacing unit size. Under Colorado's Oil and Gas Conservation Act, "no drilling unit shall be smaller than the maximum area that can be efficiently and economically drained by one well."³

In areas where mineral ownership is divided into small tracts, minimum well spacing requirements could have the unintended consequence of resources being left in the ground or individual owners' minerals being drained without just compensation. For example, if a conservation commission establishes 80-acre drilling units for a given pool based on the geologic and engineering evidence, mineral owners of tracts smaller than 80 acres could not get a drilling

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permit. On one hand, minerals in these tracts might never be produced, leading to waste.⁴ On the other hand, permitted wells in adjacent units might drain the minerals from the smaller tracts. Under the common law "rule of capture" discussed below, the owners whose minerals were drained are owed nothing, even though they cannot legally drill an offset well to protect themselves. Thus, imposing a minimum acreage requirement for a well permit can harm "correlative rights" - which is generally defined as the right of each owner and producer within a common pool or source of supply of oil and gas to have an equal opportunity to obtain and produce his just and equitable share of the oil and gas underlying such pool or source of supply, tempered by a reciprocal right not to harm the common reservoir.⁵

"Pooling," generally defined as "the bringing together ... of separately owned small tracts sufficient for the granting of a well permit under applicable spacing rules, in order to prevent the drilling of unnecessary and uneconomic wells, which will result in physical and economic waste,"⁶ overcomes the potential adverse consequences of minimum spacing requirements. Owners may voluntarily agree to pool smaller tracts into a unit large enough to meet the well spacing requirements. Typically, the owners would share costs of production and revenues proportionately, based on their surface acreage ownership within the unit. Alternatively, when a drilling unit encompasses smaller tracts or a larger tract in which the mineral ownership is divided, an owner who is willing to bear the costs and risks of drilling may seek an order from the state oil and gas commission pooling the non-consenting owners on "just and reasonable" terms.⁷ Pooling by operation of statute is intended to provide all owners within a drilling unit the "opportunity to recover or receive, without unnecessary expense, his just and equitable share" of production from the unit.⁸ See C.R.S. § 34-60-116(6).

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II. Historical Context of Spacing Units and Pooling Orders --

A. The Rule of Capture

State oil and gas regulatory agencies in general and well spacing and pooling regulations in particular developed largely in response to the "rule of capture," a common law doctrine that was adopted by almost all jurisdictions to determine oil and gas ownership. Under the rule of capture:

The owner of a tract of land acquires title to the oil and gas which he produces from wells drilled thereon, though it may be proved that part of such oil or gas migrated from adjoining lands.⁹

Thus, a mineral owner is entitled to appropriate all the oil and gas a well completed within her property "captures," without liability to adjacent owners from whose lands the resources might have been drained. The rule encourages owners to drill as many wells as possible in order to avoid losing their oil and gas to their neighbors' wells. Further, the most logical place to locate one's wells is around the perimeter of your property, whether to capture minerals from your neighbors or to prevent them from draining yours. Your neighbor's only recourse is to respond in kind, drilling as many wells as he or she can along his or her boundary.¹⁰ Applied to oil and gas, the rule of capture inevitable results in far more drilling than is necessary to efficiently recover the resources (economic waste); premature dissipation of natural reservoir energy, which raises production costs and reduces the amount of oil and gas ultimately recovered (physical waste); and drainage of minerals from adjacent property without compensation (injury to correlative rights). One engineer described the inevitable consequences of the rule as follows:

The outstanding evils commonly in mind are: Production in excess of requirements, unnecessary storage, untimely drilling of wells, the drilling of many unnecessary wells, wasteful and disorderly production practices, instability of markets, feasts and famine with respect to reserves, and particularly the unsound and burdensome

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drill-and-produce-as-you-please method to protect property lines against drainage.¹¹

A photograph of Triumph Hill in Titusville, Pennsylvania circa 1871, attached as appendix 1, indelibly captured the excesses engendered by the rule.

B. Regulatory Response to the Rule

Despite the frequently inequitable and illogical results occasioned by adherence to the rule of capture, judicial relief was uncommon short of circumstances involving either a total waste of the captured hydrocarbons or negligence by one owner that caused substantial injury to other owners.¹² Perhaps because the adverse economic and public safety impacts of unlimited drilling were more immediately apparent to local governments, legislative modifications outpaced and largely supplanted the judicial response. Municipalities began adopting zoning ordinances designed to limit drilling within their boundaries in the late 1920s.¹³ The zoning ordinances functioned as spacing and compulsory pooling ordinances by limiting drilling to one well per designated unit and providing for non-drilling mineral owners to share in production.¹⁴ In 1935, New Mexico and Oklahoma became the first states to adopt specific compulsory pooling statutes.¹⁵ The Oklahoma statute authorized the creation of spacing...