CHAPTER 17 THE IMPACT OF UNIT EVENTS UPON A FEDERAL OIL AND GAS LEASE

• Jurisdiction: United States

Federal Onshore Oil and Gas Pooling and Unitization
(Nov 2006)
CHAPTER 17
THE IMPACT OF UNIT EVENTS UPON A FEDERAL OIL AND GAS LEASE
Gregory J. Nibert
Elizabeth A. Ryan
Attorneys
Hinkle, Hensley, Shanor & Martin, L.L.P.
Roswell, New Mexico

GREGORY J. NIBERT

Gregory J. Nibert received a Bachelor of Arts degree from the University of New Mexico in 1980 and a Juris Doctor degree, cum laude, from Pepperdine University in 1983. He was Editor-in-Chief of the Pepperdine Law Review for 1982-83. He is a partner in the law firm of Hinkle, Hensley, Shanor & Martin, L.L.P. and is a New Mexico Board of Legal Specialization recognized specialist in Oil and Gas Law. Mr. Nibert is the annual update author of Chapter 18, Unitization and Communitization, of the Law of Federal Oil and Gas Leases. He has participated in several Annual and Special Institutes of the Rocky Mountain Mineral Law Foundation and has presented papers and speeches to a number of organizations on oil and gas law topics, including: "Communitization of Federal Lands: An Overview, Final Decisions and Appeal Procedures in Drainage Cases, and Non-Record Title Considerations;" "Federal Unitization: Onshore Oil and Gas Unit Agreements for Unproven Areas," 53 Inst. Oil & Gas L. 10 (The Center for American and International Law 2002). Mr. Nibert is active in the Independent Petroleum Association of New Mexico and the New Mexico Oil and Gas Association. He is a Trustee of the Rocky Mountain Mineral Law Foundation and a Research Fellow of The Center for American and International Law. He served on the Board of Directors of the Section of Natural Resources, Energy and Environmental Law of the State Bar of New Mexico and was Chair of the Section for the year 1990-91. Professionally he is a member of the State Bar of New Mexico, Chaves County Bar Association, New Mexico Landmen's Association, and American Association of Professional Landmen.

ELIZABETH A. RYAN

Elizabeth A. Ryan is an Associate of the law firm of Hinkle, Hensley, Shanor & Martin, L.L.P. in Roswell, New Mexico. She practices with the firm's natural resources section, primarily in the areas of oil and gas law. Mrs. Ryan is a 2006 cum laude graduate of Texas Tech University School of Law, where she served as Executive Student Writing Editor for the Law Review. Her student comment, "The 13th Juror: Evaluating the Factual Sufficiency Review in Criminal Cases," 37 Tex. Tech. L. Rev. 1491, was published in the summer of 2005. While a law student, she received the Outstanding Second Year Award and the distinguished W. Frank Newton Award for her service on the Law Review. More recently, her article, "Can I Start You Off With Some Drinks?: An Analysis of Commercial Alcohol Provider Liability in Texas," will be published in Book 1, Volume 40 of the Texas Tech Law Review. Mrs. Ryan was a founding member of the law school's Mineral Law Interest Group and the Sportsman's Law Group and served as Managing Editor of the Texas Tech Lawyer alumni magazine. She graduated summa cum laude from Lubbock Christian University with a Bachelor of Arts degree in Humanities, emphasis in pre-law, minor in Biblical studies.

TABLE OF CONTENTS

I. INTRODUCTION

II. DEFINITIONS

III. COMMITMENT TO THE UNIT AGREEMENT

A. Lease Conformed to Unit Agreement

1. Lease Term

2. Royalty

3. Rentals

4. Unit Area Treated as One Lease

B. Segregation of Leases Committed in Part

1. Segreation

2. Segregation Terminology

3. Extension of the Segregated Lease

4. Segregated Lease Term

5. Rental or Royalty Status of Segregated Lease

IV. EXTENSION OF UNITIZED LEASES

A. 20 Year Leases

B. Payment of Annual Rentals

C. Minimum Royalties

D. Drilling Over the End of the Primary Term

E. Production in Paying Quantities

F. Completion of a Well Capable of Producing in Paying Quantities

G. Payment of Compensatory Royalty

V. PARTICIPATING AREAS

A. Cessation of Production Prior to Unit Termination

B. Revision of Participating Area

C. Possible Rental Obligation

D. Impact of Overlapping Participating Areas - Multiple Formations

E. Rental Obligations Become a Covenant

VI. CONTRACTION OF THE UNIT AREA

A. Participating Leases

B. NonParticipating Leases

1. Extension of Term

2. Rental and Minimum Royalty Status

3. Rental Deficiency

VII. TERMINATION OF THE UNIT AGREEMENT

A. Public Interest Requirement

B. Equivalent To Contraction

C. Effective Date of Termination

VIII. THE CELSUIS DECISIONS: COMPLICATIONS OF COTERMINOUS CONTRACTION OR TERMINATION OF ONE UNIT AND COMMITMENT TO ANOTHER UNIT

A. Celsius I

B. Celsius II

C. Celsius III

IX. SUSPENSIONS

X. DISTINCTIONS REGARDING COMMUNITIZATION

XI. CONCLUSION

I. INTRODUCTION

Unitization has been defined as "the agreement to jointly operate an entire producing reservoir or a prospectively productive area of oil and/or gas."¹ Unitization provides for the exploration, development, and operation of a geologically defined area by a single operator so that drilling and production may proceed in the most efficient and economical manner.² In order to meet this objective, both the Mineral Leasing Act³ (the "Act" or "MLA") and the implementing regulations⁴ provide that certain unit events have a substantial impact on federal oil and gas leases committed to the unit agreement. One of, if not the most, important impact is the extension of leases committed to the unit agreement as a result of wells drilled upon and completed as a producing well within the unit area.

This Paper explores a number of impacts that unit events have upon federal oil and gas leases committed to the unit. Many of these impacts are readily understood and directly advance the objectives of forming the unit. An oil and gas lessee should be aware, however, of the several obvious and sometimes obscure impacts the Act and regulations have on federal oil and gas leases. Some have unusual and unfortunate results. These matters have been discussed in a number of publications and prior papers.⁵ To fully understand these impacts, Part II discusses the terminology used in this Paper.⁶ Part III covers commitment of a federal lease to a unit agreement.⁷ Part IV details extensions of a unitized lease.⁸ Unitization and communitization

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may be utilized by a federal oil and gas lessee as a tool to extend federal oil and gas leases through unit operations and to avoid the acreage limitations set forth in the regulations,⁹ in addition to the primary objective of maximizing recovery of oil and gas. Next, Part V focuses on participating area events.¹⁰ Part VI illustrates the impact of contraction of the unit area.¹¹ Part VII discusses the impact of termination of the unit agreement, while Part VIII explains the Celsius decisions and the complications involved in coterminous contraction or termination of one unit and commitment of another unit.¹² Part IX outlines BLM's authorized suspension of drilling and/or producing operations within a unit.¹³ Lastly, Part X distinguishes communitization from unitization.¹⁴ An enhanced knowledge of the foregoing, will aide unit operators and federal lessees in planning unit operations.

II. DEFINITIONS

Several of the concepts in this discussion require the use of precise terminology. When used in this Paper, the following words shall have the meanings set forth below.

Communitization: "[T]he agreement to combine small tracts for the purpose of committing enough acreage to form the spacing and proration unit necessary to comply with the applicable state conservation requirements."¹⁵ It is the same as pooling with respect to nonfederal lands.¹⁶

Unitization: "[T]he agreement to jointly operate an entire producing reservoir or a prospectively productive area of oil and/or gas. The entire area is operated as a single entity, without regard to lease boundaries, and allows for maximum recovery of production from the reservoir."¹⁷

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Primary Term: It is the term of years set forth in most federal oil and gas leases, usually five years or ten years. With respect to leases issued before September 2, 1960, the primary term is all periods of the life of the lease prior to its extension by reason of production.¹⁸

Extended Term: A federal lease will be held in an extended term when it has been held by production beyond its primary term, extended for reasons other than production, such as drilling over the end of the primary term, elimination of a lease from a unit or cooperative agreement, or upon segregation by commitment of only a portion of the leased lands to a federal unit.

Indefinite Extended Term: It is the period a lease is extended as a result of production of oil and/or gas in paying quantities or by a well capable of producing oil and/or gas in paying quantities.

Fixed Extended Term: A period a lease is extended for reasons other than production.

Original Term: The original term will be the primary term or some other fixed term of the lease at or prior to the time of commitment to the unit, regardless of whether the lease was in an indefinite extended term because of production on the lease at the time of the commitment. This term has been utilized by the Interior Board of Land Appeals ("IBLA" or "Board") to describe the term of a federal oil and gas lease in the context of an inclusion of the lease from the unit upon unit contraction or termination.

Production in Paying Quantities: In a unit context, production in paying quantities has two meanings depending upon the circumstance. For purposes of extending a federal oil and gas lease, production in paying quantities is production sufficient to repay the operating costs associated with the production and a reasonable profit. For purposes of establishing a participating area and for fulfilling the terms of a unit agreement, production in paying quantities means production sufficient to repay the costs of drilling and operating the well and returning a reasonable profit to the working...