Compulsory Pooling and Unitization: State Options
in Dealing with Uncooperative Owners
Bruce M. Kramer*
1.
INTRODUCTION-THE HISTORICAL CONTEXT
The oil and gas industry has often been compared with other forms
of games of chance as, for example, the stock market or the craps
table. You can either make it big or take a beating on your invested
capital. The following hypothetical situation and the attempts by
states to deal with it in their compulsory pooling and unitization'
statutes, illustrate the high risk nature of the business.
Assume that a stock broker or professional gambler approached
you with the following offer: the broker/gambler will advance you
$3000 or $3,000,000 if you agree to invest it at her request. She agrees
to bear the entire risk of loss should the stock decline or craps be
rolled at the gaming table. If the return on the investment is less
than $3000 or $3,000,000 you owe her nothing. If, however, the return
on the investment exceeds either of those sums, all profit is turned
over to you while she keeps only the initial investment advanced to
you. This is an offer one could truly not refuse. While nO rational
gambler or stock broker would ever make this offer, an analogous situation arises in the oil and gas industry when operators seeking to
develop their mineral holdings are unable to have unleased mineral
owners or other working interest owners voluntarily agree to pool or
unitize their interests. In the absence of a compulsory pooling or unitization mechanism," if the operator wanted to develop his interest,
* Professor of Law, Texas Tech University School of Law, Lubbock, Texas. B.A. 1968, University of California, Los Angeles; J.D. 1972, University of California, Los Angeles School of
Law; LL.M. 1975, University of Illinois College of Law.
I Pooling and unitization are analogous but not identical concepts. Pooling usually describes
the joining together of tracts in order to receive a drilling permit under the applicable well
spacing rule for the area. Unitization- refers to the joining together of tracts in order to coopera~
tively develop all or _part of a reservoir containing hydrocarbons. Unitization is sometimes referred to as a unit operation. See 8 H. Wn.LIAMS & C. MEYERS, OJL AND GAS LAW 652, 938-39
(1984). For the purposes of this paper the terms are interchangeable since we will be analyzing
the impact of compulsory pooling or unitization on the unleased mineral owner or,the uncooperative working interest owner. The fact that the compulsory procedure is part of a unitization
order or a pooling order will not drastically affect the results.
= Most of the major oil and gas producing states have statutory procedures relating to COlnpulsory pooling and unitization. For a complete list of all of those states. see 2 & 3 R. MEYERS,
255
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the unleased or uncooperative owner would be in the same position
as the fortuitous gambler or investor in the hypothetical situation.
This article will explore how states deal with this result which, on its
face, discourages voluntary agreements to pool or unitize, and therefore discourages conservation of resources and efficiency goals in the
allocation of capital investment in the oil and gas industry.
The reason why an operator might have to "carry" the unleased or
uncooperative owner has its basis in the way that the common law
treats cotenancy interests in oil and gas. Each cotenant of the mineral estate had the right to drill for and produce hydrocarbons without the consent of the other cotenants! Because the drilling cotenant
is in effect taking part of the undivided minerals owned by the other
cotenant, the common-law rule requires that the drilling cotenant
provide an accounting to the other cotenant for his pro rata share of
the oil and gas produced.' The drilling cotenant, however, is entitled
to deduct the non-drilling cotenant's pro rata share of the reasonable
costs of development, production and marketing,' If the well is dry or
never recovers sufficient revenue to pay the costs of development, the
drilling cotenant sustains the entire loss. Under the common law, a
non-consenting working interest owner or an unleased cotenant cannot be forced to share the risk of a dry or marginally productive
well."
THE LAW OF POOLING AND UNITIZATION (1985). The only exceptions are Kansas, which has no
ct. J.
compulsory pooling statute and Texas, which has no compulsory unitization statute. But
WEAVER, UNITIZATION OF OIL AND GAS FIELDS IN TEXAS: A STUDY OF LEGISLATIVE, ADMINISTRA-
TIVE AND JUDICIAL POLICIES (1986) (analysis of how Texas Railroad Commission achieved de
facto compulsory unitization in absence of de jure compulsory unitization statute).
8 See, e.g., Prairie Oil & Gas Co. v. Allen, 2 F.2d 566, 571 (8th Cir. 1924); Texas & Pac. Coal
& Oil Co. v. Kirtley,288 S.W. 61!;}, 623 (Tex. Civ. App. 1926). See generally Williams, The
Effect of Concurrent Interests on Oil and Gas Transactions, 34 TEx. L. REv. 519, 520 (1956). A
number of states do not follow the majority rule that each cotenant has the right to drill for
hydrocarbons, using as their rationale the common law doctrine of waste. TIlinois, West Virginia
and Louisiana, before their most recent changes in the Mineral Code, allowed one cotenant to
enjoin another cotenant's attempt to remove oil and gas from the ground. Zeigler v. Brenneman, 237 Ill. 15, 23-25. 86 N.R. 597. 600-01 (190S); Gulf Ref. Co. v. Carroll. 145 La. 299, 303304. 82 So. 277, 279-S0 (1919); Ree Corp. v. Sheffer. 246 So.2d 313, 320 (La. Ct. App. 1971).
aff'd, 261 La. 502, 260 So.2d 307 (1972); South Penn Oil Co. v. Aught. 71 W. Va. 720, 72S, 78
S.E. 759, 762 (1913). The changes in LA. REV. STAT. ANN. §§ 31:175-76 (West 1975) are discussed
in GMB Gas Corp. v. Cox, 340 So.2d 63S. 640-41 (La. Ct. App. 1976).
« See Prairie Oil & Gas Co. v. Allen, 2 F.2d 566, 574' (8th Cir. 1924); Gerhardv. Stephens, 68
Cal. 2d 864, 894, 442 P.2d 692, 716, 69 Cal. Rptr. 612, 636 (1968); Prewett v. Van Pelt. lIS Kan.
571, 574-76, 235 P. 1059. 1060-61 (1925); White v. Smyth. 147 Tex. 272, 2S5, 214 S.W.2d 967.
975 (194S).
Ii See cases cited supra note 4.
6 The California Supreme Court succinctly summarized the right of a cotenant to drill and
then render an accounting in Gerhard v. Stephens, 68 Cal. 2d 864, 442 P.2d 692, 69 Cal. Rptr.
1986]
POOLING AND UNITIZATION
257
Interposed with these common-law rules, including the rule of capture, 7 are complex regulations passed pursuant to state police power.
These regulations have been enacted by the states since the early
1920's in order to conserve and prevent waste of oil and gas resources. Before the regulatory era began, the owners of mineral interests were free to exploit oil and gas with little or no constraints." This
exploitation led to tremendous over-drilling because of the economic
realities of the rule of capture." One regulatory method used to con612 (196S):
Anyone of these owners individually could have entered upon section 31 and explored for oil and gas. (Callahan v. Martin, supra, 3 Cal. 2d 110, 125-126, 43 P.2d 788
(1935)). In doing so, however, he would, if unsuccessful, have been compelled to bear
the entire expense and risk of the operations. (See Little v. Mountain View Dairies
(1950) 35 Cal. 2d 232, 234. 217 l'.2d 416; cf. McCord v. Oakland Q.M. CO. (lS83) 64
Cal. 134, 149-150, 27 P. 863.) If he had succeeded in his endeavor, he could not have
exch,lded from section 31 other cotenants who had desired to drill (Dabney-Johnston
Oil Corp. v. Walden, supra, 4 Cal. 2d 637, 655, 52 P.2d 237; Callahan v. Martin,
supra, 3 Cal. 2d 110, 125~126, 43 P.2d 788), and, as to the remaining cotenants, he
would have been required to render an accounting for the profits (Dabney-Johnston
Oil Corp. v. WaJden. supra, 4 Cal. 2d 637, 655-657, 52 P.2d 237) (footnote omitted).
Id. at 894, 442 P.2d at 716, 69 Cal. Rptr. at 636; see also P & N Inv. Corp. v. Florida Ranchettes, Inc., 220 So.2d 451, 453-54 (Fla. Dist. Ct. App. 1969); Krug v. Krug, 5 Kan. App. 2d 426,
618 P.2d 323, 325-26 (1980).
7 Professor Hardwicke has defined the rule of capture as it applies to oil and gas as follows:
"The owner of a tract of land acquires title to the oil or gas whic;h he produces from wells
drilled thereon, though it may be proved that part of such oil or gas migrated from adjoining
lands." Hardwicke, The Rule of Capture and Its Implications as Applied to Oil and Gas, 13
TEX. L. REV. 391, 393 (1935); see also 5 E. KUNTZ, LAW OF OIL AND GAS § 77.1 (1978).
8 Under the classic definition the owner of the mineral estate has an absolute right to drill as
many wells OIl his land as his pocket book and fancy will allow. Breaux v. Pan Am. Petroleum
Corp., 163 So.2d 406, 415 (La. Ct. App. 1964), writ re{'d. 246 L.. 5S1. 165 So.2d 481 (1964).
Professor Kuntz summarized the impact of the rule of capture on the overdriIling of wells as
follows:
The consequences of the law of capture which made it necessary to regulate the pro~
duction of oil also made it necessary to regulate the density of drilling. Under the law
of capture, each landowner has the right to extract oil and gas from beneath his land
without violating the rights of another even though the oil or gas so produced is
drained from b~neath the land of another. Fllrther, subject to the correlative rights of
others, each owner may drill as many wells on his land as he chooses. To avoid the
loss of oil or gas by drainage, each owner is inclined to drill all of the wells which he
can economically drill in order to produce as much oil or gas as possible and to produce it as quickly as possible.
S E. KUNTZ, supra note 7, § 77.1, at 390 (footnote omitted).
9 It is estimated that in the East Texas field over 17,000 wells were drilled while only 1500
would have adequately drained the reservoir underlying'the largest oil and gas field in the
continental United States. W. LOVEJOY & P. HOMAN, ECONOMIC ASPECTS OF OIL CONSERVATION
REGULATION 121 (1967); see also J. WEAVER, supra note 2; McDONALD, PETROLEUM CONSERVATION IN THE UNITED STATES: AN ECONOMIC ANALYSIS (1971). Professor Hardwicke estimated that
in the period 1947-1952 the amount spent on the drilling of unneeded wells was in the range of
$100 million, at a time when oil was selling for $1.00 or $2.00 a barrel. Hardwicke, Oil- Well
Spacing Regulations and Protection of Property Rights in Texas, 31 TEx. L. REV. 99, 111 &
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JOURNAL OF ENERGY LAW AND POLICY
1986)
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trol this waste of natural resources was the enactment of compulsory
pooling and unitization statutes.'o
The concepts of well spacing and pooling go hand in hand. Without
well spacing regulation, if only one well were to be drilled on a forty
acre tract in which multiple interests existed, disputes would certainly arise as to which mineral owner or mineral lessee would be
entitled to that single well. If the well spacing provisions were fixed ,
the economic necessities of the circumstances would force the owners
of the mineral or working interests to reach a private accommodation
in order to drill their one well." Unfortunately, as the Texas experience illustrates, well spacing regulations were rife with exceptions;
governing policy normally allowed the drilling of more wells than was
otherwise needed in order to efficiently and effectively drain the
reservoir.12
Because the impediments placed in the way of voluntary pooling
and unitization agreements by various state regulatory programs and
the common-law rule of capture, efforts were made to force pool or
unitize oil and gas properties in order to achieve three goals: conserving oil and gas, preventing waste, and protecting correlative rights."
As early as 1929, the Section of Mineral Law of the American Bar
Association had developed a model compulsory unit operation statute
in order to force uncooperative mineral and working interest owners
to join in cooperative development and operation of the oil and gas
pool." Since then, compulsory pooling and unitization statutes have
n.27 (1952).
10 The other principal methods of oil and gas conservation were: (1) Well Spacing-The reg-
ulation of the number and location of wells that can be drilled within a specified amount of
acreage; (2) Drilling Operations':-'"The regulation of procedures used in drilling and completing
wells; (3) Maximum Efficient Rate_Limiting productive capabilities to the· maximum efficient
rate (MER) of the well based on its geological capabilities; and (4) Prorationing-Limiting the
amount of oil and gas that can be sold from each well within a common source of supply or
reservoir and allocating that amount between the various wells that are producing from that
common source. R. SULLIVAN, HANDBOOK OF OIL AND GAS LAW 285 (1955).
For a complete history of oil and gas conservation efforts at both the federal and state governmentallevel, see AMERICAN BAR ASSOCIATION, CONSERVATION OF OIL AND GAS: A LEGAL HISTORY, (B. Murphy ed. 1948); AMERICAN BAR ASSOCIATION, LEGAL HISTORY OF CONSERVATION OF
OIL AND GAS (1938).
11 For a general discussion of spacing units, see 5 E.KuNTZ, supra note 7, §§ 77.1w.3, at 391401; R. SULLIVAN, supra note 10, at 297w305.
12 The history of Rule 37 in Texas is summarized in Hardwicke, supra note 9, at 101-05, and
R. SULLIVAN, supra note 10, at 305-30B.
13 1 R. MEYERS, THE LAW OF POOLING AND UNITIZATION 256 (1967).
14 Report of the Committee on Conservation of Mineral Resources of the American Bar Association, 54 REP. A.BA 739, 762-70 (1929).
•
POOLING AND UNITIZATION
259
been adopted in almost every state which produces oil and gas, '5 although in the tradition of Brandeis' aphorism of the states as fifty
grand experiments, there are substantial differences between the
states in their approach to the problem.'·
The function of the compulsory pooling or unitization process
should be to remedy the weaknesses of the marketplace while achieving the public objectives of preventing waste, conserving oil and gas,
and protecting correlative rights. Because of the impact of the rule of
capture and the geologic quality of the movement of oil and gas to
areas of lower pressure, the marketplace may not operate as the ideal
mechanism for the allocation of this scarce resource. The best way to
determine how the marketplace would operate is to see how voluntary pooling and unitization agreements deal with the problem of
non-consenting working interest owners who choose not to participate in the drilling of the unit well.
Voluntary agreements normally provide one of four different alternatives for the non-consenting working interest owner if he does not
participate in the drilling program." One option is for the other
working interest owners to buyout the working interest owned by the
non-consenting owner. A second option allows the non-consentor to
See supra note 2.
For example Texas, which does not have a compulsory unitization statute, requires that an
operator Who wishes to use the compulsory pooling process must make a "fait and reasonable
offer to pool voluntarily" before the Railroad Commission has jurisdiction to entertain the compulsory pooling petition. TEx. NAT. RES. CODE ANN. § 102.013 (Vernon 1978). Oklahoma on the
other hand does not require the applicant for a pooling order to attempt to voluntarily pool
The applicant need only file with the Corp<?ration Commission a petition seeking to force pool
the interests located in a drilling or spacing unit. OKLA. STAT. ANN. tit. '52, § 87.1(e) (West 1984
1&
16
& Supp. 19S5).
11 6 H. WILLIAMS & C. MEYERS, OIL AND GAS LAW 23·30.3 (1985). The four alternatives offered
by Professors Williams and Meyers are couched in slightly different· terms in Ryan,' Current
Problems in Federal Unitization, with Particular Reference to Unit Operating Agreements, 2
ROCKY MTN. MIN. L. INST. 157, 171 w75 (1'956). In discussing a model unitization agreement deal·
ing with federal lands ,the author concluded that there were three main approaches, with one of
those approaches having two different alternatives. Under the "acreage" plan any non-consentor would be required to assign his interest to the operator for a cash bonus based on the
fair market value per acre. Id. at 172. This is equivalent to the first option presented by Williams and Meyers. The second option is called the "cash" plan and mirrors the second option
presented by Williams and Meyers in that the nonwconsentor is given a free ride up until the
moment a producing well is completed. At that time, the entire amount of his pro rata share or
share of costs plus a penalty becomes immediately due~ See id. The third option has two subparts in the "production" plan. In the first sub-part the non-consentor's share of production
from a producing well is off-set against his pro rata share of costs plus a risk penalty in an
accounting transaction. The second sub·part is more formalistic in that the non-consentor for w
mally transfets an interest to the operator with a reverter when the operator recovers the nonconsentor's pro rata share of the costs plus a risk penalty. Id. at 173. As can be seen, the means
are changed but the descriptions are basically the 'same.
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be "carried" for his pro rata share of expenses until a productive well
is completed. The share of costs is then immediately due. This option
is often accompanied by a penalty, sometimes denoted as a risk penalty, in order to compensate the operator for the risk of drilling a dry
hole.'· A third option allows the non-consentor to be "carried" without risk but does not call for immediate payment upon completion of
a producing well. Instead, the share of costs plus the risk penalty are
recovered out of the non-consentor's allocated share of the production.'· A fourth option is to require the non-consentor to relinquish
to the operator his working interest in the well subject to a future
interest retained by the non-consentor. The future interest becomes
possessory when the non-consentor's share of the costs plus risk penalty is paid out of his share of the oil/gas.'·
In all but the first alternative, the non-consenting working interest
owner's share of the costs of drilling are "carried" by the other operators. The risk penalty concept is utilized in order to compensate the
risk takers for the chances taken by them in drilling a dry hole. In
the first alternative, there is essentially no lOnger a non-consent problem because the operator has transferred voluntarily all of his interests to the remaining operators and no longer has a stake in
production.
If no voluntary pooling or unitization agreement can be worked out
by the proposed operator, either the non-consenting mineral or the
working interest owner must be "carried" without any liability for
their share of the expenses of drilling a dry hole. This is the example
raised by the opening hypothetical. 21 The economic incentive for
working interest owners to join in such voluntary agreements is
thereby diminished unless the proposed operator can resort to a compulsory process which forces the owner to make choices which are
equally or less palatable to such holdouts. Unfortunately, several
state approaches to the compulsory pooling and unitization process
1986]
261
do not make it less palatable but seemingly reward holdouts by offering more than the marketplace would if a holdout forces the operator
to go through the administrative process.
II.
,
18 This option has several disadvantages. The first is defining when a productive well occurs.
Is a marginally productive well which covers operating costs but will never recoup the initial
investment in the drilling costs a productive well? In addition, the transfer of a large lump sum
might be treated as ordinary income by the operator with negative tax liability consequences.
See Ryan, supra note 17. at 173.
19 See, e.g., Minor v. Pan Am. Petroleum Corp., 216 F. Supp. 86, 88-89 (w.n. La. 1962)
(agreement enforced imposing 150% risk penalty on non-consentor's share of production
caused by deepening an existing well).
20 This last option may run into problems with the Rule Against Perpetuities. See Kuntz,
The Rule Against Perpetuities and Mineral Interests, 8 OKLA. L. REV. 183, 199 (1955). If the
grantor's interest is treated as a possibility of reverter, the rule would not apply.
21 See supra text accompanying note 1.
POOLING AND UNITIZATION
I'
THE PROBLEM OF THE NON-CONSENTING WORKING INTEREST
OWNER
To contrast with the four alternatives normally offered in the private sector, state compulsory pooling and unitization statutes utilize
a somewhat different set of four alternatives in order to force a nonconsenting working interest owner to pool or unitize his interests
with those other operators working to develop the mineral interests.
The first alternative can be labeled the "free ride." The non-consenting working interest owner is "carried" as to his proportionate
share of expenses without penalty during the time that the weI! is
being drilled. If the well is successful" the non-consentor is only liable
for his share of the costs out of the production actually achieved. If
the well is a dry hole, the non-consentor owes nothing.'· The second
option also allows the non-consentor to be "carried" during the drilling period, but it imposes upon him a risk penalty to compensate the
drilling parties for the risk of drilling a dry hole. Again, if the well is
dry, the non-consentor pays nothing, while if oil is found, the nonconsentor is assessed a risk penalty.'· A third groUP of statutes authorizes the governmental body to permit the non-consentor to elect
or choose one of several options. The options usually given the colessee include accepting a cash bonus in exchange for the transfer of
the working interest, electing to participate on an uncarried basis by
payment of his proportionate share of expenses, or participating on a
carried basis with the imposition of a risk penalty'" The last group of
statutes does not address the problem of the non-consenting working
interest owner. Any power to deal with the non-consentor must be
gleaned from the regulato~y agency's general authority to issue pooling or unitization orders. Practices of administrative agencies, which
have broad discretion, vary from state to state."
A.
"Free Ride" States
Eleven states which have compulsory pooling statutes give the nonconsenting working interest owner a "free ride" in the drilling of a
See
See
24 See
n See
22
28
infra
infra
infra
infra
section
section
section
section
lIA.
lIB.
lIC.
lID.
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well." Although there are three different methods of discerning the
nature of the free ride, the effect is to allow the non-consentor to
have his share of the cost of the well taken solely out of production.
If the well is a dry hole, the non-consentor is not forced to pay anything. The statute in effect requires the operator to give an interestfree loan to the non-consentor. In the absence of substantial production from the well, the loan will be defaulted, with no further recourse available to compensate the operator for potential losses. This
is the hypothetical situation which opened the discussion of this
problem."'
The first group of free ride states essentially gives the operator the
right to charge his expenditures against the proportionate interests of
all of the non-consenting owners. The charge is reimbursed to the
operator out of the first production from the well."' The non-consentor is treated as a non-drilling cotenant who is entitled to an accounting of expenditures and production, but who receives no actual
money until the operator has recouped his out-of-pocket expenses in
drilling and operating the well. Of these states, only Florida authorizes the operator to have a lien on the leasehold estate of each separately owned tract in order to provide a security interest in the
amount of production.'· This lien also applies to consenting owners
who are otherwise being carried by the operator.
Another group of three states provides for "reimbursement of costs
chargeable to each lessee out of, and only out of, production from the
" ALA. CODE § 9-17-13 (1980); ALASKA STAT. § 31.05.100(e) (1979); MIZ. REv. STAT. ANN. § 27505(A) (1976); FLA. STAT. ANN. § 377.27 (West 1974); IND. CODE ANN. § 13-4-7-14 (Burns 1981);
IOWA CODE ANN. § 84.8(2) (West 1984); Mo. ANN. STAT. § 259.110 (Vernon Supp. 1985); MONT.
CODE ANN. § 82-11-202(2) (1983); NEV. REv. STAT. § 522.060(3) (1983); N.C. GEN. STAT. § 113-393
(1983); N.D. CENT. CODE § 38·08-08 (Supp. 1985).
2'1 See supra text accompanying note 1.
28 See, e.g., ALA. CODE § 9-17-13 (1980); FLA. STAT. ANN. § 377.27 (West 1974); IND. CODE ANN.
§ 13-4-7-14 (Burns 1981); N.C. GEN. STAT. § 113-393 (19S3).
The Alabama provision is typical of this group of statutes. It provides:
[T]he operator designated by the Board to develop and operate the integrated or
pooled unit shall have the right to charge against the interest of each other owner in
the production from the wells drilled by such designated operator the actual expenditures required for such purpose, not in excess of what are reasonable, including a
reasonable charge for supervision; and the operator shall have the right to receive the
first production from such wells drilled by him thereon which otherwise would be
delivered or paid to the other parties jointly interested in the drilling of the well so
that the amount due by each of them for his share of the expense of drilling, equipping and operating the well may be paid to the operator of the well out of production.
ALA. CODE § 9-17-13(e) (19S0).
.. FLA. STAT. ANN. § 377.28(e)(1) (West Supp. 19S5).
1986]
POOLING AND UNITIZATION
263
unit belonging to each lessee."3. Again the non-consentor is given a
free ride in that the operator's right of reimbursement only comes
out of actual production. The major distinction between this group
and the preceding group is the inclusion of a statutory lien on the
share of production accruing to the interest of each non-consenting
owner. Thus, the operator has both the right to reimbursement out of
production and a lien on that production_ The lien is normally marketable and may be sold in order to pay the pro rata share of costs
attributable to the individual lessees. 31
The three remaining free ride states do not even provide the operator with a direct entitlement to production. Instead, these states provide for an operator's lien covering the non-consenting owner's share
of production up to the amount owed the operator." In practice,
however, the results will probably be no different than those states
which do provide for a direct entitlement to production.
The problem with all these provisions is that they encourage individual working interest owners to hold out of voluntary pooling or
unitization agreements. It would not be in the best interest of the
working interest owner to buy into an operating agreement and face
the dual burden of providing up-front capital for the drilling, and
also the risk of losing his entire investment in the event of a dry hole.
.. ALASKA STAT. § 31.05.100(c) (1979); ARIZ. REV. STAT. ANN. § 27-505(A) (1976); NEV. REV.
STAT. § 522.060(3) (19S3).
The Arizona statute is typical. It provides in pertinent part:
If one or more of the owners drills and operates, or pays the expense of drilling and
operating the well for the benefit of others, then, in addition to any other rights conferred by the pooling order, the owner or owners so drilling or operating shall have a
lien on the share of production from the unit accruing to the interest of each of the
other owners for the payment of his proportionate share of the expenses. All the oil
and gas subject to the lien, or so much thereof as necessary, shall be marketed and
sold by the creditor and the proceeds applied iJ;J. payment of the expenses secured by
the lien, with the balance if any payable to the debtor.
Amz. REV. STAT. ANN. § 27·505(A) (1976).
" IOWA CODE ANN. § S4.S(2) (West 19S4); Mo. ANN. STAT. § 259.110 (VernonSupp. 19S5);
N.D. CENT. CODE § 3S-08-0S (Supp. 19S5).
The North Dakota statute is typical. It provides in pertinent part:
If one or more of the owners shall drill and operate, or pay the expenses of drilling
and operating the well for the benefit of others, then, the owner or owners so drilling
or operating shall, upon complying with the terms of section 38-08-10, have a lien on
the share of production from the spacing un~t accruing to the interest of each of the
other owners for the payment of his proportionate share of such expenses. All the oil
and gas subject to the lien shall be marketed and sold and proceeds applied in payment of the expenses secured by such lien as provided for in section 38~08-10.
N.D. CENT. CODE § 38-08-08(2) (Supp. 1985). Section 38-08-10 requires the operator to file for
record with the register of deeds an affidavit setting forth the amount due and the interest of
the non-consentor in such production. Foreclosure of the lien is provided in the general requirements relating to foreclosures of liens on chattels. [d. § 38-08-10 (1980).
31
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JOURNAL OF ENERGY LAW AND POLICY
1986]
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share of the produced hydrocarbons. The states disagree, however, on
how - and on what costs - the risk factor is to be computed. In five
states, including Colorado, the non-consentor is given a free ride as to
certain expenses, while other expenses are subject to a one hundred
percent risk penalty.'·
Severa! states set the amount of risk penalty as a matter of law in
the pooling and unitization statute. 37 The responsible administrative
agency is required to assign the percentage penalty to those expenses
which fall under the various categories listed in the statute. This system is somewhat counterproductive if the purpose of the penalty is to
make an assessment for the risk. Not all wells carry with them the
same risk of coming up totally dry or insufficiently productive to pay
off drilling and operating expenses. By having a laundry list approach
in which certain items are recoverable only as to their actua! costs
while others are subject to a penalty, an intent to limit the operator's
recovery to those items truly at risk in the venture is evident. For
example, surface equipment that is readily moveable is exempt from
the penalty under the Colorado'· and Nebraska'· provisions. This is
because risk does not exist in the use of that type of equipment;
The statute, by essentially allowing free riders, operates in a counter_
productive manner. The potential operator will be discouraged from
drilling if he knows that he has to carry the full risk of a dry hole
d , in addition, share the benefits from a profitable well with thos~
Interest owners who have sat on the sidelines and bore none of the
usual risk of drilling for oil and gas. If the percentage of ownership of
the ,:"orking int~rests i.s o~er. a minimal amount, then the compulsory
P?olIng mechanism falls. In Its goal~ of ?reventing waste, conserving
011 and gas, and protectIng correlatIve rIghts. Operators will have to
attempt to buyout their fellow operators who hold the trump card
because, without their agreement, the putative operator must bear
the entire risk of a dry hole.
Because this type of provision is so counter-productive to the essence of the compulsory pooling and unitization idea, most of the major oil producing states have followed the private sector and imposed
a substitute for the risk factor on the nonparticipating working interest owner. To this type of statute we now turn.
:m
B. Risk Penalty Statutes
1. State Approaches to Rish Penalty Provisions. In In re Kohlman," the South Dakota Supreme Court concluded that the purpose
of imposing a risk penalty on non-consenting working interests owners is to "relieve the nondrilling interest owner from having to advance his proportionate share of the drilling costs, but provide extra
compensation from production (if oil is found) to the drilling party
who had advanced the entire cost of a 'dry hole.' "•• All risk penalty
statutes seek to achieve the objective of compensating the risk-taker
and preventing the free ride by the non-consenting owner'" As such,
t~e pe~alty provisions provide an incentive for voluntary participatIon wIth the proposed operator on terms worked out in the marketplace rather than in a governmental context.
Within the various states that have risk penalty provisions, a substantial disparity still exists between approaches. The areas of commo~ali~y include the imposition of a specified percentage risk penalty
whIch IS to be recovered from the non-consentor's proportionate
" COLO. REv. STAT. § 34-60-116(7) (1984); NER. REV. STAT. § 57-909(2) (1984); UTAH CODE
ANN. § 40-8-8(6) (Supp. 1985); WASH. REV. CODE ANN. § 78.52.240 (Supp. 1986); WYo. STAT. §
30-5-109(g) (1977).
The Colorado statute is typical of this variety. It provides:
(b) Upon the determination of the commission, proper costs recovered by the consenting owners of a drilling unit from the nonconsenting owner's share of production
from such a unit shall be as a follows:
(1) One hundred percent of the nonconsenting owner's share of the cost of surface equipment beyond the wellhead connections (including, but not limited to, stock
tanks, separators, treaters, pumping equipment, and piping) plU$ one hundred percent of the nonconsenting owner's share of the cost of operation of the well commencing with first production and contjnuing until the consenting owners have recovered
such costs. It is the intent that the nonconsenting owner's share of these costs of
equipmfmt and operation will be that interest which would have been chargeable to
the nonconsenting owner had he initially agreed to pay his share of the costs of the
well from the beginning of the operation.
(II) Two hundred percent of that portion of the costs and expenses of staking,
well site preparation, obtaining rights-of-way, rigging up, drilling, reworking, deepen~
ing or plugging back, testing, and completing the well, after deducting any cash contributions received by
consenting owners, and two hundred percent of that portion of the cost of equipment in the well, including the wellhead connections.
COLO. REV. STAT. § 34-80-116(7) (1984).
" See, e.g., COLO. REv. STAT. § 34-60-116(7) (1984); WYo. STAT. § 30-5-109(g) (1977).
Ohio saw the difficulties of enforcing a fixed rate risk penalty and amended their statute in
1967 to adopt a flexible risk penalty provision. For a complete discussion of the Ohio experience
see,6 H. WILLIAMS & C. MEYERS, supra note 17, at 30~31 n.9.
38 COLO. REV. STAT. '§ 34-60~1l6(7) (1984); see supra note 36.
" NEB. REv. STAT. § 57-909(2) (1984).
the
" In re Kohlman, 263 N.W.2d 674 (S.D. 1978).
ld. at 675.
84
" COLO. REV. STAT. § 34-60-116(7) (1984); LA. REv. STAT. ANN. § 30-10 (West Supp. 1985);
NEB. REV. STAT. § 57-909(2) (1984); N.M. STAT. ANN. § 70-2-17(C) (1978); N.Y. ENVTL. CONSERV.
LAW § 23-0901 (McKinney 1984); OHIO REv. CODR ANN. § 1509.27 (Page 1978); fix. NAT. REs.
CODE ANN. § 102.052 (Vernon 1978); UTAH CODE ANN. § 40-6-6(6) (Supp. 1985); WASH. REV.
CODE ANN. § 78.52.240 (Supp. 1986); WYo. STAT. § 30-5-109(g) (1977).
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calculating the penalty must be the likelihood or unlikelihood that oil
or gas will be found at the well's proposed location.
Other states provide flexibility by giving the administrative agency
the power to set the penalty within a range set out in the statute'"
Again, this discretion tends to achieve the penalty's objective of rewarding the risk-taker according to the degree of risk being taken.
In states that do not delimit the type of activities for which the
penalty applies, the respective state administrative agencies have varying degrees of discretion to impose the risk penalty and to set its
amount. Louisiana specifically provides for a penalty as a "charge for
risk" and requires that the penalty that is to be imposed be fixed at
one hundred percent of the actual costs incurred'" The Louisiana
Commissioner of Conservation must impose the penalty on persons
who choose not to participate in the proposed well"·
Texas provides greater flexibility in its compulsory pooling order
by allowing the Railroad Commission the. discretion to impose a risk
charge not to exceed one hundred percent of drilling and completion
costs." The Railroad Commission, however, must impose a risk
charge on all non-consentors"· New Mexico provides the greatest
flexibility of those states which authorize the use of risk penalties by
giving the Oil Conservation Commission the power to determine not
only the amount of the risk charge, but also whether or not a risk
rather, depreciation of that equipment is allowed for its intended use.
Thus, a statute taking the Colorado approach attempts to tailor the
penalty provisions to the risk in terms of the equipment being used,
but not as to the geophysical or geologic risk that oil or gas will not
be found where the drilling takes place.
The problem of including a fixed penalty, whether it be limited to
specified costs or not, is that it is inconsistent with the purpose of
imposing a risk penalty because the risks change from well to well.
There are at least three types of risks that may be involved in drilling
an oil and gas prospect"· The greatest risk is in drilling a dry hole. A
second risk is encountering unexpected mechanical or geological
problems which greatly increase the actual cost of drilling. The third
type of risk is the risk of drilling a marginally productive well which
will never return to the operator his investment in the drilling and
operating expenses'" Unfortunately, most state statutes and administrative agencies do not adequately explain the basis for imposing a
risk penalty'"
Several states which use the laundry list approach attempt to remedy the problem of inflexibly mandated risk penalty percentages by
allowing the responsible state administrative agency to decide
whether or not the penalty is to be imposed. Nebraska, while setting
the penalty for some expenditures at one hundred percent, allows the
agency to decide if a penalty is appropriate under the circumstances'" However, the statute does not set out the criteria for determining when the penalty should be imposed. If the overall purpose of
the penalty is to reward the risk taker for bearing someone else's
share of a dry or marginally productive well, the leading factor in
4(1 Morris, Compulsory Pooling of Oil and Gas Interests in New Mexico, 3 NAT. RESOURCES J.
31S, 326 (1963).
41 ld. at 325-26.
42 ld. at 326; see also Nutter, Some Engineering Aspects of the New Mexico Compulsory
Pooling Statute, paper delivered to the Mineral Law Section of the State Bar of Texas (July 5,
1962), reprinted in 6 H. WILLIAMS & C. MEYERS, OIL AND GAS LAW 29-30 (1985) [hereinafter
cited as Nutter].
43 The Nebraska statute reads in part:
The order shall determine the interest of each owner in the unit, and may provide in
substance that, . . . as to each owner who does not agree, he shall be entitled to
receive from the person or persons drilling and operating said well on the unit his
share of the production applicable to his interest, after the person or persons drilling
and operating said well have recovered two hundred per cent of that portion of the
costs and expenses of staking, well site preparation, drilling, reworking, deepening or
plugging back, testing, completing, and other intangible expenses approved by the
commission chargeable to each owner who does not agree, and one hundred percent
[of other enumerated costs].
NEB. REV. STAT. § 57-909(2) (19S4).
POOLING AND UNITIZATION
" See, e.g., N.M. STAT. ANN. § 70-2-17(C) (197S); N.Y. ENV']'L. CONSERV. LAW § 23-0901 (McKinney 1984); UTAH CODE ANN. § 40-6-6(6) (Supp. 1985); WASH. REV. CODE ANN. § 78.52.240
(Supp. 1986).
" LA. REv. ANN. § 30:1O(2)(b)(i) (West Supp. 1985). Vermont b88 tbe bighest risk penalty
figure: 300 percent is required to be imposed if the lessee chooses not to participate. VT. STAT,
ANN. tit. 29, § 523(c) (Supp. 1985).
" LA. REV. STAT. ANN. § 30:1O(2)(b)(i) (West Supp. 1985). The statute does not differentiate
between those who voluntarily elect not to participate and those who either want to participate
but cannot bear the financial burden, or those who make a good faith effort to participate but
later become delinquent in their payments due to financially exigent circumstances. Arguably
the party who chooses to participate but becomes delinquent should not be subject to a 100
percent penalty but merely to the typical damages recovery for breach of contract which would
include the amount of the unpaid cost of drilling plus interest on the funds that the operator
had to forward on behalf to the breaching participant.
47 TEX. NAT. RES. CODE ANN. § 102.052(a) (Vernon 1978). See also Windsor Gas Corp. v.
Railroad Comm'n, 529 S.W.2d 834 (Tex. Co. App. 1975) wr~t of error dism'd on motion of
[
II
parties.
48 TEX. NAT. RES. CODE ANN. § 102.052(a) (Vernon 1978):
As to an owner who elects not to pay his proportionate share of the drilling and
completion costs in advance, the commission shall make provision in the pooling order for reimbursement solely out of production, to the parties advancing the costs, of
all actual and reasonable drilling, completion, and operating costs plus a charge for
risk not to exceed 100 percent of the- drilling and completion costs.
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and costs are not to be imposed if the well does not produce in paying quantities. This provision adds an ambiguity to the right to recover since it is unclear whether a marginally producing well, which
might be sufficient to satisfy a leasehold habendum clause definition
of paying quantities, will be producing in paying quantities so as to
allow for the imposition of the penalty." Finally, the operator is only
entitled to the penalty if he complies with a series of requirements
including filing a petition with the Board and giving to each working
interest owner an offer to participate or farm out his interests to the
operator." Therefore, agency decisions are going to be difficult to
overturn where the agency has been vested with wide discretion by
the pooling and unitization statute.
2. Criteria By Which Agencies Determine The Risk Penalty. In
states where agencies have discretion to determine the risk penalty,
there is a paucity of legislative guidance regarding criteria to be considered by the agency in determining whether a risk penalty should
be imposed, and what the amount should be if a penalty is warranted
by the facts. There is little judicial precedent discussing the underlying Commission decisions in which discretion is given by the statute.
All that the New Mexico Supreme Court stated in the Viking Petroleum decision was that the decision on the amount of risk penalty
imposed was, by its very nature, an ad hoc factually determined issue
which was to be given broad deference by a reviewing court."
Certain factual issues are obviously relevant to an agency making a
risk penalty provision given the penalty's purpose of compensating
the risk taker and avoiding free rides. The major factual issue relates
to a determination or quantification of the amount of risk carried by
the operator. Factors include the proposed well's proximity to other
charge should be imposed!'
The degree of agency discretion may also impact the scope of judicial review of risk penalty decisions made by the agency. In Viking
Petroleum, Inc. v. Oil Conservation Commission," a challenge to a
New Mexico pooling order which had imposed a two hundred percent
risk penalty was turned back, largely on the traditional notion that
such determinations were within the particular expertise of the
agency and should be given great deference by a reviewing court."
Therefore, agency decisions are going to be difficult to overturn
where the agencies have been vested with wide discretion by the
pooling and unitization statute.
Mississippi's statute most narrowly confines the discretion of the
administrative agency in imposing risk penalties. '2 Mississippi is also
unique because it is the only state which gives the operator, not the
non-consentor, an option to carry the non-consentor's interest or
seek, in addition to the pro rata share of expenses, a penalty of up to
250 percent of such costs. '3 The statute also requires that the penalty
411 N.M. STAT. ANN. § 70·2-17(C) (1978). Ohio has a similar provision but may allow the operator to continue to recoup a 200 percent penalty from the continuing operating expenses for the
life of the productive well. This result would truly be too harsh and overcompensate the operator for the risks he had taken. OHIO REv. CODE ANN. § 1509.27 (Page 1978); see also Williams &
Meyers, Petroleum Conservation in Ohio, 26 OHIO ST. L.J. 581, 608 (1965).
lJ,O Viking Petroleum, Inc. v. Oil Conservation Comm'n., 100 N.M. 451, 672 P.2d 280 (1983).
111 Viking Petroleum is a fascinating Clllie. HEyeO wanted to drill a well to test several different formations. Viking wanted to participate in the expenses only through the shallower
formations. The Commission denied the Viking petition for partial participation and gave them
a limited time to participate or be carried with the imposition of a 200 percent risk penalty.
Viking chose not to participate, and brought an action seeking to overturn the Commission's
order denying them the right to partial participation. 672 P.2d at 281. The Supreme Court
decision treated the matter of partial participation and risk penalty as a matter of law, rather
than as an issue of fact. It nonetheless applied a substantial evidence standard, which is normally reserved to judicial review of agency findings of fact. Id, at 283. The court reviewed the
evidence presented to the Commission in a deferential way, making all reasonable inferences in
favor of the Commission and excluding from consideration all evidence· unfavorable to the
Commission's findings. Id.
The court concluded:
The grantipg or refusal to grant forced pooling of multiple zones with an election to partici·
pate in less than all zones, the amount of costs to be reimbursed to the operator, and the
percentage risk charge to be assessed, if any, are determinations to be made by the Commission on a case-to·case basis and upon the particular facts in each case.
Id. at 284; see also Rutter & Wilbanks Corp. v. Oil Conservation Comm'n, 87 N.M. 286, 289291,532 P.2d 582, 585-87 (1975) (findings of Commission are sufficient; orders are supported by
substantial evidence).
~1I MISS. CODE ANN. § 53·3-7 (Supp. 1985); see also McDavid, Mississippi's New Operator
Risk Compensation Statute, THE LANDMAN, Nov. 1984, at 7.
II~ Section 53-3-7(2)(a) of the Mississippi Code provides:
In the event that a majority of the drilling interests. in a. drilling unit has voluntarily
consented to the drilling of a unit well thereon, and the operator has made a good
faith effort to (i) negotiate with each nonconsenting owner to have said owner's interest voluntarily integrated into the unit, (ii) notify each nonconsenting owner of the
names of all owners with drilling rights whO have agreed to integrate any interests in
the unit, (iii) ascertain the address of each nonconsenting owner, (iv) give each nonconsenting owner written notice of the 'proposed operation, specifying the work to be
performed, the location, proposed depth, objective formation and the estimated cost
of the proposed operation, and (v) to offer each nonconsenting owner the opportunity
to lease or farm out on reasonable·· terms, or to participate in the cost and risk of
developing and operating the unit well involved, on reasonable terms, by agreeing in
writing, then the operator may petition the board to allow it to charge alternate
charges as hereinafter set out (alternate to and in lieu of the charges provided for in
subsection (l)(b) above).
MISS. CODE ANN. § 53-3-7(2)(.) (Supp. 1985).
.. Id. § 53-3·7.
MId
Viking Petroleum, Inc. v. Oil Cons~rvation, Comm'n, 100 N.M. 451, 672 P.2d 280 (1983);
see supra note 51.
66
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successful wells, the geologic information regarding the known
reserves in the area, and the productivity of any existing offset wells
in the area. 07 These factors all relate to the issue of whether - and
if so, how much - oil or gas will be found. Other factors may relat~
to the speed at which the operator can be expected to recoup his
investment assuming the geologic information was correct. Speed criteria include current and expected demand of the product, location
of the nearest pipelines for gas transportation, if gas is the expected
mineral to be discovered, depth of expected find and the cost of
drilling.'·
Texas has a unique requirement which must be met before an operator can seek to force pool other working interest owners. The
Texas Railroad Commission cannot exercise jurisdiction until the
proposed operator has made a fair and reasonable offer to voluntarily
pool the other working interests.'· In Windsor Gas Corp. u. Railroad
Commission, B. the court had to ascertain whether a voluntary offer to
pool was fair and reasonable. The offer required a one hundred percent penalty be attached to the other working interest owner should
he opt not to participate. B1 The operator was planning to drill eight
wells within the area to be pooled because there had been production
on both sides of the proposed drilling locations, and the region had a .
long history of productive drilling. In addition there had been an 84.6
percent success rate in drilling during the previous year, excluding
offset wells. B2 The court held that there was essentially no risk in the
drilling activities. Therefore, an offer to have a one hundred percent
penalty in excess of actual costs was not "fair and reasonable," and
G'1
Nutter, supra note 42.
6'8 Holmes v. Corporation Comm'n, 466 P.2d 630 (Okla. 1970). The court in Holmes dealt
with a ~on-consenting mineral owner who had burdened his working interest with a very high
production payment. Under those circumstances the working interest owner in Oklahoma
would have been faced with an election between participation or transfer of his interest with
the payment of a bonus. However, because of the high production payments burdening the
interest, it would have been likely that the lessee would have received nothing for his interest.
See infra note 88. Therefore the operator asked for a third option, namely being carried with a
risk penalty. The court upheld a risk penalty of 250% primarily because the well was a deep
well with concomitantly higher costs and longer period of payout if the gas was found. Id. at
633.
Ge TEX. NAT. R~s. CODE ANN. § 102.013(b) (Vernon 1984). See generally Smith, The Texas
Compulsory Poolmg Act (pt. 2), 44 TEx. L. REV. 387, 393 (1966) (describing possible application
of the Commission's requirement).
60 Windsor Gas Corp. v. Railroad Comm'n., 529 S.W.2d 834 (Tex. Civ. App. 1975) writ of
error dism'd on motion of parties.
61 Id. at 835.
62 Id. at 837.
1986]
POOLING AND UNITIZATION
271
the compulsory pooling process was not triggered. B'
The amount of the penalty itself is not determinative of whether it
. is fair or reasonable. Undoubtedly the negotiation process that would
take place in a voluntary pooling agreement would better reflect the
amount of risk that knowledgeable parties predict is encompassed by
the proposed drilling plan. The compulsory pooling process is required to bring parties together who cannot agree on a risk penalty or
other provisions. The need fot a compulsory process stems from a
need to achieve important public objectives of protecting correlative
rights, preventing waste, and encouraging efficient development of
the oil and gas resource. In In re Kohlman, B4 the court reviewed a
Commission's determination that a one hundred percent penalty was
reasonable, even though the operator had sought a two hundred fifty
percent penalty and the non-consenter had apparently agreed in private negotiations to a one hundred fifty percent penalty. B' Because a
successful well was located about three-quarters of a mile from the
proposed well site, a smaller risk penalty should have been imposed
because the risk of a dry hole was less. The court concluded that the
Commission's one hundred percent penalty was reasonable even
though it was a smaller penalty than the non-consentor had voluntarily agreed to.·B
The Commission's decision is probably supportable under an arbitrary and capricious or substantial evidence scope of judicial review
given the closeness of the productive well. The result, however, is
probably inefficient from an economic viewpoint because it gives to
the non-consentor more than he had agreed to in the market place.
In states like Texas where a voluntary offer to pool must be made,
the Commission should give great weight to both the operator's offer
on the risk penalty and the carried interest owner's counter-offer, if
any was made. Where the agency has credible evidence placing lower
and upper limits on the amount of the penalty, the agency should
restrict its exercise of discretion to those limits because they are the
best evidence of the market place valuation of the resource.·7
63 [d. at 836-37; see TEX. NAT. RES. CODE ANN. § 102.013(b) (Vernon 1984); the definition of a
fair and reasonable offer was discussed in Carson v. Railroad Comm'n of Texas, 669 S.W.2d
315, 318 (Tex. 19S4).
.. In re Kohlman, 263 N.W.2d 674 (S.D. 1975).
6G [d. at 679. A previous agreement between the parties on another tract of land had led to a
voluntary agreement in which a 250 percent penalty was mutually acceptable. [d. at 678.
1I6 [d. at 679.
67 [d. at 678·79. The court said that the penalty is based on several unidentified factors,
including proximity to successful wells.- Nonetheless, the parties who have the greatest to gain
or lose are the best judges of what the risk is. Where the non-consentor has voluntarily agreed
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Several p.ooling. and uni~ization statutes specify that the non-con_
be gwen either deSignated or undesignated options before his
mterest can be force pooled. Several states including Illinois 6S P
. 69 V' . . 70 d W "
,
enn~
syIvama,
~r~mla, an
est Virginia,71 specifically include a risk
pen.alty prOVISIOn as one of the qesignated options that must be made
available
. mand t th to hthe non-consenting working interest owners. Ill'mOls
.a es at t e non-~o~sentor be given alternatives, including: 1) the
right ~o surrender hiS mteres~ to participating owners for a reasonable pnc.e .to be set by the parties or by the Mining Board, 2) the ri ht
to. participate on a noncarried basis, and 3) the right to be carrred
with a penalty of fifty percent of the drilling, testing and completio
costs. of the well."' Where the compulsory order does not include ~
elec~lOn, the order is void, but only as to that part which relates to
the Impos.ed penalty.73 That part of the order pooling the interest
and allowmg the operator to drill will be deemed valid. 74
s
A~kansas a.uth?rizes a somewhat different option for its non-consentmg ~ork.mg mterest owner."" Besides the option to participate,
the workmg mterest owner can transfer his rights to the operator on
~entor
order.
Several states, including South Dakota,77 merely provide that the
order must include just and reasonable alternatives, without mentioning what those alternatives are." In In re Kohlman,7. the South
Dakota Supreme Court upheld the ability of the state agency to provide a risk penalty as one of the alternatives to be presented to the
non-consenting working interest owner. so While the right to impose a
penalty was not specifically mentioned in the statute, the court
treated the power to impose the penalty as necessarily implied from
the general power to provide just and reasonable alternatives for nonconsenting mineral and working interest owners. The Board, in carry-
t
affected
determined what the risk was. ConstlamIng
. . th e agency
mosto
th m by the decision has already
.
e 0 era and counter-offers might encourage inflating and deflating the figures and discourage
vol~~ agreements. In some circumstances the agency should be able to set risk penalt
re.gardless of the figures met by the parties, jf for example, new geological evidence
aV.81lable or if ODe or both of the parties offers are deemed to be unreasonable or made in bad
faIth.
.. ILL. ANN. STAT. ch. 96'h, § 5436(d) (Smith-Hurd 1979).
e9 PA. STAT. ANN. tit. 58, § 408(c) (Purdon 1964)'(provides for a 100 percent penalty)
" VA. CODE § 45.1-302(C) (Supp. 1985).
.
pro~lSlons
:: w. VA.
273
a permanent or temporary basis. The permanent transfer, which is
merely a total assignment of the working interest in exchange for a
cash consideration, eliminates the owner from further development of
the field. The second option turns into a risk penalty option because
the assignment of the working interest is for a limited time, subject
to recoupment. 76 While not labeled a risk penalty, the additional sum
mentioned must be related to the carried status and the lack of risk.
By legislative default the state agency is given wide latitude in setting the criteria used to determine if a penalty is to be imposed and
the range of possible penalties in issuing the compulsory pooling
Option States
to a 150 percent penalty there seems to be no reason to go below it since the person
POOLING AND UNITIZATION
The provision states in part:
Such order shall also provide that an owner who does not affirmatively elect to participate in the risk and cost of such operations shall transfer his rights in such drilling
unit and the production from the uIiit well to the parties who elect to participate
therein for a reasonable consideration and on a reasonable basis. which in the absence
of agreement between the parties, shall be determined by the Commission. Such
transfer may be either a permanent transfer or may be for a limited period pending
recoupment out of the share of production attributable to the interest of such nonparticipating owner by the participating parties of an amount equal to the share of
the costs that would have been borne by such- non-participating party had he participated in such operations. plus an addtional sum to be fixed by the Commission.
77 S. D. CODIFIED LAWS AN~. § 45-9-31 (1983).
" IDAHO CODE § 47.322 (1977); Ky. REV. STAT. § 353.640 (1983); S.C. CODE ANN. § 48-43-
76
i~
CODE § 22-8·7(b)(6) (1985) (provides for a 100 percent penalty).
ILL. ANN. STAT. eh. 96Y" § 5436(d) (Smith-Hurd 1979).
" Newkirk v. Bigard, 125m. App. 3d 454, 462, 466 N.E.2d 243, 248 (19S4). Although this
case l~volved an un~eased nuneral owner, the issue is the same for working interest owners. In
~e.wk;r~. t.he,CQUlt l~terpreted the compulsory pooling statute as requiring the Mining Board
me u e In Its poolIng order reasonable alternatives for the non-consenting mineral owners to
choose from, even though the statute used the phrase "if requested" to modify th
.
t
of
"d'
It
.
, ' "
' e reqUlremen
proVl mg a e~natlves. 4~6 N.E.2d at 248 (quoting ILL. REv. STAT. ch. 96'12, § 5436 (SmithHurd 1979», WhIle the notice for the hearing included a provision relating to alternatives the
ac~~al order required Newkirk. an unleased owner, to participate. Id. at 247.
'
. or respon d
t thId. at. 248.thWhere
..the non-consentor chooses not to partier'pate m' the h earIng
o e notices. e MmIng Board can avoid a problem by having its order state that if the nonconsentor does not respond to the notice within a specified time. the pre-designated option will
be de~med to have heen selected. This procedure will prevent the nonconsenter from unduly
delaymg the ?perators' schedule merely by sitting on the election which the statute mandates
h e must be gIven.
" ARE. STAT. ANN. § 53-1l5(A-I)(e) (1971).
I
[d.
340(C) (Supp. 1984).
" In re Kohlman, 263 N.W.2d 674 (S.D. 1978).
80 [d. at 675. The order provided in part:
That the operator (Depco) is hereby authorized to withhold the following costs and
charges from production:·The pro rata share of reasonable well costs attributable to
each nonconsenting working interest owner who had not paid his share of estimated
well costs within 30 days from the date the schedule of estimated well costs is furnished to him. As a charge for ~he risk involved in the drilling of the well, 100 percent
of the pro rata share of reasonable well costs attributable to each nonconsenting
working interest owner who has not paid his share of estimated well costs within 30
days from the date the schedule -of estimated well costs is furnished to him .. , .
Id.
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fair and reasonable bonus to be determined by the governmental
:gency.a. Soon after the adoption of the statewide com~~sory pooling law, the Corporation Commission issued an order glvmg ~ nonconsentor those same options. The order was attacked as bemg an
unconstitutional taking of property without just compensation and. as
not being authorized by the statute. In Anderson v. Corporatwn
Commission,aa the Oklahoma Supreme Court upheld the validity of
the compulsory pooling statute and the Commission order which essentially required the non-consentor to partici~ate.or a~nvolunt~:ilY
sell his working interests to the operator for a faIr prt~e. In ad~lt~on
to the straight cash bonus alternative, the CorporatIOn CommISSIOn
has issued orders combining a cash bonus with an overriding royalty
interest. It also ordered the transfer of an overriding royalty in lieu of
a cash bonus. aa In determining the amount of cash bonus and/or
overriding royalty to be paid the non-consentor, the Corporation
Commission examines available geologic information regarding the
likelihood of success, plus any analogous sales of working interest in
the area and the results of drilling in the immediate region"·
The addition of the overriding royalty to the buyout alternatives
shifts some of the risk of a dry hole to the non-consentor. But since
the non-consentor's interest is cost-free, he benefits from a marginally productive well which never pays out because he receives his royalty regardless of the well's profitability. Because the transfer of
ing out the generally stated purpose of preventing waste in the development of the state's oil and gas resources, was within its power
when it chose the risk penalty alternative.al
States that authorize the use of alternatives provide a more realistic replica of the actual marketplace for working interests and, therefore, more closely achieve what the market cannot do because of the
ruIe of capture. As stated earlier, operators who seek to jointly operate a pool or reservoir have several choices available to them in order
to persuade the other owners to join in their venture. By giving the
administrative agency the same kind of alternatives, the agency can
tailor an order which reflects what the market would bear were it not
for the impediments placed in the road to voluntary agreements.
D. Silent States
The final group of states essentially does not make any specific
mention in their pooling and unitization statutes of what to do with
the non-participating owner's interest. Most of these states' statutes
contain only the general instruction to the Board that the order must
be on "terms and conditions that are just and reasonable, and will
afford to the owner of each tract . . . the opportunity to recover or
receive his just and equitable share of the oil or gas."a2
Of all these states, Oklahoma by far has the most highly developed
administrative and judicial doctrine to fill in the lacunae caused by a
compulsory pooling statute which does not deal with the problem of
non-consenting working interest 'owners. a8 The alternatives that have
developed in the Oklahoma Corporation Commission to deal with the
non-consentor have as their antecedents the municipaI ordinances
that were the predecessors to statewide compulsory pooling statutes.a4 The two alternatives normally given to municipal lot owners
who could only drill a single well in one city block were: electing to
share proportionately in the costs; or not participating and accepting
SlId. at 677-78.
.. MICa. STAT, ANN, § 13,139(13) (Callaghan 1981); see alsa GA, CODE ANN, § 43-706(.)(1)
(Supp. 1985) (no standards outlined); OR. REV. STAT. § 520.220 (1983) Gust and reasonable conditions); TENN, CODE ANN, § 60-1-202 (Supp. 19&5) (uo standards outliued).
83 The Oklahoma statute provides in part:
Where, however, such owners have not agreed to pool their interests and where one
such separate owner has drilled or proposes to drill a well . . . the Commission . . .
shall. . . require such owners to pool and develop their lands in the spacing unit as a
unit. . . . All orders requiring such pooling shall be made. . . upon such terms and
conditions as are just and reasonable . . . .
OKLA, STAT. ANN, tit. 52, § 87.1(e) (19S4 & Supp. 1985).
84 Id.; see also Curlee, The Problem of the "Free-Riding" Lessee and Some Suggested Solutions, 9 INST. ON MIN. L. 21, 24 (1962).
POOLING AND UNITIZATION
.. OKLA. STAT. ANN. tit. 52, § 87.1(e) (1984 & Supp. 1985).
86 Anderson v. Corporation Comm'n., 327 P.2d 699 (Okla. 1958); see also Superior Oil ?o. v.
Oklahoma Corp. Comm'n, 242 P.2d 454, 458 (Okla. 1952) (Commission ord~r requiring ~meral
interest owner to pay $85,000 wit1)in 10 qays or accept $500 per acre for Its lease modifi~d).
87 Anderson 327 P .2d at 702·03. This notion of a forced sale has been analogized to a pXlvate
eminent domain proceeding. If a party chooses not to or is unable to participat~ in the we.ll
costs through the payment of cash or a bond, the Commissi.on:s actions ~equi~e him ~ sell hiS
property interest to the operator at a price which the CommissIon determmes IS t~e fair mark~t
value. One could analogize this situation to the common statutory grant of emment d~malD
powers to public utilities operating under a government permit or certificate of conven~e?~.
See, e.g., TEx. REV. ClY. STAT. ANN. art. 1436 '(Vernon 1980) (giving to certain public utilitIes
right to condemn land for right 'of way purposes).
88 For a more complete discussion of the alternatives available under the Oklahoma statute,
see Nesbitt, A Primer on Forced Pooling of Oil and. Gas Interests in Oklahoma, 50 OKLA. RA.J.
f
t
648 (1979).
6& In Home-Stake Royalty Corp. v. CorporationComm'n, 594 P.2d 1207 (O~. 1979~, the
court said that confidential geologic information need not be provided by the poolmg applicant,
but that evidence of the fair market value of the non-consenting working interest owners may
be determined by looking at the teJIDs and prices given by other lessees or in recent leases in
the area. ld. at 1209·10. But in Miller v. Corporation Comm'n, 635 P.2d 1006 (Okla. 1~81), the
court rejected an attack on an order setting a bonus of $75/acre and a 118th override even
though the state had, in a sealed bid auction, received a larger bonus and royalty on a nearby
tract located in the same unit. Id. at 1007-09.
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THE NON-CONSENTING UNLEASED MINERAL OWNER
A. The Silent Treatment
While almost all of the state statutes provide some formal guidance
and standards for the state agency regarding the terms which may be
imposed on the nonconsenting working interest owner that oversees
the compulsory pooling or unitization process, it is somewhat surprising that most state statutes make no mention whatsoever of what the
agency is to do when unleased lands are contained within a pooled or
unitized area.· 3 The fact that the statute is silent does not necessarily
mean that unleased owners fall in the lacunae and present impediments to the compulsory pooling process. Montana's compulsory
pooling statute provides a good illustration of how unleased owners
would be treated even though they are neglected by specific statutory
language.·' Under the Montana statutory scheme, all "owners" must
110
III
See, e.g., Holmes v. Corporation Comm'n, 466 P.2d 630, 633 (Okla. 1969).
See Texas Oil & Gas Corp. v. Rein, 534 P.2d 1280, 1282 (Okla. 1974); Ranola Oil Co. v.
Corporation Comm'n, 460 P.2d 415, 417 (Okla. 1969); Wakefield v. State, 306 P.2d 305, 308
(Okla. 1957).
IIlI. Nesbitt, supra note 88, at 652-53. This might lead to a conclusion that the Commission
favors owners who are not in the oil arid gas industry and who cannot bear the financial risk of
the all or nothing shot at a producing well. But the cases do not necessarily agree with that
conclusion, and it has not been stated to be a factor in the Commission's decision to allow an
owner to be carried with a penalty.
98 Approximately 24 states which have a compulsory pooling or unitization statute or both do
not deal with the problem of the unleased owner. See, e.g., COLO. REV. STAT. § 24~60-116(7)
(1984); ILL. ANN. STAT. ch. 96V" § 5436(d) (Smith-Hurd 1979); OHIO REv. CODE ANR § 1509.27
(Page 1978); TEX. NAT. RES. CODE § 102.052 (Vernon 1978).
k
MONT. CODE ANN. § 82-11-202(1) (1985) provides:
When two or more separately owned tracts are embraced within a spacing unit or
when there are separately owned interests in all or a part of the spacing unit, then
277
be afforded an opportunity to recover their just and equi~able share
il and gas. 9 ' An owner is defined by statute to mclude all
of the o .
.
9' An unIeased
rsons possessing the right to dnll for 011 and gas.
~ineral owner clearly has the right to drill or the power to lease to
working interests in the oil and gas industry usually involves some
form of overriding royalty interest as the prime consideration, inclusion of that option by the Commission reflects the realities of the
operation of the free market system and should be encouraged.
The Oklahoma Corporation Commission has allowed a fourth alternative under its just and reasonable order powers-the inclusion of a
risk penalty. Although the risk penalty option has been upheld on a
number of occasions,·· it does not appear to be a preferred option;
and the courts have unanimously upheld the Commission's decision
not to include the option when it issues an order.· ' In the view of one
author/practitioner, the Commission feels that the other options better allocate the risk of a dry hole and the rewards of a producing well
than the penalty provisions.·2
III.
POOLING AND UNITIZATION
(
;
the persons owning those interests may popl their interests for. the ~ev.elopment ~nd
operation of the spacing unit. In the absence of voluntary poolIng wIthm the spacmg
unit, the board, upon the application of an interested person, may ent:r an order
pooling all interests in the spacing unit for the development and operatIOn th~~eof.
The pooling order shall be made after hearing and shall be upon terms and ~ondltlo~S
that are just and reasonable and that afford to the ?wne: of each tract or mterest In
the spacing unit the opportunity to recover or receIve WIthout unnecessary expen~es
his just and equitable share of the oil or gas produced and sav.ed from the .spacIn.g
unit. Operations incident to the drilling of a well upon any portIOn of a spacmg umt
covered by a pooling order shall be considered, for all purposes, the conduct of the
operations upon each separately owned tract in the spacing unit b;y the sev~ral ownerS thereof. That portion of the production allocated to each tract I?cluded In a spac~
. g unit covered by a pooling order shall when produced be consIdered for all pur:oses to have been produced from the tract by a well drilled th~reon.
(2) (a) The pooling order shall provide for the drilling an~ operatIng of. a well on the
spacing unit and for the payment of the cost thereof, whIch cost may Include a reasonable charge for supervision, handling, and storage. As to each owner who refu~es
to pay his share of the costs of drilling and operating the well, the o~der shall proVlde
for payment of his share of the cost out of and only. out of production fr?m the well
allocable to his interest in the spacing unit, excludmg royalty or other mterest not
obligated to pay any part of the cost thereof, and excluding the royalty provided for
in subsection (2)(c) of this section. If a dispute arises as to the cost, the board by
order shall determine the proper cost. The order may provid~ in substance that the
owners who agree to share in the cost of drilling and operatIn~ ~e well. are; unless
they agree otherwise, entitled to receive, subject to royalty or SImIlar oblIgatIOns, all
of the production of the well until they' have recovered all of the c~sts out of ~he
production, and thereafter all of the owners in the spacing. u~it are entItled to receIve
their respective shares of the production of the well as theIr mterest may appear after
. '
deducting their respective s;hares of current operating costs.
Professor Smith in his analysis of the then-nascent Mineral Interest Pooling Act I~ Texas
also discussed the problem of the unleased owner. Sniith, The Texas Compulsory Poolmg Act,
44 TEX, L. REv. 387, 405-06 (1966). He suggested that it would be proper, although not
ere
mandatory, for the Commission to force pool unleased o~ers u~~er term.s where they
given an option to participate as to %th of the interest and In addItion receive a cost-free !hth
royalty. [d. at 406. A problem that Professor Smith foresaw was the ~ovement away from t::
standard l/sth royalty. If nearby lessors hai::lleased for more than a Vsth royalty, should t
unleased owner be forced to accept' a J/s th royalty? Professor Smith thought not m:-d contra~ted
the Texas provision with other states in which the statute mandated the receIpt of a .!hth
royalty by an unleased owner. Id. at' 406. See N~M. STAT. ANN. § 70-2-17(c) (1978). See mira
text accompanying notes 137 to 141.
7
" MONT. CODE ANN. § 82-11-202(1) (1985).
The statute provides in part:
"Owner" ineans the person who has the right to drill into and produce from a pool
and to appropriate the oil or gas he produces there from either .for himself or ~thers
or for himself and others, and the ~rm includes all persons holdmg such authorIty by
or through him.
MONT. CODE ANN. § 82-11-101(8) (1985).
99
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JOURNAL OF ENERGY LAW AND POLICY
1986]
[Vol. 7
another the right to drill. 97 Therefore, the compulsory pooling order
cannot ignore the unleased owner and must resolve any problems
caused by his inclusion within the pooled or unitized area.·· In addition, the Montana provision dealing with the right to participate in
the well costs also uses the term "owner," which would include the
unleased mineral owner.·· Therefore, the unleased owner would have
to at least be given the opportunity to participate in the well as a
working interest owner.'OO
The problem with ignoring the unleased owner is that, as an
"owner," he is in many circumstances treated solely as a working in~erest o,",:ner, alth?ugh he has in essence both a working and royalty
mterest m the mmeral estate.'O' An essential attribute of the unleased mineral estate is the right to receive royalty upon its leasing to
and production by another.'o, Merely treating him as a working interest owner would give him the right to participate in the costs of
the well but deny him his right to receive a cost free royalty regardless of whether the well ever makes a profit.
B.
POOLING AND UNITIZATION
279
maining fraction, % ths, becomes the equivalent of a working interest,
and the unleased owner is then treated as any other working interest
owner whose leasehold interest is being pooled.'·· The statutory provision essentially creates a leasehold interest and arbitrarily allocates
a 'Ia th royalty to the unleased owner as if he had leased the land to
himself while retaining a '/a th royalty. That result may not have been
unfair at a time when the 'Ia th royalty was almost universally used;
but, today there is really no standardized royalty in the oil and gas
field, and if anything, the 'Ia th royalty is below the market standard
in today's leasing activities.
One response to the artificial setting of the royalty at '/a th is to
allow the unleased owner's royalty interest to be directly tied to the
prevailing royalty rates in the leases which have been signed in the
pooled or unitized area. Again, that will best reflect the true value of
the unleased owner's interest and most closely compensate him for
the value of his mineral interest, North Dakota has sought to achieve
that result by enacting a compulsory. pooling statute which gives to
the unleased owner the "weighted average royalty interest of the
leased tracts within the spacing unit" but never less than a 'Is th
interest.,oB
The North Dakota provision was challenged by an operator of a
pooled unit who argued that the Commission was without authority
to establish a lessor-lessee relationship where none existed and that
consequently, the unleased owner's full interest was essentially that
of a working interest owner who could join in and pay the proportionate share of drilling costs or be carried subject to a lien against
his pro rata share of production.'·7 In a state such as North Dakota
where the working interest owner gets a free ride without a risk penalty, the benefits to an unleased owner are substantial.,oB Not only
does he receive a cost-free royalty out of the first barrel of produc-
The %-Yil Solution
The approach taken by the majority of state pooling and unitization statutes which specifically treat the unleased owner is simply to
convert the unleased owner's mineral interest into two distinct interests, a 'Is th cost-free royalty and a % ths working interest, and then
plug those interests into the prevailing statutory provisions. '03
Within this group there are two different approaches as to the
amount of royalty due the unleased owner. In Arkansas, for example,
the statute specifically limits an unleased owner to a 'Is th royalty after there has been a pooling or unitization of his interest.'·' The reR. HEMINGWAY, THE LAW OF OIL AND GAS 33-34 (2d ed. 1983).
For other statutory schemes similar to that of Montana see ARIZ. REV. STAT. ANN. §§ 27501(14) through 505(A) (1976); IDAHO CODE §§ 47-31SUJ through 322 (1977); TEx. NAT. REs.
CODE § 102.012 & .052 (Vernon 1975).
" MONT. CODE ANN. § 82-11-202(2) (19S5).
fl1
98
100Id.
101
102
Slawson v. North Dakota Industrial Comm'n., 339 N.W.2d 772 (N.D. 1983).
HEMINGWAY, supra note 97, at 34-36.
'" See, e.g., ARK. STAT. ANN. § 53-115(A-l)(e) (1971); NEB. REv. STAT. § 57-909(2) (1984);
~.M. STAT. ANN. 70-2-17(C) (197S); N.D. CENT. CODE § 3S-0S-0S (Supp. 19S5);
OKLA.
STAT. ANN.
tIt. 52, § S7.1(e) (19S4 & Supp. 19S5).
104 ARK. STAT. ANN. § 53-115(A-l)(e) (1971). The statute provides:
In .the event there is an unleased mineral interest or interests in any such ,drilling
umt, the owner thereof shall be regarded as the owner of a royalty interest· to the
extent of a one-eighth (Va th) interest in and to said unleased mineral interest and
such royalty interest shall not be affected by the provisions of subparagraphs (c) and
(d) ahove.
r
[t
105 Once the Vath interest is classified as a working interest, the various state approaches take
over and the unleased owner will be treated as if he had leased the land to himself. See supra
section II.
.
108 The North Dakota provision provides in part:
For the purposes of this section and section 38-08-10, any unleased mineral interest
pooled by virtue of this section shall be entitled to a cost-free royalty interest equal
to the acreage weighted -average royalty interest of the leased tracts within the spacing unit, but in no event shall the royalty- interest of an unleased tract be less than a
one-eighth interest. The remainder of the unlesed interest shall be treated as a lessee
or cost bearing interest.
N.D. CENT. CODE § 3S-0S-0S(I) (Supp. 19S5).
107 Slawson, 339 N.W.2d at 775-76.
108 See supra text accompanying notes 22~3l for a complete discussion of the free ride alternative for non-consenting working interest owners.
280
JOURNAL OF ENERGY LAW AND POLICY
[Vol. 7
1986]
tion, but he also gets his free ride so that, if the well ever becomes
profitable, he suddenly becomes a silent partner to the risk-taking
operator, sharing proportionately in the good fortunes of an abundantly producing well. It is therefore not surprising that an operator
would challenge the statutory scheme as giving the unleased owner
more than the market would bear.
In Slawson v. North Dakota Industrial Commission,"o the court
was able to rebut the operator's charge that the statute created a
lease where none was consented to, by concluding that an unleased
mineral interest has within it several constituent parts, including the
royalty and working interests. n • Since the statutory command is to
provide a "just and reasonable" order, the legislative determination
that the unleased owner is entitled to full compensation for his constituent rights is reasonable!n The court ignored the fact that an
unleased owner's right to royalty is normally accompanied by a transfer of the working interest to a lessee. The unleased owner changes a
risk-bearing interest to a risk and cost-free interest. On the other
hand, if an unleased owner drills his own well, he does not receive
any risk and cost-free royalty but merely receives the profits, if any,
from his business venture. ll2 North Dakota and other states which
treat the unleased owner in this way provide, in effect, a windfall for
the mineral owner where the non-consenting working interest owner
is given a free ride on the back of the operator!13
The inclusion of unleased mineral owners in compulsory pooling
orders has been accepted in Oklahoma since the early case of Ander-
C.
The!-1J th Solution
While the unlea8ed owner may be getting a windfall in the states
providing him with both a cost free working and royalty interest
share in the pooled production, the California approach seemingly
penalizes the unleased owner by reducing his unleased mineral estate
to a mere royalty interest. 12 ' While the statute has only limited appli-
'"' Slawson. 339 N.W.2d 772 (N.D. 1983).
Id. at 775-76.
Id. at 777. The court also disagreed with the operator's contention that the statutory
provision providing for a lien against the oil and gas produced applied both to the royalty and
working interests of the unleased owner. The court noted that the pooling and spacing unit
provisions essentially gave the operator the monopoly on drilling a well. The unleased owner
would therefore be deprived of leasing his land since no further wells could be drilled on the
property. Thus, it would not be improper to provide both a cost-free royalty and a free ride
working interest, subject to the statutory lien, to the unleased non~consenting owner. Id. at 77879.
111
113 Another detrimental side effect of this practice is to discourage mineral owners from leasing their interests. This will undoubtedly further hamper development of the oil and gas
resource.
281
son v. Corporation Commission.''' In Anderson, unlike Slawson, the
operator was happy with the order giving the unleased owner his proportionate share of a Vs th royalty and subjecting hi8 'Va th working
interest to the option of paying a proportionate share of the well
costs or accepting a cash bonus in exchange for the transrer of the
working interest. ll5 The court had no difficulty accepting the validity
of the order, both as to the inclusion of the I/S th royalty "6 and the
options afforded the unleased owner regarding the 'Va th working interest that the statute carved out of the unleased mineral estate!l7
Another way of achieving the 'Va -Va solution is through the definition section of the pooling and unitization statute. That i8 the approach taken by West Virginia, which defines an operator in terms
that would include an unleased mineral owner, but only to the extent
of a 'Va ths interest. 116 The unleased mineral owner is also considered
a royalty owner as to a Vs th interest. That is important because the
statute prevents the drilling on the tract of an unleased royalty
owner without his prior written consent!'· The unleased owner is
given one of the two option8 afforded working interest owners as to
the .'Vs ths working interest he has pur8uant to the 8tatute. 12 '
llO
m Of course it might be possible for the unleased owner to lease the minerals to himself
providing for a royalty interest in excess of the royalties secured in the other leases pooled in
the area. The statute may in effect encourage such transactions, although they may be viewed
as a totally sham transaction. It is not unheard of for an unleased mineral owner, especially a
cotenant, to lease the minerals to himself. See, e.g., Manges v. Guerra, 673 S.W.2d 180 (Tex.
1984).
POOLING AND UNITIZATION
I
114
Anderson v. Corporation Comm'n., 327 P.2d 699 (Okla. 1958).
IH;
[d. at 700-01. The unleased owner also cannot complain about the location of the well on
his land nor the use of his land for access to and from a well located elsewhere on the pooled or
spacing unit. See, e.g., McDaniel v. Moyer, 662 P.2d 309 (Okla; I9B3); Cormack v. Wil-Mc
Corp., 661 P.2d 525 (Okla. 1983); Texas Oil and Gas Corp. v. Rein, 534 P.2d 1277 (Okla. 1974).
116 Anderson, 327 P.2d at 70l.
117 [d. at 702~03. The Oklahoma statute provides in part:
For the purpose of this section, the owner or owners of oil and gas rights in and under
an unleased tract of land shall be regarded as a lessee to the extent of a seven-eighths
(VB) interest in and to said rights and a lessor to the extent of the remaining oneeighth (lis) interest therein.
'" W. VA. ConE § 22-8-2(5) (1985).
lIB W. VA. CODE § 22-4A-7(b}(1) (l985) deals with written consent. For a contrary view, see
LA. REV. STAT. ANN. § 30.9(c} (West Supp. 1985); Nunez v. Wainoco Oil & Gas, 488 So.2d 955
(La. 1986); McDaniel v. Moyer, .662 P.2d 309 (Okla. 1983).
'" W. VA. ConE § 22-8-7(b)(5) (1985).
121 CAL. PUB. REs. CODE § 3608 (West 1984) provides in part:
Where land aggregating less than one acre is surrounded by other lands, which other
lands are subject to an oil and gas lease aggregating one acre or more, and if, under
282
JOURNAL OF ENERGY LAW AND POLICY
1986]
[Vol. 7
283
senting mineral owner was entitled to a basic royalty of '/8 th, the
Board of Oil, Gas and Mining and the Utah Supreme Court modified
the provision in resolving a dispute between an unleased owner and
an operator in Bennion v_ Utah State Board of Oil, Gas & Mining."·
This case involved a classic problem with spacing units, pooling orders, the rule of capture and the rights of non-consenting owners.
Bennion owned a small fractional unleased mineral interest in an
area which, by a Board order, had been pooled into 640-acre spacing
units. In June 1973, Shell proposed a voluntary pooling order for the
section in question, and all owners except Bennion agreed. Shell completed a well on the section but off of the acreage owned by Bennion.''' The statute then in force provided that nonconsenting owners
were entitled to a V8 th royalty, but Shell took the position that, in
the absence of a pooling agreement or order, they owed nothing to
Bennion. Bennion then filed a petition with the Board to force pool
the interest in question, but the order was not entered until 1979."·
Notwithstanding the statute's sole reference to a royalty interest for
nonconsenting unleased owners, the Board trifurcated its order regarding payment by Shell to Bennion. For the period prior to payout
and beginning with first production, an unleased owner is entitled to
a cost-free royalty. From the time of payout to the effective date of
pooling, the non-consenting unleased owner is entitled to his share of
the revenue set off by his share of expenses, including those expenses
incurred prior to payout, Le., drilling costs. After the pooling order is
entered, the unleased owner is entitled to receive his proportionate
cation to unleased tracts of less than one acre,'" it provides the unleased owner solely with royalty benefits. Thus, the cash bonus paid
to other mineral owners in the area will not be paid to the small tract
mineral owner. This will encourage lessees to leave small tracts unleased since no delay rentals or bonuses will have to be paid. Further,
these interests cannot share in the working interest by paying over
their proportionate share of well costs because, upon the spacing unit
declaration, their lands are de jure treated as leased to the lessee of
the surrounding acreage. An unleased owner, in attacking the validity
of such a spacing order with its compulsory leasing ramifications, was
rebuffed in Hunter v. Justice's Court'23 on the grounds that the provision of a royalty interest adequately protected the unleased owner
from a taking of his property. The court noted that while other states
may also allow the unleased owner to participate in the working interest as well, that issue was a matter of legislative judgment, not
constitutional imperative.'"
At one time Utah also had apparently opted for the 'Is th solution
in its pooling statute.'" Although the Act specified that the non-conthe provisions of Section 3600 to 3607. inclusive, of t'he Public Resources Code, the
drilling or producing of a well on said land is declared to be a public nuisance, said
land shall, for oil and gas development purposes and to prevent waste and to protect
the oil and gas rights of landowners, be deemed included in said oil and gas lease on
said other lands, and shall be subject to all the terms and provisions thereof.
1 22 Id.
123 Hunter v. Justice's Court, 36 Cal. 2d, 315, 223 P.2d 465 (1950).
124 [d. at 468-69. The California statute does not expressly deal with unleased mineral owners
of tracts larger than 1 acre, except that it does provide that the state can force pool larger
parcels under a plan or agreement subject to such rules and regulations as the state may adopt.
CAL. PUB. REs. CODE § 3609 (West 1984).
". UTAH COOE ANN. § 40-6-6(g) (1966), amemied by UTAH CODE ANN. § 40-6-6 (Supp. 19S5).
The statute provides:
[11 Each pooling order shall make provision for the drilling and operation of a well
on the drilling unit, and for the payment of the reasonable actual cost thereof, includ~
ing a reasonable charge for supervision and storage facilities. [2] As to each owner
who refuses to agree upon the terms for drilling and operating the well, the order
shall provide for reimbursement for his share of the costs out of, and only out of,
production from the unit representing his interest, excluding royalty or other interest
not obligated to pay the cost thereof. [3J In the event of any dispute as to such costs,
the commission shall determine the proper costs. [4J The order shall determine the \
interest of each owner in the unit, and may provide in substance that as to each
owner who agrees with the person or persons drilling and operating the well for the
payment by the owner of his share of the costs, such owner, unless he has agreed
otherwise, shall be entitled to receive, subject to royalty or similar obligations, th,e
share of the production of the well applicable to the tract of the consenting owner,
and as to each owner who does not agree, he shall be entitled to receive from the
person or persons drilling and operating the well on the unit his share of the produc·
tion applicable to his interest, after the person 01' persons drilling and operating the
said well have recovered the share of the cost of drilling and operating applicable to
POOLING AND UNITIZATION
l
such nonconsenting owner's interest plus a reasonable charge for supervision and
storage. [5] Each consenting and nonconsenting owner shall be entitled to receive,
subject to his paying or making arrangements with the owner or owners operating the
well for the payment of all applicable royalties, over-riding royalties or other burdens
on production and his respective share of current operating or other costs incidental
to the efficient operation of the well, his share, respectively, of production allocated to
the tract or tracts in which he holds an interest; provided, however, that a nonconsenting owner of a tract in a drilling unit, which is not subject to any lease or other
contract for the development thereof for oil and gas shall be deemed to have a basic
landowner's royalty of one-eighth (lh) or twelve and one-half percent (12- 1/2 %) of the
production allocated to such tract.
12.8 Bennion v. Utah State Board of Oil, Gas & Mining, 675 P.2d 1135 (Utah 1983).
l2.7 Id. at 1137. At this point, under the rule of capture, Bennion is without recourse. Since he
has not signed the pooling agreement, he would not be entitled to any share of.production from
a well not located on the 80 acres in which he owned the fractional share. Havmg been created,
the spacing unit only provides for a limitation on drilling, not a pooling of interests. For the
difference between spacing and pooled units, see 5 E. KUNTZ, OIL AND GAS § 77.3 (1978).
l2.8 Bennion, 675 P .2d at 1138. In the meantime the well had achieved payout, meaning that
the value of the hydrocarbons recovered, had exceeded the cost of drilling and operating the
well. In other words it was producing a profit for the working interest owners. Id.
284
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D.
129
130
[d.
134
Id.
285
As amended, the Utah compulsory pooling provision codifies the
Bennion decision.'3. It more clearly states that the royalty provision
is only payable until payout, plus risk penalty, but it does not state
that the unleased owner's interest thereafter turns into a working interest. The new provision also liberalizes the royalty amount by tying
the royalty to the average of the royalty received in the leases on the
spacing unit rather than pegging the royalty at ",. th of production.
The Utah approach tends to penalize the unleased owner, by eliminating his right to both a royalty and working interest after payout.
Given the fact that Utah has a risk penalty provision to compensate
the operator for the risk of a dry hole, it seems somewhat disingenuous to suggest that the royalty interest suddenly merges into the
working interest only after payout including risk penalty. The royalty
interest should be continued throughout production and the working
interest share remaining after deducting the specified royalty should
be subject to the normal rules for non-consenting working interest
owners. Where the statute allows a risk penalty, the unleased owner
is not getting a windfall, as was the case in Slawson, since the penalty provision will act as an incentive to lease the interest prior to
pooling or spacing in order to receive a bonus as part of that transaction. If the penalty reflects the risk of drilling, it will provide incentives for the unleased owner to participate in drilling the well.
share of the hydrocarbons in kind, if he pays his proportionate shar
of the operating expenses of the well.I2.
e
This .approach is certainly not required by the statute, which onl
speaks m terms of a royalty interest. Further, it is certainly differe~
from the approa~h taken by the ~lawson court, which maintained
that th~ royalty mterest was. reqUired to be maintained as long as
~roductIOn. occurred because It was an inherent part of the mineral
mterest bemg affected by the state's spacing and pooling laws."· The
court gives a rather crabbed reading to the statute when it conclude
that the royalty interest which the provision clearly creates someho:
gets merged into the working interest after payout.I'I Why should th
recoupment of drilling costs suddenly transform this royalty interes~
in!o ~ workin~ interest? The majority of states which statutorily treat
thiS Issue ObvIOusly consider the royalty interest as surviving payout
cont!nuing through the life of the well.''' The court's discussion of
the Issue of the termination of the royalty interest also confuses the
statute's provision relating to the sharing of costs of working interest
owners and mineral owners. 13 ' The court erroneously suggests that
the c~st. of drilling should b~. deducted from each non-consenting
?wner s mterest, but the provISIon they quote refers only to working
mterest owners who have no royalty interest. 1"
Id. at 1138.39.
See supra text accompanying notes 107 and 112.
131 Bennion, 675 P.2d at 1142.
13:1. See supra text accompanying notes 93.119.
133 Bennion, 675 P.2d at 1142. The court states:
C. The Cost"Free Royalty
!he Board's calculation of Bennion's one·eighth royalty interest for the period
prior to payout made no deduction for expenses. However, in the Board's view once
payout occurred the royalty interest "merged" with the working interest. Thereafter
~ennion's share was calculate~ on· the basis of his fractional share of the workin~
mterest (2.94898 percent), subject to his payment of his fractional share of the drilling and operating expenses from the beginning of development and drilling. Bennion
charges that this calculation deprived him of his statutory "basic landowners' royalty," ,:",hich he contends should be cost-free as to all costs incurred during the period
for whICh the royalty was paid (i.e., prior to payout).
Here also, the Board made a reasonable-indeed, the only permissible-con?truction of its governing statut~. The fourth sentence of subse'ction (g)
(quo~ed In note 2, supra), which prescribes the nonconsenting owner's share of production after payout, makes the owner's rights subject to the operator's first recovering the "share of the cost of drilling and operating applicable to such nonconsenting
?wner's int?rest." (Emphasis added.) Since the cost of drilling is, by definition, a cost
Incurred prIOr to payout, Bennion's argument that he is entitled to a cost-free royalty
prior to payout is meritless.
POOLING AND UNITIZATION
I,
Option State
Washington, a state with little production, has the most extensive
statutory treatment for unleased mineral owners. I3 • It is probably the
best alternative because it attempts to mirror the marketplace and
provide a balance between the interests of the unleased owner and
the operator. The statute creates three different options for the unleased owner once a pooling order has been entered covering the unleased lands!" The first option is the modified Va -",. election,
13~
The statute now provides:
(7) The order shall provide that:
(b) A nonconsenting owner of a tract in a drilling unit~ which is not subject to a lease
or other contract for the development of oil and gas, shall receive as a royalty the
average landowners royalty attributable to each tract within the drilling unit, determined prior to the commencement of drilling and payable from the production allocated to each tract until the consenting owners have recovered the costs as provided
in subsection (6).
UTAH CODE ANN. § 46-6-6(7) (Supp. 1985).
". WASH. REV. CODE ANN. § 78.52.250(4) (Supp. 19S6).
In The statute provides:
(4) A nonconsenting owner of a tract in a development unit which is not subject to
any lease or other contract for the development thereof for oil and gas shall elect
zoo
dUUltNAL
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whereby the unleased owner is entitled to a royalty of V.th or a
higher royalty if that is the basic royalty received by other pooled
lands. The owner of the remaining interest is treated as a working
interest owner and is given the right to participate or be carried with
a risk penalty on certain types of costs."· The statute, however, modifies the unleased owner's right to a higher royalty by limiting that
owner's right to receive this "presumed" royalty to the period prior
to payout. After payout, the landowner only receives the basic royalty
until production ceases.
The second option authorizes the unleased owner to grant a lease
to the operator at the current market price for comparable leases or
interests."· In addition, the statute lists certain provisions in leases
or pooling orders as they relate to non-consenting unleased owners
which, if included, make the order or lease unfair and therefore invalid. H• The last option allows the unleased owner to treat his entire
interest as a working interest and pay his pro rata share of the costs
of the well and receive his pro rata share of production.'" If the unleased owner fails to make an election within the fifteen day period
allowed after the entry of the pooling order, he is automatically
within fifteen days of the issuance of the pooling order or such further time as the
committee shall, in the order, allow:
(a) To be treated as a nonconsenting owner as provided in subsections (2) and (3) of
this section and is deemed to have a basic landowner's royalty of one-eighth, or
twelve and one-half percent, of the production allocated to the tract, unless as a
higher basic royalty has been established in the development unit. If a higher royalty
has been established, then the nonconsenting owner of a nonleased tract shall receive
the higher basic royalty. This presumed royalty shall exist only during the time that
costs and expenses are being recovered under subsection (2) of this section. and is
intended to assure that the owner of a nonleased tract receive 'a basic royalty free of
all costs at all times. Notwithstanding anything herein to the contrary, the owner
shall at all times retain his or her entire ownership of the property, including the
right to execute an oil and gas lease on any termS negotiated, and be entitled to all
production subject to subsection (2) of this section; or
(b) To grant a lease to the operator at the current fair market value for that interest
for comparable leases or interests at the time of the commencement of drilling; or
(c) To pay his or he,r pro rata share of the costs of the well or wells in the development unit and receive his or her pro rata share of production, if any.
A nonconsenting owner who does not make an election as provided in this subsection
is deemed to have elected to be treated under (a) of this subsection.
WASH. REV. ConE ANN. § 7S.52.250(4) (Supp. 1986)
u, WASH. REV. COOE ANN. § 78.52.240(2-3) (Supp. 1986).
'" Id. § 78.52.250(4)(b).
140 [d. § 78.52.253. The provisions relate to preferential rights of the operator to purchase
mineral interests in the unit, calls or options to purchase production from the unit, imposition
of unreasonable operating charges or prohibition against nonoperators questioning the 9peration of the unit.
,.. Id. § 78.52.250(4)(c).
T
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POOLING AND UNITIZATION
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treated as opting for the modified % - Va alternative.
E.
The Unclassified Residuary
I.
Each of the several other states which deal with the unleased
owner take a unique approach to the problem. Virginia, for example,
allows the unleased owner to escape the risk penalty authorized to be
imposed on other working interest owners who choose to be carried.H2 The statute also obliquely authorizes an unleased owner to
participate in the operation under such terms and conditions as he
and the operator agree to. H3 It does not provide for the options available to the non-consenting unleased owner in the event that a voluntary agreement cannot be worked out.'"
.,
Louisiana, which recently amended its compulsor~ poolIng proVIsions to deal with the issue of unleased owners and rIsk penalty, has
chosen to treat the unleased owner solely as a working interest
... VA. ConE § 45.1-302(C)(2) (Supp. 1985).
H3 [d. § 45.1-302(B). The statute provides in part:
.
The owner of an unleased tract who elects to be a participating operator shall m
addition to his share of production, be entitled to participate in accordance with the
terms and conditions which he and the operator agree upon.
Id.
... Id. § 45.1-302(C).
j
.
The statute is also somewhat confusing in the way it defines a well operator, a royalty owner
and a participating operator. One cannot easily determine from the statute whether or not the
unleased owner is entitled to both royalty owner and well operator status for purposes of the
compulsory pooling provisions. The statute provides in part:
40. "Owner" means (i) when used with reference to any well, any person who o~~,
operates, or has the right to operate such a well as principal or as lessee, and (11)
when used with reference to any coal seam, any person who owns, leases, operates, or
has the right to operate the coal seam;
41. "Participating operator" or "participating well ope!"a.tor" means ~ well o~er~tor
who elects to bear a share of the risks and costs of drillIng, completmg, eqUIppmg,
operating, plugging and abandoning a well on a drilling unit and to rec~ive a sh~~ of
production from the well equal to the proportion which the acreage I.n.the d:lllmg
unit he owns or holds under lease bears to the total acreage of the drilling umt;
52. "Royalty owner" means any owner of oil and gas in place, or oil and gas rights, to
the extent that such owner is not a well operator- or a gas operator.
65. "Well operator" means any person who has the right to operate or does operate a
well. For purposes of oil and gas conservation under Article 2 (§ 45.1-299 et se.q.) of
this chapter, the term means any owner of the right to develop and produc~ 011 and
gas from a pool and to appropriate the oil and gas produced. therefro~ elt~er for
himself or for himself and others. In the event there is no oil or gas lease In eXistence
with respect to the tract in question, the owner of the oil and gas rights therein s~aU
be considered a well operator of the oil and gas in that portion of the pool underlymg
the tract which he owns. In the event that the. oil is owned separately from the g:as'
the definitions contained herein shall apply separately to the owners of the respective
interests.
VA. CODE § 45.1-288 (40, 41. 52 and 65) (Supp. 1985).
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owner.'" As such, the owner has the election to participate or be carried, but, unlike the working interest owner who is subject to a risk
penalty for nonparticipation, the statute specifically exempts the unleased owner from any risk charge.'" Therefore, the unleased owner
can sit back and be carried without risk and will never have to participate in the drilling costs. While that would seem to overcompen_
sate the unleased owner, the statute does not provide for a royalty
payment; and if the well never achieves a payout status, the unleased
owner will have received nothing even though his mineral estate
would have been essentially extinguished.
IV.
CONCLUSION
Compulsory pooling and unitization is a vital regulatory tool created to conserve oil and gas, protect correlative rights and prevent
waste. The aim of the state statutory and regulatory program should
be to achieve those objectives in an economically efficient manner.
The two major impediments to preventing the attainment of these
goals are the "carried" interest problem referred to in my introductory statement and the silent treatment given to unleased owners.
Compulsory pooling and unitization statutes which give the nonconsenting working interest owner a free ride, discourage the use of
the regulatory scheme,"7 Working interest owners do not want to
bear the entire risk of a dry or marginally productive well when they
must share their profits with the non-consenting owners. The preferred alternative, which would probably encourage more private
agreements, is to have a statute which authorizes the administrative
agency to afford the non-consenting working interest owner several
alternative choices. The statute should give both direction and discretion to the administrative agency to implement the option program."" A listing of alternatives should include: a risk penalty provision for those who wish to be carried; a transfer option, either
... LA. REv. STAT. ANN. § 30:10(2) (West Supp. 1985).
ld. § 30:1O(e). The statute provides in part:
(e) The provisions of Paragraph 2(b) above with respect to the risk charge shall not
apply to any unleased interest not subject to an oil. gas, and mineral lease. Notwithstanding the provisions of Paragraph 2(b) the royaItyowner and overriding royalty
146
owner shall receive that portion of production due to them under the terms of the
contract creating the royalty.
[d.
,,, See, e.g., ARK. STAT. ANN. § 53-115 (A-1)(c) (1971);
ILL. ANN. STAT. ch. 96V" § 5436(d)
(Smith-Hurd 1979), S.D. CODIFlED LAWS ANN. § 45-9-31 (1983).
146
For example the South Dakota statute which merely provides for just and reasonable
alternatives is too broad. See S.D,
CODIFIED LAWS ANN. § 45~9-31
(1983).
1986]
POOLING AND UNITIZATION
289
permanent or temporary; a buy-in option; and an overriding royalty
buy-out option. A catch-all provision should be included that allows
the state agency more discretion to fashion innovative orders to deal
with problems such as requests for partial participation. It is also important that the statute allow a range of risk penalty figures to be set
by the Commission depending on its determination of the amount of
risk that accompanies the drilling of the pooled or unitized well. The
statute may also provide a laundry list of rel~vant factors as long as
they are not treated as exclusive considerations. The statute should
require the election to b~ made within a limited time with a forced
election should the non-consenting owner fail to respond. Reference
to voluntary pooling or unitization agreements dealing with the same
or similar geological conditions should be made when available.
Those will reflect th~ private sector's assessment of the actual risks
involved in the drilling program. A statute encompassing these major
features would come closer to attaining the objectives ofa compulsory pooling and unitization regulatory program.
The greatest need in ·the area of how to deal with unleased mineral
owners is to expressly include them within the statutory scheme.
Again the best way to deal with this problem is to provide the unleased owner several options. The Washington pooling and unitization statute'·' is an excellent paradigm. The options would include
treating the unleased owner as both a working and royalty interest
owner with the amount of royalty dependent on the average royalty
in the field. The working interest share would then fall within the
options granted to other nonconsenting working interest owners in
the pooled or unitized field. The second option would authorize the
leasing of the unleased owner's interest at the current market price
for comparable leases. The final option would allow the entire UIlleased interest to be treated as a working interest and allow the
owner to be carried with a penalty or pay his pro rata share of expenses. Again, the order should provid~ for a mandatory choice if the
owner does not make a voluntary election after a short period of
time.
Compulsory pooling and unitization statutes provide a mechanism
to prevent waste, conserve resources and protect correlative rights.
As presently written, several state statutory schemes not only do not
achieve those goals, but in fact hinder achievement through the private market sector. Movement away from treating working interests
as free rides, along with an explicit policy towards unleased owners,
,.. WASH. REV. CODE ANN. § 78.52.250(4) (Supp. 1986).
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will go a long way to maximizing the efficiency of a compulsory pooling and unitization scheme.