WELLHEAD IMBALANCES

• Jurisdiction: United States

Natural Gas Transportation and Marketing
(2001)
CHAPTER 2A
WELLHEAD IMBALANCES
Edward B. Poitevent, II
Phelps Dunbar, LLP
New Orleans, Louisiana

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I. INTRODUCTION^*

A. The Problem of Gas Balancing

Gas imbalances occur when a mineral lessee sells gas from a co-owned lease in which it owns an undivided interest, while at the same time another lessee is not selling gas. In these circumstances, when the selling party sells more than his pro-rata share of production, he is "overproduced," while the non-selling party is "under produced." The parties are "in balance" when each party sells his pro rata share of production and, conversely, are "out of balance" when one party sells more than his pro rata share of production. "Gas balancing" refers to the process by which parties that are "out of balance" are brought "in balance."

For example, if A and B each own a 50% interest in a mineral lease, and if A has a purchaser for his interest in the lease but B does not, then A is selling 100% of the production from the lease even though it owns only a 50% interest in the lease. In these circumstances, A will become "overproduced" and B "underproduced," and the parties will be "out of balance." The purpose of gas balancing is to allow B to make up B's proportionate share of production, or to be paid an appropriate amount for the production in question.

B. Scope of Paper

Gas imbalances among undivided interest owners of a mineral lease or in a unit raise numerous legal questions, many of which have been addressed in various agency and court proceedings. Broadly speaking, for purposes of this paper, the legal questions relating to gas balancing fall into two categories: (1) those pertaining to the relationship between leasehold owners, and (2) those pertaining to the allocation of payments to royalty owners.

This paper discusses these two categories as they relate to onshore properties in Louisiana and Texas and to offshore properties in the Gulf of Mexico, including an overview and analysis of the laws and decisions governing gas balancing questions as to federal lands located onshore and on the Outer Continental Shelf,¹ Indian leases and state lands offshore Louisiana. In this regard, this paper focuses on the topic of gas balancing from two points of view: (1) when the parties have no gas balancing agreement, and (2) when the parties have entered into a gas balancing agreement. In the latter case, the parties have, in effect, negotiated the rules governing gas balancing. Given the significance of a well-drafted gas balancing agreement, this paper also discusses the various provisions in a gas balancing agreement.

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C. The Causes of Gas Imbalances

Numerous events may create gas imbalances, and it is beyond the scope of this paper to discuss all of the possible causes. Two causes, however, are of special note.

First, split stream sales of gas at the wellhead often cause gas imbalances. Split stream sales occur when co-owners of a mineral lease sell gas to different purchasers. In such circumstances, disproportionate sales may take place, leaving the parties out of balance.

Second, failure of gas markets may cause gas imbalances. During the late 1970s and early 1980s, when industry analysts forecast increasing prices and demand for natural gas, pipeline purchasers generally contracted for the purchase of all the gas they believed they could market. At that time, mineral lessees had a ready market for the production attributable to their interests. In the mid-1980s, however, with the collapse of the price and demand for gas, pipeline purchasers began to reduce their purchases of gas. In many cases, pipelines only purchased gas from parties with whom they had existing contracts and refused to purchase any additional gas. These reductions of purchases by pipelines created, or exacerbated, gas imbalances between those co-lessees with a market for their gas and those co-lessees without a market.

II. CHOICE OF LAW

A. State Waters

Transactions in state waters are governed by the law of the state in which the production is located. Louisiana law, for example, controls gas balancing issues in Louisiana state waters offshore Louisiana.² This result is in accordance with the general statement in most joint operating agreements that the law of the state in which the production is located governs resolution of disputes between parties to the agreement.³

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B. Federal Waters

Transactions in federal waters on the OCS are governed by the choice of law provision in the Outer Continental Shelf Lands Act (OCSLA).⁴ The OCSLA provides that the laws of the adjacent state "[t]o the extent that they are applicable and not inconsistent with this subchapter or with other Federal laws and regulations" are the laws that apply to that portion of the OCS which "would be within the area of the State if its boundaries were extended seaward..."⁵ Under this provision, federal laws and regulations govern resolution of disputes, but when there are no such laws or regulations the law of the adjacent state is applied as "surrogate federal law" in order to fill existing "gaps" in federal law.⁶

The United States Fifth Circuit Court of Appeals has adopted a two-part test for determining whether a particular state law should be incorporated as surrogate federal law on the OCS. In Continental Oil Co. v. London Steamship Owners' Mutual Insurance Ass'n,⁷ the Fifth Circuit held that "the deliberate choice of federal law, federally administered, requires that 'applicable' be read in terms of necessity — necessity to fill a significant void or gap [in federal law]."⁸ The court further stated:

This approach likewise makes something more out of the 'not inconsistent' element of § 1333(a)(2) than a more disjunctive for mechanical invocation and assessment. In determining whether it is appropriate to call in adjacent state law, it permits an analysis in the light of the interests sought to be served in the domestic intramural contest over the oil rich tidelands without disturbing interests of an International character having equal, if not greater importance....⁹

Under this test, state law should not be incorporated as federal law on the OCS in those areas where Congress has established federal legislation or regulation, such as unitization, which creates federal policy with which the adjacent state's law is not in accord. On the other hand, if there is no

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federal law to the contrary¹⁰ and the state law appears pertinent, the law of the adjacent state should control.¹¹

Although these choice-of-law rules appear straightforward, one 1986 decision demonstrates the difficulty of the application of the choice-of-law provision of the OCSLA. In Tidelands Royalty "B" Corp. v. Gulf Oil Corp.,¹² Tidelands owned an overriding royalty interest on one of two adjacent offshore blocks held by Gulf. Gulf completed several producing wells on the block on which Tidelands had no royalty interest, and these wells drained production from the block on which Tidelands had its overriding royalty interest. The United States Fifth Circuit Court of Appeals held that, under Louisiana law, the relationship between Gulf and Tidelands was that of executive interest owner and non-executive interest owner, respectively, and that, therefore, Gulf had no affirmative duty to protect Tidelands' interest against drainage.¹³

The outcome of Tidelands, however, would have been different if the property had been located in Louisiana because, in Louisiana, Tidelands could have initiated compulsory unitization proceedings before the Louisiana Commissioner of Conservation (Commissioner).¹⁴ Under regulations enforced by the Minerals Management Service (MMS), however, only a lessee or lessor (the United States) may initiate unitization proceedings on the OCS.¹⁵ Accordingly, Tidelands demonstrates that, while one aspect of the law of the adjacent state may apply to a given problem (because there is no federal law to the contrary), another aspect of the law of the adjacent state will not apply to the same problem (because there is federal law to the contrary), thus creating two separate sets of laws and regulations which may ultimately apply to a given situation.

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The application of the OCSLA choice-of-law rules to co-ownership issues involving gas balancing questions on the OCS reflects this selective use of state law. MMS regulations specifically govern both unitization and the payment of royalties by a lessee to the United States.¹⁶ Given their comprehensive scope, these regulations most likely constitute "federal law" sufficient to displace any contrary state law on these matters.

On the other hand, there are no federal regulations governing the gas balancing relationship among leasehold interest owners. In this area, therefore, one must look to the law of the adjacent state to resolve gas balancing questions.¹⁷

C. Summary

In sum, applicable choice of law rules are generally as follows: (1) co-ownership and gas balancing questions in state waters are governed by the law of the state in question, and (2) co-ownership and gas balancing questions in federal waters are governed by federal law, to the extent such issues involve unitization and lease royalty payments, but are governed by the law of the adjacent state, to the extent that such issues involve gas balancing between leasehold owners. Thus, when dealing with Gulf of Mexico properties covered by OCSLA, careful attention must be paid to the law of Louisiana and Texas, in particular.

III. GAS IMBALANCES WITH OR WITHOUT A GAS BALANCING AGREEMENT

A. Relationship Between Leasehold Owners

1. Generally

When mineral lessees have not entered into a gas balancing agreement, or if their gas balance agreement fails to cover a particular fact situation, they must rely on applicable state or federal law to resolve their disputes over gas...