Although I have written about the concept of Allocation Wells previously, I realized that it is a semi-complex topic, one with many arguments to be made on both sides, and therefore one which requires a more detailed explanation. This thought might serve as a starting point: when a horizontal well is permitted as an Allocation Well, its operator may drill and complete the well across several tracts of land without clear pooling authority or consent of the Lessors.

Such was not always the case, as this phenomena developed over many years, so a discussion of the background is helpful.

First, let’s begin with a quick primer on what exactly is the effect that pooling has with respect to vertical wells. With a vertical well, where you only have one drillsite tract, but one or more non-drillsite tracts in the unit (in order to drill a well in compliance with the Texas Railroad Commission's density and spacing requirements), the owners of the tracts will necessarily have their revenue proportionally reduced. An example: an 80 acre proration unit is comprised of two 40 acre tracts, Blackacre and Whiteacre, both having leases providing for a 25 percent royalty, but not allowing pooling without consent. The well is to be drilled on Blackacre—known as the drillsite tract. If the owner of Blackacre consents to pooling, he will receive 25 percent of ½ of the oil revenue, and the owner of Whiteacre would receive the other ½ of 25 percent of the oil revenues. If Blackacre does not consent to pooling, he would be entitled to 25 percent of 100 percent of the oil revenue. Brown v. Getty Reserve Oil, Inc., 626 S.W.2d 810, 815 (Tex. App.—Amarillo 1981, writ dism'd). If the owner of Whiteacre—the non-drillsite tract—does not consent, he would not share in any of the revenue. The downside of the owner of Blackacre NOT consenting to pooling is that the well may not be drilled at all.

With respect to horizontal wells, the courts have recognized that this concept should not apply. Texas law and courts have horizontal wells as "[a]ny well that is developed with one or more horizontal drainholes having a horizontal drainhole displacement of at least 100 feet." 16 TEX. ADMIN. CODE § 3.86(a)(4) (2013). Like vertical wells, horizontal wells are initially drilled vertically down to a formation suspected of being productive. Browning Oil Co., Inc. v. Luecke, 38 S.W.3d 625 (Tex. App.—Austin 2000, pet. denied) at 634. At a point, the drill stem continues horizontally. Id. Horizontal wellbores can extend across several leased tracts each having different owners and contain multiple production points along the drainhole rather than only one drillsite. Id. at 632.

Texas courts ultimately agreed that “Each tract traversed by the horizontal wellbore is a drillsite tract, and each production point on the wellbore is a drillsite.” Id. at 634. Today, any tract penetrated by a horizontal wellbore is considered a drillsite tract. Luecke, 38 S.W.3d at 634. A horizontal wellbore will usually traverse through several tracts, and thus will have multiple drillsites. A problem may arise when certain owners refuse to consent to the pooling of their interest, and demand their full share of production from the horizontal well. One Texas appellate court, Browning Oil Co., Inc. v. Luecke, rejected the applying of the rule used for vertical wells, holding that the court found it was more appropriate to calculate the royalty share of production attributable to the interest holder's tract with reasonable probability. Id. at 647.

The facts of the case are as follows: In 1979, the Lueckes executed three oil and gas leases covering about 420 acres. Browning Oil Company eventually acquired these leases. The leases allowed pooling, but were limited to 80 acre proration units, and contained anti-dilution language that required that each pooled unit contain at least 60 percent of the Lueckes' acreage. In 1994, Browning asked the Lueckes to amend the pooling language to allow for larger pooled units because Browning wanted to drill horizontal wells. The Lueckes refused. Without pooling authority, Browning drilled two horizontal wells crossing Luecke’s tracts and several other tracts.

The Lueckes’ sued, claiming violation of the leases pooling authority. At the trial, the Lueckes claimed royalty on 100 percent of the production from the wells even though only about 25 percent of the horizontal wellbore was located on acreage in which Luecke owned an interest. The jury held for the Lueckes.

On appeal, court agreed that the pooling provision had been violated, but reversed the damages. The Court of Appeals noted that the jury charge and Luecke’s royalty calculations failed to take into account that substantial portions of producing wellbore were located on lands with which Luecke had not been pooled, and the Lueckes would be paid for production from tracts they did not own. The Court ruled that Luecke’s royalty was limited to the production that can be attributed to their tracts with reasonable certainty. Therefore, the Lueckes were entitled to royalty on 25 percent of the total production from the well. And so began the Railroad commission’s issuance of “PSA Well” permits.

Using the logic in the Luecke case, Devon Energy asked the Railroad Commission to issue permits if a majority of the Mineral and Working interest owners had entered into Production Sharing Agreements. These Agreements allocate production of the horizontal well based upon the length of the lateral under the tract. Since late 2007, the Railroad Commission has issued such permits based upon the operator’s representation that at least 65 percent of the interest owners of each tract agreed.

Pushing the matter further, in 2010, Devon submitted an application for a permit to drill a horizontal well in which they did NOT have either pooling authority or a PSA, calling it an Allocation Well. Colin K. Lineberry (a representative of the Railroad Commission) issued a letter to Devon Energy approving Devon Energy’s application for an Allocation Well. Since that time, the Railroad Commission has issued many Allocation Well permits, and has not required the previous minimum amount of interest owners’ execution of Production Sharing Agreements. The Commission agreed that Devon’s representation that it held leases covering 100 percent of the minerals met the minimum good faith claim to title threshold showing merit to process the application. The Commission also noted that the permit did not endorse the proposed allocation, leaving that issue to the Courts. Since that time, many Allocation Well permits have been issued by the Commission.

In 2012, Allocation Well permits were challenged when EOG Resources, Inc., applied for a permit to drill an Allocation Well that crossed leases in which it did not have the contractual right to pool. The mineral owners, the Klotzmans, had previously refused to permit pooling for horizontal development. The Klotzmans protested the issuance of the permit, claiming that the leases did not include pooling authority, and they did not execute a PSA. The Klotzmans claimed allowing well would be forced pooling. A hearing was held in November 2012. Ultimately, the Railroad Commission issued the permit. Unfortunately for us (although fortunate for EOG and the mineral owners), the parties settled their dispute, leaving us without judicial guidance.

There are cases pending that will test the legal propriety of Allocation Wells. We will have to wait to see the outcomes at trial and whether they appealed before we have a published judicial determination on these issues. It will be interesting to see if horizontal operators will be given the legal green light to allocate production without pooling authority. Texas public policy supports this, as it is preventing waste in oil and gas development. In the meantime, as I noted before, expect to see lease provisions that specifically address and limit attempts to file allocation well permits, or even just the allocation of production.