Allocation wells have become a fairly hot topic with the Texas Railroad Commission, and Lessors. Although I have written about this previously, a refresher may be in order.
The Texas Railroad Commission has been issuing permits since 1998 based on Production Sharing Agreements. These Agreements, signed by the interest owners, combine units or unpooled tracts and allocate production of the horizontal well based upon the length of the lateral under the tract. Since 2008, the Railroad Commission has issued such permits based upon the operator’s representation that at least 65 percent of the interest owners of each tract agreed.
The theory behind such permitting is that since the operator is Lessee on the tracts involved, Rule 37 notice and hearing requirements when the wellbore is within 467 feet of the lease line are waived, and the operator may obtain a permit to drill without pooling. The Railroad Commission permits these wells because Lessors on the tracts are adequately protected from drainage. If there are unsigned owners on the tracts, the operator must show that “(1) production is attributed with reasonable probability to each unit traversed by the well’s productive drainhole and (2) such production is paid to the lessors in compliance with the lessors’ royalty and pooling clauses.” Drafting Production Sharing Agreements, 39th Annual Ernest E. Smith Oil, Gas, and Mineral Law Institute, March 22, 2013, Robert D. Jowers and Mickey R. Olmstead.
In 2010, Colin K. Lineberry (a representative of the Railroad Commission) issued a letter to Devon Energy approving Devon Energy’s application for an Allocation Well, despite no representation by Devon Energy that it had the agreement of at least 65 percent of the interest owners. Since that time, the Railroad Commission has issued many Allocation Well permits, and has not required the previous minimum amount of interest owners’ execution of Production Sharing Agreements.
In 2012, EOG Resources, Inc., applied for a permit to drill an Allocation Well that crossed leases in which it did not have the contractual right to pool. The mineral owners protested the issuance of the permit, and a hearing was held in November 2012. Ultimately, the Railroad Commission issued the permit. Unfortunately for us (although fortunate for EOG and the mineral owners), the parties settled their dispute, leaving us without judicial guidance.
On the horizon, however, there is another lawsuit also involving the issue of allocation. Titled Spartan Texas Six Capital Partners, Ltd., et. al v. EOG Resources, Inc., it is in the 11th Judicial District of Harris County, Texas.
As in their previous dispute, the EOG leases did not authorize pooling. Despite this, EOG filed pooled unit designations covering several tracts. EOG, relying on Texas Supreme Court precedent, computed royalties “based upon a reasonable allocation of the total production attributable to the lands covered by the […] leases.” The Plaintiff mineral owners claim they should be paid royalties based upon 100 percent of the production from the well, instead of being proportionately reduced, since pooling was not proper. EOG, though, argues that the leases are not pooled, and the only determination to make is whether their computation of royalty is correct.
This lawsuit is set for trial in Houston on April 21st. Unfortunately, we will have to wait to see the outcome at trial and—if a verdict is given but appealed—wait to see the result of any possible appeal before we have a published judicial determination on these issues. It will be interesting to see if horizontal operators will be given the legal green light to allocate production without pooling clauses. Texas public policy does support this, as it leans towards preventing waste in oil and gas development. In the meantime, I suspect we will see new lease provisions that specifically address and limit attempts to file allocation well permits, or even just the allocation of production.