CHAPTER 7 GAS BALANCING AND SPLIT STREAM SALES UNDER JOINT OPERATING AGREEMENTS AND UNIT OPERATING AGREEMENTS

• Jurisdiction: United States

Onshore Pooling and Unitization
(Jan 1997)
CHAPTER 7
GAS BALANCING AND SPLIT STREAM SALES UNDER JOINT OPERATING AGREEMENTS AND UNIT OPERATING AGREEMENTS
Patrick H. Martin
Louisiana State University Law Center
Baton Rouge, Louisiana

I. Introduction

Under operating agreements, pooling or unit agreements and pooling statutes, diverse parties will each have a right to a share of production and each will have a right to take in kind or separately dispose of its share of production. This poses an apparent contradiction: if each owns an undivided share, how can one party sell its share while another does not? The parties to a joint operating agreement or unit operating agreement can address the problem by use of a gas balancing agreement. Often, however, such agreements have not included a provision for gas balancing. This paper is a review of the law affecting gas production under joint operating agreements and unit operating agreements and discusses the utilization and management of the gas balancing agreement to resolve problems, including consideration of operator-nonoperator relationships in gas marketing.

The interest in gas balancing agreements is reflected in the fact that there are many more papers on gas balancing than there are cases.¹ Practitioners are aware of the changing conditions in the gas market that have made the gas balancing agreement of greatly increased importance. The market has shifted from long-term contracts to short-term contracts as pipelines have shifted from a merchant role to a transporter role. Gas pricing regulation has gone from area rates to national rates to NGPA categories to Order 451 to the Natural Gas Wellhead Decontrol Act of 1989.² These changes have serious repercussions for relations among working interest owners, for lessor/lessee

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relations, and for the functions of conservation agencies in fulfilling their responsibilities and duties in preventing waste and protecting correlative rights. Imbalance problems could have been somewhat reduced by state ratable take/common purchaser statutes, but these state programs have been invalidated by the United States Supreme Court.³ The court has ruled that state regulation is preempted by a federal regulatory program that does not in any manner deal with the problems associated with gas production.

A review of several aspects of the law applicable where there is no gas balancing agreement should precede an examination of the gas balancing agreement. It may suggest why some working interest owners have been reluctant to sign a gas balancing agreement. Moreover, if one knows the consequences of a lack of a gas balancing agreement, it may help in recognizing what should be put into a gas balancing agreement to induce others to agree to it and to resolve the problems that may emerge in the absence of agreement.

The courts are at a juncture much as they were when they faced the problem of adapting (or developing) the common law principles of waste to the peculiar circumstances of oil and gas production. The courts of most producing states considered the principles of waste of the common law developed in regard to solid minerals and land after the Statute of Westminster, II, of 1285 and concluded those principles would have to yield in light of the consequences of the rule of capture.⁴ One cotenant could not restrain all others from developing the oil or gas, thereby subjecting all to loss from drainage. The courts today face the necessity of molding the common law to the new realities of the gas market. While the courts are coming to grips with the intricacies of the multilevel relationships in gas production and marketing, the regime of freedom and self-governance embodied in the law of contracts, coupled with judicious exercise of existing authority by the conservation agencies, offers the best hope of making the appropriate adjustments in relations among working interest owners that must be made to accommodate the new era of gas marketing.⁵

II. Production Imbalances: Circumstances in Which They Arise

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The typical joint operating agreement and unit operating agreement and the pooling orders of most state conservation agencies generally establish a regime of oil and gas ownership susceptible of "production imbalance," as opposed to a regime of "capture" or a regime of "true contenancy." It is thus necessary to discuss gas imbalances, because there cannot be balancing unless an imbalance has first arisen. Production imbalances often arise from "split-stream sales."⁶ There need not be multiple pipeline connections at a single well in order to have a split-stream sale. The marketing of gas today includes multiple sales carried by a single pipeline, and a pipeline may be performing both a merchant function and a transport function in the same well. Production imbalances may arise from a single buyer who is buying at differing levels (unratably) from the same well. The courts apparently have on occasion been confused concerning this aspect of current gas marketing.

Imbalances can arise in different ways, and they can arise in different contexts. Imbalances occur by design and by happenstance. A purchaser may refuse to take natural gas from one or more of the parties within a unit or from one or more cotenants.⁷ A working interest owner in a unit may decide it does not wish to sell at current prices. Such an owner may wish to have an opportunity to sell its share of gas later at a better price or it may hope to demand a share of a selling party's receipts; indeed, such an owner may wish to have it both ways i.e. to have the opportunity to sell later at a better price than anyone today or if the better price never materializes to demand money from the selling parties. Imbalance may arise where one producer and one purchaser dominate the field and other, smaller producers have no opportunity to sell their share of the gas. A producer may wish to sell gas and have a contract for the sale of the gas but the pipeline is unable to make a connection to the production facility.⁸ Gas purchase contracts frequently have provisions allowing the purchaser to suspend takes or to opt out of the contract, thereby resulting in imbalance.

When a stream of gas is produced from a well, an imbalance occurs if someone who has a right to a portion of that stream does not take that portion. If each takes his share we do not really say they are balancing by taking their proper share. And if there is a duty to account to another for a sale of something that was owned in common and

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that duty has not been fulfilled, we properly speak of that as a failure to account, not as an imbalance. Discussion of balancing presupposes a right to take and a failure to take. One is presupposing some type of ownership right in gas that is produced, and to say that there is an imbalance is also to suppose that the right to take includes the right to make up the failure to take at a particular time.

The "production imbalance" approach is to be distinguished from a "true cotenancy" approach and from a "capture" approach. These two latter approaches have been urged on the courts. The "true contenancy" approach is to say that there is an ownership right in every molecule of gas, and that any sale of the gas stream inures to the benefit or detriment of every party with an ownership interest. Failure to account for the value realized by a selling party would be keeping money that rightfully belongs to others. Such an approach must reject the idea that any party has a right to take a share in kind because everyone shares an ownership right in each and every molecule.

The "capture" approach is to say that each party has a right to take its share of gas but where a party has the right to take a portion of the stream of gas from a well and that party fails to take its share, the share is forfeited, abandoned or otherwise lost, much as with the rule of capture where multiple tracts of land are owned by different parties.⁹ In some situations such an approach may be harsh and in others it may be entirely fair. For example, Alpha and Beta may each have a 50% interest in the production of a unit well where the well is capable of producing 100 Mcf per day. Alpha agrees to sell his gas to X at $1.00 per Mcf and X promises to take gas based on Alpha's share of the deliverability of the well. Beta foregoes an opportunity to sell his gas on the same terms and instead takes a short term sale at $2.00 which soon ends. Thereafter X takes 50 Mcf a day and pays the money to A. Beta asserts that half of the 50 Mcf is his and he wants his share of the money. In the meantime, another well on an adjacent competitive unit is producing at 100 Mcf and is draining gas from beneath the unit in which Alpha and Beta have an interest. It would be very harsh to make Alpha have to share his market when Beta forewent an opportunity to make a sale. It would be better to apply to that situation a rule that says Beta has simply foregone his right to a share of production. There is no unjust enrichment to Alpha who has done no more than take the amount of gas that he had a right to take.

Neither the "true cotenancy" model nor the "capture" model is particularly attractive because each fails to take into consideration some important practical aspects

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of the gas business. But each model influences the thinking of judges and people in the oil and gas industry, and this is reflected in the approaches they take to interpreting joint operating agreements and unit operating agreements and gas balancing provisions of such agreements.

A. Cotenancy

1. The Nature of Cotenancy

A cotenancy or tenancy in common in property is a tenancy by several distinct titles but by unity of possession or any joint ownership or common interest with its grantor.¹⁰ As Powell states, "The chief attribute of a tenancy in common is unity of possession by two or more owners...