ROYALTY PAYMENTS AND OTHER CURRENT ISSUES FROM HORIZONTAL WELLS
Jurisdiction | United States |
(Nov 2012)
ROYALTY PAYMENTS AND OTHER CURRENT ISSUES FROM HORIZONTAL WELLS
Kelly, Hart & Hallman LLC
Fort Worth, TX
ROBERT C. GRABLE is a partner at Kelly Hart, Fort Worth, Texas, and is the senior member of its Oil & Gas/Energy practice group, and one of the firm's seven founding members. He obtained his bachelor of arts from Southern Methodist University in 1968 and graduated with high honors in 1971 from the University of Texas School of Law, where he was a member of the Order of the Coif and Chancellors, an Associate Editor of the Texas Law Review, and Grand Chancellor of his class. Mr. Grable's practice encompasses energy transactions and litigation and administrative hearings involving various facets of the oil and gas industry. He has represented independent producers, major oil companies, pipelines, and royalty owners in a wide variety of litigation in state and federal trial and appellate courts and before state and federal administrative agencies. He is counsel of record in over 30 appellate decisions, including five significant oil and gas opinions of the Texas Supreme Court, in all of which he represented the prevailing party. Although Mr. Grable's practice principally involves legal matters arising in domestic on-shore activities, he also has represented clients in certain aspects of U.S. offshore and international oil and gas operations. Mr. Grable is a former President and Trustee of the University of Texas Law School Foundation, and a member of the McDonald Observatory and Astronomy Board of Visitors at the University of Texas at Austin, the University of Texas Development Board and the Chancellor's Council Executive Committee. He also serves on the Board of Directors of ATMOS Energy Corporation.
I. INTRODUCTION.
Advancement of industry technology to make possible drilling to ever deeper depths and in inhospitable environments, and to increase the recovery factor in established oil fields have been constant themes of industry progress. Most such progress has been gradual and incremental. However, the evolution and refinement of horizontal drilling technology and multistage large fracture stimulation treatments have combined to establish a transformational quantum leap. Not since the invention and perfection of rotary bit drilling, which consigned cable tools and their rigs to museums, has there been a development with such enormous impacts. Horizontal drilling and multistage fracture stimulation have opened up to commercial development enormous areas of regionally deposited tight formations with extremely low permeability and low porosity, which have always been considered non-commercial source rocks until these new techniques were perfected.
This "unconventional reservoir" development has spread from its beginnings with gas wells in the Barnett Shale of North Texas, to gas wells in the Woodford, Fayetteville, Haynesville and Marcellus Shales, to tight oil plays that are now reaping extraordinary success from the Bakken Shale of North Dakota in the North, to the Eagle Ford Shale in the Gulf Coast region of Texas in the South. Other areas of great promise for domestic unconventional oil plays exist from California, through the Rockies, to areas of the Midwest.
The effects of these technological successes have been transformational, having established a 100-year plus domestic natural gas reserve and reversing the 40-year
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national oil production decline curve. Tight oil production has already resulted in increasing domestic production by more than 500,000 BOD to an estimated 6.2 MMBOD by year end 2012. And, estimates of possible future domestic oil production now range up to 10 MMBOD, a level not seen in over 40 years. Some geopolitical experts believe this shift in oil production and economic power to North America from hostile producing regions, such as the Persian Gulf, Africa and Russia, will have worldwide transformational economic effects.1 Governor Romney mentioned North America energy independence as an achievable goal and a central part of his economic plans in the 2012 Presidential Debates, and this goal is widely believed to be achievable with reasonable governmental energy policies.
While these technological advances enabling large scale production from unconventional reservoirs have been rapid and accelerating, the evolution of common and regulatory law to this technical progress has been slow, halting and uncertain. In the 100 years from Spindle Top in 1901 to the early years of the Barnett Shale boom in 2001, oil and gas law has focused almost exclusively on vertical wells in traditional reservoirs. Even Texas, which has the longest and broadest history of oil and gas common law and regulation, is struggling to have its laws keep up with industry developments, needs and practices.
This paper will present a survey of developments and trends in pooling, regulatory and royalty litigation developments arising from horizontal wells in unconventional reservoirs, with a primary focus on Texas.
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II. BACKGROUND.
As directional drilling of vertical wells gradually evolved into the ability to drill horizontally, its first widespread application in Texas was in the Austin Chalk formation, a member of the Upper Cretaceous System occurring just above the Eagle Ford.2 Like the Eagle Ford, the Austin Chalk is deposited regionally and had experienced prior periods of active development from Pearsall in the Southwest through Giddings southeast of Austin to areas north of College Station. Vertical wells in the Austin Chalk were problematic, however, with only those that encountered natural fractures having commercial success. Large bonuses were paid to a handful of geologists and engineers who promised they could crack the code of predicting where fractures would be encountered by vertical wells. Given its large areal extent, significant oil saturation, and known natural fracturing with vertical orientation, it was much more successfully drilled with early horizontal wells in the 1990s. The most significant appellate case on horizontal well royalty obligations came out of this horizontal Austin Chalk drilling in the 1990s and is discussed in V.A., below.
The success of horizontal drilling to encounter multiple natural fractures in the Austin Chalk was magnified as the Barnett Shale moved from vertical wells with large sand frac jobs to horizontal wells with ever increasing horizontal length and multiple stages of fracture stimulation. This drilling boom in the Barnett Shale also produced a boom in resulting litigation.
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III. TEXAS REGULATION OF HORIZONTAL DEVELOPMENT.
While a detailed description of the Railroad Commission's ever evolving Special Field Rules for horizontal wells in unconventional reservoirs is beyond the scope of this paper, a basic understanding of how those rules have developed and are applied is necessary for understanding the sorts of potential royalty owner and other issues they may create.
A. Railroad Commission of Texas Statewide Rules and Special Field Rules for Horizontal Wells:
The Railroad Commission of Texas regulates horizontal drilling through its Statewide Rule 86, and Special Field Rules adopted in most of the major shale basins and other areas of Texas where unconventional reservoirs are developed primarily with horizontal wells.3
Railroad Commission Statewide Rule 86 was adopted in 1986 as the nation's first regulation of horizontal drilling; it applies to all horizontal wells in Texas, except as modified by applicable Special Field Rules for individual designated fields. The general approach and effect of Rule 86 is to allow additional acreage to be assigned to the proration unit for a horizontal well so that it will be eligible for proportionately larger production allowables as the size of the proration unit is increased. For fields with a designated density rule of 40 acres per well or less, 20 additional acres are allowed to be assigned for each 585 feet of horizontal drainhole displacement within the "correlative interval" of the productive reservoir, as defined by the Commission; for fields with a density rule greater than 40 acres, an additional 40 acres is allowed to be assigned for
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each 827 feet of horizontal drainhole displacement. The production allowable for the well is then increased by multiplying the allowable for a vertical well by a fraction, the numerator of which is the acreage assigned to the horizontal well and the denominator of which is the maximum acreage authorized by the field rules for the field for a vertical well. For example, in a field with 40-acre density for vertical wells, a horizontal well having a horizontal displacement of 3,500 feet in the reservoir would have an allowable 4 times that of a vertical well (40 + 120) ÷ 40 = 4X the vertical well allowable.
Rule 86, while helpful in encouraging drilling of horizontal wells by creating proportionally larger allowables, was only the beginning of the revolutionary changes in Railroad Commission rules for most fields where horizontal development is dominate. For instance, in the Barnett Shale, the Commission adopted Special Field Rules which eliminate the usual requirement of a minimum between-well spacing rule, and for the first time adopted a "take point rule" which applied the lease line spacing rule, 467 feet under Statewide Rule 37, and 330 feet by Special Field Rules in the Barnett Shale, to apply not to the entire location of the wellbore in the target formation, but rather only to the portion of the horizontal well from the first perforation to the last perforation, if the wellbore in the formation is completed with casing (or a liner) cemented back to above the top of the Barnett Shale. By doing so, operators could drill wells much nearer property lines, and extend the last stage of fracture treatment down to just outside...
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