CHAPTER 6 HOW TO PROPERLY DRAFT AND USE THE POOLING CLAUSE

• Jurisdiction: United States

Drafting and Negotiating the Modern Oil and Gas Lease
(May 2018)
CHAPTER 6
HOW TO PROPERLY DRAFT AND USE THE POOLING CLAUSE
John W. Morrison, Jr.
Wade C. Mann
Crowley Fleck PLLP
Bismarck, ND

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JOHN W. MORRISON, JR., is a Partner in the Crowley Fleck PLLP Bismarck, ND office. He has been a shareholder in the Bismarck firm of Fleck, Mather & Strutz, Ltd. since 1986. He practices in the area of natural resources, public utilities and commercial law, and regularly represents clients in both litigation matters in state and federal courts and before state and federal administrative agencies, including the North Dakota Industrial Commission, the North Dakota Public Service Commission, the North Dakota Tax Department and the Bureau of Land Management. Mr. Morrison received his Bachelor of Arts from Mary College and his Juris Doctorate from the University of North Dakota School of Law. Before entering private practice in 1981, he worked for the North Dakota Legislative Council, the North Dakota State Land Department, and the North Dakota Attorney General's Office. He is a co-author of "Lobbying, PACs and Campaign Finance" (West 1996-2008), and has authored "Regulation of Gas Gathering Systems," 39 Rocky Mtn. Min. L. Inst. 18-1 (1993); "Doing the Lateral Lambada: Negotiating the Technical and Legal Challenges of Horizontal Drilling" 43 Rocky Mtn. Min. L. Inst. 601 (1997).

WADE C. MANN is a Partner in the Bismarck, ND office of Crowley Fleck PLLP. He is part of the Energy, Environment and Natural Resources group and focuses his practice primarily on energy and natural resources related litigation and regulatory work. He represents clients before the North Dakota Industrial Commission and North Dakota Public Service Commission as well as in state and federal courts. Wade is back with the firm after recently completing a gubernatorial appointment as the Director of the North Dakota Office of Administrative Hearings where he served as an administrative law judge in addition to heading the agency.

I. Introduction

The purpose of this paper is to give a brief introduction to the concept of pooling for purposes of oil and gas production and the methods by which pooling is accomplished. In recent years horizontal development of shale reservoirs has fundamentally changed the oil and gas industry in the United States and has presented challenges to the traditional methods of conservation regulation. Two of those challenges have been the drilling of "lease line" wells on overlapping spacing units in North Dakota and the drilling of "allocation" wells in Texas.

II. Terminology

Pooling has been defined as "the bringing together of small tracts sufficient for the granting of a well permit under applicable spacing rules."¹ In order to prevent the physical and economic waste caused by overdrilling undertaken to reap the benefits of the "rule of capture",² many states in the early 1900's began to adopt oil and gas conservation statutes which relied heavily on restricting the number of wells drilled to a specified number (usually one) per a specified areal accumulation of land referred to as a "spacing unit "or a "proration unit."³ By bringing together, or combining, all smaller tracts of land included in a "spacing unit," pooling ensures that the "correlative rights"⁴ of all owners of interests within each of these tracts are protected in that each owner is afforded an opportunity to recover a proportionate share of the oil and gas produced from the spacing unit. "Pooling [is] a necessary complement to spacing to avoid confiscation of the right to produce oil and gas."⁵

Contrasted with, and sometimes confused with, pooling is the concept of "unitization," which has been defined as "the consolidation of mineral or leasehold interests covering all or part of a common source of supply."⁶ Unitization usually, but not always, is used to facilitate some form

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of enhanced or secondary recovery operation through the injection of fluids or other forms of energy into the producing formation, but may also be used to facilitate the maximization of production by efficient drainage of the reservoir, using the best engineering techniques that are economically feasible.⁷

The primary effect of pooling is to provide that both operations on and production from one tract in the pooled area constitutes operations on and production from each separate tract in the pooled unit and allocate the production to each separate tract, usually on the basis of the number of surface acres contained in the tract. Under a typical oil and gas lease, the lease is maintained into the secondary term by either operations on or production from the leased premises and royalty is owed on oil or gas produced from the leased premises. Pooling generally results in production from or operations on any tract included in the pooled area constituting production from or operations from the premises covered by each pooled lease and entitles all mineral, royalty, or working interest owners who are subject to the pooling to payment of production proceeds on a proportionate share of production allocation to the individual tracts.

III. Pooling Methods

In modern practice, pooling is generally accomplished by one or more of three methods: the execution of a voluntary pooling agreement by all interest owners; the exercise of pooling authority under a pooling clause in an oil and gas lease; or the entry of a forced or compulsory pooling order. On spacing units which include federal or Indian lands, a "communitization agreement" or "CA" is generally necessary to pool the federal interests.⁸ A "community lease" in which separate owners of interests in two or more separate tracts enter into a single lease as if they were joint owners, is sometimes viewed as a type of voluntary agreement.⁹

A. Voluntary Pooling Agreement

Largely because of the prevalence of compulsory pooling statutes and the inclusion of pooling clauses in oil and gas leases, the use of a voluntary pooling agreement, which is a contract between the parties to the agreement, has become what one treatise describes as "antiquated."¹⁰ Caution must be exercised when utilizing voluntary pooling agreements. In Texas, it has been held that a mineral owner with the executive right to lease minerals does not have the authority to commit the interests of a carved-out royalty interest (sometimes referred to as a non-participating royalty interest or NPRI) to a pooling agreement.¹¹ As a result, an NPRI owner in Texas who has not pooled its interest or ratified a pooling agreement entered into by the executive interest owner is

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entitled to be paid on a nonpooled basis - meaning the owner would be entitled to be paid its royalty interest on an unapportioned share of production from a well located on the tract in which the NPRI owns, but would not receive its royalty share on any other production from the pooled unit.¹² In some states, pooling agreements are treated as effecting a cross-conveyance of interests.¹³ In such states, a pooling agreement may be required to meet the formal requirements of a conveyance of real property, including the Statute of Frauds.

B. Compulsory Pooling

Most oil and gas producing states have enacted compulsory or force pooling statutes that allow spacing units to be pooled by administrative action. In some states, obtaining a forced pooling order is a relatively simple administrative process. North Dakota enacted its "integration" or force pooling statute in 1953, when it first adopted a comprehensive conservation statute.¹⁴ The substantive portions of the statute are relatively brief and straightforward:

When two or more separately owned tracts are embraced within a spacing unit, or when there are separately owned interests in all or a part of the spacing unit, then the owners and royalty owners thereof may pool their interests for the development and operation of the spacing unit. In the absence of voluntary pooling the commission upon the application of any interested person shall enter an order pooling all interests in the spacing unit for the development and operations thereof. Each such pooling order must be made after notice and hearing, and must be upon terms and conditions that are just and reasonable, and that afford to the owner of each tract or interest in the spacing unit the opportunity to recover or receive, without unnecessary expense, that owner's just and equitable share. ¹⁵

Thus, to obtain a pooling order in North Dakota, an applicant must establish (1) that the applicant is an interested party (i.e., an owner of an interest); (2) that a spacing unit exists;¹⁶ (3) that there are separately owned tracts or separately owned interests within tracts within the spacing unit; and (4) that a voluntary pooling covering all interests within the spacing unit does not exist. The

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conservation agency in North Dakota has adopted a policy of including applications for force pooling orders on an "administrative" docket for which a simple affidavit may be submitted and no testimony or other evidence is required. The effect of a pooling order is that operations incident to the drilling of a well on or production from any portion of the spacing unit is considered to be operations on or production from each separately owned tract in the spacing unit.

The Montana pooling statute is based on the same model act as North Dakota's and is very similar to the North Dakota statute.¹⁷ One difference is that in North Dakota either a temporary spacing unit or a "proper" spacing unit may be force pooled; in Montana, the statute recognizes that either a temporary or permanent spacing unit may be voluntarily pooled, but only a "permanent" spacing unit may be force pooled.

The forced pooling statutes of Wyoming, Colorado and Oklahoma are similar in substance to those of North Dakota and Montana. Each provides that if there are separately...