Chapter 3B Permian Basin Oil & Gas Conservation Regulation: The Texas Approach

• Jurisdiction: United States

Chapter 3B Permian Basin Oil & Gas Conservation Regulation: The Texas Approach

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Ana Maria Marsland Davis Gerald & Cremer Austin, TX

ANA MARIA MARSLAND is a shareholder with Davis, Gerald & Cremer, P.C. She focuses on regulatory compliance for oil and gas operators, service companies and pipelines subject to the jurisdiction of the Railroad Commission of Texas, which includes advising clients with filings, rule interpretation and operation, and representing parties in contested and uncontested hearings before the commission. She is licensed in Texas and graduated from the University of Texas School of Law. She is a member of the Oil & Gas Section of The Austin Bar Association and the State Bar of Texas. Publications and Presentations:

I. Introduction

I am often asked why an agency called the Railroad Commission of Texas regulates oil and gas in Texas. Working in the Texas oil and gas industry, especially in any area that intersects with the Railroad Commission's regulation of the industry, it is important to know there is a reason, and to know what the reason is, in order to understand the fundamental basis for the Commission's regulatory structure.

The Railroad Commission of Texas' regulatory structure is partly historical, arising from the nexus between production of oil and gas and access to market for produced oil and gas. It is also very intentional, driven by actual experience. Finally, it is dictated by the law in Texas applicable to ownership of oil and gas in place and after severance. To interpret and apply the requirements of the regulations the Commission applies to the oil and gas industry, a bit of background is always handy.

Under Texas law, oil and gas in place is real property, and the landowner is the absolute owner of the oil and gas in place. ¹ If severed, the mineral estate is the dominant estate.² The most common avenue for developing oil and gas reserves is to lease property to an oil and gas company. An oil and gas lease granting the right to develop oil and gas is a determinable fee.³ It is also a contract.⁴ When oil and gas is produced, it becomes personal property. If oil and gas beneath the ground moves from one tract to another and is produced from a well on another's land, that producer has no liability to the owner of the tract under which the oil or gas originated.⁵ This is the rule of capture. This legal framework dictates the boundaries within which regulatory action can occur.

Using crude oil seeps as a source for lamp oil (kerosene) dates to the 1860s. By the 1870s, the clear, brightly burning and generally non-odorous kerosene lamp was the preferred fuel for light. Industrial scientists were also working to develop multiple uses for crude oil, as a lubricant, and eventually, as an all-purpose fuel. A market waited to be supplied. Drilling for crude oil commenced in Pennsylvania to develop sources for this new raw material. Unfortunately, crude at the wellhead was nowhere near the market where it had actual value. Access and transportation of crude to market was the lynchpin to making production of oil a commercial venture. The early oil fields developed in Pennsylvania and New York were not too far from the cities and industry

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that sought to use the product for light and fuel and lubricant. Pipelines were constructed and existing railcar access was also available. Even truck and wagon loads could reach markets.

In Texas, the factories and cities of the north were thousands of miles away. A man could poke a hole in the ground and crude oil would come to the surface, only to sit in earthen pits because there was no way to transport it. Pipelines were expensive and those who could afford to build them controlled access to them. Transportation of significant (i.e., marketable) volumes required trains. Movement by train, access to and charges for such movement, was the purview of the Texas Railroad Commission.

In 1917, Texas amended its Constitution to include the declaration that the conservation and development of natural resources was a public right and duty, and the Legislature was authorized to adopt laws to ensure such conservation.⁶ In 1919, the Texas Railroad Commission was designated as the state agency charged with regulating the oil and gas industry to ensure that the constitutional mandate to protect the State's natural resources was met.⁷ Crude oil was merely another good to be moved, and regulating goods by train was already the Commission's job. Since movement to market was directly tied to prevention of physical waste (fire and surface pollution from the earthen pits then used to store produced oil), the Commission was given authority to prevent physical waste associated with oil and gas operations.⁸ This is why the agency regulating oil and gas in Texas is called the Texas Railroad Commission.

The original governing statutes providing the statutory basis for the Commission power were adopted between 1917 and 1934, and have been added to, but remain largely unchanged, since their adoption. These provisions are now codified in Chapters 85 through 102 of the Texas Natural Resources Code. Commencing in 1919⁹ , the Commission began to promulgate rules applicable to drilling, completing, and producing oil and gas wells in specific reservoirs and areas of the state to prevent waste. These initial rules were adopted by individual orders, based on reservoir specific data, often requested and supported by operators. The Commission's orders were bundled together in pamphlets called circulars which were updated and expanded as development of new areas of Texas occurred. In 1919, the Commission adopted its first "statewide" rule by order. This was its general well spacing rule, now known as Rule 37.¹⁰

Once the Commission began to regulate the spacing, density and amount of production from oil and gas wells to prevent waste, the Legislature, the industry, and the Texas courts recognized that such regulation, in common sources of supply, necessitated addressing and adjusting for the correlative rights of the owners in that common source of supply to ensure confiscation did not occur. After much litigation, the Commission's authority to promulgate rules that prevent waste and protect correlative rights for both oil and gas wells is well established.¹¹

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From the 1930s forward, where the Commission acts to prevent waste, if such actions affect a party's correlative right to produce its fair share of the hydrocarbons in a reservoir and confiscation might result, the Commission must regulate in a manner that both prevents waste and provides the opportunity for the interest owners in that reservoir to obtain their fair share of the hydrocarbons. Please note this is not a guarantee. Conservation of natural resources is the Commission's express constitutional mandate, and once an opportunity is provided, no confiscation arises.

II. The Commission's Regulatory Structure

The Commission has a tiered approach to regulating the oil and gas industry in Texas which underpins the resilience, adaptability, and responsiveness of the Commission's regulation over the past 100 years and is the key to its unique success as a regulator. Pursuant to its authority to prevent waste and protect correlative rights, the Commission has adopted 105 statewide rules with public notice and comment as required by the Administrative Procedure Act applicable to oil and gas operations everywhere in Texas.¹²

By contrast there are over 40,000 pages of special field rule orders adopted by the Commission applicable to individual reservoirs which are based on specific geologic and engineering data and development practices particular to each reservoir. Each of these special field rule orders is adopted after notice to potentially affected parties, and an evidentiary hearing, which may be contested or uncontested.¹³

In addition, the Commission has also granted hundreds of thousands of individual well-specific compliance exceptions to statewide and special field rules (for example, wells drilled at less than the minimum lease line spacing under Rule 37) by orders issued after notice to potentially affected parties, as required, in contested and non-contested hearings as well as granted by administrative approval. Each of these exception applications is unique to each well or wells for which the exception is requested and can only be granted to prevent waste or protect correlative rights. This mosaic of regulation has resulted in a regulatory environment where compliance is focused on primary goals, prevention of waste, protection of correlative rights and protection of water, rather than rigid one size applies to all regulatory checklists. By focusing on the purpose of compliance in the context of specific facts, the rule language applicable and the overarching purpose of the Commission's authority to regulate, compliance with Railroad Commission rules has, in the past and today, resulted in a net benefit to operators because it supports development and production with mitigation of risk.

III. Recent Compliance Issues at the Commission

As discussed below, three specific areas arising from the drilling of longer laterals in unconventional reservoirs currently make up the bulk of compliance issues at the Commission. These areas are spacing of wells and assignment of acreage for proration purposes, production of gas and produced water takeaway. What is new is old, and all of these three areas have been hot

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issues requiring regulatory response in the past. Reviewing past regulatory action provides a window into current regulatory compliance that is always helpful.

A. Flaring of Gas

Oil production from horizontal development targets contains entrained gas that seldom can be reduced by mechanical means (choking back production) or selection of perforations (in vertical wells perforating a well low in an oil reservoir to avoid a gas cap). One of the early operational issues that...