Pooling and UnitizationPresented by:

Ryan J. MorganMLBC AAPL

June 16, 2011Bridgeport Conference Center

Bridgeport, WV

These materials are public information and have been prepared solely for educational purposes to contribute to the understanding of energy and oil and gas law. These materials reflect only the personal views of the author and are not individualized legal advice. It is understood that each case is fact-specific, and that the appropriate solution in any case will vary. Therefore, these materials may or may not be relevant to any particular situation.  Thus, the author and Steptoe & Johnson PLLC cannot be bound either philosophically or as representatives of their various present and future clients to the comments expressed in these materials. The presentation of these materials does not establish any form of attorney-client relationship with the author or Steptoe & Johnson PLLC. While every attempt was made to insure that these materials are accurate, errors or omissions may be contained therein, for which any liability is disclaimed.

Material Disclaimer

What motivates this presentation topic?

#1 Understand background of pooling concepts

#2 Understand uses of pooling clause in lease and importance of language and terms

What We Are Going to Cover

5

• Review of pooling

• Current pooling laws in OH, PA , and WV

• Discussion of issues with use of pooling/ unitization in the development of horizontal wells

• Review of lease provisions

An Overview – Origins and Evolution of Pooling

The key to understanding oil & gas law….

Origins of Pooling

In the beginning…

The Rule of Capture

ferae naturae

Origins of Pooling

The Rule of Capture

THE DECISION:

YOU PRODUCE IT…

YOU OWN IT !

Origins of Pooling

The Rule of Capture

THE RESPONSE:

DRILL YOUR OWN

DARN WELL !

Origins of Pooling

The Rule of Capture

THE RESULT:

Origins of Pooling

The Rule of Capture

THE AFTERMATH:

GOVERNMENT ACTION

& THE EXERCISE OF

“POLICE POWERS”

Origins of Pooling Emergence of the concepts (pooling and unitization)

Surely there is a better way to do things…

Origins of Pooling

Distinguishing contractual/voluntary integration from statutory unitization or pooling

History & Development of Pooling

Review of development in the states

Current Pooling Laws

Ohio

Statutory Pooling in Ohio

General statewide spacing and unit size is authorized in 1509.24 to be set by rule

Current general rule is:0-1000 feet in depth200 feet from any well in the same pool100 feet from a tract or unit boundary

1000-2000 feet 10 acre tract

2000-4000 feet 20 acre tract

4000 feet or deeper 40 acre tract

• No distinction between shallow and deep wells as in WV or PA

• Section 1509.27 authorizes mandatory pooling orders

• Section 1509.28 permits unitized operations• Section 1509.29 permits exception tracts

subject to production allowable where statewide or special rules would otherwise preclude development

Statutory Pooling in Ohio

Application submitted to the Director with information required by statute or rule including:a)description of the unit boundariesb)identification of drill sitec)ownership of tractsd)explanation of need for mandatory poolinge)evidence of attempts to form voluntary unitf)estimated costsg)limit of 5 pooling applications per person per yearh)no surface operations are permitted on tracts which are force pooled

Mandatory Pooling Applications

• The Technical Advisory Council on Oil and Gas was created under Section 1509.38 of the Ohio Revised Code. The T.A.C. consists of eight members appointed by the Governor and meets once a calendar quarter.

• The applicant must submit all the information required to the Division at least forty days prior to a scheduled T.A.C. meeting to ensure scheduling of their request on the T.A.C. agenda.

• The Division provides T.A.C. members with the documentation provided by the applicant at least two weeks prior to the hearing.

Review by Technical Advisory Council

Pennsylvania

Pooling in Pennsylvania

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58 P.S. § 403 – applies to all wells except those that are less than 3,800 ft. or do not penetrate the Onondaga (Marcellus wells do not qualify as Conservation well)

58 P.S. § 405(c)(1)(iv) – gives Oil & Gas Conservation Commission specific authority, upon proper application, to enter spacing and pooling orders and provide for the integration or communitization of interests within a drilling unit

58 P.S. § 408 provides that two or more separately owned tracts can be voluntarily integrated to create a pool

Recent Attempts at Legislation

SB 447 (Yaw, White, Mensch, Fontana 2/11/2010)

– Places statutory integration in the PUC– 65% ownership threshold to invoke the act– Horizontal wells and unconventional formations– A “shade” of the industry consensus bill of 2010

West Virginia

Spacing in West Virginia

Spacing Rules in WV• Shallow Wells• < 3000 ft.- Min. distance of 1000 ft. from nearest existing well• >3000 ft. -Min. distance of 1500 ft. from nearest existing

well• (If coal owner objects, gas operator has burden to

establish need if nearest existing well is between 1500-2000 feet)

• Deep Wells• Completed below Onondaga formation• Oil & Gas Conservation Commission determines

spacing

Pooling in West Virginia

Statutory Pooling 1.Shallow Wells2.Deep Wells & Secondary Recovery 3.Coalbed Methane Wells

Pooling in West Virginia

Deep Wells – Pooling Process1.Operator must drill “discovery well” to establish pool2.Application then filed by operator of well or other operator affected by a well in the pool3.Notice, including area to be covered by spacing order4.O&G Conservation Commission enters order setting spacing and acreage for each drilling unit5.Must have lease/agreement on tract where drilling operations will be located6.Operator must have written consent and easement from surface owner of record identifying the well location

Development Issues

Pooling vs. Unitization

Often used interchangeably, these words have traditionally had unique meanings

Example of a Modern Unit

» Chesapeake Durig Unit» 603 Acres» 20 Tracts» Largest tract 109 ac.» Smallest tract 0.08 ac.

How is pooling accomplished?

Voluntary

• Pooling clause in lease or subsequent agreement needed to bind lessor’s interest

• Amends lease habendum (term) clause – unit operations maintain lease beyond primary term

• Amends royalty clause – pay fractional part

Issue - Apportionment

Apportionment Rule – all owners of subdivided tracts under one lease entitled to royalty– Followed in PA, CA, MS– Example: A, B, C each get 1/3

A B C

Unit Well

Subdivided Tracts (one lease)

Issue - Apportionment

Non-Apportionment Rule – owner of subdivided tract where well is located is entitled to all royalties– Followed in AR, CO, IL, IN, KS, KY, LA, NE,

NM, OH, OK, TX, WV– Example: A gets all royalties

A B C

Unit Well

Subdivided Tracts (one lease)

Issue - Apportionment

Non-Apportionment Rule can be avoided by Entireties Clause

– Example: “If the leased premises shall hereafter be owned severally or in separate tracts, the premises nevertheless shall be developed and operated as one lease and all royalties accruing hereunder shall be treated as an entirety and shall be divided among and paid to such separate owners in the proportion that the acreage owned by each such separate owner bears to the entire leased acreage.”

How is pooling accomplished?

Involuntary = Statutory Integration(“Force Pooling”)

• Exercise of police power by state

• Ordered to prevent waste, increase ultimate recovery, avoid drilling of unnecessary wells, protect correlative rights

• Widespread in producing states

Issue – Use of PremisesCan regulatory commission permit unit well to be located on

unleased premises over objection of owner?

Some courts permit owner to maintain action for surface damages against unit operator (see Cormack v. WIL-MC Corp., 661 P.2d 525 (Okla. 1983))

A BLeased Tract

Well

Unleased Tract –

Can drill well on B?

Lease Provisions

Sample Lease Term

Unitization/Pooling Clause

Lessor hereby grants to the Lessee the right at any time to consolidate the leased premises or any part thereof or strata therein with other lands to form an oil and gas development unit of not more than 640 acres, or such larger unit as may be required by state law or regulation for the purpose of drilling a well thereon, but the Lessee shall in no event be required to drill more than one well on such unit. Any well drilled on said development unit whether or not located on the leased premises, shall nevertheless be deemed to be located upon the leased premises within the meaning and for the provisions and covenants of this lease to the same effect as if all the lands comprising said unit were described in and subject to this lease.

Key Provisions

• Lease Must Allow Pooling– Grant Lessee Authority to Form Pool/Unit (i.e., you do not have to come

back to the lessor)– Avoid restrictions (e.g., well must be on/off lessor’s land, lease must

contribute minimum % to the unit, etc.)

• Spell out calculation/division of Royalties

– Should be consistent from lease to lease

– Should be clear and based on engineering/geology

• Pooling of any acreage construed as “Operations” on the leasehold– Hold acreage without need to drill on each leasehold

Issue - Allocation & PaymentRoyalties may be based on surface acreage

Royalties may be based on formula (e.g. acre feet, net reservoir pay, material balance, determination of remaining reserves, present production, cumulative production, surface acres underlined by productive reservoir, number of usable wells bores)

Method should be clearly expressed in leases and administrative orders

Issue – Development ObligationsSet out the basis for unit size and shape

Replace implied covenants with express obligations

THANK YOU !