Association of Lease and Title Analysts

April 22, 2013

Houston, Texas

Unitization and Pooling

Lucas LaVoy
Rebecca Seidl
 Unit is one of the most confusing terms in oil
& gas
Can mean many different things
Used interchangeably without explanation
We will try to cover as many types of units as
we can, explain where they came from, and how
they differ
Why do we care?
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What is a Unit?

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 What is a Unit?

Merriam-Webster:
a single thing, person, or group that is a
constituent of a whole
an amount of a biologically active agent (as a
drug or antigen) required to produce a specific
result

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 Unit

Urbandictionary.com:

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 Unit

Urbandictionary.com:

*(these definitions were neither relevant nor appropriate)

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 Unit

Urbandictionary.com:

*(these definitions were neither relevant nor appropriate)

Collinsdictionary.com:
a complete system, apparatus, or establishment
that performs a specific function

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The Rule of Capture

Westmoreland & Cambria Natural Gas Co. v.

Dewitt, 18 A. 724
[O]il, and still more strongly gas, may be
classed by themselves, if the analogy be not too
fanciful, as minerals ferae naturae. In common
with animals, and unlike other minerals, they
have the power and the tendency to escape
without the volition of the owner. Their fugitive
and wandering existence within the limits of a
particular tract is uncertain. They belong to
the owner of the land, and are part of it, so long
as they are on or in it, and are subject to his
control; but when they escape, and go into
other land, or come under another's control, the
title of the former owner is gone. If an
adjoining, or even a distant, owner, drills his
own land, and taps your gas, so that it comes
into his well and under his control, it is no
longer yours, but his.
-Justice Mitchell, Pennsylvania Supreme Court, 1889

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The Rule of Capture

Actually developed from the

English law relating to ownership
of wild animals
Rule of capture states you may
extract as much as you want
(except for waste)
You may drain your neighbor
without liability
Creates the incentive to drill as
much and as quickly as possible
Each party will seek to extract
maximum production quickly for
fear of drainage

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and predictable results ensue

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and predictable results ensue

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Boiler Avenue, Spindletop 1903

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The Rule of Capture

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 and predictable results ensue

Rampant wasteful drilling led to damage to reservoirs

and precipitous price drops
Particularly prominent in the East Texas Field, where
production reached 1.1 million barrels in 24 hours on
May 1, 1933.
Prices hit $0.10/bbl.
Railroad Commission attempted to limit production, but
had limited power at the time
Operators ignored the limits and filed numerous
lawsuits against the RRC, tying its hands
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 This led to significant public and political pressure to
effectively regulate waste.
In April of that year, the Texas House passed a bill to
create a stronger commission to regulate oil and gas
Independent operators and their allies fiercly opposed
this, even leading to fistfight in the Capitol building
between representatives Burns (opposing) and Roeser
(supporting)
Burns lost the fistfight but won the debate; the bill
failed in the Texas Senate.

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 Conservation Regulation

Two main regulatory concepts emerged from this

period:
Density
Proration

RRC gained jurisdiction over oil & gas in 1919,

and promulgated 38 original rules
To address the crowding of wells and waste due to
close spacing, RRC promulgated Rule 37:
The very first spacing rule required only 150 feet to a lease line,
and only 300 feet to the nearest well

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 Drilling Units

This spacing limitation led to what we now know as

Drilling Units
Also known as the spacing unit
Shows the RRC that there is sufficient unassigned
acreage to satisfy the density rule for the field
Could be special field rules for density, or statewide
rules for density

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 Drilling Units

Filed with the W-1 application for permit to drill

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 Drilling Units

Plat to be attached for

permit

Describes unit on the

ground

But

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 Drilling Units

In Texas this 40 acre

Drilling Unit has:

Zero effect on title

Zero effect on royalty

allocation

Zero effect on well

participation

Zero effect on lease

maintenance

Purely regulatory
concept
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 Drilling Units

To re-cap:

Drilling Unit is the result

of the density
regulations

Avoids packed wells

Does not, by itself, affect

the quantity of oil that
may be produced from
any given well

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Meanwhile, back in 1933

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 Limitations on Production

Spacing and density rules (Rules 37 and 38 in Texas)

alone were not working
They remained difficult to enforce, many exceptions
Many tracts were so small they would be un-drillable

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 Limitations on Production

Small Operators
objected, in court &
in the legislature
Wanted equal
access to the
reservoir,
regardless of
acreage
Commission
granted thousands
of exceptions,
hoping to avoid a
showdown

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 Limitations on Production

One Texas example was the Hendrick field in Winkler

County
So many spacing exceptions granted that the field
began to water out and price plummeted
17,000 of the 24,269 wells in the East Texas Field drilled
before 1938 were exception wells
$100,000,000 per year wasted on drilling unnecessary
wells
Needed a second component to regulation

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 Limitations on Production

Texas has used different systems for limiting overall

production of oil and gas
One concept is Maximum Efficient Rate of production.
MER is the maximum rate a particular oilfield will produce that
will not damage the field
Used where there is high demand for certain field production.
E.g., during WWII, or the 1970s energy crisis
Under MER, a field receives a maximum field-wide allowable,
which is then distributed to the wells based on various formulae
(i.e., it is prorated among the wells)

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 Limitations on Production

The second production limitation concept is Market

Demand prorationing
This is used when there is not a supply crisis
Looks at the market demand for oil & gas and attempts
to provide price stability
Since 1973, market demand factor has been set at 100%
This means that most fields may produce at 100% of
their maximum allowable

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 Proration Rules

Wells within a field have a limit on how much they may

produce (their allowable)
The proration unit is the acreage assigned to a well
for determining the wells production allowable (Rule
38(a)(3)).
Some field rules allocate production based on
productive surface acres
Some fields allocable allowables based only on well
deliverability and/or well count. There are less-common
variants as well.

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 Proration Rules

Interestingly, for virtually all fields in Texas, gas

allowables are all suspended. Therefore, no proration
units for gas
If there are no applicable field rules, and Statewide
Rules apply, proration units are unnecessary
Instead, Rule 45 allocates production based on a yardstick according
to the depth of the reservoir

Furthermore, if the field rules use deliverability, well

count, or something other than acreage for the oil
allowable, proration units are unnecessary

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 Proration Units

IF the field uses

productive acreage
allocation, then
acreage is assigned to
a wells proration unit
on the form P-15
Accompanied by a
certification that the
acreage claimed is
productive

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 Proration Units

This 40-acre proration

unit:
May be different land
than the drilling unit
Has zero effect on title
Has zero effect on
allocation of royalties

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 Proration Units

Potential for confusion:

Contracting parties
may use proration
unit to describe land
Even where there is no
acreage allocation for
allowables, and hence
no proration unit

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 Pooled Units

Back to the small

tract problem
None of these tracts
large enough to drill
a well under 40-acre
spacing

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 Pooled Units

Operator files a P-12

with RRC, designating
all 4 lease tracts as a
pooled unit
Now the Operator has
40 acres on which to
drill the well
Operator can also
assign 40 acres to the
well to get the allowable

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 Pooled Units

If operator does nothing

more than file this P-12:
Operator has enough
acreage to drill on
the 40-acre pooled
unit
Able Lease Baker Lease
The well is on
Bakers tract
Baker gets his
royalty share of 100%
of production

Charlie Lease Dog Lease

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 Pooled Units

If operator does nothing

more than file this P-12:
Able, Charlie and
Dog get nothing
No well can be drilled
on Able, Charlie or Able Lease Baker Lease
Dog tracts
Not enough acreage
remains

Charlie Lease Dog Lease

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 Pooled Units

If operator does nothing

more than file this P-12:
But, assume all 4
primary terms end on
the same day
At end of primary terms: Able Lease Baker Lease
Baker has
production, so his
lease is HBP

Charlie Lease Dog Lease

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 Pooled Units

If operator does nothing

more than file this P-12:
But, assume all 4
primary terms end on
the same day
At end of primary terms: Able Lease Baker Lease
Baker has
production, so his
lease is HBP
Able, Charlie and
Dog Leases
terminate for no
production Charlie Lease Dog Lease
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 Pooled Units

Filing the P-12 does not, by itself, affect title

RRC normally has no jurisdiction over title or
property rights
Filing the P-12 does not allocate royalties
among the separate tracts

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 Pooled Units

The Pooled Units we all know and love are

created by contract
(i.e., by the oil & gas lease)

The pooling clause in the Leases would have

allowed:
Able, Charlie and Dog to share in production, and
That production would have been deemed to
have occurred on all their tracts, making them HBP

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 Pooled Units

Example:
Lessee, at its option, is hereby given the right and power to pool
or combine the acreage covered by this lease or any portion thereof
as to oil and gas, or either of them, with any other land, lease or
leases in the immediate vicinity.
Lessee shall file for record in the appropriate records of the
county in which the leased premises are situated an instrument
describing and designating the pooled acreage as a pooled unit
In the event of operations for drilling on or production of oil or
gas from any part of a pooled unit which includes all or a portion of
the land covered by this lease . such operations shall be
considered as operations for drilling on or production of oil or gas
from land covered by this lease whether or not the well or wells be
located on the premises covered by this lease

41
 Pooled Units

Traditionally, the tracts

participate in 25% 25%
production from the
well proportionate to
their acreage
Royalty owners get
paid on the basis of Able Lease Baker Lease
their tract participation
in the pooled unit
25% 25%
Production from Baker
now holds Able,
Charlie and Dog
Leases
Charlie Lease Dog Lease
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 Pooled Units

Alternative tract participation formulas now

becoming common
Particularly for horizontal development and
in leases with sophisticated landowners
Often there are restrictions on the ability to
pool:
Example: If my tract is pooled with other tracts, at
least 50% of the resulting pooled unit must be my
lands.

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 The Same Unit

A pooled unit
may also be the
same land as a
drilling unit and
a proration unit
The plat looks
identical for each
They do not have
to be the same
land
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 Differences between the units

For example:
Operator has four
adjacent leases
This field has 40-
acre spacing
Field has 80-acre
proration units

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 Differences between the units

Operator drills a 40 acre drilling unit

well on the 40 acre
lease
No pooling is
needed

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 Differences between the units

Operator wants the

larger allowable,
so files an 80 acre
proration unit,
using the 3 west
leases

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 Differences between the units

Operator wants
to hold more
acreage, so
creates a 160-
acre pooled unit
Files the P-12
Files in the
County
Courthouse

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 Pugh Clause
The Pugh Clause
3,000 acre lease
modifies the
pooling clause
Provides that
operations or
production from
the pooled unit will
not preserve the
whole lease

500 acre Gas

Unit (pooled)

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 Pugh Clause
In other words,
3,000 acre lease
such operations or
production will
only preserve that
200 acres
portion of the HBP
lease which
covers land in the
pooled unit

500 acre Gas

Unit (pooled)

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 Pugh Clause
Severs the
unpooled acreage
from the pooled
acreage
200 acres
HBP
To keep the lease
in force on the
unpooled acreage,
the lessee must
pay delay rentals
or drill a well
500 acre Gas
Can be vertical or Unit (pooled)
horizontal
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 Quiz:

Which of these is the Pugh Clause?

A: if, after the expiration of the primary term, Lessee fails to
conduct drilling operations for more than 180 days between the
completion of one well and the spudding of the next well this
Lease shall terminate except as to a Unit being the number of
acres surrounding each producing well required to obtain the
full monthly production allowable
B: each horizontal well producing on the leased premises, or
on lands pooled or unitized therewith, shall hold only the acres
out of this lease (or such pooled or unitized acreage) as is
located within a rectangle measured 500 feet on each side of the
horizontal wellbore within the correlative interval and 500 feet
from the penetration point and terminus of such wellbore in a
direction perpendicular to the path of the well...
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 Answer:

None of the above

These are Continuous Development / Released
Acreage Clauses.
These clauses require sequential drilling operations to
keep the lease alive after the primary term (Continuous
Development)
The units around the producing wells, that survive the
expiration of the primary term and the end of
Continuous Development, are the Production Units

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 Continuous Development/Released Acreage

The lessee should

3,000 acre lease
have a reasonable
time to develop the
leased premises

500 acre Gas

Unit (pooled)

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 Continuous Development/Released Acreage

Designate a
specified tract (a 480 acre
Production Unit
"production unit")
around each well
then producing on
the leased premises

500 acre Gas

Unit (pooled)

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 Continuous Development/Released Acreage

One 480 acre

Production Unit HBP 480 acre
Production Unit
A Second Unit
consisting of
Acreage HBP
Acreage HBP from
the Pooled Unit

500 acre Gas

Unit (pooled)

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 Continuous Development Continued

After the designation of production units,

production from each production unit will maintain
the lease in effect only as to the lands included
within that production unit.
In effect, each production unit becomes a separate
lease for lease maintenance purposes.

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 Possible Problems

Take care to be clear when referring to any unit:

what type of unit are you really talking about?
For example: Oil & Gas Lease
At the expiration of the primary term this lease shall
terminate except for the acreage within the proration
unit for each well then producing oil or gas
If these are oil wells, and there is no acreage
allocation in the field rules for oil, arguably the lease
is terminated except for the producing wellbores

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 Possible Problems

Net Profits Interest Conveyance:

The Net Profits Interest shall cover and apply to the
Subject Wells, and also to the acreage within the unit
for each such Subject Well.

Farmout Agreement:
If Farmee should drill and complete a producing
well Farmee shall earn the acreage out of the lease
associated with such well in the records of the
Railroad Commission of Texas

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 Forced Pooled Unit-Texas

Mineral Interest
Pooling Act
Precluded in most
major fields (i.e.,
Permian Basin, the
East Texas Field)
RRC cannot compel Lease A Lease B
based on its own
motion Lease E

Fair & Reasonable

Offer
Muscle-in Provision
Lease C Lease D
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 In Oklahoma

Favors forced pooling

Represents the
Majority View
Pool all of the interests
in the drilling unit
Name one of the
interest owners as Lease A Lease B
operator
Three options: Lease E
Participate, Be Carried
with Penalty or Lease

Lease C Lease D
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 Unitization

Unitization refers to a slightly different

concept than pooling
Both involve combined multiple tracts to be
operated together
Pooling is about complying with density
regulations and assigning acreage for
allowables
Unitization is about operating a common
source of supply, for maximum efficiency
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 Unitization

Here, the entire field can become the Unit,

sometimes thousands of acres
Many states allow parties seek compulsory
unitization where they can show it will benefit
the field
Texas is the only major producing state that
does not allow this. Texas Units are voluntary

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 Secondary Recovery Units

Today, units (in Texas) are encountered in

fields for secondary recovery operations

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 Secondary Recovery Units

Generally the parties will enter into a Unit

Agreement (including the royalty owners)
Provides for the sharing of costs and allocating
production to various unit tracts
May designate one party to operate the new
Unit, or may provide for coordinated operations
Approval of the Unit provides for immunity to
some tort actions

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 Secondary Recovery Units

There will be an approval process at the RRC, usually

not contested (normally a large majority of
stakeholders sign the agreement)
An approved Unit provides for limited immunity to
antitrust actions

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 Secondary Recovery Units

Usually the Unit Agreement will provide that all leases in the unit
will be HBP from production anywhere in the Unit.
Usually provides for specified participation factors for the
individual tracts in the unit
These may be acreage based, but likely will take into account
geological advantages as well
RRC approval of the Unit does NOT bind stakeholders (WI owners
or royalty owners) that have not signed it
Those parties may still sue for tort damages, although their burden of
proof will be more difficult
These parties leases are not kept alive by Unit production

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 Federal Units

Where a large portion of the lands for a reservoir are

federally owned lands, a federal unit is often used
Most important type of federal unit is the Exploratory
Unit
Can be huge (20,000+ acres)
Administered by various federal agencies (often the
BLM)

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 Federal Units

A federal exploratory unit is a contract between the United States

and participating parties for joint exploration and development
There is a statutory form of unit agreement
The federal agency (varies by jurisdiction) will generally require
some large majority of interest owners agree to the proposal,
before the agency will approve it
Provides for lease maintenance by unit operations/production,
although terms are considerably more complex than private unit
agreements
Usually there will be a Unit Operating Agreement as well,
negotiated separately

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ANY QUESTIONS?

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ANY QUESTIONS?
Lucas.LaVoy@tklaw.com

Rebecca.Seidl@tklaw.com

www.tklaw.com

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