compulsory pooling and unitizations_state options in dealing with unco-opearive owners

8/6/2019 Compulsory Pooling and Unitizations_State Options in Dealing With Unco-Opearive Owners

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Compulsory Pooling and Unitization: State Optionsin Dealing with Uncooperative OwnersBruce M. Kramer*

1. INTRODUCTION-THE HISTORICAL CONTEXTThe oil and gas industry has often been compared with other formsof games of chance as, for example, the stock market or the crapstable. You can either make it big or take a beating on your investedcapital. The following hypothetical situation and the attempts by

states to deal with it in their compulsory pooling and unitization'statutes, illustrate the high risk nature of the business.Assume that a stock broker or professional gambler approachedyou with the following offer: the broker/gambler will advance you$3000 or $3,000,000 if you agree to invest it at her request. She agreesto bear the entire risk of loss should the stock decline or craps berolled at the gaming table. If the return on the investment is lessthan $3000 or $3,000,000 you owe her nothing. If, however, the returnon the investment exceeds either of those sums, all profit is turnedover to you while she keeps only the initial investment advanced toyou. This is an offer one could truly not refuse. While nO rationalgambler or stock broker would ever make this offer, an analogous situation arises in the oil and gas industry when operators seeking todevelop their mineral holdings are unable to have unleased mineralowners or other working interest owners voluntarily agree to pool orunitize their interests. In the absence of a compulsory pooling or unitization mechanism," if the operator wanted to develop his interest,* Professor of Law, Texas Tech University School of Law, Lubbock, Texas. B.A. 1968, University of California, Los Angeles; J.D. 1972, University of California, Los Angeles School ofLaw; LL.M. 1975, University of Illinois College of Law.I Pooling and unitization are analogous but not identical concepts. Pooling usually describesthe joining together of tracts in order to receive a drilling permit under the applicable wellspacing rule for the area. Unitization- refers to the joining together of tracts in order to c o o p e r a ~

tively develop all or _part of a reservoir containing hydrocarbons. Unitization is sometimes referred to as a unit operation. See 8 H. Wn.LIAMS & C. MEYERS, OJL AND GAS LAW 652, 938-39(1984). For the purposes of this paper the terms are interchangeable since we will be analyzingthe impact of compulsory pooling or unitization on the unleased mineral owner or,the uncooperative working interest owner. The fact that the compulsory procedure is part of a unitizationorder or a pooling order will not drastically affect the results.=Most of the major oil and gas producing states have statutory procedures relating to COlnpulsory pooling and unitization. For a complete list of all of those states. see 2 & 3 R. MEYERS,


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n.27 (1952).10 The other principal methods of oil and gas conservation were: (1) Well Spacing-The regulation of the number and location of wells that can be drilled within a specified amount of

acreage; (2) Drilling Operations':-'"The regulation of procedures used in drilling and completingwells; (3) Maximum Efficient Rate_Limiting productive capabilities to themaximum efficientrate (MER) ofthe well based on its geological capabilities; and (4) Prorationing-Limiting theamount of oil and gas that can be sold from each well within a common source of supply orreservoir and allocating that amount between the various wells that are producing from thatcommon source. R. SULLIVAN, HANDBOOK OF OIL AND GAS LAW 285 (1955).

For a complete history of oil and gas conservation efforts at both the federal and state governmentallevel, see AMERICAN BAR ASSOCIATION, CONSERVATION OF OIL AND GAS: A LEGAL HIS-TORY, (B. Murphy ed. 1948); AMERICAN BAR ASSOCIATION, LEGAL HISTORY OF CONSERVATION OFOIL AND GAS (1938).

11 Fo r a general discussion of spacing units, see 5 E.KuNTZ, supra note 7, 77.1w.3, at 391401; R. SULLIVAN, supra note 10, at 297w305.12 The history ofRule 37 in Texas is summarized in Hardwicke, supra note 9, at 101-05, and

R. SULLIVAN, supra note 10, at 305-30B.13 1 R. MEYERS, THE LAW OF POOLING AND UNITIZATION 256 (1967).14 Report of the Committee on Conservation of Mineral Resources of the American Bar Asso

ciation, 54 REP. A.BA 739, 762-70 (1929).

trol this waste of natural resources was the enactment of compulsorypooling and unitization statutes.'oThe concepts of well spacing and pooling go hand in hand. Withoutwell spacing regulation, if only one well were to be dri lled on a fortyacre tract in which multiple interests existed, disputes would certainly arise as to which mineral owner or mineral lessee would beentitled to that single well. I f the well spacing provisions were fixed,the economic necessities of the circumstances would force the ownersof the mineral or working interests to reach a private accommodationin order to drill their one well." Unfortunately, as the Texas experience illustrates, well spacing regulations were rife with exceptions;governing policy normally allowed the drilling of more wells than was

otherwise needed in order to efficiently and effectively drain thereservoir.1 2Because the impediments placed in the way of voluntary pooling

and unitization agreements by various state regulatory programs andthe common-law rule of capture, efforts were made to force pool orunitize oil and gas properties in order to achieve three goals: conserving oil and gas, preventing waste, and protecting correlative rights."As early as 1929, the Section of Mineral Law o f t he American BarAssociation had developed a model compulsory unit operation statutein order to force uncooperative mineral and working interest ownersto join in cooperative development and operation of the oil and gaspool." Since then, compulsory pooling and unitization statutes have

been adopted in almost every state which produces oil and gas, '5 although in the tradition of Brandeis' aphorism of the states as fiftygrand experiments, there are substantial differences between thestates in their approach t o t he problem.'The function of the compulsory pooling or unitization processshould be to remedy the weaknesses of the marketplace while achieving the public objectives of preventing waste, conserving oil and gas,and protecting correlative rights. Because of the impact of the rule ofcapture and the geologic quality of t he movement of oil and gas toareas of lower pressure, the marketplace may not operate as the idealmechanism for the allocation of this scarce resource. The best way todetermine how the marketplace would operate is to see how voluntary pooling and unitization agreements deal with the problem ofnon-consenting working interest owners who choose not to participate in the drilling of the unit well.Voluntary agreements normally provide one of four different alternatives for the non-consenting working interest owner i f he does notparticipate in the drill ing program." One opt ion is for the otherworking interest owners to buyout the working interest owned by thenon-consenting owner. A second option allows the non-consentor to

259OOLING AND UNITIZATION

1& See supra note 2.16 For example Texas, which does not have a compulsory unitization statute, requires that anoperator Who wishes to use the compulsory pooling process must make a "fait and reasonableoffer to pool voluntarily" before the Railroad Commission has jurisdiction to entertain the compulsory pooling petition. TEx. NAT. RES. CODE ANN. 102.013 (Vernon 1978). Oklahoma on theother hand does not require the applicant for a pooling order to a ttempt to voluntarily poolThe applicant need only file with the Corp


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18 This option has several disadvantages. The first is defining when a productive well occurs.Is a marginally productive well which covers operating costs but will never recoup the initialinvestment in the drilling costs a productive well? In addition, the transfer of a large lump summight be treated as ordinary income by the operator with negative tax liability consequences.See Ryan, supra note 17. at 173.

19 See, e.g., Minor v. Pan Am. Petroleum C orp ., 2 16 F . Supp. 86, 88-89 (w.n. L a. 1962)(agreement enforced imposing 150% risk penalty on non-consentor's share of productioncaused by deepening an existing well).

20 This last option may run into problems with the Rule Against Perpetuities . See Kuntz,The Rule Against Perpetuities and Mineral Interests, 8 OKLA. L. REV. 183, 199 (1955). If thegrantor's interest is treated as a possibility of reverter, the rule would not apply.

21 See supra text accompanying note 1.

be "carried" for his pro rata share of expenses until a productive wellis completed. The share of costs is then immediately due. This optionis often accompanied by a penalty, sometimes denoted as a risk penalty, in order to compensate the operator for the risk of drilling a dryhole. ' A third option allows the non-consentor to be "carried" without risk bu t does not call for immediate payment upon completion ofa producing well. Instead, the share of costs plus the risk penalty arerecovered out of the non-consentor's allocated share of the production.' A fourth opt ion is to require the non-consentor to relinquishto the operator his working interest in the well subject to a futureinterest retained by the non-consentor. The future interest becomespossessory when the non-consentor's share ofthe costs plus risk penalty is paid out of his share of the oil/gas.'In all bu t the first alternative, the non-consenting working interestowner's share of the costs of drilling are "carried" by the other operators. The risk penalty concept is utilized in order to compensate therisk takers for the chances taken by t hem in drilling a dry hole. In

the first alternative, there is essentially no lOnger a non-consent problem because the operator has transferred voluntarily all of his interests to the remaining operators and no longer has a stake inproduction.If no voluntary pooling or unitization agreement can be worked outby the proposed operator, either the non-consenting mineral or theworking interest owner must be "carried" without any liability fortheir share of the expenses of drill ing a dry hole. This is the exampleraised by the opening hypothetical.21 The economic incentive forworking interest owners to join in such voluntary agreements isthereby diminished unless the proposed operator can resort to a com

pulsory process which forces the owner to make choices which areequally or less palatable to such holdouts. Unfortunately, severalstate approaches to the compulsory pooling and unitization process

22 See infra section lIA.28 See infra section lIB.24 See infra section lIC.n See infra section lID.


A. "Free Ride" StatesEleven states which have compulsory pooling statutes give the nonconsenting working interest owner a "free ride" in the drilling of a

1986]do not make it less palatable but seemingly reward holdouts by offering more than the marketplace would if a holdout forces the operatorto go through the administrative process.

II. THE PROBLEM OF THE NON-CONSENTING WORKING INTERESTOWNER

To contrast with the four alternatives normally offered in the private sector, state compulsory pooling and unitization statutes utilizea somewhat different set of four alternatives in order to force a nonconsenting working interes t owner to pool or unit ize his interes tswith those other operators working to develop the mineral interests.The first alternative can be labeled the "free ride." The non-consenting working interest owner is "carried" as to his proportionateshare of expenses without penalty during the time that the weI! isbeing drilled. If the well is successful" the non-consentor is only liablefor his share of the costs out of the production actually achieved. Ift he well is a dry hole, the non-consentor owes nothing.' The secondoption also allows the non-consentor to be "carried" during the drilling period, but i t imposes upon him a risk penalty to compensate thedrilling parties for the risk of drilling a dry hole. Again, i f the well isdry, the non-consentor pays nothing, while if oil is found, the nonconsentor is assessed a risk penalty.' A third groUP of statutes authorizes the governmental body to permit the non-consentor to elector choose one of several options. The options usually given the co-lessee include accepting a cash bonus in exchange for the transfer ofthe working interest, electing to participate on an uncarried basis bypayment of his proportionate share of expenses, or participating on acarried basis with the imposition of a risk penalty'" The last group ofstatutes does no t address the problem of the non-consenting workinginterest owner. Any power to deal with the non-consentor must begleaned from the r e g u l a t o ~ y agency's general authority to issue pooling or unitization orders. Practices of administrative agencies, whichhave broad discretion, vary from state to state."

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" ALA. CODE 9-17-13 (1980); ALASKA STAT. 31.05.100(e) (1979); MIZ. REv. STAT. ANN. 27505(A) (1976); FLA. STAT. ANN. 377.27 (West 1974); IND. CODE ANN. 13-4-7-14 (Burns 1981);IOWA CODE ANN. 84.8(2) (West 1984); Mo. ANN. STAT. 259.110 (Vernon Supp. 1985); MONT.CODE ANN. 82-11-202(2) (1983); NEV. REv. STAT. 522.060(3) (1983); N.C. GEN. STAT. 113-393(1983); N.D. CENT. CODE 3808-08 (Supp. 1985).

2'1 See supra text accompanying note 1.28 See, e.g., ALA. CODE 9-17-13 (1980); FLA. STAT. ANN. 377.27 (West 1974); IND. CODE ANN.

13-4-7-14 (Burns 1981); N.C. GEN. STAT. 113-393 (19S3).The Alabama provision is typical of this group of statutes. It provides:

[T]he operator designated by the Board to develop and operate the integrated orpooled unit shall have the right to charge against the interest of each other owner inthe production from the wells drilled by such designated operator the actual expenditures required for such purpose , not in excess of what are reasonable, including areasonable charge for supervision; and the operator shall have the right to receive thefirst production from such wells drilled by him thereon which otherwise would bedelivered or paid to the other parties jointly interested in the drilling of the wel l sothat the amount due by each of them for his share of the expense of drilling, equipping and operating the well maybe paid to the operator of thewell out of production.

ALA. CODE 9-17-13(e) (19S0)... FLA. STAT. ANN. 377.28(e)(1) (West Supp. 19S5).

well." Although there are three different methods of discerning thenature of the free ride, the effect is to allow the non-consentor tohave his share of the cost of the well taken solely out of production.I f the well is a dry hole, the non-consentor is not forced to pay anything. The statute in effect requires the operator to give an interestfree loan to the non-consentor. In the absence of substantial production from the well, the loan will be defaulted , with no fur ther recourse available to compensate the operator for potential losses. Thisis the hypothetical situation which opened the discussion of thisproblem."'The first group of free ride states essentially gives the operator theright to charge his expenditures against the proportionate interests ofall of the non-consenting owners. The charge is reimbursed to theoperator out of the first production from the well."' The non-consentor is treated as a non-drill ing cotenant who is entit led to an accounting of expenditures and production, bu t who receives no actualmoney until the operator has recouped his out-of-pocket expenses indrilling and operating the well. Of these states, only Florida authorizes the operator to have a lien on the leasehold estate of each separately owned tract in order to provide a security interest in theamount of production.' This lien also applies to consenting ownerswho are otherwise being carried by the operator.Another group of three states provides for "reimbursement of costschargeable to each lessee out of, and only out of, production from the

.. ALASKA STAT. 31.05.100(c) (1979); ARIZ. REV. STAT. ANN. 27-505(A) (1976); NEV. REV.STAT. 522.060(3) (19S3).

31 The Arizona statute is typical. It provides in pertinent part:If one or more of the owners drills and operates, or pays the expense of drilling andoperating the well for the benefit of others, then, in addition to any other rights conferred by the pooling order, the owner or owners so drilling or operating shall have alien on the share of production from the unit accruing to the interest of each of theother owners for the payment of his proportionate share of the expenses. All the oiland gas subject to the lien, or so much thereof as necessary, shall be marketed andsold by the creditor and the proceeds applied iJ;J. payment of the expenses secured bythe lien, with the balance if any payable to the debtor.

Amz. REV. STAT. ANN. 27505(A) (1976)." IOWA CODE ANN. S4.S(2) (West 19S4); Mo. ANN. STAT. 259.110 (VernonSupp. 19S5);

N.D. CENT. CODE 3S-08-0S (Supp. 19S5).The North Dakota statute is typical. It provides in pertinent part:If one or more of the owners shall drill and operate, or pay the expenses of drillingand operating the well for the benefit of others, then, the owner or owners so drillingor operating shall, upon complying with the terms of section 38-08-10, have a lien onthe share of production from the spacing u n ~ t accruing to the interest of each of theother owners for the payment of his proportionate share of such expenses. All the oiland gas subject to the lien shall be marketed and sold and proceeds applied in payment of the expenses secured by such lien as provided for in section 3 8 ~ 0 8 - 1 0 .N.D. CENT. CODE 38-08-08(2) (Supp. 1985). Section 38-08-10 requires the operator to file for

record with the register of deeds an affidavit setting forth the amount due and the interest ofthe non-consentor in such production. Foreclosure of the lien is provided in the general requirements relating to foreclosures of liens on chattels. [d. 38-08-10 (1980).

263OOLING AND UNITIZATIONunit belonging to each lessee."3. Again the non-consentor is given afree ride in that the operator's right of reimbursement only comesout of actual production. The major distinction between this groupand the preceding group is the inclusion of a s tatutory lien on theshare of production accruing to the interest of each non-consentingowner. Thus, the operator has both the right to reimbursement out ofproduction and a lien on that production_ The lien is normally marketable and may be sold in order to pay the pro rata share of costsattributable t o t he individual lessees.31

The three remaining free ride states do not even provide the operator with a direct entitlement to production. Instead, these states provide for an operator's lien covering the non-consenting owner's shareof production up to the amount owed the operator." In practice,however, the results will probably be no different than those stateswhich do provide for a direct entitlement to production.

The problem with all these provisions is that they encourage individual working interest owners to hold out of voluntary pooling orunitization agreements. I t would no t be in the best interes t of theworking interest owner to buy into an operating agreement and facethe dua l burden of providing up-front capital for the drilling, andalso the risk of losing his entire investment in the event ofa dry hole.

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" In re Kohlman, 263 N.W.2d 674 (S.D. 1978).84 ld. at 675." COLO. REV. STAT. 34-60-116(7) (1984); LA. REv. STAT. ANN. 30-10 (West Supp. 1985);

NEB. REV. STAT. 57-909(2) (1984); N.M. STAT. ANN. 70-2-17(C) (1978); N.Y. ENVTL. CONSERV.LAW 23-0901 (McKinney 1984); OHIO REv. CODR ANN. 1509.27 (Page 1978); f ix . NAT. REs.CODE ANN. 102.052 (Vernon 1978); UTAH CODE ANN. 40-6-6(6) (Supp. 1985); WASH. REV.CODE ANN. 78.52.240 (Supp. 1986); WYo. STAT. 30-5-109(g) (1977).

The statute, by essentially allowing free riders, operates in a counter_productive manner. The potential operator will be discouraged fromdrilling if he knows that he has to carry the full risk of a dry hole:md, in addition, share the benefits from a profitable well with t h o s ~Interest owners who have sa t on the sidelines and bore none of theusual risk of drilling for oil and gas. I f the percentage of ownership ofthe ,:"orking i n t ~ r e s t s i.s o ~ e r . a minimal amount, then the compulsoryP?olIng mechanism falls. In Its g o a l ~ of ?reventing waste, conserving011 and gas, and protectIng correlatIve rIghts. Operators will have toattempt to buyout their fellow operators who hold the trump cardbecause, without their agreement, the putat ive operator must bearthe enti re risk of a dry hole.Because this type of provision is so counter-productive to the essence of the compulsory pooling and unitization idea, most of the major oil producing states have followed the private sector and imposeda substitute for the risk factor on the nonparticipating working interest owner. To th is type of statute we now turn.

B. Risk Penalty Statutes1. State Approaches to Rish Penalty Provisions. In In re Kohl-

man," the South Dakota Supreme Court concluded that the purposeof imposing a risk penalty on non-consenting working interests owners is to "relieve the nondrilling interest owner from having to advance his proportionate share of the drilling costs, bu t provide extracompensation from production (if oil is found) to the drilling partywho had advanced the ent ire cost of a 'dry hole.' " All risk penaltystatutes seek to achieve the objective of compensating the risk-takerand preventing the free ride by the non-consenting owner'" As such,t ~ e p e ~ a l t y provisions provide an incentive for voluntary participatIon wIth the proposed operator on terms worked out in the marketplace rather than in a governmental context.Within the various states that have risk penalty provisions, a substantial disparity still exists between approaches. The areas of comm o ~ a l i ~ y include the imposition of a specified percentage risk penaltywhIch IS to be recovered from the non-consentor's proportionate


" COLO. REv. STAT. 34-60-116(7) (1984); NER. REV. STAT. 57-909(2) (1984); UTAH CODEANN. 40-8-8(6) (Supp. 1985); WASH. REV. CODE ANN. 78.52.240 (Supp. 1986); WYo. STAT. 30-5-109(g) (1977).

The Colorado statute is typical of this variety. It provides:(b) Upon the determination of the commission, proper costs recovered by the consenting owners of a drilling unit from the nonconsenting owner's share of production

from such a unit shall be as a fol lows:(1) One hundred percent of the nonconsenting owner's share of the cost of surface equipment beyond the wellhead connections (including, butnot limited to, stock

tanks, separators, treaters, pumping equipment, and piping) plU$ one hundred percent of the nonconsenting owner'sshare ofthe cost of operation of the well commencing with first production and contjnuing until the consenting owners have recoveredsuch costs. It is the intent that the nonconsenting owner's share of these costs ofequipmfmt and operation will be that interest which would have been chargeable tothe nonconsenting owner had he initially agreed to pay his share of the costs of thewell from the beginning of the operation.

(II) Two hundred percent of that portion of the costs and expenses of staking,well site preparation, obtaining rights-of-way, rigging up, drilling, reworking, d e e p e n ~ing or plugging back, testing, and completing the well, after deducting any cash contributions received by the consenting owners, and two hundred percent of that portion of the cost of equipment in the well, including the wellhead connections.

COLO. REV. STAT. 34-80-116(7) (1984)." See, e.g., COLO. REv. STAT. 34-60-116(7) (1984); WYo. STAT. 30-5-109(g) (1977).Ohio saw the difficulties of enforcing a fixed rate risk penalty and amended their statute in1967 to adopt a flexible risk penalty provision. For a complete discussion of the Ohio experience

see,6 H. WILLIAMS & C. MEYERS, supra note 17, at 3 0 ~ 3 1 n.9.38 COLO. REV. STAT. ' 3 4 - 6 0 ~ 1 l 6 ( 7 ) (1984); see supra note 36." NEB. REv. STAT. 57-909(2) (1984).

share of the produced hydrocarbons. The states disagree, however, onhow - and on what costs - the risk factor is to be computed. In fivestates, including Colorado, the non-consentor is given a free ride as tocertain expenses, while other expenses are subject to a one hundredpercent risk penalty.'Severa! states set the amount of risk penal ty as a matter of law inthe pooling and unitization statute.37 The responsible administrativeagency is required to assign the percentage penalty to those expenseswhich fall under the various categories listed in the statute. This system is somewhat counterproductive if the purpose of the penalty is tomake an assessment for the risk. Not all wells carry with them thesame risk of coming up totally dry or insufficiently productive to payoff drilling and operating expenses. By having a laundry list approachin which certain i tems are recoverable only as to the ir actua! costswhile others are subject to a penalty, an intent to limit the operator'srecovery to those items truly at r isk in the venture is evident. Forexample, surface equipment that is readily moveable is exempt fromthe penalty under the Colorado' and Nebraska' provisions. This isbecause risk does no t exist in the use of that type of equipment;

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266 JOURNAL OF ENERGY LAW AND POLICY [Vol. 7 1986] POOLING AND UNITIZATION 267rather, depreciation of that equipment is allowed for its intended use.Thus, a statute taking the Colorado approach attempts to tai lor thepenalty provisions t o th e risk in terms of the equipment being used,bu t not as to the geophysical or geologic risk that oil or gas will notbe found where the drilling takes place.The problem of including a fixed penalty, whether it be limited tospecified costs or not, is that it is inconsistent with the purpose ofimposing a risk penalty because the risks change from well to well.There are at least three types of risks that may be involved in drilling

an oil and gas prospect" The greatest r isk is in drill ing a dry hole. Asecond risk is encountering unexpected mechanical or geologicalproblems which greatly increase the actual cost of drilling. The thirdtype of risk is the risk of drilling a marginally productive well whichwill never r et urn t o t he operator his investment in the drilling andoperating expenses'" Unfortunately, most state statutes and administrative agencies do not adequately explain the basis for imposing arisk penalty'"Several states which use the laundry list approach attempt to remedy the problem of inflexibly mandated risk penalty percentages byallowing the responsible state administrative agency to decidewhether or not the penalty is to be imposed. Nebraska, while settingthe penalty for some expenditures at one hundred percent, allows theagency to decide if a penal ty is appropri ate under the circumstances'" However, the statute does not se t out the criteria for determining when the penalty should be imposed. If the overall purpose ofthe penal ty is to reward the r isk taker for bearing someone else'sshare of a dry or marginal ly product ive well, the leading factor in

4(1 Morris, Compulsory Pooling of Oil and Gas Interests in NewMexico, 3 NAT. RESOURCES J.31S, 326 (1963).41 ld. at 325-26.42 ld. at 326; see also Nutter, Some Engineering Aspects of the New Mexico CompulsoryPooling Statute, paper delivered to the Mineral Law Section of the StateBar of Texas (July 5,1962), reprinted in 6 H. WILLIAMS & C. MEYERS, OIL AND GAS LAW 29-30 (1985) [hereinaftercited as Nutter].

43 The Nebraska statute reads in part:The order shall determine the interest of each owner in theunit , and may provide insubstance that, . . . as to each owner who does not agree, he shall be entit led toreceive from the person or persons drilling and operating said well on the unit hisshare of the production applicable to his interest, after the person or persons drillingand operating said well have recovered two hundred per cent of that portion of thecosts and expenses of staking, well site preparation, drilling, reworking, deepening orplugging back, testing, completing, and other intangible expenses approved by thecommission chargeable to each owner who does not agree, and one hundred percent[of other enumerated costs].

NEB. REV. STAT. 57-909(2) (19S4).[II

calculating the penalty must be the likelihood or unlikelihood that oilor gas will be found at the well's proposed location.Other states provide flexibility by giving the administrative agencythe power to set the penalty within a range set out in the statute'"Again, this discretion tends to achieve the penalty's objective of rewarding the risk-taker according to the degree of risk being taken.In states that do not delimit the type of activities for which thepenalty applies, the respective state administrative agencies have varying degrees of discretion to impose the risk penalty and to set itsamount. Louisiana specifically provides for a penalty as a "charge forrisk" and requires that the penalty that is to be imposed be fixed atone hundred percent of the actual costs incurred'" The LouisianaCommissioner of Conservation must impose the penalty on personswho choose not to participate in the proposed well"Texas provides greater flexibility in its compulsory pooling orderby allowing the Railroad Commission the. discretion to impose a riskcharge not to exceed one hundred percent of drilling and completioncosts." The Railroad Commission, however, must impose a riskcharge on all non-consentors" New Mexico provides the greatestflexibility of those states which authorize the use of risk penalties bygiving the Oil Conservation Commission the power to determine notonly the amount of the risk charge, but also whether or not a risk

" See, e.g., N.M. STAT. ANN. 70-2-17(C) (197S); N.Y. ENV']'L. CONSERV. LAW 23-0901 (McKinney 1984); UTAH CODE ANN. 40-6-6(6) (Supp. 1985); WASH. REV. CODE ANN. 78.52.240(Supp. 1986)." LA. REv. ANN. 30:1O(2)(b)(i) (West Supp. 1985). Vermont b88 tb e bighest risk penaltyfigure: 300 percent is required to be imposed if the lessee chooses not to participate. VT. STAT,

ANN. tit. 29, 523(c) (Supp. 1985)." L A. R EV . S TA T. A NN . 30:1O(2)(b)(i) (West Supp. 1985). The sta tu te does no t differentiatebetween those who voluntarily elect not to participate and those who either want to participatebut cannot bear the financial burden, or those who make a good faith effort to participate butlater become delinquent in their payments due to financially exigent circumstances. Arguablythe party who chooses to participate but becomes delinquent should not be subject to a 100percent penalty but merely to the typical damages recovery for breach of contract which wouldinclude the amount of the unpaid cost of drilling plus interest on the funds that the operatorhad to forward on behalf to the breaching participant.

47 TEX. NAT. RES. CODE ANN. 102.052(a) (Vernon 1978). See also Windsor Gas Corp. v.Railroad Comm'n, 529 S.W.2d 834 (Tex. Co. App. 1975) w r ~ t of error d ism'd on mot ion ofparties.

48 TEX. NAT. RES. CODE ANN. 102.052(a) (Vernon 1978):As t o an owner who el ects not to pay his proportionate share of the drilling andcompletion costs in advance, the commission shall make provision in the pooling order for reimbursement solely out of production, to the parties advancing the costs, ofall actual and reasonable drilling, completion, and operating costs plus a charge forrisk not to exceed 100 percent of thedrilling and completion costs.[d.


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268 JOURNAL OF ENERGY LAW AND POLICY [Vol. 7 1986] POOLING AND UNITIZATION 269charge should be imposed!'The degree of agency discretion may also impact the scope of judicial review of risk penalty decisions made by the agency. In VikingPetroleum, Inc. v. Oil Conservation Commission," a challenge to aNew Mexico pooling order which had imposed a two hundred percentr isk penalty was turned back, largely on the traditional notion thatsuch determinations were within the par ticula r exper tise of theagency and should be given great deference by a reviewing court."Therefore, agency decisions are going to be difficult to overturnwhere the agencies have been vested with wide disc ret ion by thepooling and unitization statute.Mississippi's statute most narrowly confines the discretion of theadministrative agency in imposing risk penalties.'2 Mississippi is alsounique because it is the only state which gives the operator, not thenon-consentor, an option to carry the non-consentor's interest orseek, in addition to the pro rata share ofexpenses, a penalty of up to250 percent of such costs. '3 The statute also requires that the penalty

411 N.M. STAT. ANN. 702-17(C) (1978). Ohio hasa similar provisionbut mayallow the operator to continue to recoup a 200 percent penalty from the continuing operating expenses for thelife of the productive well. This result would truly be too harsh and overcompensate the operator for the risks he had taken. OHIO REv. CODE ANN. 1509.27 (Page 1978); see also Williams &Meyers, Petroleum Conservation in Ohio, 26 OHIO ST. L.J. 581, 608 (1965).

lJO Viking Petroleum, Inc. v. Oil Conservation Comm'n., 100 N.M. 451, 672 P.2d 280 (1983).111 Viking Petroleum is a fascinating Clllie. HEyeO wanted to drill a well to test several dif

ferent formations. Viking wanted to participate in the expenses only through the shallowerformations. The Commission denied the Viking petition for partial participation and gave thema limited time to participate or be carried with the imposition of a 200 percent risk penalty.Viking chose not to participate, and brought an action seeking to overturn the Commission'sorder denying them the right to partial participation. 672 P.2d at 281. The Supreme Courtdecision treated the matter of partial participation and risk penalty as a matter of law, ratherthan as an issue of fact. It nonetheless applied a substantial evidence standard, which is normally reserved to judicial review of agency findings of fact. Id, at 283. The court reviewed theevidence presented to the Commission in a deferential way, makingall reasonable inferences infavor of the Commission and excluding from consideration all evidenceunfavorable to theCommission's findings. Id.

The court concluded:The grantipg or refusal to grant forced pooling of multiple zones with an election to participate in les s than a ll zones , the amount of costs to be reimbursed to the operator, and thepercentage risk charge to be assessed, if any, are determinations to be made by the Commission on a case-tocase basis and upon the particular facts in each case.Id. at 284; see also Rutter & Wilbanks Corp. v. Oil Conservation Comm'n, 87 N.M. 286, 289

291,532 P.2d 582, 585-87 (1975) (findings of Commission are sufficient; ordersare supported bysubstantial evidence).

~ 1 MISS. CODE ANN. 533-7 (Supp. 1985); see also McDavid, Mississippi's New OperatorRisk Compensation Statute, THE LANDMAN, Nov. 1984, at 7.I I Section 53-3-7(2)(a) o f t h e Mississippi Code provides:In the e v en t t h at a majority of the drilling interests.in a.drilling unit has voluntarilyconsented to the drilling of a uni t wel l thereon, and the opera tor has made a good

It

and costs are not to be imposed i f th e well does not produce in paying quantities. This provision adds an ambiguity to the r ight to recover since it is unclear whether a marginally producing well, whichmight be sufficient to satisfy a leasehold habendum clause definitionof paying quantit ies, will be producing in paying quantit ies so as toallow for the imposition of the penalty." Finally, the operator is onlyentitled to the penalty if he complies with a series of requirementsincluding filing a petition with the Board and giving to each workinginterest owner an offer to participate or farm out his interests to theoperator ." Therefore, agency decisions are going to be difficult tooverturn where the agency has been vested with wide discretion bythe pooling and unitization statute.2. Criteria By Which Agencies Determine The Risk Penalty. Instates where agencies have discretion to determine the risk penalty,there is a paucity of legislative guidance regarding criteria to be considered by the agency in determining whether a risk penalty shouldbe imposed, and what the amount should be if a penalty is warrantedby the facts. There is little judicial precedent discussing the underlying Commission decisions in which discretion is given by the statute.All that the New Mexico Supreme Court stated in the Viking Petro-leum decision was that the decision on the amount of r isk penal tyimposed was, by its very nature, an ad hoc factually determined issuewhich was to be given broad deference by a reviewing court."Certain factual issues are obviously relevant to an agency making arisk penalty provision given the penalty's purpose of compensatingthe risk taker and avoiding free rides. The major factual issue relatesto a determination or quantification of the amount of r isk carried by

the operator. Factors include the proposed well's proximity to otherfaith effort to (i) negotiate with each nonconsenting owner to have said owner's interest voluntarily integrated into the unit, (ii) notify each nonconsenting owner of thenames of all owners with drilling rights whO have agreed to integrate any interests inthe unit, (iii) ascertain the address of each nonconsenting owner, (iv) give each nonconsenting owner written notice of the 'proposed operation, specifying the work to beperformed, the location, proposed depth, objective formation and the estimated costof the proposed operation, and (v) to offer each nonconsenting owner the opportunityto lease or farm out on reasonableterms, or to participate in the cost and risk ofdeveloping and operating t h e u ni t well involved, on reasonable terms, by agreeing inwriting, then the operator may petition the board to allow it to charge alternatecharges as hereinafter s e t o u t (alternate to and in l ieu of the charges provided for insubsection (l)(b) above).

MISS. CODE ANN. 53-3-7(2)(.) (Supp. 1985)... Id. 53-37.MId66 Viking Petroleum, Inc. v. Oil C o n s ~ r v a t i o n , Comm'n, 100 N.M. 451, 672 P.2d 280 (1983);

see supra note 51.


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G1 Nutter, supra note 42.6'8 Holmes v. Corporation Comm'n, 466 P.2d 630 (Okla. 1970). The court in Holmes dealt

with a ~ o n - c o n s e n t i n g mineral owner who had burdened his working interest with a very highproduction payment. Under those circumstances the working interest owner in Oklahomawould have been faced with an election between participation or transfer of his interest withthe payment of a bonus. However, because of the high production payments burdening theinterest, it would have been likely that the lessee would have received nothing for his interest.See infra note 88. Therefore the operator asked for a third option, namely being carried with arisk penalty. The court upheld a risk penalty of 250% primarily because the well was a deepwell with concomitantly higher costs and longer period of payout if the gas was found. Id. at633.

Ge TEX. NAT. R ~ s . CODE ANN. 102.013(b) (Vernon 1984). See generally Smith, The TexasCompulsory Poolmg Act (pt. 2), 44 TEx. L. REV. 387, 393 (1966) (describing possible applicationof the Commission's requirement).

60 Windsor Gas Corp. v. Railroad Comm'n., 529 S.W.2d 834 (Tex. Civ. App. 1975) writ oferror dism'd on motion of parties.61 Id. at 835.62 Id. at 837.

successful wells, the geologic information regarding the knownreserves in the area, and the productivity of any existing offset wellsin the area.07 These factors all relate t o t he issue of whether - andif so, how much - oil or gas will be found. Other factors may r e l a t ~to the speed at which the opera tor can be expec ted to recoup hisinvestment assuming the geologic information was correct. Speed criteria include current and expected demand of the product, locationof the nearest pipelines for gas transportation, if gas is the expectedmineral to be discovered, depth o f expected find and the cost ofdrilling.'Texas has a unique requirement which must be met before an opera tor can seek to force pool other working interes t owners. The

Texas Railroad Commission cannot exercise jurisdiction until theproposed operator has made a fair and reasonable offer to voluntarilypool the other working interests.' In Windsor Gas Corp. u. RailroadCommission, B. the court had to ascertain whether a voluntary offer topool was fair and reasonable. The offer required a one hundred percent penalty be attached t o th e other working interest owner shouldhe opt not to participate. B1 The operator was planning to drill eightwells within the area to be pooled because there had been productionon both sides ofthe proposed drilling locations, and the region had a .long history of productive drilling. In addition there had been an 84.6percent success rate in drill ing during the previous year, excludingoffset wells.B2 The court held that there was essentially no risk in thedrilling activities. Therefore, an offer to have a one hundred percentpenalty in excess of actual costs was not "fair and reasonable," and

63 [d. at 836-37; see TEX. NAT. RES. CODE ANN. 102.013(b) (Vernon 1984); the definition of afair and reasonable offer was discussed in Carson v. Railroad Comm'n of Texas, 669 S.W.2d315, 318 (Tex. 19S4)... In re Kohlman, 263 N.W.2d 674 (S.D. 1975).6G [d. at 679. A previous agreement between the parties on another tract of land had led to a

voluntary agreement in which a 250 percent penalty was mutually acceptable. [d . at 678.1I6 [d. at 679. -67 [d . at 67879. The court said that the penalty is based on several unidentif ied factors,

including proximity to successful wells.- Nonetheless, the parties who have the greatest to gainor lose are the bestjudges of what the risk is. Where the non-consentor has voluntarily agreed

271OOLING AND UNITIZATION986]the compulsory pooling process was not triggered.B'The amount of the penalty itself is not determinative of whether it. is fair or reasonable. Undoubtedly the negotiation process that wouldtake place in a voluntary pooling agreement would better reflect theamount of risk that knowledgeable parties predict is encompassed bythe proposed drill ing plan. The compulsory pooling process is required to bring parties together who cannot agree on a risk penalty orother provisions. The need fo t a compulsory process s tems from aneed to achieve important public objectives of protecting correlativerights, preventing waste, and encouraging efficient development ofthe oil and gas resource. In In re Kohlman, B4 the court reviewed aCommission's determination that a one hundred percent penalty was

reasonable, even though the operator had sought a two hundred fiftypercent penalty and the non-consenter had apparently agreed in private negotiations to a one hundred fif ty percent penalty.B' Because asuccessful well was located about three-quarters of a mile from theproposed well site, a smaller r isk penalty should have been imposedbecause the r isk of a dry hole was less. The court concluded that theCommission's one hundred percent penal ty was reasonable eventhough it was a smaller penalty than the non-consentor had voluntarily agreed to.BThe Commission's decision is probably supportable under an arbitrary and capricious or substantial evidence scope of judicial reviewgiven the closeness of the productive well. The result, however, isprobably inefficient from an economic viewpoint because it gives tothe non-consentor more than he had agreed to in the market place.In s ta tes like Texas where a volunta ry offer to pool must be made,the Commission should give great weight to both the operator's offeron the risk penalty and the carried interest owner's counter-offer, i fany was made. Where the agency has credible evidence placing lowerand upper limit s on the amount of the penalty, the agency shouldrestrict its exercise of discretion to those limits because they are thebest evidence of the market place valuation of the resource.7



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C. Option StatesSeveral p.ooling. and u n i ~ i z a t i o n statutes specify that the non-con_

~ e n t o r be gwen either deSignated or undesignated options before hismterest can be force pooled. Several states including Illinois 6S PI . 69 V' . . 70 d W " , e n n ~sy vama, ~ r ~ m l a , an est Virginia,71 specifically include a riskpen.alty prOVISIOn as one of the qesignated options that must be madeavailable to the non-consenting working interest owners Ill ' .d t th h . mOls man-.a es at t e n o n - ~ o ~ s e n t o r be given alternatives, including: 1) theright ~ surrender hiS m t e r e s ~ to participating owners for a reasonable pnc.e .to be set by the parties or by the Mining Board, 2) the ri htto. par ticipate on a noncarr ied basis , and 3) th e r ight to be carrredwith a penalty off ifty percent of the drilling, testing and completiocosts. of the well."' Where the compulsory order does no t includee l e c ~ l O n , the order is void, but only as to tha t par t which relates tothe Impos.ed penalty.73 That par t of the order pooling th e interestand allowmg the operator to drill will be deemed valid.74 s

A ~ k a n s a s a.uth?rizes a somewhat different option for its non-consentmg ~ o r k . m g mterest owner."" Besides the option to participate,the workmg mterest owner can transfer his r ights to the operator onto a 150 percent penalty there seems to be no reason to go below it since the person taffected by the decision has already determined what the risk was Const . . th mosth m . . lam In g e agency toe 0 era and counter-offers might encourage inflating and deflating the figures and discouragev o l ~ ~ agreements. In some circumstances the agency should be able to se t risk penaltp r o ~ l S l o n s re.gardless of the figures met by the parties, jf for example, new geological evidence i aV.81lable or if ODe or both of the parties offers are deemed to be unreasonable or made in badfaIth... ILL. ANN. STAT. ch. 96'h, 5436(d) (Smith-Hurd 1979).e9 PA. STAT. ANN. tit. 58, 408(c) (Purdon 1964)'(provides for a 100 percent penalty)" VA. CODE 45.1-302(C) (Supp. 1985). .:: w. VA. CODE 22-87(b)(6) (1985) (provides for a 100 percent penalty).ILL. ANN. STAT. eh. 96Y" 5436(d) (Smith-Hurd 1979).

" Newki rk v. Bigard, 125m. App. 3d 454, 462, 466 N.E.2d 243, 248 (19S4). Although thiscase l ~ v o l v e d an u n ~ e a s e d nuneral owner, the issue is the same for working interest owners. In~ e . w k ; r ~ . t.he,CQUlt l ~ t e r p r e t e d the compulsory pooling statute as requiring the Mining Boardme u e In Its poolIng order reasonable alternatives for the non-consentingmineral owners tochoose from, even though the statute usedthe phrase "if requested" to modify th . tof "d' It . ,'" ' e reqUlremenproVl mg a e ~ n a t l v e s . 4 ~ N.E.2d at 248 (quoting ILL. REv. STAT. ch. 96'12, 5436 (Smith-Hurd 1979, WhIle the notice for the hearing included a provision relating to alternatives thea c ~ ~ a l order required Newkirk. an unleased owner, to participate. Id. at 247. '

Id. at 248. Where the non-consentor chooses not to partier'pate m' the h . dt th . th .. earIng or respono e notices. e MmIng Board can avoid a problem byhaving its order state that if the nonconsentor does not respond to the notice within a specifiedtime. the pre-designated option willbe d e ~ m e d to have heen selected. This procedure will prevent the nonconsenter from undulyhdelaymg the ?perators' schedule merely by sitting on the election which the statute mandatese must be gIven." ARE. STAT. ANN. 53-1l5(A-I)(e) (1971). Id.

273POOLING AND UNITIZATION

76 [d . The provision states in part:Such order shall also provide that an owner who does not affirmatively elect to participate in the risk and cost of such operations shall transferhis rights in such drillingunit and the production from the uIiit well to the parties who elect to participatetherein for a reasonable consideration and on a reasonable basis. which in the absenceof agreement between the parties, shall be determined by the Commission. Suchtransfer may be either a permanent transfer or may be for a limited period pendingrecoupment out of the share of production attributable to the interest of such nonparticipating owner by the participating parties of an amount equal to the share ofthe costs that would have been borne by such- non-participating party had he participated in such operations. plus an addtional sum to be fixed by the Commission.

77 S. D. CODIFIED LAWS A N ~ . 45-9-31 (1983)." IDAHO CODE 47.322 (1977); Ky. REV. STAT. 353.640 (1983); S.C. CODE ANN. 48-43-340(C) (Supp. 1984)." In re Kohlman, 263 N.W.2d 674 (S.D. 1978).

80 [d. at 675. The order provided in part:That the operator (Depco) is hereby authorized to withhold the following costs andcharges from production:The pro rata share of reasonable well costs attributable toeach nonconsenting working interest owner who had not paid his share of estimatedwell costs within 30 days from the date the schedule of estimated well costs is furnished to him. As a charge for ~ h risk involved in the drilling of the well, 100 percentof the pro rata share of reasonable well costs attributable to each nonconsentingworking interest owner who has not paid his share of estimated well costs within 30days from the date the schedule -of estimated well costs is furnished to him .. , .

a permanent or temporary basis. The permanent transfer, which ismerely a total assignment of the working interest in exchange for acash consideration, eliminates the owner from further development ofthe field. The second option turns into a r isk penalty option becausethe assignment of the working interest is for a l imited time, subjectto recoupment.76 While no t labeled a risk penalty, the additional summentioned must be related to the carried status and th e lack of risk.By legislative default the state agency is given wide lat itude in sett ing the cri teria used to determine if a pena lt y is t o be imposed andthe range of possible penalt ies in issuing the compulsory poolingorder.Several states, including South Dakota,77 merely provide that theorder must include just and reasonable alternatives, without mentioning what those alternatives are." In In re Kohlman,7. the SouthDakota Supreme Court upheld the ability of the state agency to provide a risk pena lt y as one of the alternatives to be presented to thenon-consenting working interest owner.so While the r ight to impose apenalty was no t specifically mentioned in the statute, the courttreated the power to impose the penalty as necessarily implied fromthe general power to provide just and reasonable alternatives for nonconsenting mineral and working interest owners. The Board, in carry-

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SlId. at 677-78... MICa. STAT, ANN, 13,139(13) (Callaghan 1981); see alsa GA, CODE ANN, 43-706(.)(1)(Supp. 1985) (no standardsoutlined); OR. REV. STAT. 520.220 (1983) Gust and reasonable conditions); TENN, CODE ANN, 60-1-202 (Supp. 19&5) (uo standards outliued).83 The Oklahoma statute provides in part:Where, however, such owners have no t agreed to pool their interests and where onesuch separate owner has drilled or proposes to drill a well . . . t he Commission . . .

shall. . . require such owners to pool and develop theirlands in the spacing unit as aunit. . . . All orders requiring such pooling shall be made. . . u pon such t e rms andconditions as are just and reasonable ....

OKLA, STAT. ANN, tit. 52, 87.1(e) (19S4 & Supp. 1985).84 Id.; see also Curlee, The Problem of the "Free-Riding" Lessee and Some Suggested Solutions, 9 INST. ON MIN. L. 21, 24 (1962).

ing out the generally stated purpose of preventing waste in the development of the state's oil and gas resources, was within i ts powerwhen it chose the risk penalty alternative.alStates that authorize the use of alternatives provide a more realistic replica of the actual marketplace for working interests and, therefore, more closely achieve what the market cannot do because of theruIe of capture. As stated earlier, operators who seek to jointly operate a pool or reservoir have several choices available to them in orderto persuade the other owners to join in their venture. By giving theadministrative agency the same kind of alternatives, the agency cantailor an order which reflects what the market would bear were it notfor the impediments placed in the road to voluntary agreements.D. Silent States

The final group of states essentially does not make any specificmention in their pooling and unitization statutes of what to do withthe non-participating owner's interest. Most of these states' statutescontain only the general instruction to the Board that the order mustbe on " terms and conditions that are jus t and reasonable, and willafford t o t he owner of each tract . . . the opportunity to recover orreceive his jus t and equitable share of the oil or gas."a2Of all these states, Oklahoma by far has the most highly developedadministrative and judicial doctrine to fill in the lacunae caused by acompulsory pooling statute which does not deal with the problem ofnon-consenting working interest 'owners.a8 The alternatives that havedeveloped in the Oklahoma Corporation Commission to deal with thenon-consentor have as their antecedents the municipaI ordinancesthat were the predecessors to statewide compulsory pooling statutes.a4 The two alternatives normally given to municipal lot ownerswho could only drill a single well in one city block were: electing toshare proportionately in the costs; or not participating and accepting

.. OKLA. STAT. ANN. tit. 52, 87.1(e) (1984 & Supp. 1985).86 Anderson v. Corporation Comm'n., 327 P.2d 699 (Okla. 1958); see also Superior Oil ?o . v.Oklahoma Corp. Comm'n, 242 P.2d 454, 458 (Okla. 1952) (Commission o r d ~ r requiring ~ m e r a linterest owner to pay $85,000 wit1)in 10 qays or accept $500 per acre for Its lease m o d i f i ~ d ) .87 Anderson 327 P.2d at 70203. This notion of a forced sale has been analogizedto a pXlvateeminent domain proceeding. If a party chooses no t to o r is unabl e t o p a r t i c i p a t ~ in the we.llcosts through the payment ofcash or a bond, the Commissi.on:s actions ~ e q u i ~ e him sell hiSproperty interest to the operator at a price which th e CommissIon determmes IS t ~ fair m a r k ~ tvalue. One could analogize this situation t o t he common statutory grant o f emment d ~ m a l Dpowers to public utilities operating under a government permit or certi ficate of c o n v e n ~ e ? ~ .See, e.g., TEx. REV. ClY. STAT. ANN. art. 1436'(Vernon 1980) (giving to certain public utilitIes

right to condemn land for right 'of way purposes).88 For a more complete discussion of the alternatives available under the Oklahoma statute,see Nesbitt, A Primer on Forced Pooling of Oil and.Gas Interests in Oklahoma, 50 OKLA. RA.J.

648 (1979).6& In Home-Stake Royalty Corp. v. CorporationComm'n, 594 P.2d 1207 ( O ~ . 1 9 7 9 ~ , thecourtsaid that confidential geologic information need no t be provided by the poolmg applicant,

but that evidence of the fair market value of the non-consenting working interest owners maybe determined by looking at the teJIDs and prices given by other lessees or in recent leases inthe area. ld. at 120910. Bu t in Miller v. Corporation Comm'n, 635 P.2d 1006 (Okla. 1 ~ 8 1 ) , thecourt rejected an at tack on an order setting a bonus of $75/acre and a 118th override eventhough the state had, in a sealed bid auction, received a larger bonus and royalty on a nearbytract located in the same unit. Id. at 1007-09.

275POOLING AND UNITIZATIONfair and reasonable bonus to be determined by the governmental:gency.a. Soon after the adoption of the statewide c o m ~ ~ s o r y pooling law, the Corporation Commission issued an order glvmg nonconsentor those same options. The order was attacked as bemg anunconstitutional taking of property without just compensation and. asnot being authorized by the statute. In Anderson v. CorporatwnCommission,aa the Oklahoma Supreme Court upheld the validity ofthe compulsory pooling statute and the Commission order which essentially required the non-consentor to p a r t i c i ~ a t e . or a ~ n v o l u n t ~ : i l Ysell his working interests to the operator for a faIr p r t ~ e . In a d ~ l t ~ o nto the straight cash bonus alternative, the CorporatIOn CommISSIOnhas issued orders combining a cash bonus with an overriding royaltyinterest. I t also ordered the transfer of an overriding royalty in lieu ofa cash bonus.aa In determining the amount of cash bonus and /oroverriding royalty to be paid the non-consentor, the CorporationCommission examines available geologic information regarding thelikelihood of success, plus any analogous sales of working interest inthe area and the results of drilling in the immediate region"The addit ion of the overriding royalty to the buyout alternativesshifts some of the r isk of a dry hole to th e non-consentor. But sincethe non-consentor's interest is cost-free, he benefits from a marginally productive well which never pays out because he receives his royalty regardless of the well's profitability. Because the transfer of

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110 See, e.g., Holmes v. Corporation Comm'n, 466 P.2d 630, 633 (Okla. 1969).III See Texas Oil & Gas Corp. v. Rein, 534 P.2d 1280, 1282 (Okla. 1974); Ranola Oil Co. v.

Corporation Comm'n, 460 P.2d 415 , 417 (Okla . 1969) ; Wakefield v. State, 306 P.2d 305, 308(Okla. 1957).

IIlI Nesbitt, supra note 88, at 652-53. This might lead to a conclusion that the Commissionfavors owners who are not in the oil arid gas industry and who cannot bear the financial risk ofthe all or nothing shot at a producingwell. But the cases do not necessarily agree with thatconclusion, and i t h a s no t been stated to be a factor in the Commission's decision to allow anowner to be carried with a penalty.

98 Approximately 24 states which have a compulsory pooling or unitization statute or both donot deal with the problem of the unleased owner. See, e.g., COLO. REV. STAT. 2 4 ~ 6 0 - 1 1 6 ( 7 )(1984); ILL. ANN. STAT. ch. 96V" 5436(d) (Smith-Hurd 1979); OHIO REv. CODE ANR 1509.27(Page 1978); TEX. NAT. RES. CODE 102.052 (Vernon 1978).

k MONT. CODE ANN. 82-11-202(1) (1985) provides:When two or more separat ely owned t ract s are embraced within a spacing unit orwhen there are separately owned interests in all or a part of the spacing unit, then

working interests in the oil and gas industry usually involves someform of overriding royalty interest as the prime consideration, inclusion of that option by the Commission reflects the realities of theoperation of the free market system and should be encouraged.The Oklahoma Corporation Commission has allowed a fourth alternative under its jus t and reasonable order powers-the inclusion of arisk penalty. Although the risk penal ty opt ion has been upheld on anumber of occasions, it does not appear to be a prefer red option;

and the courts have unanimously upheld the Commission's decisionnot to include the option when it issues an order.' In the view of oneauthor/practitioner, the Commission feels that the other options better allocate the risk ofa dry hole and the rewards of a producing wellthan the penalty provisions.2

III. THE NON-CONSENTING UNLEASED MINERAL OWNERA. The Silent Treatment

While almost all of the state statutes provide some formal guidanceand standards for the state agency regarding the terms which may beimposed on the nonconsenting working interest owner that overseesthe compulsory pooling or unitization process, it is somewhat surprising that most state statutes make no mention whatsoever of what theagency is to do when unleased lands are contained within a pooled orunitized area.3 The fact that the statute is silent does not necessarilymean that unleased owners fall in the lacunae and present impediments to the compulsory pooling process. Montana's compulsorypooling statute provides a good illustration of how unleased ownerswould be treated even though they are neglected by specific statutorylanguage.' Under the Montana statutory scheme, al l "owners" must

be afforded an opportunity to recover their just and e q u i ~ a b l e sharef th il and gas.9 ' An owner is defined by statute to mclude allo eo. . 9' A I drsons possessing the right to dnll for 011 and gas. n un ease~ i n e r a l owner clearly has the right to dril l or the power to lease to

the persons owning those interests may popl their interests for. the ~ e v . e l o p m e n t ~ n operation of the spacing unit. In the absence of voluntary poolIng wIthm the spacmgunit, the board, upon the application of an interested person, may ent:r an orderpooling all interests in the spacing unit for the development and operatIOn t h ~ ~ e o f .The pooling ordershall be madeafter hearing and shall beupon terms and ~ o n d l t l o ~ Sthat are just and reasonable and that afford to the ?wne: of each tract or mterest Inthe spacing unit the opportunity to recover or receIve WIthout unnecessary e x p e n ~ e shis just and equitable share of the oil or gas produced and sav.ed from the .spacIn.gunit. Operations incident to the dri ll ing of a well upon any portIOn of a spacmg um tcovered by a pooling order shall be considered, for all purposes, the conduct of theoperations upon each separately owned tract in the spacing unit b;y the s e v ~ r a l ownerS thereof. That portion of the production allocated to each tract I?cluded In a s p a c ~. g unit covered by a pooling order shall when produced be consIdered for all pur:oses to have been produced from the t ract by a well drilled t h ~ r e o n .(2) (a) The pooling order shall provide for the drilling a n operatIng of.a well on thespacing unit and for the payment of the cost thereof, whIch cost may Include a reasonable charge for supervision, handling, and storage. As to each owner who r e f u ~ e sto pay his share of the costs of drilling and operating the well, the o ~ d e r shall proVldefor payment o f h is share of the cost out of and only. out of production fr?m the wellallocable to his interest in the spacing unit , excludmg royal ty or other mterest notobligated to pay any part of the cost thereof, and excluding the royalty provided forin subsect ion (2)(c) of this section. If a d ispu te ari ses as to the cost, the board byorder shall determine the proper cost. The order may p r o v i d ~ in substance that theowners who agree to share in the cost of drilling and o p e r a t I n ~ ~ well.are; unlessthey agree otherwise, entitled to receive, subject to royalty or SImIlar oblIgatIOns, allof the production of the well unti l they' have recovered al l of the c ~ s t s out of ~ h production, and thereafter all of the owners in the spacing. u ~ i t are entItled to receIvetheir respective shares ofthe production of the well as theIr mterest may appear afterdeducting their respective s;hares of current operating costs. .'

Professor Smith in his analysis of the then-nascent Mineral Interest Pooling Act I Texasalso discussed the problem of the unleased owner. Sniith, The Texas Compulsory Poolmg Act,44 TEX, L. REv. 387, 405-06 (1966). He suggested t ha t i t would be proper, al though notmandatory, for the Commission to force pool unleased o ~ e r s u ~ ~ e r term.s where they 7eregiven an option to participate as t o % th of the interest and In addItion receive a cost-free !hthroyalty. [d. at 406. A problem that Professor Smith foresaw was the ~ o v e m e n t away from t: :standard l/sth royalty. If nearby lessors hai::lleased for more than a Vsth royalty, should tunleased owner be forced to accept'a J/s th royalty? Professor Smith thought not m:-d c o n t r a ~ t e dthe Texas provision with other states in which the statute mandated the receIpt o f a . !h throyalty by an unleased owner. Id. at' 406. See N ~ M . STAT. ANN. 70-2-17(c) (1978). See miratext accompanying notes 137 to 141." MONT. CODE ANN. 82-11-202(1) (1985).99 The statute provides in part:"Owner" ineans the person who has the r ight to d ri ll i nto and produce from a pooland to appropriate the oil or gas he produces there from either.for himself or ~ t h e r sor for himself and others, and the ~ r includes all persons holdmg such authorItybyor through him.

MONT. CODE ANN. 82-11-101(8) (1985).

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278 JOURNAL OF ENERGY LAW AND POLICY [Vol. 7 1986] POOLING AND UNITIZATION 279another the right to drill .97 Therefore, the compulsory pooling ordercannot ignore the unleased owner and mus t resolve any problemscaused by his inclusion within the pooled or unitized area. In addition, the Montana provision dealing with the right to participate inthe well costs also uses the term "owner," which would include theunleased mineral owner. Therefore, the unleased owner would haveto at least be given the opportunity to participate in the well as aworking interest owner.'OOThe problem wi th ignoring the unleased owner is that, as an"owner," he is in many circumstances treated solely as a working in

~ e r e s t o,",:ner, alth?ugh he has in essence both a working and royaltymterest m the mmeral estate. 'O' An essential attribute of the unleased mineral estate is the right to receive royalty upon its leasing toand production by another.'o, Merely treat ing him as a working interest owner would give him the right to participate in the costs ofhe well but deny him his right to receive a cost free royal ty regardof whether the well ever makes a profit.

B. The %-Yil SolutionThe approach taken by the majority of state pooling and unitizastatutes which specifically t reat the unleased owner is simply to

the unleased owner's mineral interest into two distinct interts, a 'Is th cost-free royalty and a % ths working interest, and thenlug those interests i nto the prevailing statutory provisions. '0 3ithin this group there are two different approaches as to theof royalty due the unleased owner. In Arkansas, for example,

statute specifically limits an unleased owner to a 'Is th royalty afr there has been a pooling or unitization of his interest. ' ' The re-fl1 R. HEMINGWAY, THE LAW OF OIL AND GAS 33-34 (2d ed. 1983) .98 For other statutory schemes similar to that of Montana see ARIZ. REV. STAT. ANN. 27

through 505(A) (1976); IDAHO CODE 47-31SUJ through 322 (1977); TEx. NAT. REs. 102.012 & .052 (Vernon 1975)." MONT. CODE ANN. 82-11-202(2) (19S5).100Id.101 Slawson v. North Dakota Industrial Comm'n. , 339 N.W.2d 772 (N.D. 1983).102 HEMINGWAY, supra note 97, at 34-36.'" See, e.g., ARK. STAT. ANN. 53-115(A-l)(e) (1971); NEB. REv. STAT. 57-909(2) (1984);

STAT. ANN. 70-2-17(C) (197S); N.D. CENT. CODE 3S-0S-0S (Supp. 19S5); OKLA. STAT. ANN.52, S7.1(e) (19S4 & Supp. 19S5).104 ARK. STAT. ANN. 53-115(A-l)(e) (1971). The statute provides:

In .the event there is an unleased mineral interest or interests in any such ,drillingumt, the owner thereof shall be regarded as the owner of a royalty interestto theextent of a one-eighth (Va th) interes t in and to said unleased mineral interest andsuch royalty interest shall not be affected by the provisions of subparagraphs (c) and(d) ahove.

r[t

maining fraction, % ths, becomes the equivalent of a working interest,and the unleased owner is then treated as any other working interestowner whose leasehold interest is being pooled.' The statutory provision essentially creates a leasehold interest and arbitrarily allocatesa 'Ia th royalty to the unleased owner as if he had leased the land tohimself while retaining a '/a th royalty. That result may not have beenunfair at a time when the 'Ia th royalty was almost universally used;but, today there is really no standardized royal ty in the oil and gasfield, and if anything, the 'Ia th royalty is below the market standardin today's leasing activities.One response to the artificial setting of the royalty at '/ath is toallow the unleased owner's royalty interest to be directly tied t o t heprevailing royalty rates in the leases which have been signed in thepooled or unitized area. Again, that will best reflect the true value ofthe unleased owner's interest and most closely compensate him forthe value of his mineral interest, North Dakota has sought to achievethat result by enacting a compulsory. pooling statute which gives tothe unleased owner the "weighted average royal ty interest of theleased tracts within the spacing unit" but never less than a 'Is thinterest.,oBThe North Dakota provision was challenged by an operator of apooled unit who argued that the Commission was without authorityto establish a lessor-lessee relationship where none existed and thatconsequently, the unleased owner's full interest was essentially thatof a working interes t owner who could jo in in and pay the proportionate share of drilling costs or be carried subject to a l ien againsthis pro rata share of production.'7 In a state such as North Dakotawhere the working interest owner gets a free ride without a risk pen

alty, the benefits to an unleased owner are substantial.,oB Not onlydoes he receive a cost-free royalty ou t of the first barrel of produc-105 Once the Vath interest is classified as a working interest, the various state approaches take

over and the unleased owner will be treated as if he had leased the land to himself. See suprasection II. .

108 The North Dakota provision provides in part:For the purposes of this section and section 38-08-10, any unleased mineral interestpooled by virtue of this section shall be entitled to a cost-free royalty interest equalto the acreage weighted-average royalty interest of the leased tracts within the spacing unit, but in no event shall the royalty- interes t of an unleased tract be l es s than aone-eighth interest. The remainder of the unlesed interest shall be treated as a lesseeor cost bearing interest.

N.D. CENT. CODE 3S-0S-0S(I) (Supp. 19S5).107 Slawson, 339 N.W.2d at 775-76.108 See supra text accompanying notes 2 2 ~ 3 l for a complete discussion of the free ride alter

native for non-consenting working interest owners.


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280 JOURNAL OF ENERGY LAW AND POLICY [Vol. 7 1986] POOLING AND UNITIZATION 281tion, bu t he also gets his free ride so that, if the well ever becomesprofitable, he suddenly becomes a silent partner to the risk-takingoperator, sharing proportionately in th e good fortunes of an abundantly producing well. I t is therefore no t surprising that an operatorwould challenge th e statutory scheme as giving the unleased ownermore t ha n t he market would bear.

In Slawson v. North Dakota Industrial Commission,"o th e courtwas able to rebut th e operator's charge that t h e s t at ut e created alease where none was consented to, by concluding that an unleasedmineral interest has within it several constituent parts, including theroyalty and working interests.n Since the statutory command is toprovide a "just and reasonable" order, th e legislative determinationthat th e unleased owner is entitled to full compensation for his constituent rights is reasonable!n Th e court ignored th e fact that anunleased owner's right to royalty is normally accompanied by a transfer of th e working interest to a lessee. Th e unleased owner changes arisk-bearing interest to a risk an d cost-free interest. On th e otherhand, if an unleased owner drills his own well, he does no t receiveany risk and cost-free royalty bu t merely receives the profits, if any,from his business venture. ll2 North Dakota and other states whichtreat the unleased owner in this way provide, in effect, a windfall forth e mineral owner where th e non-consenting working interest owneris given a free ride on th e back of the operator!13

Th e inclusion of unleased mineral owners in compulsory poolingorders has been accepted in Oklahoma since th e early case of Ander-'"' Slawson. 339 N.W.2d 772 (N.D. 1983).llO Id. at 775-76.111 Id. at 777. The court also disagreed with the operator's contention that the statutoryprovision providing for a lien against the oil and gas produced applied both to the royalty and

working interests of the unleased owner. The court noted that the pooling and spacing unitprovisions essentially gave the operator the monopoly on drilling a well. The unleased ownerwould therefore be deprived of leasing his land since no further wells could be drilled on theproperty. Thus, i t would not be improper to provide both a cost-free royalty and a free rideworking interest, subject to the statutory lien, to the unleased n o n ~ c o n s e n t i n g owner. Id. at 77879.

m Of course i t might be possible for the unleased owner to lease the minerals to himselfproviding for a royalty interest in excess of the royalties secured in the other leases pooled inthe area. The statute may in effect encourage such transactions, although they may be viewedas a totally sham transaction. It is not unheard of f or a n unleased mineral owner, especially acotenant, to lease the minerals to himself. See, e.g., Manges v. Guerra, 673 S.W.2d 180 (Tex.1984).

113 Another detrimental side effect of this practice is to discourage mineral owners from leasing their interests. This will undoubtedly further hamper development of the oil and gasresource.

I

son v. Corporation Commission.''' In Anderson, unlike Slawson, th eoperator was happy with th e order giving th e unleased owner his proportionate share of a Vs th royalty an d subjecting hi8 'Va th workinginterest to th e opt ion of paying a proport ionate share of th e wellcosts or accepting a cash bonus in exchange for th e transrer o f t heworking interest.ll 5 Th e court ha d no difficulty accepting th e validityof th e order, both as to th e inclusion of th e I/Sth royalty" 6 and theoptions afforded th e unleased owner regarding th e 'Va th working interest that t h e s t at ut e carved out of the unleased mineral estate!l7Another way of achieving th e 'Va -Va solution is through th e definition section o f t he pooling an d unitization statute. That i8 th e approach taken by West Virginia, which defines an operator in termsthat would include an unleased mineral owner, bu t only t o t he extentof a 'Va ths interest.116 Th e unleased mineral owner is also considereda royal ty owner as to a Vs th interest. That is important because th estatute prevents th e drilling on th e tract of an unleased royaltyowner without his prior wri tten consent!' Th e unleased owner isgiven one of th e two option8 afforded working interest owners as tothe .Vs th s working interest he has pur8uant to the 8tatute.12 '

C. The!-1J th SolutionWhile th e unlea8ed owner may be getting a windfall in th e statesproviding him with both a cost free working an d royalty interestshare in th e pooled production, th e California approach seeminglypenalizes th e unleased owner by reducing his unleased mineral estateto a mere royalty interest.12 ' While th e statute has only limited appli-114 Anderson v. Corporation Comm'n., 327 P.2d 699 (Okla. 1958).IH; [d. at 700-01. The unleased owner also cannot complain about the location of the well on

his landnor the use of his land for access to and from a well located elsewhere on the pooled orspacing unit. See, e.g ., McDaniel v. Moyer, 662 P.2d 309 (Okla; I9B3); Cormack v. Wil-McCorp., 661 P.2d 525 (Okla. 1983); Texas Oil and Gas Corp. v. Rein, 534 P.2d 1277 (Okla. 1974).116 Anderson, 327 P.2d at 70l.117 [d. at 7 0 2 ~ 0 3 . The Oklahoma statute provides in part:For the purpose of this section, the owner or owners of oil and gas rights in and under

an unleased tract of land shall be regarded as a lessee to the extent of a seven-eighths(VB) interest in and to sa id rights and a les sor to the extent of the remaining oneeighth (lis) interest therein.

'" W. VA. ConE 22-8-2(5) (1985).lIB W. VA. CODE 22-4A-7(b}(1) (l985) deals with written consent. For a contrary view, see

LA. REV. STAT. ANN. 30.9(c} (West Supp. 1985); Nunez v. Wainoco Oil & Gas, 488 So.2d 955(La. 1986); McDaniel v. Moyer,.662 P.2d 309 (Okla. 1983).'" W. VA. ConE 22-8-7(b)(5) (1985).121 CAL. PUB. REs. CODE 3608 (West 1984) provides in part:Where land aggregating less than one acre is surrounded by other lands, which other

lands are subject to an oil and gas lease aggregating one acre or more, and if, under


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cation to unleased tracts of less than one acre,'" it provides the unleased owner solely with royalty benefits. Thus, the cash bonus paidto other mineral owners in the area will not be paid to the small tractmineral owner. This will encourage lessees to leave small tracts unleased since no delay rentals or bonuses will have to be paid. Further,these interests cannot share in the working interest by paying overtheir proportionate share of well costs because, upon the spacing unitdeclaration, their lands are de jure treated as leased t o t he lessee ofthe surrounding acreage. An unleased owner, in attacking the validityof such a spacing order with its compulsory leasing ramifications, wasrebuffed in Hunter v. Justice's Court'23 on the grounds that the provision of a royalty interest adequately protected the unleased ownerfrom a taking ofhis property. The court noted that while other statesmay also allow the unleased owner to participate in the working interest as well, that issue was a matter of legislative judgment, notconstitutional imperative.'"At one time Utah also had apparently opted for the 'Is th solutionin its pooling statute. '" Although the Act specified that the non-con-the provisions of Section 3600 to 3607. inclusive, of t'he Public Resources Code, thedrilling or producing of a wel l on said land is declared to be a public nuisance, saidland shall, for oil and gas development purposes and to prevent waste and to protectthe oil and gas rights of landowners, be deemed included in said oil and gas lease onsaid other lands, and shall be subject to all the terms and provisions thereof.

122 Id.123 Hunter v. Justice's Court, 36 Cal. 2d, 315, 223 P.2d 465 (1950).124 [d. at 468-69. The California statute does not expressly deal with unleased mineral owners

of tracts larger than 1 acre, except that it does provide that the state can force pool largerparcels under a plan or agreement subject to suchrules and regulations as the state may adopt.CAL. PUB. REs. CODE 3609 (West 1984).

" . UTAH COOE ANN. 40-6-6(g) (1966), amemied by UTAH CODE ANN. 40-6-6 (Supp. 19S5).The statute provides:[11 Each pooling order shall make provision for the drilling and operation of a well

onthe drilling unit, and for the payment of the reasonable actual cost thereof, i n c l u d ~ing a reasonable charge for supervision and storage facilities. [2] As to each ownerwho refuses to agree upon the terms for drilling and operating the well, the ordershall provide for reimbursement for his share of t he cos ts out of, and only out of,production from the unit representing his interest, excluding royalty or other interestnot obligated to pay the cost thereof. [3J In theevent of any dispute as to such costs,the commission shall determine the proper costs. [4J The order shall determine the \interest of each owner in the unit, and may provide in substance that as to eachowner who agrees with the person or persons drilling and operating the well for thepayment by the owner of his share of the costs, such owner, unless he has agreedotherwise, shall be entitled to receive, subject to royalty or similar obligations, th,eshare of the production of the well applicable to the tract of the consenting owner,and as to each owner who does not agree, he shall be ent it led to receive from theperson or persons drilling and operating the wellon the unithis share of the production applicable to his interest, after the person 01' persons drilling and operating thesaid well have recovered the share of the cost of drilling and operating applicable to

such nonconsenting owner's interest plus a reasonable charge for supervision andstorage. [5] Each consenting and nonconsenting owner shall be entitled to receive,subject to his paying or makingarrangements with the owner or owners operating thewell for the payment of all applicable royalties, over-riding royalties or other burdenson production and his respective share of current operating or other costs incidentalto the efficient operation of the well, his share, respectively, of production allocated tothe tract or tracts in which he holds an interest; provided, however, that a nonconsenting owner of a tract in a drilling unit, which is not subject to any lease or othercontract for the development thereof for oil and gas shall be deemed to have a basiclandowner's royalty of one-eighth (lh) or twelve and one-half percent (12-1/2 %) of theproduction allocated to such tract.

12.8 Bennion v. Utah State Board of Oil, Gas & Mining, 675 P.2d 1135 (Utah 1983).l2.7 Id. at 1137. At this point, under the rule of capture, Bennion is without recourse. Sincehe

has not signed the pooling agreement, he would not be entitled to any share of.production froma well not located on the 80 acres in which he owned the fractional share. Havmg been created,the spacing unit only provides for a limitation on drilling, not a pooling of interests. For thedifference between spacing and pooled units, see 5 E. KUNTZ, OIL AND GAS 77.3 (1978).

l2.8 Bennion, 675 P.2d at 1138. In the meantime the well had achieved payout, meaning thatthe value of the hydrocarbons recovered, had exceeded the cost of drilling and operating thewell. In other words it was producing a profit for the working interest owners. Id.

283OOLING AND UNITIZATIONsenting mineral owner was entitled to a basic royalty of '/8 t h, theBoard of Oil, Gas and Mining and the Utah Supreme Court modifiedthe provision in resolving a dispute between an unleased owner andan operator in Bennion v_ Utah State Board of Oil, Gas & Mining."This case involved a classic problem with spacing units, pooling orders, the rule of cap tu re and the rights of non-consenting owners.Bennion owned a small fractional unleased mineral interest in anarea which, by a Board order, had been pooled into 640-acre spacingunits. In June 1973, Shell proposed a voluntary pooling order for thesection in question, and all owners except Bennion agreed. Shell comple ted a well on the section bu t off of the acreage owned by Bennion.''' The statute then in force provided that nonconsenting ownerswere ent it led to a V8 th royalty, bu t Shell took the position that, inthe absence of a pooling agreement or order, they owed nothing toBennion. Bennion then filed a petit ion with the Board to force poolthe interest in question, bu t the order was not entered until 1979."Notwithstanding the statute's sole reference to a royalty interest fornonconsenting unleased owners, the Board trifurcated its order regarding payment by Shell to Bennion. For the period prior to payoutand beginning with first production, an unleased owner is entitled toa cost-free royalty. From the t ime of payout t o t he effective date ofpooling, the non-consenting unleased owner is entitled to his share ofthe revenue set off by his share of expenses, including those expensesincurred prior to payout, Le., drilling costs. After the pooling order isentered, the unleased owner is entit led to receive his proportionate

1986]

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[d.134 Id.

129 Id. at 1138.39.130 See supra text accompanying notes 107 and 112.131 Bennion, 675 P.2d at 1142.13:1 See supra text accompanying notes 93.119.133 Bennion, 675 P.2d at 1142. The court states:C. The Cost"Free Royalty!h e Board's calculation of Bennion's oneeighth royalty interest for the periodprior to payout made no deduction for expenses. However, in the Board's view once

payout occurred the royalty interest "merged" with the working interest. Thereafter~ e n n i o n 's share was c a l c u l a t e ~ onthe basis of his fractional share of the w o r k i n ~mterest (2.94898 percent), subject to his payment of his fractional share of the drilling and operating expenses from the beginning of development and drilling. Bennioncharges that this calculation deprived him of his statutory "basic landowners' royalty," ,:",hich he contends should be cost-free as to all costs incurred duringthe periodfor whICh the royalty was paid (i.e., prior to payout).Here also, the Board made a reasonable-indeed, the only permissible-con?truction of its governing s t a t u t ~ . The fourth sentence of subse'ction (g)

( q u o ~ e d In note 2, supra), which prescribes the nonconsenting owner's share of production after payout, makes the owner's rights subject to the operator's first recovering the "share of the cos t o f d ri ll ing and operating applicable to such nonconsenting?wner's int?rest." (Emphasis added.) Since the cost of drilling is, by definition, a costIncurred prIOr to payout, Bennion's argument that he is entitled to a cost-free royaltyprior to payout is meritless.

285OOLING AND UNITIZATIONAs amended, the Utah compulsory pooling provision codifies theBennion decision.'3. It more clearly states that the royalty provisionis only payable until payout, plus risk penalty, but it does not s tate

that the unleased owner's interest thereafter turns into a working interest. The new provision also liberalizes the royalty amount by tyingthe royalty to the average of the royalty received in the leases on thespacing unit rather than pegging the royalty at ",. th of production.The Utah approach tends to penalize the unleased owner, by eliminating his right to both a royalty and working interest after payout.Given the fact that Utah has a risk penalty provision to compensatethe operator for the risk of a dry hole, it seems somewhat disingenuous to suggest that the royalty interest suddenly merges into the

working interest only after payout including risk penalty. The royaltyinterest shoul

compulsory pooling and unitizations_state options in dealing with unco-opearive owners

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