CHAPTER 4 UNIT AGREEMENTS—HISTORICAL PERSPECTIVE AND THEORETICAL UNDERPINNINGS

• Jurisdiction: United States

Federal Onshore Oil and Gas Pooling and Unitization II
(Jan 1990)
CHAPTER 4
UNIT AGREEMENTS—HISTORICAL PERSPECTIVE AND THEORETICAL UNDERPINNINGS
Bruce M. Kramer
Professor of Law Texas Tech University School of Law
Lubbock, Texas

I — INTRODUCTION

This paper is designed to present the historical and theoretical background which will enrich your understanding of the present system by which federal and Indian mineral interests are unitized. The remaining presentations will focus on the administrative process and standards that govern the unitization of federal and/or Indian lands. To be consistent as used in this paper the terms "unitization" or "unit operations" refer to the consolidation of mineral or leasehold interests covering all or part of a common source of supply.¹ In the private sector there are normally two separate instruments which are executed to implement a plan of unitization. The unit agreement typically includes all interest owners, mineral, leasehold and royalty. This document defines the purpose of the agreement, the areal limits, creates the unit, designates the unit operator, establishes a voting mechanism to replace the unit operator and most importantly determines the participation formula that is to be used to distribute the unitized production.² The second agreement is called the unit operating agreement and controls the relationship between the parties sharing the costs of unit development, typically the leasehold and unleased mineral owners.³

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There are two primary "types" of unitized operations. These are developmental and operational.⁴ The exploratory unit, which is the predominant form of federal unit is treated as a sub-set of the developmental unit. This type of unit is designed to be formed soon after the discovery of the reservoir which will allow for systematic and efficient development minimizing both surface and underground waste. The major difference between the developmental and the exploratory unit is the amount of information known to the engineers or geologists about the nature and extent of the conditions in the reservoir. The operational unit is one that deals with a mature field or reservoir, typically created in order to implement a secondary or tertiary recovery process.⁵

A since repealed section of the Interior regulations defined a unit agreement as follows:

An agreement or plan for the development and operation which provides for the recovery of oil and/or gas from the lands made subject thereto as a single consolidated entity without regard to separate ownerships and for the allocation of costs and benefits on a basis as defined in the agreement or plan.⁶

This definition not only explains what a unit agreement accomplishes but also describes how it operates by the elimination of internal property lines within the unit area. Once unitization (or pooling or communitization) is implemented the boundaries of the unit area become the new property line boundaries so that previously divided ownership in separate tracts becomes the functional equivalent of undivided ownership in a unified tract.

II — HISTORICAL UNDERPINNINGS

The unitized development of reservoirs was advocated in the early 1900's.⁷ The issue came to the forefront, however, through the advocacy of A.L. Doherty, an

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independent oil man during the mid-1920's. The widespread adoption of the rule of capture created substantial problems for efficient and technologically sound development of oil and gas. The two leading negative impacts of the adoption of the rule were the over-drilling needed to prevent drainage and the loss of natural reservoir pressure caused both by overdrilling and poor locational decisions for wells.⁸

The federal government played an important role in these early days through the Federal Oil Conservation Board which conducted numerous hearings and adopted several reports about the oil industry in the late 1920's. In 1926 a Board report made the following comments about unit operations:

The unit idea in producing oil is bound to win out because the natural unit is the oil pool...[and it] means both efficiency in development and operation and the determination of equities among the owners.⁹

The private sector was less than enthusiastic about the concept of unitization, especially those like Mr. Doherty who wanted the federal government to compel unitization upon unwilling mineral owners and lessees. Nonetheless both the Section of Mineral Law of the American Bar Association and the Mid-Continent Oil & Gas Association adopted positions encouraging unit development through both voluntary and compulsory means. Nonetheless, little voluntary unitization took place during the 1930's and neither the federal government nor any state government adopted a compulsory unitization statute.¹⁰ It was not until 1945 that Oklahoma enacted the first compulsory unitization statute.¹¹

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While the federal government did not adopt a compulsory unitization statute applicable to private development, it was an early supporter of voluntary unitization.¹² The Mineral Leasing Act of 1920 did not contain any provision relating to unitization.¹³ But pressure to unitize the North Dome Kettleman Hills Field in the late 1920's prompted the Secretary of the Interior to seek authority to unitize federal oil and gas interests. In 1930 Congress enacted a statute modifying the 1920 Act which authorized the Secretary to approve unit plans. As a result two such federal unit plans were approved by the Secretary.¹⁴ In 1931 shortly after the temporary authorization provision had expired a new provision gave the Secretary of the Interior power to approve unit plans. That authority has been continued until the present although the language of the Mineral Leasing Act has been amended on several different occasions. The statute was which was recently amended provides in part:

226(m) Cooperative or unit plan;.... For the purpose of more properly conserving the natural resources of any oil or gas pool, field, or like area, or any part thereof (whether or not any part of said oil or gas pool, field, or like area, is then subject to any cooperative or unit plan of development or operation), lessees thereof and their representatives may unite with each other, or jointly or separately with others, in collectively adopting and operating under a cooperative or unit plan of development or operation ... whenever determined and certified by the Secretary of the Interior to be necessary or advisable in the public interest. The Secretary is thereunto authorized, in his discretion, with the consent of the holders of leases involved, to establish, alter, change or revoke drilling, producing, rental, minimum royalty, and royalty requirements of such leases and to make such regulations ... as he may deem necessary. ...¹⁵

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Detailed regulations have been adopted by the Secretary for onshore oil and gas unit agreements.¹⁶ As part of those regulations the Secretary has developed a model unit agreement for federal exploratory units.¹⁷

III — THE UNITIZATION CONCEPT

The unitization of oil or gas fields whether on federal or private lands serves important societal interests. The following excerpt suggests some of the benefits that unitization accomplishes especially where unitization is implemented early in the developmental stage of the field:

Why launch into a competitive and wasteful program of drilling an excessive number of costly wells in a pool, located arbitrarily with respect to surface boundary lines and having no relation whatever to reservoir conditions, when from experience in most every unitized pool half as many wells properly and strategically located with respect to structure are all that are needed to produce a greater quantity of oil at approximately the same or an increased rate of production?

Why lay duplicate water, fuel and gas gathering systems, build duplicate warehouses and duplicate everything else when ultimately you plan to unitize and will consolidate all such systems and installations?

Why sit by and see the common source of supply ravaged, watch the dissipation of vital natural reservoir energy, hear the vented gas as it goes to the air and suffer all the other disadvantages of competitive cupidity, all with the thought of later going in and, in part only and at great expense, repairing damage that should never have occurred in the first place? ...Why follow a program of pressure depletion, followed by an artificial repressuring of the formation? ...Why wait until much of the rich gas is gone to build adequate gas processing and injection facilities... Early unitization permits a coordinated development and gasoline plant operation Why competitively produce edgewater well or wells close to water, accelerate channeling or create needless problems of water disposal and pollution...¹⁸

These problems are all matters that fall within the Department's purview when it decides to allow a unit agreement to affect federal lands. The statute gives the Secretary broad discretion to approve unit plans and unit

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operating agreements when it is in the public interest. Unlike many states which may have limited purpose unitization statutes the federal government has broad powers to approve unit agreements when they prevent waste, protect correlative rights and encourage the development of hydrocarbons. Unitization accomplishes all of those purposes when it is promptly implemented after the discovery of a field or pool.

Unitized operations achieve the just described objectives by changing the legal framework for the development of fugacious hydrocarbons.¹⁹ Under traditional oil and gas jurisprudence the Rule of Capture determines the owner of the oil and gas. In simple terms the Rule assigns ownership to a party who captures or controls the hydrocarbons by bringing it to the surface, regardless of where the hydrocarbons may have been located...