Formation Of Drilling And Production Units

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Formation Of Drilling And Production Units


The Board creates a drilling and production unit when it issues its drilling permit for a well. See Ala. Code § 9-17-12 (Supp. 1990); State Oil & Gas Board of Ala. Admin. Code § 400-1-2-.01.  In order to get the drilling permit, the person or company seeking to become the operator must submit an application for the permit to the Board.  The application must be on Form OGB-1 and must be accompanied with a check in the amount of $300 for the permit fee.  Corporate applicants not organized in Alabama must be qualified to do business in Alabama.

Among other things, the applicant must submit an affidavit verifying that it owns or controls one hundred per cent of the mineral estate underlying the land comprising the drilling unit.  See Ala. Code § 9-17-12 (Supp. 1990); State Oil & Gas Board of Ala. Admin. Code § 400-1-2-.01 (3)(c).  If the applicant does not own or control all the drilling rights on the land constituting the proposed drilling unit, Board will not issue a permit until it has force-pooled the unit pursuant to Section 9-17-13 of the Code of Alabama (Supp. 1990).

Because of the Alabama spacing statutes and the Board’s spacing regulations promulgated pursuant to those statutes, the issuance of the drilling permit by the Board logically should pool all the lands described in the drilling permit into one drilling and production unit.  Likewise, production from a well on that unit logically should be allocated among all the owners in an equitable fashion.  Logically, production from the one well should maintain all the leases covering lands in the drilling and production unit.  Almost all oil and gas leases used in Alabama provide for a set term (‟primary term”) that can be extended so long as oil and gas are produced in paying quantities.  If the premises covered by a lease were included in a drilling and production unit but the unit well was not located on those premises, the lease could be maintained beyond its primary term only if production from the unit well constructively applied to the leased premises.  These are essentially the goals of both the Board and the lessees under our statutory scheme in Alabama.  In this regard, see Ala. Code § 9-17-2 (Rep.Vol. 1987), which provides:  “the prevention of waste of oil and gas and the protection of correlative rights are declared to be in the public interest.”   Unfortunately, not all those goals are always met due to two Alabama cases decided in 1982 and in 1984, which severally restrict the operator’s ability to form a valid drilling and producing unit in  Alabama. Those cases are Michigan Oil Co. v. Black, 455 So.2d 824 (Ala. 1984), and Walker v. Cleary Petroleum Corp., 421 So.2d 85 (Ala. 1982).

 The Michigan Oil Co. case establishes that an operator cannot maintain a lease through a voluntarily pooled unit unless every person owning the right to control drilling operations in the lands within the unit validly and effectively agrees to pool the lands in the unit.   Voluntary units are normally formed through “pooling declarations,” which are also sometimes called “unit declarations.”  Pooling declarations are written contracts among lessees and/or unleased mineral owners where the parties agree to develop their lands together by sharing the costs and the production from those lands.  Most oil and gas leases used in Alabama contain a “pooling clause” authorizing the lessee to pool the lessor’s lands with other lands into a drilling and production unit.   A typical pooling clause is set out below:

4. Lessee is hereby granted the right, at its option, to pool or unitize all or any part of said land and of this lease as to any or all minerals or horizons thereunder, with other lands, lease or leases, or portion or portions thereof, or mineral or horizon thereunder, so as to establish units containing not more than 80 surface acres plus 10% acreage tolerance; provided, however, a unit may be established or an existing unit may be enlarged to contain not more than 640 acres plus 10% acreage tolerance, if unitized only as to gas or only as to gas and liquid hydrocarbons (condensate) which are not a liquid in the subsurface reservoir. If larger units are required, under any governmental rule or order, for the drilling or operation of a well at a regular location, or for obtaining maximum allowable, from any well to be drilled, drilling, or already drilled, any such unit may be established or enlarged, to confirm to the size required by such governmental order or rule. Lessee shall exercise said option as to each desired unit by executing an instrument identifying such unit and filing it for record in the public office in which this lease is recorded. Each of said options may be exercised by lessee from time to time, and whether before or after production has been established either on said land or on the portion of said land included in the unit or on other land unitized therewith and any such unit may include any well to be drilled, being drilled or already completed. A unit established  hereunder shall be valid and effective for all purposes of this lease even though there may be land or mineral, royalty or leasehold interests in land within the unit which are not pooled or unitized. Any operations conducted on any part of such unitized land shall be considered, for all purposes, except the payment of royalty, operations conducted under this lease. There shall be allocated to the land covered by this lease included in any such unit that proportion of the total production of unitized minerals from wells in the unit, after deducting any used in lease or unit operations, which the number of surface acres in the land covered by this lease included in the unit bears to the total number of surface acres in the unit. The production so allocated shall be considered for all purposes, including the payment or delivery of royalty, overriding royalty, and any other payments out of production, to be the entire production of unitized minerals from the portion of said land covered hereby and included in such unit in the same manner as though produced from said land under the terms of this lease. The owner of the reversionary estate of any term royalty or mineral estate agrees that the accrual of royalties pursuant to this paragraph or of shut-in royalties from a well on the unit shall satisfy any limitation of term requiring production of oil or gas. . .


Taken from Hederman Brothers—Jackson, Mississippi, Lease Form Producers 88 (9-70) With Pooling Provisions—Mississippi, Alabama, Florida.


When an applicant for a drilling permit verifies that it owns or controls all the drilling rights in the proposed unit, pooling declarations normally provide the applicant control over the portions of lands in the unit not actually owned by the applicant. Of course, if one lease covers the entire drilling unit, no pooling declaration would be necessary.

In the Michigan Oil Co. case, an operator obtained a drilling permit for a unit, but did not get all the lessees owning leases in the unit to join in a pooling declaration. The lawsuit concerned whether or not production from a well on the unit would maintain one of the leases in the unit past its primary term even though the well was not located on that lease. The lease in question contained the following contractual language: “A unit established hereunder shall be valid and effective for all purposes of this lease even though there may be land or  mineral,  royalty,  or  leasehold  interests in land within the unit which are not pooled or  unitized.” Michigan Oil Co., 455 So.2d at 827, 828.  The Michigan Oil Co. case holds that Section 9-17-13 of the Code of Alabama controls all pooling in Alabama and provides only two ways to pool: (i) by agreement of the parties; or (ii) by statutory force-pooling. The court further held that, in order to pool by agreement, unanimous agreement of all parties owning the drilling rights is necessary.   The lease provision providing lease maintenance by operations on a pooled unit described by a unit declaration entered by only some of several owners was invalid in the face of Section 9-17-13.

Frequently, land titles create confusion as to the true ownership of the drilling rights.  (For example, see the facts set forth in Jones v. Bronco Oil & Gas Co., 446 So.2d 611 (Ala. 1984).)  The reported decision in Michigan Oil Co. indicated that the operator in that case simply neglected to get all the lessees to sign the unit declaration.  Apparently the unit declaration was prepared for execution by all the parties, who were identified on the unit declaration. A literal reading of the Michigan Oil Co. decision leads to the conclusion that a voluntary agreement to maintain a lease through production from a well in a spacing unit containing a portion of the leased premises would be ineffective if an owner of the drilling rights failed to join the unit declaration, even if title problems concealed the identity of the nonjoining owner. Since title problems in Alabama frequently are more the rule than the exception, Michigan Oil Co. creates a significant lease maintenance risk for all voluntarily pooled units in Alabama.        The case of Walker v. Cleary Petroleum Corp., 421 So.2d 85 (Ala. 1982). invalidated the Board’s practice of giving notice by publication of force-integration hearings. Relying upon Mullane v. Central Hanover Bank & Trust Co., 339 U.S. 306 (1950), the Alabama Supreme Court held that notice by publication was insufficient when the operator knew the identity and the general location of the person that did not join in the unit agreement.

In response to Walker the Board revised its notice procedures for force-integration hearings. Now, the petitioner must give individual notice of a force-integration hearing to each owner of a unleased mineral interest, a working interest, an overriding royalty interest, or a royalty interest within the proposed  unit who has not joined in a unit declaration.  See Ala. Code § 9-17-12 (Supp. 1990); State Oil & Gas Board of Ala. Admin. Code § 400-1-12-.10(2)(f). Furthermore, the current board regulations require the operator to make a “reasonably diligent effort to determine the name and mailing address” of each such owner.  Id., at (i) (2).  To the extent that the current board regulations require a diligent search to determine the identities of all possible owners, the current regulations may go beyond Mullane, which on its face did not require searches.

The Michigan Oil Co. and Walker decisions attempt to balance concerns of the State of Alabama and of individuals. The State is concerned about allowing drilling only on conditions that are fair and equitable and that do not cause waste. On the other hand, the individuals are concerned about being able to agree on how to allocate their production from a well and how to provide a lease is to be maintained. It seems that the two interests are not exclusive and that the State’s interest could be protected in ways that would not destroy a written agreement of a lessor and a lessee as to how a lease is to be maintained. For instance, the issuance of the drilling permit prohibits the drilling of more than one well on the drilling unit and thus prevents waste.

Consider a slightly different twist to the Michigan Oil Co. facts, where the lease at issue happened to be the lease covering the actual well tract. Does anyone think for a minute that the Alabama Supreme Court would have allowed the owner of the lease with the well to keep all the production from the well on the grounds that the unit was invalid. Keep in mind that no other lessee could have drilled a well within the spacing unit designated in the drilling permit for the well that was drilled. It would be predictable that the Alabama Supreme Court would uphold the unit and compel the owner of the lease where the well is located to share production from that well on an equitable basis with all the other owners in the drilling unit. Why then defeat the lease maintenance clause under the facts of Michigan Oil Co., where the parties had expressly agreed upon lease maintenance even though not all parties joined in the pooling agreement?

   In 1989, the Alabama Legislature amended Alabama’s force-pooling statute to provide for a risk compensation fee of one hundred fifty percent (150%) against  non-consenting owners under certain circumstances.  Ala. Code § 9-17-13 (Supp. 1990).  The risk compensation fee applies only when:


1.        The operator or the operator together with all consenting owners owns a majority in interest of the drilling and operating rights in the pooled unit; and

2.        The operator has made a good faith effort to:


(i)        Negotiate with each non-consenting owner to enter a voluntary pooling agreement.


(ii)        Notify each non-consenting record owner of the identities of all consenting owners.


(iii)        Determine the address of each non-consenting owner.


(iv)        Give each non-consenting owner notice of the proposed operation together with certain other information.


(v)        Offer each non-consenting owner the opportunity to lease or farm out on reasonable terms or participate in the cost and risk of developing the unit on reasonable terms. Id.


By an opinion dated October 26, 1989, the Attorney General of the State of Alabama determined that the risk compensation fee provided by Section 9–17–13©  of the Code of Alabama (Supp. 1990) does not apply against the State of Alabama.  Opinion of Don Siegelman, Ala. Att’y. Gen. to Commissioner James D. Martin, Oct. 26, 1989.  The opinion reasoned that the legislative intent to impose such a fee on the State must be “specifically and unequivocally indicated” and that the risk compensation statute does not have such a specific and unequivocal indication. Further, the opinion reasons that the State of Alabama does not fall within the meanings of the terms “persons,” “owner,” or “nonconsenting owner” as defined in Section 9–17–1 of the Code of Alabama (Rep. Vol. 1987).

Copyright 2011 by Edward G, Hawkins. All rights reserved.