POOLING ISSUES FOR HORIZONTAL DEVELOPMENT IN TEXAS

• Jurisdiction: United States

Horizontal Oil & Gas Development
(Nov 2012)
CHAPTER 6C
POOLING ISSUES FOR HORIZONTAL DEVELOPMENT IN TEXAS
Barry D. Thomas
Encana Oil & Gas (USA) Inc.
Dallas, TX

BARRY D. THOMAS is the Group Lead, Legal (MCBU) for Encana Oil & Gas (USA) Inc. He has been with Encana for the last six years, during which he has been responsible for managing Encana's legal needs associated with its operations in the southern tier states. Prior to that, he practiced with the Dallas office of Hunton & Williams, LLP, handling primarily upstream oil and gas transactions. He has also been the president of a small private exploration and production company operating in East Texas. He graduated from Rice University in 1985 with a degree in history and from Texas Tech University School of Law in 1988.

Unlike most other oil producing states, pooling in Texas has always been, in large measure, a purely contractual matter between the lessor and lessee. The contract, of course, is the oil and gas lease.¹ Unfortunately, the oil and gas lease has not evolved as rapidly as drilling technology. The evolution (or lack of it) of the pooling provision, in particular, is causing problems for the developers of unconventional resource plays in Texas.² Two major problems encountered by unconventional resource developers on a daily basis are the need for larger units and the constraint that existing units (whether small or large) place on new development.

I. The Need for Larger Units

The Producers 88 (7/69) oil and gas lease form³ is often used in Texas. The pooling provision in that form states:

Lessee is hereby granted the right, at its option, to pool or unitize any land covered by this lease with any other land covered by this lease and/or with any other land, lease or leases, as to any or all minerals or horizons, so as to establish units containing not more than 80 surface acres, plus 10% acreage tolerance; provided, however, units may be established as to any one or more horizons, or existing units may be enlarged as to any one or more horizons, so as to contain not more than 640 surface acres plus 10% acreage tolerance, if limited to one or more of the following: (1) gas, other than casinghead gas, (2) liquid hydrocarbons (condensate) which are not liquid in the subsurface reservoir, (3) minerals produced from wells classified as gas wells by the conservation agency having jurisdiction. If larger units than any of those herein permitted, either at the time established or after enlargement, are required under any governmental rule or order, for the drilling or operation of a well at a regular location, or for obtaining maximum allowable from any well to be drilled, drilling or already drilled, any such unit may be established or enlarged to conform to the size required by such governmental order or rule.

Until quite recently, except for the Austin Chalk, the majority of horizontal drilling in Texas has been for gas.⁴ Since many standard lease pooling provisions, like the one

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above, allow gas units to contain up to 704 acres, unit size has not often been an issue. The drop in the price of gas, however, has led operators to attempt to find and develop horizontal oil plays, and also to drill gas wells with laterals longer than can be accommodated in a 704 acre unit. As discussed below, lessees should consider modifying the standard pooling provision, or risk the nullification of their units.

A. Prescribe or Permit

A lessee may pool the lands covered by its leases only to the extent stipulated in the leases.⁵ Typically, form leases like the one above limit units pooled for oil production to 80 (sometimes 40) acres. Needless to say, a 40 acre or 80 acre unit will not allow for the drilling of a commercial horizontal well.⁶

In Jones v. Killingworth⁷ (hereafter, "Killingswort.") a 1966 Texas Supreme Court case, the lessee had pooled approximately 20 acres of the plaintiff's land into an oil unit of 170.86 acres.⁸ The plaintiffs lease limited oil units to 40 acres, but contained the proviso that, "should governmental authority having jurisdiction prescribe or permit the creation of units larger than those specified, units thereafter created may conform substantially in size with those prescribed by governmental regulations [emphasis added]."⁹ The Texas Railroad Commission had promulgated special field rules for the field in which the well was located. The special field rules established proration units of 80 acres, but allowed an operator to drill a well on as little as 40 acres (if that was all the acreage the operator had) or to assign up to 160 acres to the proration unit in exchange for an increased allowable.¹⁰ The Supreme Court determined that the Railroad Commission thus prescribed that units contain 80 acres, but permitted units to be up to 160 acres. Since the second clause in the above quoted proviso requires units to conform in size to those "prescribed" by governmental authority, the lessee was without authority to create a 170,86 acre unit.¹¹

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Under statewide rules, an oil well is assigned allowable based on depth and density as determined under Statewide Rule 38.¹² The largest amount of acreage required or prescribed for a well to be assigned an allowable is 40 acres.¹³ Various other rules¹⁴ will allow or permit the assignment of additional acreage in order to increase allowable, but under the Killingsworth analysis this may not help the lessee whose leases contain a pooling provision like the 7/69 lease quoted above. Under Statewide Rule 86¹⁵ (hereafter, "Rule 8."), the operator of a horizontal well is allowed to assign additional acreage in order to increase a well's allowable. But what if the well won't actually produce the amount of the allowable increase? In that case would the increased acreage be required?

B. Rule 86

As noted above, Rule 86 allows, but does not require, an operator to assign additional acreage to a horizontal well in order to gain an increased allowable.¹⁶ The rule, originally adopted in 1990, applies to any field in Texas not covered by special horizontal field rules.¹⁷ Under the rule, as the length of a horizontal lateral (called the "drainhol." in the rule) is increased, the number of assignable acres increases in accordance with a chart that is part of the rule. The rule defines the drainhole length as the length from the penetration point (the point where the drainhole enters the target zone) to the terminus (the farthest point drilled in the horizontal drainhole). The target zone is referred to in the rule as the "correlative interva". The rule distinguishes between fields with densities of 40 acres or less and fields with densities of greater than 40 acres. For fields with densities of 40 acres or less (any oilfield under statewide rules), the rule allows the assignment of an additional 20 acres for every 585 feet of drainhole displacement in the correlative interval.

For example, assume an operator drills a horizontal oil well in a field under statewide rules in which the density for oil wells is 40 acres. From the point at which the wellbore enters target formation (the correlative interval) to the farthest point in the wellbore is 6,435 feet (585 feet multiplied by 11). The operator will be allowed to assign up to 220 acres in addition to the 40 acres required for a vertical well, for a total pooled unit size of 260 acres.

What will such a unit look like? Assume the well is drilled in a straight line from the penetration point to the terminus. Horizontal wells must comply with Statewide Rule 37,¹⁸ the same as vertical wells.¹⁹ The penetration point and the terminus must each be

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467 feet (the minimum distance from the lease or unit line under Rule 37 for fields covered by the statewide rules) from the boundary line of the pooled unit. In order to be a regular location, then, the pooled unit must be 7,369 feet long (6,435 feet plus 467 feet plus 467 feet). A 260 acre unit that is 7,369 feet long will be only 1,536 feet wide. That is a long and narrow unit, which may or may not promote the orderly development of a play.

C. Proposed Pooling Provision

Currently, gas prices are very low. Operators in Texas have turned to liquids-rich gas and oil in the search for economic drilling opportunities. The economics of each of these types of plays can be improved through the drilling of long laterals. In fact, many of the current gas and oil plays can only be economically developed right now with long lateral wells.

The parties to an oil and gas lease must strictly comply with its terms.²⁰ There is some risk, therefore, in relying on the "prescribe or permit" formulation when drafting a lease. There is always a temptation to rely on this language when taking a lease, because it is usually in the printed form and avoids discussion of the matter at the time the lease is taken. This approach, however, only defers the issue. The lessee will never have a better opportunity to negotiate the size of pooled units than it will have before it hands over the bonus check. This can be a difficult concept for lessors to understand given their overall goal to limit the dilution of their interest in production from their land; it can also be difficult for landmen to explain.

It has become quite common, in custom lease forms, to see pooling provisions use the "prescribe or permit" formulation in combination with a specific mention of Rule 86 in connection with horizontal wells. As shown above, however, at least for oil wells, such a provision is still very restrictive on the operator. A better choice for pooling provisions in an oil play would be to provide for specific acreage amounts. An example provision is quoted below:

Lessee, at its option, is hereby given the right and power to pool or combine the leased premises, or any portion thereof, as to oil and gas, or either of them, with any other land covered by this lease, or with any other...