Is the Allocation Well Debate About to Boil Over?

Originally published by Charles Sartain.

Co-author Paul Yale

Issues surrounding the legality of allocation wells in Texas have been percolating for some time, and lately we’ve heard of potential litigation. So, what’s the fuss about? The results in Klotzman (a Texas Railroad Commission dispute) and Spartan et al v. EOG (a district court case) didn’t resolve the legal questions. Both settled before a ruling. Browning Oil Company v. Luecke provided theoretical underpinnings but didn’t go far enough.

Why does the controversy exist?

Primarily because landowners have argued that the Commission has created a process by which operators can obtain drilling permits for horizontal wells, allowing producers to bypass the traditional requirement that agreements be reached with lessors for allocation of royalty payments. The landowners say the Commission has implicitly authorized unilateral allocation of royalty payments to various tracts along a horizontal wellbore.  Some in the industry would say there is a predetermined allocation method; it’s the royalty clause in oil and gas lease.

Here is a presentation from our Gray Reed colleague Philip Jordan explaining allocation wells in more detail.

Caveat: The remainder of this post is a grossly simplified discussion of the issues, and it’s not intended to sponsor or renounce any argument. It’s some of what parties have been saying.

Allocation wells – good …

… and legal, says, among others, Professor Ernest Smith.

• The lessee’s right to drill overrides uncertainty over how production should be allocated. Proportionate reduction clauses cover the uncertainties.
• An allocation well is not a cross-conveyance of interests or a contractual agreement among the parties by which production is allocated. Instead the lessor simply receives a royalty based on production from his lease.
• The Commission is meeting its statutory duty to protect the correlative rights of the parties consistent with case law. Let the courts and private parties sort out the contractual and title issues, which is not the Commission’s function.
• Under Browning, even in an improperly pooled unit, well production can be attributed to each tract with “reasonable certainty”. There is no illegal commingling.

Allocation wells – evil …

… or at least illegal, says, among others, Professor Bret Wells in the Baylor Law Review.

• The permitting process has been imposed without formal rulemaking and without sanction by the Legislature.
• It is, in effect, forced pooling, which is not authorized in Texas (except under the Mineral Interest Pooling Act, which has very limited application).
• The lessees impose royalty allocation methods that one or more lessors could dispute. It is not the same as a pooling arrangement, in which lessors bind themselves in advance to a method of allocation.
• A nonparticipating owner of a non-drill site tract can be excluded from participating in an allocation well, unlike ordinary Texas law which gives NPRI owners the right to ratify a lease.
• A mineral lessee may not increase the burden on the surface estate for the benefit of other lands. To do so is to trespass.
• The Commission should not regulate commingling via allocation wells because Commission’s commingling rules (6 and 10) are directed to production from separate reservoirs.

And a musical interlude appropriate for the season.

Curated by Texas Bar Today. Follow us on Twitter @texasbartoday.

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