Forced Pooling in Oklahoma

Pooling is the process of combining the interests of two or more tracts in the same spacing unit. The area is called a pool, or a unit. Pooling provides benefits to the operator by uniting all landowners’ interests in one common pool under one drilling unit and utilizing one or more common underground geological reservoirs/formations, commonly referred to as a “common sources of supply” by the Oklahoma Corporation Commission (“OCC”). The primary purpose of pooling is to develop and operate a given formation in order to recover the greatest amount of hydrocarbons that can reasonably be produced, and also to achieve equity among the interest owners by permitting each owner to recover a fair share of hydrocarbons (or proceeds) therefrom. There are several types of pooled units – voluntary pooled units, forced pooled units, drilling units, working interest units, enhanced recovery units, and specially defined units in lease agreements.

Owners wishing to propose a well must secure the commitment of other owners in the unit. If any owners are not subject to a Joint Operating Agreement (“JOA”), there is no set timeframe under which the owner must make a timely election to the proposed well. Therefore, the proposing party must file a pooling application through the OCC in order to “force” or secure commitment from all parties. This process is called forced pooling in Oklahoma.  Below is an example to explain the concept further:

The operator on Tract A owns a 320 acre lease and has exhausted all negotiations for a lease with Farmer Brown who is the mineral owner on Tract B. Farmer Brown recently inherited $100 Million dollars from his deceased Aunt Nellie and has no incentive to negotiate for a lease bonus sum. Not to mention, the operator is only offering $25 per acre for the lease. The operator has a rig lined up to spud this well in 90 days and is under a critical time crunch to drill. If the operator fails to drill, he must pay the rig company a financial penalty to release the rig.  The operator immediately submits a well proposal to Farmer Brown and includes an Authority for Expenditure (“AFE”) outlining all costs which will be incurred for drilling a 10,850’ TMD (Total Measured Depth) well to test the targeted Mississippi formation. Once Farmer Brown is in receipt of the operator’s well proposal, the operator can commence with the pooling application to obtain a commitment from Farmer Brown.

The pooling application will provide notice to all of the unleased mineral owners or all lessees not subject to a JOA, who will be listed as respondents on Exhibit “A”.  In the case of the example above, the only unleased mineral owner is Farmer Brown, so he will be the only entity listed on Exhibit “A”.   The pooling notice is mailed to all respondents having the right to drill and/or participate in the well. The notice sets a time and place for the upcoming hearing and allows any respondent to be present in order to protect his interest.

At the hearing, the landman who attempted to lease Farmer Brown in the above example, will testify under oath that proper notice was given to each of the respondents and also that a good faith effort was made to come to terms with each respondent listed on Exhibit “A”. Testimony by the landman will include the fair market value of the mineral interests in the section and the surrounding eight contiguous sections, as it relates to lease bonuses paid and royalties offered within the last year; and may include any competitive single section trades such as farmout agreements or term assignments made in the same area.

After the hearing, the judge will decide whether to issue a pooling order or not.  If a pooling order is issued, the respondent(s) will have 20 days from the issuance of the order to make an election on the options provided. A pooling order typically provides for one of the following three options:

1. Participate and become a working interest owner. This means the mineral owner, Farmer Brown in the above example, will be charged his proportionate share of the well costs before receiving any monies from production;
2. Take one of the fair market equivalents (typically a cash plus 1/8th, 3/16 or 1/5 royalty); or
3. Take a “no cash” 1/4 royalty option.

This process is extremely beneficial to the operator as the OCC causes all undecided landowners to make elections pursuant to the pooling order. Oklahoma’s forced pooling process benefits operators, working interest partners and mineral interest owners. It stimulates a competitive market for development of oil and gas, which results in revenues for investors and royalty owners.

Currently, there are several debates and pending litigation that have been brought in front of the OCC regarding horizontal units and how they relate to existing vertical units in the same section. This is called concurrent development and occurs when a party desires to drill a horizontal well in the same formation as a vertical producing well with a smaller spacing unit.

Concurrent development of non-horizontal and horizontal drilling and spacing units is creating issues in Oklahoma at this very moment. For example, what is the fair market value for existing non-horizontal units included in a horizontal unit and how are subsequent well elections regarding different formations that are productive in the vertical wellbores versus the horizontal proposals addressed?

Other items being discussed at the OCC are: 1) pooling order expiration/termination for formations that are not primary targets; 2) pooling periods longer than a year or pooling periods not to exceed six months; 3) providing more than 20 days for elections or default elections minimally at 3/16 royalty versus 1/8 royalty; and 4) payments for dry hole/completion costs upon notice of intent to spud.

We are just now seeing the effects of horizontal drilling and how this relates to spacing, pooling and the protection of correlative rights and prevention of waste for landowners in Oklahoma. As these issues get litigated, Oklahoma’s pooling laws will be amended to reflect these progressions in the future.

Written by:  Mark Oates, CPL – Land Manager, Midcontinent Division. Mark oversees multiple due diligence, leasing and title projects in Cinco Energy Management Group’s Oklahoma City office.

For further reading, we suggest the following resources:

www.occeweb.com/ap/pooling.html
www.oil-gas-leases.com/oil-gas-pooling.html
http://lawschool.unm.edu/nrj/volumes/26/3/02_eubanks_economic.pdf