Do Horizontal Wells Implicate Texas Pooling Laws?
by D. Jason McCoy
One of the latest hot topics in Texas oil and gas litigation involves the issue of implied pooling of horizontal wells. The issue is whether and to what extent horizontal wells implicate the pooling laws designed for traditional, pooled wells. Specifically, must an operator first obtain pooling consent from all drillsite royalty owners represented by a horizontal well before using their tracts to host a portion of the well? Operators and royalty owners answer this question differently.
Royalty owners often argue the consent requirement should apply to all horizontal wells merely because, like a traditional pooled well, the operator must allocate royalty payments among multiple owners jointly represented by a single well. They allege that this is tantamount to a cross-conveyance of real property, which cannot be conveyed without express written consent of the owner. The argument is premised on the fact that an operator intends to produce minerals from multiple drillsites and commingle them within the horizontal wellbore.
Operators assert the royalty owners’ argument fails to recognize that the sort of pooling uniquely associated with horizontal well production has nothing to do with real property. Texas property law distinguishes between minerals before and after production: oil and gas in place (i.e., pre-production) is real property; oil and gas production is not. According to Texas courts, oil and gas in place becomes production when it leaves the formation and enters the wellbore. In contrast to traditional pooling, which involves constructively joining tracts (via contract) to pool oil and gas in place, tracts pooled via horizontal wellbore are actually, physically joined, and the pooling of minerals would be pooled production (not pooled minerals in place). Accordingly, operators argue this sort of pooling has no effect on minerals in place or real property, therefore consent is not necessary.
Because horizontal pooling does, by definition, involve pooling of production, it may be more prudent to apply the rules governing surface commingling, where production from disparately owned tracts are combined into tanks for storage and royalties are allocated back to the rightful owner when sold. There, operators do not need consent as long as production allocations can be attributed to the true royalty owners with reasonable probability based on the operator’s measurements prior to commingling. Notably, in 2011, the legislature seemed to adopt this logic when it proposed House Bill 2087 (Bill), which implied that horizontal wells did not necessarily require consent provided minerals are allocated to the rightful drillsite tract based on methods prescribed in the Bill or by the Texas Railroad Commission (Commission). However, despite favorable reception, the Bill died before it passed, and it remains to be seen whether it will be revived.
Currently, there is no clear guidance on the horizontal pooling issue. In fact, administrators of Texas oil and gas laws have taken different approaches to address the interplay between horizontal and pooled wells. In 1995, the Commission began changing its permitting rules to suggest that horizontal wells do not imply pooling. It introduced two permitting options—production sharing agreement (PSA) well permits and allocation well permits. With this, the Commission began permitting horizontal wells without first requiring drillsite royalty owners’ consent authorizing the operator’s method for allocating royalties among the various drillsite tracts represented by the well. Notably, to the extent an operator seeks to constructively join non-drillsite tracts with drillsite tracts (i.e., traditional pooling), the Commission still requires consent before issuing a permit.
While the issue remains unsettled, operators must be wary of the method for allocating royalties among the drillsite owners joined by a PSA or allocation well. The courts and legislature have taken a stagnant approach and provided no meaningful guidance as to whether drillsite-to-drillsite royalty allocations require consent. As it is, an operator who uses PSA or allocation well permits to drill a horizontal well across a non-consenting drillsite owner’s tract could risk a financially devastating lawsuit for exceeding its allocation authority, which is generally established in an existing pooling clause as part of the lease or a separate contract. Notwithstanding that the parties unlikely intended such clause would apply to a horizontal well, to avoid this risk, an operator’s only choice is to incur the costly burden of renegotiating lease terms to expand the scope of the pooling clause by expressly providing operators with authority to allocate proceeds among drillsite royalty participants of a horizontal well.
In the meantime, in order to navigate the inevitable litigation that will emerge from this issue, oil and gas attorneys must familiarize themselves with the complex policy arguments for and against imputing pooling laws to horizontal wells, and, more importantly, how to calculate potential damages.
Jason McCoy is an associate at Rapier & Wilson, P.C. and can be reached at email@example.com.