Update on PSA and Allocation Permits

The Railroad Commission ruling on the Klotzman Allocation Permit

A new trend in permitting brought about by the proliferation of horizontal drilling has encouraged the Texas Railroad Commission to examine its position on a form of compulsory pooling. Below is a brief background of the topic, the recent history, and a summary of the September, 2013 Commission ruling.

Background

Prior to the large scale implementation of horizontal drilling, most leases containing a pooling provision provided for 40 acre oil units, a standard size for vertical wells. Horizontal drilling opened up the opportunity to efficiently drain areas larger than 40 acres, and operators desired to drill lateral extensions across pooled units to more efficiently produce minerals held under existing leases. If authorized under the lease, the operator can form a new larger unit. However, if the lease does not authorize larger pooled units, the operator may choose to negotiate a Production Sharing Agreement (“PSA”) with the owners of the minerals affected by the proposed new well. Generally, these PSAs allow for the crossing of existing pooled unit boundaries and apportion production to each existing unit based on the proportionate length of the lateral drilled under each unit. In a typical PSA, the mineral owners within each unit are treated as though the production relating to the lateral portion of the well under their unit is a well drilled completely within their unit. If negotiations fail, as to one or more mineral owners, the operator can request either a PSA Permit or an Allocation Permit from the Texas Railroad Commission (“RRC”).

Recent History

For several years the RRC has been administratively issuing PSA Permits under an informal policy when an operator has 65% or more approval from the interest owners in the units affected by the new well. In April of 2010, the RRC began issuing Allocation Permits, which are similar to PSA Permits, although absent the 65% requirement, as long as the operator represented it owned the requisite 100% leasehold interest. In July of 2012, EOG applied for an Allocation Permit for the “Klotzman Allocation No. 1-H.” The permit application was to drill one well on 80 acres comprised of 40 acres from each of two different leases. The subject leases did not allow for pooling. Four days after filing, one of the mineral owners protested. A hearing was held and a Proposal For Decision (“PFD”) was submitted to the RRC Commissioners by the RRC Staff. The PFD recommended dismissal of the application because EOG did not have contractual authority to pool.

Ruling

On September 10, 2013, the Commissioners unanimously approved EOG’s permit. The Commissioners reasoned that they would have permitted drilling two wells, one on each of the 40 acre tracts in question. Accordingly, because drilling two wells would be economically wasteful, the Commissioners argued that it was their responsibility to approve the permit as requested.

The Commissioners further explained that the RRC has no jurisdiction as to the contractual relationship between the parties, it is not in the business of reviewing lease terms, and the economics of how to pay the mineral owners is irrelevant to the permitting process. Thus, it appears the Commissioners expressly disregarded these factors in coming to their conclusion. Indeed, the Commissioners stated that they are removing the regulatory hurdle so that the most economical well can be drilled, and that the parties, either through negotiation or court, would need to determine how to share the production.

As of the date of this article, the RRC has yet to release its final findings and order announcing its decision, but the matter is currently scheduled to be addressed at the next Commission open meeting on September 24, 2013. However, due to the existing public statements of the Commissioners, it is unlikely the order will provide much guidance for operators considering an approach similar to the one taken by EOG in this case. Whether the issue of such compulsory pooling will be now taken up in court or by the Texas Legislature remains to be seen. In the meantime, it appears the RRC will continue to approve Allocation Permits.

For additional information about how Axia Land Services can assist with negotiating PSA’s, Leases, or providing any other land services, please contact Bryan May at 682-367-1856 ext. 157.