Every division order analyst working Texas properties needs to be aware of a recent Texas court case that has changed the operator’s statutory obligations toward non-JOA, non-participating leasehold owners in a producing well. This new ruling affects pooled unit ownerships.
The gist of the new ruling is that the production from a well before payout does not continue a non-JOA, non-participating (“carried”) lease after the expiration of its primary term, even if that non-JOA, non-ratified, non-participating leasehold owner paid the lease royalties out of pocket during payout. Such a lease can be held only by ongoing production from the lease outside the pooled unit, otherwise the lease expires at the end of its primary term (or when production from that other well ceases).
To begin, this new ruling places quite a burden on the division order analyst and landman, not to mention the mineral rights owner. This new Texas ruling drives home the fact that a Declaration of Pooled Unit (DPU) is the legal document that carries a lease from its primary term into its secondary term, if the lease was still in its primary term when the well was spud, and the lease acreage is outside the drill site in the pooled unit.
In essence, Cimarex v. Anadarko confirms that a lease can be carried into its secondary term only by production as it is defined in the habendum clause of the lease. The following case study should illustrate this point.
Case study: Acme Resources Co. files a DPU into public records that includes in Exhibit A the leases they own, the leases owned by their JOA partner Barter Production Company, but also the leases of public record owner Zappit Energy, not a JOA partner. Zappit did not sign the JOA, did not sign a ratification of the pooled unit, and did not pay its share of drilling or completion costs. Zappit is a leasehold owner of three leases, all falling outside the drillsite in the unit well, and covering a total of 5% of the entire unit area mineral rights interest.
Under Texas statutes, Zappit’s 5% gross interest in the well will be carried to 100% payout of drilling and completion costs. The JOA allows Acme to carry all of Zappit’s 5% gross working interest; Barter will not carry a proportionate share.
Zappit’s leases were all in their primary term when the well was spud and all of those primary terms ended between three and six months after the date of first production from the unit. This well is the first, and only, well in the unit when the well paid out twelve months after first production.
According to Cimarex v. Anadarko, all of Zappit’s leases are expired on the date of 100% payout. The mineral interest covered by them are now unleased minerals as of the date of 100% payout. Acme would be obligated to sell the production attributable to the now-unleased minerals and distribute 100% of the proceeds directly to the unleased mineral owners, deducting only production taxes, IF those mineral interests were inside the drill site of the horizontal well. The tract covered by the three partial-interest Zappit expired leases is outside the drill site, therefore, those mineral owners are not entitled to receive any revenues from the sale of production from that well, for the life of that well. If density wells are drilled later, the unleased tract might fall inside the drill site of one of those subsequent wells, at which time they would be entitled to begin receiving revenues from that well after 100% payout, but not otherwise.
Zappit lost their leases because they failed to sign any legal document allowing their leases to be included as part of the pooled unit. Just because a lease contain a pooling clause giving the lessor’s permission to pool the lease, that clause must be invoked—triggered—by effective inclusion in a pooled unit. Otherwise, part of the wellbore lateral would need to be on, or within 100 feet, of the land covered by the lease. Remember, pooling converts the mineral interests inside the pooled area into the equivalent of one big lease, all to share and share alike in the revenues. The exception to that are the leases that have no contract effectively connecting them to the pooled unit—the pooling clause is not triggered by a unilaterally signed DPU alone.
Some companies have chosen to interpret Cimarex v. Anadarko to mean that since Zappit didn’t sign the JOA allowing Acme to sign the DPU on their behalf, nor did they sign a Ratification of Pooled Unit allowing Acme to control their leases for the purposes of production from the pooled unit, Zappit did not give permission for their leasehold to be pooled.
In this case study, Zappit did pay their unit-reduced share of royalties and overriding royalties to the owners entitled to them, out of pocket. Zappit used Texas Railroad Commission production volumes reported by Acme each month, and the field posted price available in public TRC records. But, according to Cimarex v. Anadarko, the leases still expired under their own terms for lack of actual production from the leases. The royalty payments were token payments, not paid out of actual production, and not calculated on a contractually permitted reduction.
In closing, all analysts should always remember that every oil company has the right to decide what level of financial risk they will take in any given transaction, so it is up to each individual oil company distributing revenues from pooled units in Texas as to how, or if, they will apply Cimarex v. Anadarko in the work that their division order analysts do.
Next week’s blog will be “Stacked Pooled Units: Division of Interest Issues.”
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