HORIZONTAL DRILLING AND SURFACE DAMAGE by Richard A. Grimes

The Eugene Kuntz Conference on

Natural Resources Law & Policy

 

University of Oklahoma College of Law

Oklahoma Bar Association Mineral Law Section

 

November 7, 2008

 

 

 

 

 

 

 

HORIZONTAL DRILLING AND SURFACE DAMAGE

 

 

 

 

 

 

 

 

Richard A. Grimes

Grimes, Anderson & Day

Edmond, Oklahoma

 

BIOGRAPHY

 

 

            Richard A. Grimes received a B.S. in Business from Oklahoma State University in 1974. He received his JD in 1977 from the University of Oklahoma College of Law, where he was a member of the Board of Editors of the Oklahoma Law Review. He currently practices with the firm of Grimes, Anderson & Day in Edmond, Oklahoma. His practice consists exclusively of representation of independent operators at the Oklahoma Corporation Commission; and, District Court litigation involving oil and gas related matters. He is the past president of the Oklahoma City Minerals Lawyers Association.

 

HORIZONTAL DRILLING AND SURFACE DAMAGE

RICHARD A. GRIMES

GRIMES, ANDERSON & DAY

 

 

            The development of oil and gas reserves in Oklahoma utilizing horizontal drilling techniques has accelerated over the past several years. The technical aspects of such operations have advanced well beyond the legal ramifications which result therefrom. There is very little Oklahoma case law addressing the issues which may arise from the drilling and production of horizontal laterals. As discussed in subsequent portions of this paper the original rules of the Oklahoma Corporation Commission pertaining to horizontal drilling and spacing units were originally adopted in 1991 and have not been significantly amended or supplemented. In addition, the provisions of The Oklahoma Surface Damages Act¹ have not been the subject of reported opinions as regards horizontal operations. This paper will attempt to identify some of the issues which may arise as a direct result of horizontal drilling; and, hopefully offer insight as to the potential resolution thereof.

 

I.

SURFACE DAMAGES

            The drilling of horizontal laterals for many geological formations is typically a more expensive proposition than a well drilled as a vertical well for the same formation. In Oklahoma the Woodford Shale and Cleveland Sand are just two (2) of several formations which have been subjected to a significant number of horizontal tests. The lithological characteristics of those formations have tended to limit the ultimate recovery of oil and gas in a vertical well. However, some success in economically increasing recoveries has resulted from production of horizontal laterals. The length of the lateral has been an integral factor in the degree of such success. In some cases the maximization of lateral length can only be accomplished by using a surface location outside the geographical boundaries of a drilling and spacing unit. The vertical section of the wellbore is drilled beneath that adjacent surface tract, with the lateral section of the wellbore located beneath the drilling and spacing unit to be developed. That circumstance raises the question of whether the provisions of the Oklahoma Surface Damages Act (hereinafter “the Act”) would be available to the operator of such a well if no agreement can be reached with the surface owner of the drillsite. There is no reported case in Oklahoma involving such factual scenario. Although the language of the several parts of that Act do not expressly rule out its application to the defined circumstance, a detailed review of the history of the relationship of the mineral and surface estates; and, the Oklahoma Appellate Courts’ various opinions interpreting that Act, raise questions about its use for the stated purpose.

 

            The Act was passed in 1982. Prior to its enactment there was a relatively well defined relationship between the owners of the surface estate and the mineral estate.²   The owners of severed minerals were deemed by the Oklahoma Supreme Court to possess the dominant estate in relationship to the surface estate covering such minerals. The common law rule prior to the Act was that an oil and gas lessee was not liable to the surface owner of a drillsite unless there was actual damage resulting from negligence or wanton misconduct, or if the operator of a well used more of the surface than was reasonably necessary for that particular operation. Marland Oil Co. v. Hubbard, 1934 OK 385, 168 Okla. 518, 34 P.2d 278. As held in Stone v. Texoma Production Co.,1959 OK 38, 336 P.2d 1099, the right to go upon land to explore for oil and gas is a proper subject of ownership which may be granted or reserved. Inasmuch as the purpose of an oil and gas lease is to explore for and produce oil and gas, it is necessarily implied that the right to enter the land is included in the grant of that lease. The literal application of those common law rules would often result in a conclusion that a surface owner burdened with the use of its land for both drilling operations and subsequent production, was entitled to little, if any, compensation for such operations.

 

            Based on the perceived inequity of the circumstance described above, lobbying efforts begun by surface owners to create a method for compensating such owners for any use of their land for drilling operations resulted in the passage of the Act.   The relevant provisions of the Act include 52 O.S. §318.3 which provides in pertinent part as follows:

“Before entering upon a site for oil or gas drilling . . . the operator shall give to the surface owner a written notice of his intent to drill containing a designation of the proposed location and the approximate date that the operator proposes to commence drilling . . .”

 

            52 O.S. §318.5 provides the following additional obligations and rights to the operator:

 

“A.    Prior to entering the site with heavy equipment, the operator shall negotiate with the surface owner for the payment of any damages which may be caused by the drilling operation. If the parties agree, and a written contract is signed, the operator may enter the site to drill. If agreement is not reached, or if the operator is not able to contact all parties, the operator shall petition the District Court in the county in which the drilling site is located for appointment of appraisers to make recommendations to the parties and to the Court concerning the amount of damages, if any. Once the operator has petitioned for appointment of appraisers, he may enter the site to drill . . .”

 

            Nothing within the Act refers to the necessity of an operator to own an oil and gas lease covering mineral interests beneath the surface drill site, or within a drilling and spacing unit incorporating such drill site into its geographical boundaries. In fact, 52 O.S. §318.2 provides the following definitions:

            “1. ‘Operator’ means a mineral owner or lessee who is engaged in drilling or preparing to drill for oil or gas; and

 

            2.   ‘Surface owner’ means the owner or owners of record of the surface of the property on which the drilling operation is to occur.”

 

            In light of these provisions it could be argued that an operator must merely own an oil and gas lease on the tract or drilling and spacing unit beneath which the horizontal lateral is intended to be produced to have standing to petition for appraisers in the District Court and gain access to an adjacent surface location. However, both the apparent purpose of the legislature in its implementation of the Act; and, the interpretation of that Act by the Oklahoma Supreme Court, appear to suggest otherwise.

 

            Davis Oil Co. v. Cloud, 1986 OK 73, 766 P2d 1347, was the first important test of the Act. In that case the Court commented on legislative intent as follows:

 

            “In the present case, instead of dealing with correlative rights of ownership in the same natural resources, the Legislature has acted to balance conflicting rights between owners of different resources.

 

            It cannot be said that the surface of the land constitutes a less vital resource to the State of Oklahoma than does the mineral wealth which underlies it . . .” 766 P.2d at 1351.

 

            That same philosophy was repeated in Houck v. Hold Oil Corp.,1993 OK 166, 867 P.2d 451, wherein the Court stated:

            “The general purpose of the Act as we recognized in Davis, was an effort by the Legislature to provide a mechanism to balance the conflicting interests of the owners of two of our State’s important natural resources; the mineral interest holder on the one hand and the land owner on the other. (Citation omitted). The Act was a recognition that not only are the mineral resources or wealth underlying the surface a vital resource which support an important industry in our State, but the surface is also a vital resource which supports development of business, industry and residential endeavors, and our vital agricultural industry. (Citation omitted).” 867 P.2d at 457.

 

            If the sole purpose of the Act was to create a balance between the lessee of a severed mineral interest and the surface estate from which the minerals were severed, the scenario hypothesized above would not trigger use of its provisions by the operator of the horizontal well to gain access to an adjacent surface tract. Clearly, if the surface tract upon which a well is to be commenced (directional or horizontal) was never a part of a fee tract which was underlain by the mineral interest sought to be developed, there is no common law right in the lessee of such minerals to go upon that surface to drill a well to produce oil and gas from adjoining land. In fact, any such attempt would be considered a trespass upon that surface tract. See Angier v. Matthew Exploration Corp., 1995 OK CIV APP 109, 905 P.2d 826. Therefore, in such a factual circumstance the only apparent way to condone the use of the Act to grant the operator of the horizontal well access to the adjacent surface tract is to conclude that the Act creates a new possessory right which clearly did not exist before its enactment. There is nothing in the Act, or in the case law which has followed its enactment, to suggest that the Legislature was intending such an expansion of rights. However, a different conclusion might result if the factual setting is changed to include an operator who owns an oil and gas lease from a lessor owning minerals in both the drilling and spacing unit to be developed and beneath the surface of the drillsite. 

 

            If an operator proposes to drill a horizontal well with the entire productive lateral beneath one of the two (2) units covered by an oil and gas lease, but use a surface location on the other unit for its drillsite, it would probably not be considered a trespasser upon the surface of the adjoining unit. That operator would possess the right granted under its lease to go upon any part of the leased premises for the purpose of conducting exploration for oil and gas. While it could certainly be argued that such right might be limited to exploration of the minerals beneath the unit drilled from because of the segregation created by establishment of two (2) separate units, there is case law in Oklahoma which makes that assertion debatable.

 

            In Atlantic Richfield Co. v. Tomlinson, 859 P.2d 106, 859 P.2d 1088, the Oklahoma Supreme Court was asked to respond to a series of certified questions from a United States District Court. Several of those questions involved the issue of whether a separate oil and gas leasehold estate could be adversely possessed by the drilling of and production of oil and gas from a well drilled on another separate tract of land within a drilling and spacing unit created by the Corporation Commission. In that case the unit well for a 640-acre drilling and spacing unit was located in the NW/4 of the section. The separate tract was a 40-acre tract consisting of the NW/4 NE/4 of that same section. There was a mistaken assumption concerning ownership of the minerals of the 40-acre tract with the result that the production proceeds attributable thereto were paid to the wrong royalty and working interest owner for over twenty-five (25) years. The working interest owner paid those proceeds also owned undisputed leasehold on other tracts within the unit. After discovery of the error, that working interest owner claimed to have acquired a prescriptive leasehold to the severed mineral interest for that 40-acre tract. The claim was based on the argument that after the creation of a drilling and spacing unit by the Corporation Commission, production from a unit well is treated as occurring from all tracts within the unit. The Supreme Court refused to accept this “attribution” theory in the context of adverse possession. The basis for that rejection provides an interesting look at the Court’s analysis of the purpose and affect of drilling and spacing units.

 

            As defined in Atlantic Richfield, the purpose of spacing is to prevent the drilling of unnecessary wells. Except as necessary to accomplish the task of protecting correlative rights and preventing waste, the Commission’s power to affect oil and gas owner’s rights was viewed as limited to the least interference necessary. Quoting from Samson Resources Co. v. Corporation Com’n, 1985 OK 31, 702 P.2d 19, the Court noted that “aside from the recognized power to monitor certain terms and conditions of the contract imposed on the parties through a forced pooling order, no other powers to protect correlative rights are granted or implied by this statute.” 859 P.2d at 1095.

 

            The reluctance of the Oklahoma Supreme Court to expand the affect of spacing beyond the aim of correlative right protection is a reiteration of the philosophy previously expressed in Winter v. Corporation Com’n of State of Okla., 1983 OK CIV APP 1, 660 P.2d 145. In that case the Court of Appeals cited with approval the proposition that oil and gas owners should have their contractual leasehold rights remain undisturbed by Commission regulatory action “except insofar as their abrogation is absolutely necessary to effect accomplishment of the conservation objective . . .” 660 P.2d at 149.   If that philosophy is applied to the question at hand, it is possible that the fact of two (2) separate drilling and spacing units covered by one oil and gas lease should not serve to diminish the leasehold owner’s right to use the surface of one such unit to drill beneath the other.   The operation on one of the two (2) separate units could result in benefit to the lessor in both units. Using that approach, it is at least arguable that the provisions of the Oklahoma Surface Damages Act might well be available to the operator of the hypothesized horizontal well.

 

            In all fairness, it must be noted that one well known commentator appears to dispute the viability of this theory. In Williams & Myers, Oil and Gas Law, Vol. 1, §218.4 it is suggested that the owner of the surface rights for a drillsite may bar the use of that surface for a well location for a wellbore intended to produce oil and gas from adjoining premises even though the owner of mineral rights in the surface location has authorized such use. However, it is admitted in that discussion that there is little case authority to support this “veto power” of the surface owner.³

 

            In summary, it appears unlikely that the operator of a horizontal well may use the Oklahoma Surface Damages Act to access a surface location on land adjoining the drilling and spacing to be produced unless that operator owns an oil and gas lease from a mineral owner beneath both tracts. However, even that circumstance leaves questions about the Act’s availability to the operator.

 

 

II.

SURFACE AND/OR SUBSURFACE

TRESPASS ISSUES

 

 

            In Oklahoma “the owner of land in fee has the right to the surface and to everything permanently situated beneath or above it.” 60 O.S. §64. After the severance of oil and gas rights from the surface estate, the owner of the surface estate and the owner of the mineral estate are not considered to be co-tenants. As noted in Kuntz, Oil and Gas, §3.2(a) the relationship which remains after severance of the mineral estate “is more like that of adjoining landowners and there is no privity of estate between them . . .” The existence of that defined relationship following severance of the mineral estate raises several questions relating to the impact of horizontal drilling upon rights of owners of the divergent estates.

 

(A)       THE RIGHT TO DRILL THROUGH THE SUBSURFACE SOIL OF A TRACT.

 

            Under the original factual premise presented above, if the operator of the horizontal well reaches agreement with the surface owner of the actual drillsite it obviously avoids the problems presented by the limitations of the Oklahoma Surface Damages Act. However, what would happen if there is an intervening surface tract separating the drillsite from the drilling and spacing unit intended for development? For example, assume the drillsite is in the N/2 SW/4 of a section north of that drilling and spacing unit, but the surface of the S/2 SW/4 of that section is owned by a different party than the surface owner of the drillsite. Does the operator need to be concerned about reaching agreement with the surface owner of the S/2 SW/4 beneath whose land the wellbore will pass in drilling to the unit to be produced.   The answer is yes. The subsurface ‘soil” to be penetrated in the S/2 SW/4 of that section is owned by the surface owner of such tract. The wellbore’s penetration of that subsurface “soil” is an act entailing physical invasion thereof. “Trespass” involves actual physical invasion of real estate of another without the permission of the party lawfully entitled to possession. Williamson v. Fowler Toyota, Inc., 1998 OK 14, 956 P.2d 858. Admittedly there may be little, if any, compensable damage flow from that trespass. However, it would certainly seem to merit negotiation of a separate surface use agreement with the owner of the surface of the S/2 SW/4 of the section.

 

(B)       SUBSURFACE TRESPASS UPON THE RIGHTS OF A MINERAL OWNER, OR OIL AND GAS LESSEE.

 

            Under the hypothetical discussed above a question may arise regarding liability for trespass upon the mineral estate beneath the surface drillsite for the horizontal well, or the mineral estate of owners within any drilling and spacing unit incorporating that drillsite within its boundaries. It would appear in some jurisdictions that if a wellbore travels through a tract of land but does not produce from it, and absent interference with the owner of the mineral estate’s right to produce, the agreement with the surface owner would preclude liability. See e.g., Humble Oil & Refinery Co. v. L & G Oil Co., 259 S.W. 2d 933 (Austin App. 1953), as cited in 28 Energy & Min. L. Inst. Ch 14 (2008).⁴ There must be some chance of meaningful interference with the mineral owner’s right to develop. In Humble the court discounted a claim by the mineral owner that it “might” drill at such location in the future. The mineral owner would have needed to show that it needed the surface immediately. 

 

            There is no reported case in Oklahoma involving the suggested facts. However, the analysis of the Texas Court in Humble did not appear to depend upon property concepts different than those existing in Oklahoma.

 

            A more significant risk of subsurface trespass could exist within the drilling and spacing unit intended for development. Typically before an operator will commence operations for any well within a drilling and spacing unit in Oklahoma it will either commit all of the non-operating working interest to a voluntary agreement in the form of an operating agreement; or, subject such working interest to a forced pooling proceeding at the Corporation Commission. However, there are instances in which an operator may choose to “carry” an interest; or, simply fails to recognize the absence of an operating agreement or pooling order covering such a working interest owner. If that working interest owner owns all of a divided tract within the drilling and spacing unit there could arise issues of trespass as regards such interest. Those issues would be triggered if any portion of the horizontal lateral traverses through the divided tract of that owner.

 

            Drilling operations performed upon the land of a party with whom an operator has no agreement with the intention of producing oil and gas would constitute trespass. Trespass to real property includes the physical invasion or drilling upon the oil and gas lease owned by another party. Jennings v. Elliott, 97 P.2d 67.   Even if there exists a drilling and spacing unit which includes the divided tract within its boundaries such fact may not authorize the drilling of a horizontal lateral across such tract.

           

            In Kingwood Oil Company v. Hall-Jones Oil Corp., 1964 OK 231, 396 P.2d 510, the Oklahoma Supreme Court first raised the possibility of the issue discussed above but refused to rule on same. In that case the Court reversed a District Court dismissal of a claim for money damages involving a dry hole drilled in the W/2 of a 640-acre drilling and spacing unit by an operator owning leases only in the E/2 of the section. The leasehold owner in the W/2 of the unit sued for what the District Court characterized as “an action for damages in the nature of trespass to realty.” The District Court dismissed that claim based on a finding of exclusive jurisdiction by the Corporation Commission.    In its reversal of that dismissal the Supreme Court stated as follows:

            “At least by inference, [the operator] argues that the Commission’s entry of the well spacing order alone gave it the legal right to drill the well. This argument goes to the merit of plaintiff’s alleged cause of action which are not before us, and is of no assistance on the question of jurisdiction.” 396 P.2d at 513.

 

 

 

            There is no question that a pooling order issued by the Corporation Commission will create a relationship based on concurrent ownership between the unit operator and pooled non-operating working interest owners who elect to participate in unit development. In Texas Oil & Gas Corporation v. Rein, 1974 OK 8, 534 P.2d 1277,  the Oklahoma Supreme Court found that after the entry of a pooling order the unit operator could drill a well at any location authorized within the boundaries of the unit. The Appellant was an unleased mineral owner who also owned the surface of the drillsite for the initial unit well. He appealed the pooling order which covered his working interest claiming that the combination of such order and a location exception order for the well was an unconstitutional taking of his land. The court rejected his claim by holding as follows:

“We conclude that 87.1(b) authorized the Commission to establish the well location at any location upon the spacing unit and that §87.1(d) authorizes the Commission to pool the working interests within the spacing unit and designate an operator to drill and operate the well at the designated well location.

 

To hold otherwise would frustrate the intent of the Act because the owner desiring to drill would not be entitled to do so unless he held a lease covering the well location designated by the Commission.” 534 P2d at 1279.

 

 

            That holding does not make it clear whether a spacing order alone would protect the operator of a horizontal well with a portion of its lateral located within a divided tract in the unit owned by another working interest owner. It can certainly be argued that the conservation purposes intended to be furthered by drilling and spacing units may fail if the operator of a well within a spaced unit is limited in potential locations by virtue of a recalcitrant working interest owner. However, there is also no question that the obvious purpose of forced pooling is the removal of the risk imposed by that owner’s refusal to enter into a private agreement. I would strongly suggest that prior to drilling a lateral through any divided tract within a drilling and spacing unit not leased by the operator, a pooling order be obtained which covers that working interest.

 

III.

HORIZONTAL DRILLING AND SPACING UNITS

 

A.        HORIZONTAL DRILLING AND SPACING UNITS FOR GAS.

 

            The jurisdiction of the Oklahoma Corporation Commission relating to conservation of oil and gas is limited to the power expressly or impliedly granted to it by the Oklahoma Constitution or Statues.    Gulf Oil Corp. v. State, 1961 OK 71, 360 P.2d 933.   The provisions of 52 O.S. §87.1 provide to the Commission its power to establish drilling and spacing units. Prior to a 2007 amendment to that statute the Commission’s authority to establish such units was expressly limited by 52 O.S. §87.1(d). That statute originally prohibited drilling and spacing units larger than forty (40) acres in size for a common source of supply of oil, the top of which was shallower than 4,000 feet below the surface. Similar prohibitions prevented units larger than 80-acres in size for a common source of supply found shallower than 9,990 feet; and, prevented units greater than 160-acres in size for a common source of supply of oil found deeper than 9,990 feet.⁵   

 

            In 2007 the Legislature amended the conservation statute by adding 52 O.S. §87.1(f) as follows:

“Notwithstanding any provision of this section to the contrary, the Corporation Commission shall have jurisdiction upon the filing of a proper application therefor, and upon notice given as provided in subsection (d) above, to establish spacing rules for horizontally drilled oil wells whereby horizontally drilled oil wells may have well spacing units established up to six hundred forty (640) acres plus tolerances and variances as allowed for gas wells pursuant to subsection C of this section. For purposes of this subsection a ‘horizontally drilled oil well’ shall mean an oil well drilled, completed or recompleted in a manner in which the horizontal component of the completion interval in the geological formation exceeds the vertical component thereof and which horizontal component extends a minimum of one hundred fifty (150) feet in the formation. The Corporation Commission shall promulgate rules necessary for the proper administration of this subsection.” (Emphasis added)

 

 

            An immediate question arises from the highlighted language within this amendment to the conservation statute. Given the fact that the Commission may only draw its power to establish drilling and spacing units from that statute, does the Commission have the power to create a horizontal drilling and spacing unit for the production of predominantly gas? An attempt at answering that question requires digression to an explanation of the purpose and necessity of Oklahoma’s oil and gas conservation law. 

 

            Oklahoma, like a number of other states with significant oil and gas reserves, experienced the wasteful practice of production of oil and gas by too many wells drilled in too close a proximity to each other. In response to that fact the Conservation Act was originally enacted to avoid the drilling of unnecessary wells.⁶ 

 

            The Oklahoma oil and gas conservation statutes have as their primary purpose the protection of correlative rights of owners in common sources of supply, including prohibition of waste of oil and gas. The Oklahoma Supreme Court has condoned the exercise by the Commission of the State’s police power to regulate the drilling and production of oil and gas wells based upon such statute.   See Anderson-Prichard Oil Corp. v. Corporation Commission of Oklahoma, 205 Okla. 672, 241 P.2d 363, appeal dismissed 72 S.Ct. 562, 342 U.S. 038, 96 L.Ed. 698.

 

            Express language contained within the conservation statute simultaneously authorizes creation of drilling and spacing units and limits the number of wells which can be produced therein. 52 O.S. §87.1(c) includes a directive that any spacing order entered by the Commission specify the geographical surface boundaries of a unit; the size and shape of such unit; the drilling pattern for such unit; and, the location of the permitted well. That same provision obligates the Commission to issue spacing orders which “direct that no more than one well shall hereafter be produced from the common source of supply on any unit so established . . .” As noted above the statute expressly limits the size of drilling and spacing units. However, other than the general admonition for establishing a well pattern and location as described above, there is no specific footage set back requirement prescribed therein. The latter fact is significant in the analysis of the Commission’s power to create horizontal gas units. 

 

            The most apparent purpose of 52 O.S. §87.1(f) was the expansion of Commission authority so as to allow creation of an oil unit for horizontal wells of a size which would otherwise have been prohibited by the depth related unit size limitations of 40-acres, 80-acres or 160-acres for standard oil units. If that was the only purpose of the amendment, the Commission should not be constrained from creating horizontal drilling and spacing units for production of predominantly gas.   The provisions of 52 O.S. §87.1(c) already authorize the creation of drilling and spacing units for gas up to 640-acres in size. Nothing within that particular provision dictates that the authorized well for such units be drilled as a vertical well. In fact, directionally drilled wells have never been suggested to be prohibited by the wording of the statute. Accordingly, it would seem to follow that there is no prohibition of horizontal gas units as long as the 640-acre limitation is acknowledged.

 

            There is an esoteric argument that the potentially different productive characteristics of a horizontal well should be considered as significant to this argument. Although not necessarily supported by exact engineering modeling, there is often an assumption of radial drainage by a vertically drilled well. Arguably, the production of gas from a horizontal lateral changes that drainage pattern so as to exacerbate the effect upon the common source of supply in adjoining lands.   Given that assumed fact, it could be argued that the Legislature purposely limited the Commission’s power to create horizontal units to common sources of supply producing primarily oil. However, that position appears to be less supportable for no other reason than that it depends upon too many technical assumptions.  

            Another argument against Commission authority to create horizontal gas units might be based upon a contention that a horizontal unit allows the drilling of gas wells closer to an adjoining tract than would be allowed in a standard unit. There is an admitted advantage in the creation of horizontal drilling and spacing units if the permitted bottomhole locations authorized by the spacing order for such unit provides for such fact. However, that advantage has nothing to do with the statutory language of 52 O.S. 87.1(f). As noted above no part of the conservation statute has express requirements for permitted well locations. The more liberal location allowables for a horizontal unit are found in the rules implemented by the Commission.

 

 

 

 

B.        THE ADVANTAGES AND DISADVANTAGES OF HORIZONTAL DRILLING AND SPACING UNITS.

 

 

            If my opinion is requested by a client concerning whether to consider creation of horizontal drilling and spacing units for a particular geological prospect, my first question concerns whether the anticipated production is oil or gas. If the answer is that gas is expected my typical recommendation is that no application be filed for horizontal units. That answer is not based upon a jurisdictional concern. Rather, it is offered because the disadvantages of those units will often outweigh the advantage of drilling gas wells on non-horizontal units.

 

            There are two (2) primary advantages to a horizontal drilling and spacing unit. The first has application only to common sources of supply of oil. As noted above the size limitations for oil units contained within 52 O.S. §87.1(d) are removed by 52 O.S. §87.1(f).   The second advantage is a product of Corporation Commission rules for horizontal units. By virtue of Rule 165:10-1-24(a) of The General Rules of Oklahoma Corporation Commission the permitted location for a standard 40-acre unit, or the proper square 40-acre tract within a standard 80-acre unit, is not less than 330 feet from the boundary thereof. For a standard 160-acre unit, or the proper square 160-acre tract within any standard 320-acre unit, the permitted location is not closer than 660 feet from the boundary thereof. Finally, for a standard 640-acre unit the permitted location is not less than 1,320 feet from its boundary.     Rule 165:10-3-28(I) of those same General Rules relaxes the location requirements for horizontal units. The permitted location for any 80-acre or 160-acre horizontal well unit is not less than 330 feet from its boundary. The permitted location for a 320-acre or 640-acre horizontal well unit is not less than 660 feet from its boundary. Given that the first stated advantage has relevance only to oil units, the question raised if horizontal gas units are considered is whether the location allowances are enough of an advantage to overcome the problems with horizontal units.

 

            The liberal permitted locations for a 640-acre horizontal gas unit could be a significant advantage if opposition to a location exception request by an offset owner is anticipated. However, in many instances the horizontal well is being drilled because the formation is tight. That fact would tend to inhibit the ability of a protesting offset owner to either deny a location exception, or have an allowable adjustment imposed by the Commission. If that is the case, the delay caused by such protest is all that is avoided by creation of a horizontal unit.

 

            It is a fact that there is an enhanced production allowable for horizontal oil wells as described in Appendix C (Table HD) of The General Rules of the Commission.   But that increased allowable applies to any horizontally drilled oil well, not just to a well drilled in a horizontal unit. Admittedly to qualify for the highest potential allowable a minimum length of lateral must be drilled. If there is the potential for producing high volumes of oil these allowable rules do provide significant advantage to oil wells drilled in horizontal units for the simple reason that the limitations on the size of standard oil units would not allow room within which to drill the required length of lateral.  

 

            Notwithstanding the foregoing, there is one distinct disadvantage to horizontal drilling and spacing units which may override all of the described benefits accruing therefrom. That disadvantage is not a function of the provisions of 52 O.S. §87.1(f). Rather, it results from the practical implementation of horizontal units by the Corporation Commission.

 

            The Commission currently issues its spacing orders for horizontal drilling and spacing units in the form of interim orders. The operator of a horizontal well must drill the horizontal well and run bottomhole surveys during its drilling. After the surveys are run and the length and direction of the lateral identified, the operator must return to the Commission for an additional hearing before an Administrative Law Judge. If the lateral length is less than that anticipated by the Commission Rules for a specific size of unit, notice of such fact must be sent to all respondents to the application. The Commission retains the discretion to reduce the size of the horizontal unit after submission of such facts. Obviously, those facts creates risk for the parties who participated in the expense of drilling the horizontal well. A portion of the rights acquired under the interim order will be lost if the unit’s acreage is reduced. That risk is increased if there was the necessity of pooling working interest owners prior to drilling. Although the pooling orders issued by the Corporation Commission are not denominated as interim orders, the interim nature of the underlying spacing order effectively transforms the pooling order to that same type of order. If the Commission were to eliminate a portion of the original unit there would exist a question concerning the effect of such action on “vested” rights under the pooling order.

 

            There is an argument under Eason Oil v. Howard Engineering, 1990 OK 101, 801 P.2d 710, that the rights of participating working interest owners would vest in the initial horizontal well; and, that a reduction in unit size subsequent to the completion of that well should not impact those rights. However, the facts in Eason involved a change in standard units from 640-acres to 160-acre units based on a change in knowledge of condition. There is no guarantee that a court considering a change to an interim order would come to a similar conclusion. Additionally, the application of the Eason principles would not change the impact upon royalty interests and the inability to perpetuate leasehold which would follow.

 

            The Rules of the Corporation Commission allow a horizontal well to be drilled in a standard unit. See Rule 165:10-3-27(e)(I). If the size of a standard unit provides the latitude to drill a horizontal lateral, there are none of the problems associated with the interim nature of spacing orders for horizontal units. Accordingly, standard units will typically be favored for common sources of supply of gas.

 

C.        MISCELLANEOUS PROVISIONS FOR HORIZONTAL DRILLING AND SPACING UNITS.

 

 

(1)       Horizontal well units shall be created as new units after notice and hearing as provided for by the Rules of Practice of the Commission. See Rule 165:3-27(e)(2).

 

            (2)       A horizontal well unit may be established for a common source of supply for which there are already established “non-horizontal” drilling and spacing units. Such horizontal well unit may include within the boundaries thereof more than one existing non-horizontal drilling and spacing unit for the common source of supply. See Rule 165:10-3-27(e).

 

            (3)       “Horizontal well units may exist concurrently with producing non-horizontal drilling and spacing units.”   See Rule 165:10-3-27(e)(3)(A).⁷

 

            (4)       “Horizontal well units shall supersede existing non-developed non-horizontal drilling and spacing units for the duration of the horizontal well unit.” See Rule 165:10-3-27(e)(3)(B).⁸

 

            (5)       “All laterals in the same common source of supply in a horizontal well with at least one lateral which exceeds 150 feet of total horizontal component shall be considered as a single wellbore for allowable purposes.” See Rule 165:10-3-27(f)(1)

 

            (6)       “The size of the proposed horizontal well unit shall be determined by the projected length of the horizontal component as shown in Appendix C (Table HD) to this chapter.” See Rule 165:10-3-27(b)(1).⁹

 

            (7)       “The allowable for the horizontal well shall be determined by the actual length of the lateral as shown in Appendix C (Table HD) to this chapter.” See Rule 165:10-3-27(h)(2).¹⁰

 

            (8)       “The Commission may issue an order establishing horizontal well units for a common source of supply. The order shall be in effect for a period of twelve (12) months from the date of issuance and shall automatically expire at the end of the twelve (12) month period unless:

(1)               Operations for a horizontal well are being conducted, in which case the order shall expire thirty (30) days after completion of operations.

 

(2)               Form 1002A has been filed by the Commission.

 

 (3)      The order has been previously voided by written request of the applicant.

 

(4)       A request seeking an extension of time has been submitted.” Rule 165:5-7-7(q) of the Rules of Practice the Corporation Commission.