Debate over Allocation Wells Continues

Written by John McFarland of the Oil and Gas Lawyer Blog.

Three recent articles have intensified the debate over whether allocation wells are authorized by a typical oil and gas lease. Two of the articles appear in the most recent edition of the Section Report of the Oil, Gas & Energy Resources Law Section of the State Bar. The first, written by Ernest E. Smith, makes clear in its title the position of the author: Applying Familiar Concepts to New Technology: Under the Traditional Oil and Gas Lease, a Lessee Does not Need Pooling Authority to Drill a Horizontal Well that Crosses Lease Lines. View here: Applying Familiar Concepts  A later version of his article will be published in the Texas Journal of Oil, Gas and Energy Law at the University of Texas School of Law. The second article is by Ronald D. Nickum, an oil and gas attorney in Amarillo, titled Non Consent Allocation – Will it Survive Judicial Scrutiny. View here:  Non Consent Allocation Mr. Nickum’s article is more skeptical about the legality of allocation wells.

Professor Smith’s article is written in rebuttal to an article to be published in the Baylor Law Review written by Professor Bret Wells, Allocation Wells, Unauthorized Pooling, and the Lessor’s Remedies, which can be viewed here. Professor Wells argues that allocation wells are a form of pooling not authorized by a typical oil and gas lease and give rise to claims for trespass and punitive damages.

The Texas Railroad Commission ruled in the Klotzman case that it had the authority to issue permits to drill horizontal wells that cross multiple lease lines without pooling those leases together. Although the Commission has never adopted a rule defining or authorizing permits for such wells, an “allocation well” has generally come to be understood as a well that crosses one or more lease lines and that produces from more than one lease without pooling those leases and without any agreement with the royalty owners as to how production will be allocated among the leases crossed by the well. Because of the uncertainty as to the legality of allocation wells, exploration companies sought legislation in the last legislative session expressly authorizing such wells. That bill, HB 1552, died in committee. It is expected that similar legislation will be filed in the upcoming session.

The oil and gas bar is divided on whether a typical oil and gas lease allows the drilling of an allocation well. I am of the opinion that it does not. In my view, Professors Smith and Wells are asking the wrong question. They frame the debate as whether drilling an allocation well constitutes unauthorized pooling. I agree with Ron Nickum that the issue is one of contract construction. Professor Smith concedes that, if an allocation well is drilled without agreement as to how royalties will be paid, royalties will have to be based on some method of allocation of production among the tracts crossed by the well. But (except for production from a pooled unit) an oil and gas lease does not provide for calculation and payment of royalties based on an allocation of production; it requires royalties to be paid on the oil and gas “produced and saved from the leased premises.” A lessee who has drilled an allocation well cannot comply with that provision. Therefore, the drilling of an allocation well will necessarily result in a breach of the oil and gas lease.

Horizontal wells drilled across lease lines were clearly not contemplated in a typical oil and gas lease, and lessors should not be forced to accept a formula for royalty payment to which they have not agreed. Whether or not one calls it pooling, allocation of production from a well drilled across multiple tracts is a method of sharing production among the owners of those tracts. In Texas, that cannot be done without the lessors’ agreement.