POOLING FOR HORIZONTAL WELLS: CAN THEY TEACH AN OLD DOG NEW TRICKS?

• Jurisdiction: United States

Development Issues in the Major Shale Plays
(Dec 2010)
CHAPTER 8A
POOLING FOR HORIZONTAL WELLS: CAN THEY TEACH AN OLD DOG NEW TRICKS?
Bruce M. Kramer
Of Counsel, McGinnis, Lochridge & Kilgore, L.L.P.
Special Advisor, Steptoe & Johnson PLLC
Austin & Houston, Texas
Maddox Professor of Law Emeritus
Texas Tech University School of Law
Lubbock, TX

BRUCE M. KRAMER received a B.A. in International Relations from UCLA, a J.D. from the UCLA School of Law, and an L.L.M. in Environmental and Natural Resources Law from the University of Illinois College of Law. He is Maddox Professor of Law Emeritus, Texas Tech University School of Law, Lubbock, Texas and Of Counsel, McGinnis, Lochridge & Kilgore, Houston, Texas. Professor Kramer is the co-author of The Law and Pooling and Unitization (3d ed.), Williams and Meyers Oil and Gas Law (since 1996, Cases and Materials on Oil and Gas Law (6th and 7th eds.) and International Petroleum Transactions. He is the author of numerous law review articles on oil and gas law including "The Sisyphean Task of Interpreting Mineral Deeds and Leases: An Encyclopedia of Canons of Construction and Royalty Interests in the United States: Not Cut From the Same Cloth." He has been an editor of the Oil and Gas Reporter and was recently named the administrative editor of that publication. Professor Kramer is a special advisor to Steptoe & Johnson, PLLC.

§ XX.01 The Historical Antecedents and Basic Definitions

This paper will explore the issues arising from the pooling of mineral, leasehold and royalty interests for the purpose of accommodating the drilling of a horizontal well.¹ It will analyze the history of state well spacing and compulsory pooling statutes and then provide an update of legislative and regulatory changes that have occurred in the past 25 years to deal with the problems that horizontal wells create under the traditional paradigm of pooling. The paper will also cover the issues that arise from the voluntary pooling of mineral, leasehold and royalty interests including trespass, surface use and the need for a re-writing of leasehold pooling clauses to better deal with horizontal wells.

"Pooling" or a "pooled unit" will refer to the joining together of small tracts or portions of tracts for the purpose of having sufficient acreage to receive a well drilling permit under the

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relevant state or local spacing or drilling laws and regulations.² The term communitization refers to the pooling of interests where one of those interests is owned by either the federal government or a federal oil and gas lessee.³ Compulsory pooling refers to the use of the state police power to combine separately owned interests within a designated spacing and/or drilling unit. Compulsory pooling arose largely in the context of the development of state spacing and/or drilling regulation

[A] Horizontal Drilling for Dummies

Normally a horizontal well can be broken down into three operational segments: the vertical section, the build section and the lateral section.⁴ The vertical section is drilled as any vertical well would be depending on the depth and the type of rock that will be encountered. Prior to drilling the engineers will have determined the depth at which the "Kick-Off Point" is reached. The kick-off point is the depth at which the vertical drilling rig will be replaced by a horizontal drilling rig. Reaching the kick-off point leads to the build section of a horizontal well. The build section entails the building of the angle from zero degrees to around ninety degrees at the end of the build section. The subsurface tools needed to conduct the build operation segment include the drill bit, the mud motor, bent subs and the "MWD" or measurement while drilling devices. In drilling the build section, bit rotation is not provided by the drill string as in the vertical section but by a mud motor through a series of impellers that are displaced as drilling fluid is pumped down the drill string. Bent subs are then used to provide angle and are usually applied just above the mud motor. During the build section operations a MWD or measurement while drilling device will be used to provide the directional measurements necessary to steer the mud motor and bit along the proper azimuth. The build section

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operations are continued until the inclination of the bit is at or near 90 degrees or the intended production formation is reached. The last operational segment is the lateral section. The same equipment used in the build section is used in the lateral section although the bent subs employed are bent less severely. A MWD is employed to continuously monitor the angle and length of the horizontal well bore. The length will be determined by the formation being drilled, whether or not the horizontal well bore has to make "doglegs," and appropriate spacing rules. It is not uncommon for laterals to be 3000-5000 feet in length.

[B] A Condensed History of Compulsory Pooling Statutes

The domestic oil and gas industry has been in existence for around 150 years.⁵ Government regulation of the oil and gas industry, including the enactment of compulsory pooling and unitization statutes has been in existence for only a slightly shorter period of time.⁶ The need for well spacing and pooling regulation was a direct result of the early and widespread adoption of the rule of capture as the basic ownership principle for oil and gas.⁷ Because the only protection a mineral owner had under a rule of capture property regime is to drill a well to prevent drainage from a well located on a neighboring tract there is a built-in incentive for such owners to drill as many wells as quickly and as close to the property line as one could.⁸

Two Kansas municipalities, in response to the threat of over-drilling in urban areas, enacted the earliest well spacing and pooling ordinances in 1927.⁹ The City of Oxford

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ordinance resolved the problem of who would get the one drilling permit allocated per drilling unit or "block:" by using a first-in-time procedure but then requiring the permit owner to make pro rata royalty payments to all mineral owners within the "block" based on a surface acreage formula.¹⁰ The other leasehold interest owners in the "block" would receive their pro rata share of production if they tendered to the permit owner their pro rata share of the costs of drilling and operating the well.¹¹ Other municipalities in Oklahoma and Texas followed suit with their own compulsory pooling ordinances.¹²

In 1935, two states enacted compulsory pooling legislation, New Mexico¹³ and Oklahoma.¹⁴ The New Mexico provision used the proration unit system as the primary inducement for voluntary pooling but also authorized the state to force-pool separate interests within the proration unit. The Oklahoma provision used the drilling unit system to both space wells and declared that if there were two or more owners located within a designated drilling unit, their interests would be pooled on a surface acreage basis.¹⁵ The constitutionality of compulsory pooling was upheld in Patterson v. Stanolind Oil & Gas Co..¹⁶ The court's analysis of the inverse condemnation/regulatory taking claim is superficial at best, merely denoting that all property interests are held subject to the valid exercise of the police power.¹⁷ The drillsite royalty owner's claim that its interests had been taken by its dilution to accommodate the other royalty interest owners within the drilling unit was dismissed.

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The interplay between spacing regulation and pooling regulation was recognized in a series of California cases and legislative amendments that replaced a well spacing system with a well spacing and compulsory pooling system in order to deal with the inverse condemnation claims of parties who were unable to receive a well drilling permit.¹⁸ The Texas response to the regulatory takings issue was to allow Rule 37 exception well permits so that small tract owners could get a drilling permit even though they owned substantially smaller tracts than would otherwise support the issuance of a Rule 37 well permit.¹⁹ After enactment of the Mineral Interest Pooling Act in 1965, Kansas became the only major producing state that did not have a compulsory pooling statute. In an article written in 1997, the author concluded that only 4 states had any active regulation of horizontal wells under their well spacing, proration and/or pooling statutes or regulations.²⁰ Those states included North Dakota, Oklahoma, Texas and Wyoming. To the extent to which horizontal wells were regulated in other jurisdictions those regulations would typically fall under the deviated or slant hole regulation.²¹ At the end of this paper I will provide a short synopsis of state regulation that shows that state conservation agencies are responding to the increase in the use of horizontal drilling operations.

[C] The Pooling Power

Voluntary pooling has been greatly increased because of the widespread inclusion of pooling clauses in oil and gas leases.²² Without a pooling clause the lessee could pool the leasehold interest but would be powerless to pool the royalty interest or the possibility of reverter. As the Texas Supreme Court noted: "Absent express authority, a lessee has no

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power to pool interests in the estate retained by the lessor with those of other lessors."²³ While pooling clauses vary in length and detail, most pooling clauses contain provisions that may hinder pooling for a horizontal well development. There is some disagreement as to how courts should interpret pooling clauses. One Texas Court of Appeals took the following approach:

Anticipatory provisions in leases for the commitment by the lessee of such lease to unitization, of necessity, must be in general terms. Neither the lessor nor the lessee has any way of knowing at the time the lease is taken the facts with respect to which it will be...