Oil and gas companies in the state of Texas must obtain a permit from the Texas Railroad Commission (RRC) in order to commence drilling operations. Operators applying for permits must conform to certain regulations which set forth spacing and density requirements. When leases cover smaller tracts of land, operators exercise pooling rights, combining the leases into a larger unit that will meet the spacing and density requirements.
A well written oil and gas lease requires the lessee (operator) to obtain the express consent of the owner of the royalty interest in order to pool that interest. Without that consent granted in the lease or other agreement, the operator has no right to pool the interest. In recent years, operators have circumvented this requirement by applying for and receiving permits to drill “allocation wells”.
The term “allocation well” is used in the oil and gas industry to refer to a horizontal well that is drilled across lease lines without pooling the tracts on which the well is located. Originally, these wells were permitted by the RRC based on the operator’s assertion that it has production sharing agreements (PSAs) with the royalty owners. The PSAs provide that the 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.
The PSAs have advantages and disadvantages for royalty owners. The royalty owner will get royalties on production from a new well that might not be drilled unless a production sharing agreement is signed to allow drilling across lease or unit boundaries. The disadvantage is that production from one well serves to hold all the acreage in both units for as long as it produces.
More recently, the RRC has issued permits for allocation wells without requiring the operator to obtain production sharing agreements or pooling agreements from royalty owners in the tracts crossed by the wellbore. In effect, this allows operators to force-pool tracts, which in Texas is only allowed under limited circumstances and requires an application, notice to affected parties, and a hearing.
The right to consent – or not consent – 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 does not have a forced-pooling statute, like those in Oklahoma and Louisiana, that force mineral owners into pooled units against their will.
The RRC staff’s issuance of permits for allocation wells was challenged by royalty owners in DeWitt County. They protested a permit application by EOG to drill the Klotzman Well 1-H in the Eagleville Field. A hearing was held in the Klotzman case and the examiners for the RRC ruled that the commission rules do not authorize the RRC to issue allocation well permits. The Commissioners overruled the examiners, but did not provide any basis for their decision.
Several DeWitt County royalty owners have joined to file a lawsuit against the RRC in Travis County District Court, asking the court to reverse their decision on permitting such wells. The outcome of this ruling will affect all royalty owners in Texas. If operators are granted permits to drill allocation wells in the absence of pooling agreements with the royalty owners, the rights of royalty owners to negotiate pooling provisions in their leases will be seriously eroded.