CHAPTER 8 THE IMPACT OF UNIT EVENTS UPON A FEDERAL OIL AND GAS LEASE1

• Jurisdiction: United States

Federal Onshore Oil & Gas Pooling & Unitization - part 1
(Oct 2014)
CHAPTER 8
THE IMPACT OF UNIT EVENTS UPON A FEDERAL OIL AND GAS LEASE¹
Laura Lindley
Bjork Lindley Little PC
Denver, Colorado
Robert C. Mathes
Bjork Lindley Little PC
Denver, Colorado
Timothy R. Canon II
Bjork Lindley Little PC
Denver, Colorado

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LAURA LINDLEY: After earning her B.S. degree from Louisiana State University and working as an abstractor for a couple of years in south Louisiana, Laura Lindley came West to earn her law degree from the University of Denver (1980, Order of St. Ives). She was affiliated with the Denver firm of Poulson, Odell & Peterson until 1992, and since then has been a shareholder in Bjork Lindley Little PC, emphasizing oil and gas law and public land issues. Laura is a past president of the Rocky Mountain Mineral Law Foundation and continues to participate in a number of Foundation efforts, including serving as a Trustee, writing papers for annual and special institutes, and teaching at the Federal Oil and Gas Leasing Short Course. She has also written an article on the history of the Mineral Leasing Act for the ABA's Natural Resources & Environment, and contributed a chapter to The NEPA Litigation Guide published by the ABA.

ROBERT C. MATHES is a Shareholder with the Firm of Bjork Lindley Little PC in Denver Colorado. Rob has practiced with the firm since 2001. Rob's practice has focused on public land law including environmental compliance and federal land use and planning. Rob addition-ally has extensive experience with complex transactions including purchase and sale agreements and asset divestitures. Rob attended law school at the University of Wyoming where he graduated with honors in 2000 and was appointed the Editor-in-Chief of the Land & Water Law Review (now the Wyoming Law Review). Upon his graduation from law school, Rob worked for a year as a law clerk to United States Magistrate Judge William C. Beaman in Cheyenne, Wyoming. He is admitted to practice before the Supreme Court of the United States, the Tenth Circuit Court of Appeals, and both the federal and states courts in Wyoming, Colorado, and the District of Columbia. Rob actively participates in the Rocky Mountain Mineral Law Foundation and served as a Trustee of the Rocky Mountain Mineral Law Foundation from July of 2007 to July of 2010, and again from July of 2011 to July of 2014. He teaches at the Foundation's biennial Federal Oil and Gas Leasing Short Course, is the Chair of the Special Institutes Committee, reports on federal oil and gas issues for the Foundation's Mineral Law Newsletter, and served as the Public Lands Chair for the 56th Annual Rocky Mountain Mineral Law Institute. Rob was named a Colorado Super Lawyer Rising Star in 2009, 2010, 2011, and 2012 and Best Lawyers in America in 2013 and 2014.

TIMOTHY R. CANON II joined Bjork Lindley Little PC in Denver in 2013 after a brief stint with an upstream producer. He practices primarily in the areas of public land use and planning, and environmental and regulatory compliance. He has worked with the Endangered Species Act, the National Environmental Policy Act, the organic acts for both the Forest Service and the Bureau of Land Management, and the Federal Oil and Gas Royalty Management Act. To a lesser extent, he also works with mineral title and other oil and gas issues. Tim graduated summa cum laude with a degree in economics from the University of Colorado at Colorado Springs in 2010, where he received the Economics Department's Outstanding Graduate award for 2010. He also served as the student newspaper's managing editor and the vice chairman of the College Republicans. He then graduated cum laude in 2013 from Boston University School of Law, where he served as an articles editor for, and published a legal developments article in, the Review of Banking and Financial Law. Tim is admitted to practice in Colorado.

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Table of Contents

I. INTRODUCTION

II. DEFINITIONS

III. COMMITMENT TO THE UNIT AGREEMENT

A. Fee Leases

B. State Leases

C. Lease Conformed to Unit Agreement

1. Lease Term

2. Royalty

3. Rentals

4. Unit Area Treated as One Lease

5. Surface Access within Federal Exploratory Units

D. Segregation of Leases Committed in Part

1. Segregation

2. Segregation Terminology

3. Extension of the Segregated Lease

4. Segregated Lease Term

5. Rental or Royalty Status of Segregated Lease

E. State Statutory Pugh Clause

IV. EXTENSION OF UNITIZED LEASES

A. Payment of Annual Rentals

B. Minimum Royalties

C. Drilling Over the End of the Primary Term

D. Production in Paying Quantities

E. Completion of a Well Capable of Producing in Paying Quantities

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F. Payment of Compensatory Royalty

G. 20-Year Leases

V. PARTICIPATING AREAS AND RENTALS

A. Cessation of Production Prior to Unit Termination

B. Revision of Participating Area

C. Possible Rental Obligation

D. Impact of Overlapping Participating Areas - Multiple Formations

E. Rental Obligations Become a Covenant

VI. CONTRACTION OF THE UNIT AREA

A. Participating Leases

B. Non-Participating Leases

VII. TERMINATION OF THE UNIT AGREEMENT

A. Public Interest Requirement

B. Termination Equivalent to Contraction

C. Effective Date of Termination

VIII. THE CELSIUS DECISIONS: COMPLICATIONS OF SIMULTANEOUS CONTRACTION OR TERMINATION OF ONE UNIT AND COMMITMENT TO ANOTHER UNIT

A. Celsius I.

B. Celsius II.

C. Celsius III.

IX. SUSPENSIONS

X. DISTINCTIONS REGARDING COMMUNITIZATION

XI. CONCLUSION

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I. INTRODUCTION

Unitization has been defined as "the agreement to jointly operate an entire producing reservoir or a prospectively productive area of oil and/or gas."² Unitization provides for the exploration, development, and operation of a geologically defined area by a single operator so that drilling and production may proceed in the most efficient and economical manner.³ In order to meet this objective, both the Mineral Leasing Act⁴ (the "Act" or "MLA") and the implementing regulations⁵ provide that certain unit events have a substantial impact on federal oil and gas leases committed to the unit agreement.⁶ One of the impacts, and perhaps the most important, is the extension of leases committed to the unit agreement as a result of wells drilled upon and completed as a producing well within the unit area.

II. DEFINITIONS

Several of the concepts in this discussion require the use of precise terminology. When used in this paper, the following words will have the meanings set forth below.

Communitization: "[T]he agreement to combine small tracts for the purpose of committing enough acreage to form the spacing and proration unit necessary to comply with the applicable state conservation requirements."⁷ It is the same as pooling with respect to non-federal lands.⁸

Unitization: "[T]he agreement to jointly operate an entire producing reservoir or a prospectively productive area of oil and/or gas. The entire area is operated as a single entity, without regard to lease boundaries, and allows for maximum recovery of production from the reservoir."⁹

Primary Term: The term of years set forth in most federal oil and gas leases, usually five years or ten years. With respect to leases issued before September 2, 1960,

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the primary term is all periods of the life of the lease prior to its extension by reason of production.¹⁰

Extended Term: A federal lease is in an extended term when it has been held by production beyond its primary term, or extended for reasons other than production, such as drilling over the end of the primary term, elimination of a lease from a unit or cooperative agreement, or upon segregation by commitment of only a portion of the leased lands to a federal unit.

Indefinite Extended Term: The period a lease is extended as a result of production of oil and/or gas in paying quantities or by a well capable of producing oil and/or gas in paying quantities.

Fixed Extended Term: A period a lease is extended for reasons other than production.

Original Term: The original term will be the primary term or some other fixed term of the lease at or prior to the time of commitment to the unit, regardless of whether the lease was in an indefinite extended term because of production on the lease at the time of the commitment.¹¹ This term has been utilized by the Interior Board of Land Appeals ("IBLA" or "Board") to describe the term of a federal oil and gas lease in the context of unit contraction or termination and subsequent commitment to another unit.

Production in Paying Quantities: In a unit context, production in paying quantities has two meanings depending upon the circumstance. For purposes of extending a federal oil and gas lease, production in paying quantities is production sufficient to repay the operating costs associated with the production and a reasonable profit ("Yates well").¹² For purposes of establishing a participating area and for fulfilling the terms of a unit agreement, production in paying quantities means production sufficient to repay the costs of drilling, completing, and operating the well and returning a reasonable profit to the working interest owners.¹³

Fully Committed: Fully committed indicates that all interest owners in a lease have committed their interests to the unit agreement. This includes the lessee(s) of record, basic royalty owners in fee tracts, owners of overriding royalty interests or production payments, if any, and working interest owners if different from the lessee of

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record. The working interest owners must also execute the unit operating agreement. A fully committed federal lease is eligible for all benefits under the unit.¹⁴

Effectively Committed: Effectively committed indicates that all interest owners, except the owners of overriding royalty interests or production payments, have committed to the unit agreement. An effectively committed federal lease is also subject to segregation, if...