CHAPTER 19 UNCONVENTIONAL UNITS

• Jurisdiction: United States

Federal Onshore Oil and Gas Pooling and Unitization II
(Jan 1990)
CHAPTER 19
UNCONVENTIONAL UNITS
Kurt M. Petersen ¹
Davis, Graham & Stubbs
Denver, Colorado

As far back as 1916, the United States Bureau of Mines was aware of waste and other evils resulting from the individual, competitive development of oil and gas.² The emerging oil and gas industry and the associated field of petroleum engineering were slow to accept the concept of unitized development, but in 1931, the Mineral Leasing Act³ was amended to authorize the Secretary of the Interior to unitize federal lands for the development of oil and gas.⁴ Fifty-nine years after forming the first units involving federal lands,⁵ the legal issues surrounding federal oil and gas units are still being debated and discussed, as evidenced by this Special Institute.

The federal unitization of lands for the development of unconventional resources, such as coal-bed gas, tar sands and geothermal, is a relatively recent phenomenon. Although the energy potential of these resources has been known for some time, recent technological advances and a changing economic climate have made the development of these resources more attractive. There has been some development of these resources using federal units, but, in fact, not many of these units exist. In Utah, Colorado and Wyoming there are five coal-bed gas units, one tar sand unit and one geothermal unit.

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This paper will discuss the unconventional federal unit agreements used to develop coal-bed gas, tar sands and geothermal resources by presenting the author's observations, analyses and critical comments, focusing on the content of the unconventional unit agreement as it differs from conventional federal exploratory and secondary recovery unit agreements.⁶ This paper will also discuss a federally approved alternative to development of both conventional and unconventional resources short of full-blown unitization—the working interest unit. Such "units" fit on a continuum running from development on a lease basis to full-blown unitization. Two other federally approved methods for developing federal resources short of full-blown unitization— the communitization agreement and the development agreement—are addressed by other papers at this institute.⁷

This paper is organized into four sections. Because unit agreements must be tailored to fit the unique development of the particular unconventional resource, the first section will discuss the development of coal-bed gas, tar sands and geothermal. The second section will discuss alternatives to full-blown unitization that should be thoroughly considered before unitizing. The next section will discuss the actual unconventional unit agreements and compare them to the model form federal exploratory unit agreement.⁸ The final section will discuss the working interest unit agreement, and how it can be used to develop conventional and unconventional resources.

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I. THE RESOURCES—COAL-BED GAS, TAR SANDS AND GEOTHERMAL

One goal of all mineral development is to recover the maximum amount of the resource at minimum cost, with the least amount of environmental damage. All development options must be analyzed to see which strategy fits the resource and makes economic sense. To help make such decisions, the attorney must understand the engineering, geologic and operational aspects of development of the resource. If unitization is chosen as the development strategy, clear communication between the lawyer and the engineer and geologist is essential so that the lawyer understands potential operational problems.⁹ The lawyer can then formulate the permissive and restrictive conditions necessary to address the operational concerns, and negotiate those conditions with the appropriate BLM official. This is particularly true for the development of unconventional resources, where operational, technical and geological conditions may vary significantly from traditional oil and gas unitization operations. To illustrate just how geologic, engineering and operational aspects vary, the remainder of this section will describe the nature of each unconventional resource and how it is currently being developed.

A. Coal-Bed Gas.

1. Engineering and Geological Aspects. The recovery of coal-bed gas¹⁰ as an energy resource has become

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increasingly attractive due to recent technological advances, changing market conditions and the availability of a tax credit for the coal-bed gas sold from wells drilled after 1979 and before 1991.¹¹ Coal-bed gas is present in all coal-beds and is formed by biochemical and physical processes during the conversion of accumulated plant material into coal.¹² Methane constitutes 80% to 99% of the coal-bed gas, and, as a result, coal-bed gas is similar to conventional natural gas in its physical and chemical properties. Coal-bed gas is found as a monomolecular layer, absorbed onto the internal surface of the coal. Because coal has such a large internal surface area and methane molecules can be tightly packed, coal is an attractive reservoir and can hold two to three times as much gas in place as conventional sandstone reservoirs.

To be produced, the coal-bed gas must first desorb from and defuse through the coal matrix until it reaches a cleat, a natural fracture in the coal. After reaching the cleat, the gas moves toward the wellbore in a manner similar to conventional gas wells. To complicate matters, coal seams are often aquifers with water flowing through the cleat system. For gas to be produced, this water must be removed to allow the gas to move into and flow more freely through the cleat system to the wellbore. Because incorrect technical procedures can easily cause damage to the coal seam, successful development of coal-bed gas requires an experienced engineer to analyze the reservoir data and recommend the best well spacing, drilling, stimulation and spacing strategies. Drilling and well stimulation technologies, which

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are of vital importance for a successful well, are being improved with experience.

Production challenges are numerous, but generally solvable. Most coal-bed gas wells must be dewatered; in a potentially productive well, water production decreases as gas production increases. The time frames for this dewatering vary greatly and often delay determination of whether the well is capable of production in paying quantities. Dewatering raises a potentially significant operational concern—water disposal. Water disposal techniques vary depending on water quantity and quality, but may range from discharge into existing streams or evaporation to injection or transporting the water in barrels to a disposal site. Development of the geologically favorable areas of the basins (the "sweetspots") is economical at today's wellhead gas prices. Such sweetspots, however, are limited and largely developed. As drilling extends beyond these sweetspots, the economics become less favorable.

2. Property Ownership Issue. Two additional legal complexities are present in coal-bed gas plays. The first is the ownership issue. This issue is relatively simple: who owns the coal-bed gas — the coal owner or the gas owner. The answers and associated development risks vary depending upon the type of land ownership and the presence or absence of coal development. The ownership issue has been discussed by a number of legal commentaries,¹³ but an easy answer or broad resolution

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of the issue is not likely to be forthcoming; current resolution of the issue will be on a case-by-case basis.¹⁴

Of the four potential types of land ownership (fee, federal, Indian and state), the ownership question for federal lands is the most settled. The Solicitor of the Department of the Interior issued an opinion¹⁵ which analyzed federal reservations of coal and oil and gas in various patents, as well as the provisions of the Mineral Leasing Act. The Solicitor concluded that where the United States owns both the coal and the oil and gas, the oil and gas lessee has the right to extract the coal-bed gas. When the United States only owns the coal, it does not retain the right to develop the coal-bed gas. Although it is not judicial precedent and may be overturned by a subsequent Solicitor or a court, the lack of challenge to the decision in the past nine years and the amount of development that has occurred based on its ownership principles make it unlikely that the opinion will be overturned.

3. Concurrent Development of Coal and Coal-Bed Gas. The second legal issue present in coal-bed gas development concerns concurrent development of the coal and the coal-bed gas. This multimineral development issue typically takes two forms.¹⁶ The first is where the coal seam is the target of both developers. This is less likely to occur in western states because minable coal is typically near the surface and the best seams for coal-bed gas development are much deeper. In this situation, the coal-bed gas developer can provide a service to the coal developer by removing coal-bed gas from the coal seam in advance of mining. Alternatively, if a long-wall method is used to mine the coal, the coal-bed gas developer can extract the "gob" gas that remains in the mined space after the roof of the mine is collapsed. Discussion of various alternatives should occur early on and should involve all interested parties—in particular the BLM if federal coal is involved.

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The second situation occurs when the coal-bed gas developer must drill through a shallow minable coal seam to reach the coal-bed gas target formation. The well bore is the bane of the coal operator and usually the focus of this opposition. This issue has typically been resolved in favor of access; provided, however, that the oil and gas developer compensates the coal owner for damage to his resource. As above, the key to minimizing such development conflicts is advance negotiation...