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More on Production Allocation Wells

Production allocation wells continue to be a simmering issue in Texas. Last Friday I attended the Ernest E. Smith Institute on Oil, Gas and Mineral Law sponsored by the University of Texas School of Law, and one of the topics presented was a paper titled “Drafting Production Sharing Agreements.” The paper included information about allocation wells.

I’ve written about allocation wells before, here and here. The Texas Railroad Commission uses that term to refer to a horizontal well that is drilled across the boundary line of two leases or units without pooling the two leases or units. Up until recently, it was assumed that the Commission would not grant a permit for such a well. Several years ago, operators began applying for permits to drill “production sharing agreement” wells. Those are wells drilled across the boundary line of two existing leases or pooled units, where the operator has obtained a “production sharing agreement” from some or all of the royalty owners to drill such a well. The production sharing agreement with the royalty owners provides that production from the well is allocated between or among the tracts crossed by the well lateral, for purposes of calculating royalties due, based on the number of feet of well lateral on each tract compared to the total lateral length of the well. In 2008, the Commissioners agreed that they would grant permits for production sharing agreement wells if at least 65% in interest of the royalty owners in all tracts on which the well would be located had signed production sharing agreements.

According to the paper submitted to the seminar, to date some 700 production sharing agreement – or “PSA” – well permits have been granted by the Commission. More than 600 of those were granted to Devon Energy.

More recently, operators have convinced the Commission staff to grant drilling permits for wells crossing two or more leases or units even if the operator has no pooling or production sharing agreements with the royalty owners. The Commission refers to such wells as “allocation wells.” According to the seminar paper, permits have been granted for 98 allocation wells. The Commission is granting such permits even though it has no rule authorizing the granting of the permits.

As I have earlier written, our firm represents a landowner who has protested a permit EOG applied for to drill an allocation well. A hearing has been conducted on that protested permit, and the parties are awaiting a proposal for decision from the hearings examiners.

The seminar paper, written by Mickey Olmstead of the McElroy Sullivan firm here in Austin, and Robert Jowers of the Shannon Gracey firm in Houston, is in large part a brief arguing that allocation wells should be permitted by the Commission. The paper does not mention the EOG protested permit application.

I have learned since the EOG permit hearing that there is at least one pending lawsuit by a mineral owner against EOG for drilling an allocation well. I have also seen a permit granted for an allocation well based on the operator’s misrepresentation to the Commission that the well will be drilled on a pooled unit, even though the operator has no authority to pool the two leases across which the horizontal well will be drilled. I have also been told that operators are applying for permits for allocation wells without disclosing to the Commission that the well will be an allocation well. So it is difficult if not impossible to determine how many allocation wells have in fact been drilled.

The right to agree – or not agree – to the pooling of one’s royalty interest has been long-recognized by Texas courts, and is a significant right for all royalty and mineral owners in Texas. Texas has no forced-pooling statute like those in Oklahoma and Lousiana that force mineral owners into pooled units against their will. (Texas’ Mineral Interest Pooling Act does allow forced pooling under limited circumstances.) Recently there was substantial opposition to a bill pending in the Texas legislature, HB 100, that arguably grants operators the right to force-pool royalty interests. In my opinion, if operators are granted permits to drill allocation wells, despite having no pooling agreements with the royalty owners, the rights of royalty owners to negotiate pooling provisions in their leases will be seriously eroded.

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