Production Sharing Agreement and Allocation Wells the amount of oil/gas that may be produced from...

S C O T T , D O U G L A S S & M C C O N N I C O , L . L . P.

A T T O R N E Y S A T L A W W W W . S C O T T D O U G . C O M

P E R M I A N B A S I N L A N D M A N ’ S A S S O C I AT I O N

M I D L A N D , T E X A S

B Y J O H N H I C K S

F E B RUA RY 1 1 , 2 0 1 4

Production Sharing Agreement and Allocation Wells

Scope of Presentation

• Oil and Gas Law Based Upon Vertical Wells

• Distinction Between Regulatory v. Courthouse/Lease Issues

• Overview of RRC Regulation

• RRC Regulation of Horizontal Wells

o Statewide Rule 86

o Application of spacing rules to horizontal wells

o Special field rules created for horizontal wells

• Pooling to Drill Horizontal Wells

• Unpooled/Unleased Interests in Wellbore Path

• Other Pooling Issues

• Retained Acreage Clauses for Horizontal Wells

• Trespass Issues

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Oil and Gas Law Is Premised Upon Vertical Wells

• Horizontal Drilling Technology Is Relatively New

• Vertical Wells Involved in Nearly All Texas Case Law oExceptions oBrowning Oil v. Luecke (Tex.App. – Austin 2000, pet. denied)

oSpringer Ranch v. Jones (Tex.App.—San Antonio 2013, no pet. h.)

• RRC Regulation Based Upon Vertical Wells

• How to Apply This Law/Regulation to Horizontal Wells?

• Technological Advances = Increased Production = Explosion of Horizontal Drilling

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Distinction Between Regulatory v. Courthouse/Lease Issues

• Certain Questions Answered by Lease Provisions o How lease is maintained o How much / to whom royalty is paid o How production allocated – except for forced pooled units

• Other Questions Answered Solely by Regulatory Requirements o Where can well be drilled? o How many wells can be drilled? o How much can well produce? o What is required for permit to drill?

• Still Other Questions Answered by Both Lease Provisions and RRC Regulation When Lease Provisions Rely Upon RRC Regulation. o Pooling – governmental authority o Retained acreage o Lease provisions tied to RRC regulation especially prevalent for horizontal wells

• Basic Understanding of Regulatory Necessary for Proper Interpretations of Leases o Avoid non-sensical lease provisions

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Overview of RRC Regulation

• RRC Regulates the Drilling and Production of Oil and Gas Wells for Conservation Purposes oPrevention of waste and protection of correlative rights

oSpacing of wells – how close to property lines and to other wells in the same field/reservoir and in the same lease or pooled unit

oDensity of wells – how many acres are needed to drill a well/how many wells may be drilled on a given tract of land

oAllowed production from wells – how much oil/gas may be produced from each well

oAllowables – determined by RRC and allocated to each well authorizing the amount of oil/gas that may be produced from the reservoir

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What RRC Regulates and What It Doesn’t

• Distinction Between Agency v. Courthouse jurisdiction

• RRC does not adjudicate title or interpret contracts except to protect its jurisdiction

• “Good faith claim to title” – Allocation Well Permits

• RRC Regulation Affects Pooling/Acreage Retention If Lease Provisions Tie These Issues to Field Rules

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RRC Regulation of Horizontal Wells

• Necessary to Understand RRC Regulation to Draft/Apply Lease Provisions

• Statewide Rules or Special Field Rules

• Statewide Rule for Horizontal Wells = Rule 86 oApplies to all horizontal wells except wells in fields with special

horizontal well rules

oApplies to fields with special rules adopted for vertical wells only

oEffective June 1, 1990

oContemplated open hole horizontal wells, not cased/cemented horizontal wells

oMany fields with special field rules to override Rule 86

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Rule 86: Definitions

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Wellbore = open hole (no casing/cement) when Rule 86 adopted Wellbore = generally cased, cemented, perforated and stimulated today

Surface

Penetration Point

Correlative Interval

Horizontal Drainhole Displacement

Terminus

Base of Formation

Top of Formation

Important Concepts of RRC Regulation

• Longer drainhole = greater drainage area = larger proration unit = greater allowable

• Rule 86 does not require additional acreage for horizontal well oThis is critical in applying lease (pooling) authority

• Rule 86 does not require surface location to be within well’s proration unit – only from penetration point to terminus

• Acreage held by production and payment of royalties is not directly determined by RRC regulation – different than many other states

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RRC Rule 86(d)(1) Maximum Acreage Allocable to Each Horizontal Well

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•Drainhole measured from penetration point to terminus – distinguished from Take Point Rule

•Table that is applicable is determined by the density rule for the field in question

•Acreage assigned under RRC rules is not necessarily acreage held under applicable leases or determinative of how royalties paid


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Rule 86 Add On Acreage Is Permissive, Not Mandatory

• Rule 86 does not require additional acreage be assigned – flexibility for operator oBUT more acreage entitles well to greater allowable

• Application of Rule 86 is critical in interpreting lease provisions oPooling – how much acreage covered by several leases may be

pooled

oRetained acreage – how much non-pooled acreage within the lease may be maintained after expiration of lease’s primary term

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Application of Spacing Rule to Horizontal Wells

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PP

SL

T

Wholly or partially unleased lot < minimum spacing distance from surface location (but

> than minimum distance from penetration point). No spacing exception required

• Spacing rule does not apply to surface location of horizontal well

• Each point of the horizontal well from its Penetration Point (PP) to its Terminus (T) must comply with the applicable spacing rules or the well requires a spacing (Rule 37) exception under current Statewide Rule 86

Spacing Rule Applies to Entire Drainhole Under Statewide Rules

PP

SL

T

Drainhole = Part of Well from PP to T

Wholly or partially unleased lot < minimum spacing distance from drainhole requires

spacing exception under statewide rules.

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Rule 86’s Undue Restriction of Drainhole Length for Certain Wells

• If PP is minimum legal distance to lease line but 1st perforation is 300’ toward interior of lease, this 300’ is not exposed to the producing formation and recoverable hydrocarbons are not produced

Lea

se L

ine

Surface

Top of Producing Formation

Base of Producing Formation

PP

1st Perf

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Special Field Rules: Take Point Rule

• Solution to this problem: Special Field Rule

• Special Field Rules may be adopted after notice and hearing that override Statewide Rules

• Take Point Rule originated in Newark, East (Barnett Shale) Field

o Objective to increase the length of horizontal well’s exposure to producing formation without unnecessary spacing exceptions

o Leaseline spacing distance measured from perforations along drainhole for cased and cemented wells

o Authorizes use of “No Perf Zones” (NPZ’s) to avoid triggering Rule 37

o Locations of penetration point or other unperforated intervals along drainhole irrelevant

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Special Field Rule: Take Point Rule

Top of Shale

Bottom of Shale

Cement

330’

100’

Perforation Legal at 330’ From Lease Line

Lea

se L

ine

330’

Lea

se L

ine

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Surface

Take Point Rule and No Perf Zones Eliminate Spacing Exception If All Take Points Are at Legal Distances from Property Lines

PP

SL

T

Wholly or partially unleased lot < minimum spacing distance from drainhole does not

require spacing exception with no perf zone showing all perforations legal from property

lines.

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Special Field Rule: Off-Lease Penetration Point

• Rule 86(d)(4) – proration unit must include acreage from penetration point to terminus oMay not penetrate field interval outside proration unit

oMay not include wholly unleased land in proration unit

• Problem: oDrilling curve limitations result in wells being horizontal more

than lease line spacing distance absent penetration point occurring outside of lease

oUrban areas have few acceptable surface locations

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Special Field Rule: Off-Lease Penetration Point (cont.)

• Off lease penetration – allows drilling permit for well penetrating field interval off lease, but oNo perforation on off-site tract

oRequires notice to off-site possessory (non-royalty) mineral interest owners

oAllows longer drainhole in horizontal plane in producing formation

oOperator must have authority from off lease owners to use their surface/subsurface to produce from a different tract

oThis rule allows operator to obtain permit

oRRC permit does not override need for separate authorization from affected private parties to prevent trespass

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Off Lease Penetration Point

• Assumption: Tract A does not participate in production from horizontal well under Tract B

• Tract B is the producing tract; Tract A owners receive no proceeds from production

• Issues related to the authority to use Tract A to produce Tract B

A B SL

1st Perf

T

PP

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Special Field Rule: Off-Lease Penetration Point

Top of Field Interval

Bottom of Field Interval

Cement

330’

Perforation Legal at 330’ From Lease Line

Lea

se L

ine

Offset Tract

Producing Lease

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Regulatory Objective: Maximize exposure of drainhole to producing formation, thereby preventing waste of recoverable hydrocarbons, without requiring unnecessary and burdensome spacing exceptions.

Pooling To Drill Horizontal Wells

• Why Pool?

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• Why Pool?

• Have enough land to satisfy regulatory spacing and density

• Perpetuate leases without wells by unit production/operations (caution: cannot be the only reason for pooling)

• Have well-established method of allocating production for royalty purposes.

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• Horizontal Wells Must Be Drilled Certain Minimum Horizontal Distances to Be Economically Viable

• Horizontal Wells Must Often Be Drilled in Certain Direction/Aizmuth to Be Economically Viable

• Much Productive Acreage Ownership Is Not Large Enough and/or Properly Configured to Allow Horizontal Wells to Be Drilled Within the Single Tract Ownership

• Pooling Separate Tracts Is the Most Common Solution

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• The minerals underlying Tracts A, B and C are owned by different parties. • Operator obtains a separate lease from each of these owners with a clause

authorizing pooling • Operator forms a voluntary pooled unit pooling Tracts A, B and C per the

leases • Production allocated on surface acreage per leases with production being

contributed from each tract • Does surface acreage allocation fairly distribute production among owners of

each tract?

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A B C

Unpooled/Unleased Interests In Wellbore Path

• Extremely Common Problem

• Without Pooling 40% Unleased Interest in Tract B, How Does Operator Account to Unpooled Interest?

• Each Producing Tract Is a Drillsite o Absent agreement, production allocated by mineral ownership of tract where production obtained. Japhet v. McCrae (Tex. Comm.

App. 1925)

o Problem: How to allocate production to unpooled/unleased owners from horizontal well producing from several different tracts

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A B C

• Operator obtains separate leases covering Tracts A, B, C • Operator is unable to find or lease owners of undivided 40% of minerals in Tract B • Operator pools its leased interests in Tracts A, B, C without 40% of minerals in Tract B • Operator needs to drill horizontal well across Tracts A, B, C

POOLING ISSUES: What Size Unit May Be Formed For Horizontal Wells?

• Pooling clauses in most leases oSpecifically authorize maximum sizes – one for gas wells, another

for oil wells

oGovernmental authority provision sometimes allows larger units

• Various kinds of governmental authority provisions oSubtle differences = different results. READ THE LEASE!

• Pooling beyond the scope of lease’s contractual authority is invalid

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Examples of Governmental Authority Pooling Provisions

. . . Provided, however,

• “Units may conform substantially in size with those prescribed by governmental regulations”

• “Units may conform substantially in size with those permitted by governmental regulations”

• “Units prescribed or permitted by governmental regulation for a regular location or maximum allowable”

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Retained Acreage Clauses for Horizontal Wells

• Definition – clause allowing lessee to retain only specified amount of acreage around each producing well in a lease

• Distinguished from Pugh clauses applicable to pooled units

• Similar issues to pooled units formed under governmental authority provisions if clause ties acreage retained in lease to RRC rules

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Examples of Retained Acreage Provisions

• “Amount of acreage prescribed by RRC rules” • Rule 86 permissive

• “Amount of acreage prescribed or permitted by RRC to be assigned to wells”

• “Amount of acreage surrounding each producing well for obtaining maximum allowable pursuant to RRC rules”

• “Minimum acreage required to obtain the maximum allowable for the well under RRC rules”

• “Minimum acreage necessary to obtain a drilling permit under the well density rules of the RRC”

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Trespass Issues

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•Operator X leases and pools Tracts B and C, but not Tract A; •Tract A is leased to Operator Y; •Tract A’s lessor owns surface; •Y refuses to pool Tract A with Tracts B and C.

A B C

Correlative Interval

Penetration Point

Terminus

Trespass Issues

• Whose permission is necessary from unpooled Tract A for X to use surface of Tract A to produce Tracts B/C? oSurface Owner?

oMineral Owner/Lessee?

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Whose Consent is Required?

• Surface owner? o Yes

o Robinson v. Robbins Petroleum (Tex. 1973) – surface of one tract cannot be used for oil and gas operations on another tract without surface owner’s permission

o Surface owner of Tract A required

• Mineral owner? o Perhaps not

o Humble v. L & G Oil (Tex. Civ. App.—Austin 1953) seems to say mineral owner consent needed only if drilling will interfere with his right to produce from drillsite tract. Thus, Y’s consent not needed if drilling will not interfere with his operations on Tract A.

o One court has indicated otherwise in dicta, due to “inevitable” damage to subsurface. Chevron v. Howell (Tex. Civ. App.—Dallas 1966)

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Other Pooling Issues

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Pooled Unit A (4 tracts)

Pooled Unit B (3 tracts)

SL

T

•Horizontal wells needed to be drilled across multiple pooled units or unpooled leases •These wells need to be drilled horizontally in a certain orientation/azimuth direction and for certain lateral distances to be economical •Existing pooled units have been historically formed for all depths in configurations not conducive to or that prevent drilling horizontal wells at proper orientation and for needed lateral distances •Even those pooled units with appropriate configurations may have numerous unleased/unpooled interests in the wellbore path of proposed horizontal wells •In summary, there are numerous parties, in different tracts, within proposed horizontal wells drill paths who have not agreed as to how production will be allocated to their interests

Potential Solutions

• Amend Existing All Depths Pooled Interval For Existing Units and Form New Pooled Units for Target Horizon

• Production Sharing Agreements (PSA’s) oPurpose: Obtain royalty and working interest owners consent to

a basis for allocating production from a horizontal well that traverses more than one pooled unit and/or lease

• Allocation Well Permits oAssume risk of production allocation

oKlotzman v. RRC case – Lessors recently filed suit challenging the RRC’s decision to approve drilling permit for an allocation well . No action yet in the district court. Any decision is likely to be appealed.

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Production Sharing Agreements

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Supporting Documentation:

• Authorization letter to include % of participation • PSA-12 form showing acreage to be assigned to

proposed well

• Plat showing the external boundary of all tracts contributing acreage to the proposed well

• Well allocation worksheet


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Supporting Documentation: Authorization letter

• Contractual right to develop all proposed tracts

• To be approved administratively minimum of 65% of mineral and working interest owners must be signed to agreement

• If less than 65% sign-up then request to set up application for hearing


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Supporting Documentation: PSA-12 and Plat

• PSA-12 form filled out showing all tracts and acreage involved

• Plat that shows the entire boundary of all contributing tracts

• All supporting lease/unit line calls should be to exterior boundary of the contributing tracts

• Any un-leased tracts within contributing tracts should be identified


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Supporting Documentation: Acreage allocation work sheet

• Breakdown of activity for each contributing lease/pooled unit

• If any contributing lease/pooled unit is over assigned then a statement as to how the deficiency will be resolved

• If SWR 38 density exception is required then application must follow procedures set forth in the rule


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ALLOCATION WELLS

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ALLOCATION WELLS

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1. On tracts that you have a valid lease in place an “Allocation” well permit will allow you to get a drilling permit application without the qualifier that you have to provide for a “PSA” well that 65% of both mineral and working interest owners have signed an agreement as to how production proceeds will be divided.

2. What it doesn’t allow you to do is incorporate tracts into your “Allocation” unit that the wellbore does not traverse.

What is the difference between a “PSA” well and an “Allocation” well?

PSA or ALLOCATION WELLS

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SWR Exceptions: Lease line

• Allocation well application will always require an exception

• PSA application will require an exception if there is less than 100% participation

Between Well

• Normal notification procedures will be followed

Density Exception

• Unless specified in the field rules normal notification and data requirements will be followed

ALLOCATION WELLS Klotzman Case

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A

B

T

SL

• EOG has separate leases covering

100% of minerals in Tracts A and B

• No pooling for oil wells in either lease

• EOG applies for Allocation Well permit to

drill Eagle Ford horizontal well across

both leases

• Klotzman lessors protest permit

• After hearing, examiners recommend

denial of permit – allocation well permits

are invalid

• 3 commissioners overrule examiners and

sustain allocation well permits

• Commission denied Klotzman motion for

rehearing

• Klotzman has appealed RRC decision to

the District Court

ALLOCATION WELLS

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• Browning Oil v. Luecke (Tex.App. – Austin 2000, pet. denied)

• Springer Ranch v. Jones (Tex.App.—San Antonio 2013, no pet. h.)

S C O T T , D O U G L A S S & M C C O N N I C O , L . L . P.

A T T O R N E Y S A T L A W W W W . S C O T T D O U G . C O M

J O H N H I C K S

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