Forced Pooling: Both Sides of the Story

June 6, 2011

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Forced Pooling: Both Sides of the Story

Anywhere there is the potential for growth—the human body, the natural world, the business community—there also exists the reality of growing pains, and West Virginia’s thriving energy industry is no different. As the Marcellus Shale sector grows by leaps and bounds, it sees its share of growing pains, and this might be most evident in the arguments surrounding forced pooling. According to the USLegal.com Web site, forced pooling is defined as both “the act of being forced by state law into participation in an oil and/or gas producing unit” and as “a technique used by oil and gas development companies to organize an oil or gas field.”

Mineral owners who have not volunteered to participate in a drilling project that will take place on a plot of land that includes their private property can be forced to participate through forced pooling. These mineral owners are then compensated based upon the percentage of the whole plot that their contributing force-pooled acreage creates, which can become a confusing arrangement for landowners, particularly those who have little or no experience with forced pooling.

To offer some clarity on the topic, West Virginia Executive sought out two industry professionals to explain both sides of the forced pooling debate. Here, George Patterson explains the positive aspects of forced pooling while Tim Greene offers the opposing position that argues against forced pooling legislation.

 

The Case For Forced Pooling

By George Patterson

Gas producers are using new directional drilling technology to lower costs and develop West Virginia’s vast Marcellus Shale natural gas reservoir. Drillers penetrated the Marcellus Shale vertically for years, but drilling and completing a vertical well with the technology available was not a good use of capital. Recent technology advancements allow wells to penetrate the Marcellus formation vertically, approximately 6,000 to 7,000 feet in depth, and then drill horizontally in the formation as far as 8,000 feet. These horizontal wells are profitable because so much more of the producing formation is opened by drilling horizontally. Unfortunately, horizontal development of the Marcellus Shale is materially hindered by our legal rules, including the rule of capture.

The rule of capture is rooted in English decisions regarding ownership of wildlife. Law students study the case about a wild fox. The English court decided that the fox roamed freely from property to property, could be captured by a property owner on their own property and whoever captured the fox could keep the fox. Like wildlife, oil can migrate from property to property but flows underground. Property owners could drill on their own property, and if oil was captured, it was owned by the capturing owner at the surface free from claims of adjoining owners. If an adjoining owner wanted to capture oil or gas, then the adjoining owner could drill a well on their own property. Wells were drilled side by side.

When the rule of capture was adopted, little consideration was given to whether it was wise to drill two wells or whether one well would produce all the oil and gas underlying both pieces of property. No one imagined that the state could provide a means for the owners of two or more properties to pool together their resources, share the cost of development, save money by drilling only one well and produce the same amount of oil or gas from one jointly owned well.

The West Virginia Supreme Court also decided that a small fraction of unwilling owners can prevent drilling. Oil and gas land is generally valuable, frequently inherited and often owned by many heirs. Lease ownership may be splintered, too. Some people cannot be found; others object to drilling. Given that many West Virginia tracts of land are small, many horizontal wells will need to cross more than one tract of land, and that is not legally permitted unless the owners of all tracts agree. Because the owner of the tract where the well enters the ground traditionally captured all of the royalties, obtaining an agreement to divide a horizontal well’s royalties can be difficult.

Forced pooling for horizontal wells is a means for producers to pool their resources and drill wells based on economic use of capital and geological information. Pooling solves the problems created by our old legal rules, and obtaining gas for a lower cost benefits everyone. Instead of applying the rule of capture, pooling is a means of sharing income from a well regardless of the location where the well first enters the ground. Under most horizontal pooling plans, majority ownership can force the minority to share income or sell their interest, and pooling thus provides a means of leasing or acquiring non-consenting interests. A unit is formed for each horizontal lateral and therefore permits the most cost-effective means of recovering the most gas reserves.

In West Virginia, forced pooling already exists and is working for deep wells, shallow secondary oil recovery and coalbed methane wells. Pooling is available in one form or another under federal law and in most producing states.

One typical horizontal Marcellus Shale well can recover the equivalent natural gas reserves of up to 15 vertically drilled shallow wells. Oftentimes multiple wells, as many as six or eight, can be drilled in different horizontal directions from the same surface location. Environmentally conscious surface owners favor forced pooling because horizontally drilling several wells from the same location causes much less surface disturbance than recovering the same gas by drilling vertically from many different locations. When pooling occurs, tracts too small for horizontal drilling can be pooled so that more royalty owners receive oil or gas income.

People need gas and the associated hydrocarbon liquids to heat homes, generate electricity and produce petrochemicals. A federally funded study estimates that the cumulative value of West Virginia Marcellus Shale production will total $200 billion through 2020. This study predicts that Marcellus drilling will continue, grow steadily and provide in the year 2020 alone $1.5 billion in payments to suppliers, $1.2 billion in royalties, $117 million in payroll, $697 million in state and local taxes, $872 million in total taxes and 16,863 jobs. With forced pooling, West Virginia can receive substantial economic benefit, the interests of the majority achieved and the interests of the minority ownership financially compensated. Forced pooling for horizontal wells is essential to capitalizing on this amazing economic opportunity.

 

An Argument Against Forced Pooling

By Tim Greene

The issue of forced pooling for most landowners is a very emotional one. Most mineral owners, particularly small mineral owners, have a special attachment to their property. Many live on the property and have lived there for generations. Imagine a gas operator representative telling you that they are going to produce your gas without the benefit of a fair gas lease and that you might as well accept their offer because they are going to force pool your property anyway. To the small mineral owner, forced pooling is just another tactic by the gas industry to get the mineral owner to accept a less than fair gas lease, and I have heard of hundreds of cases like this in just the past six months.

As a mineral owner works through the process of negotiating a fair gas lease, each owner’s needs may be completely different than other owners in the proposed unit. Those needs may range from not wanting a well drilled on their surface to being concerned about where the gas company will get the water required for fracing the well. Once the forced pooling card is played, the landowner will lose most, if not all, of his control over what may happen on his property.

Compensation for those mineral owners that are force-pooled is unfair. Imagine if each mineral owner in the proposed pool accepts a lease offer that is below the market value or the area is already held by production under an old gas lease. The force-pooled mineral owners may then have to accept the same low values. Forced pooling negates the need for the gas companies to negotiate a fair lease with the mineral owner, and typically forced pooling does not allow for a bonus payment to be paid to the mineral owner being forced, another revenue stream that could be denied.

Forced pooling might also allow for the gas companies to take deductions from the mineral owner’s royalty revenues, therefore lowering the amount of royalty revenues the mineral owner actually receives each pay period. These deductions often are expenses incurred by the gas company that should not be shared with the royalty owner unless specifically agreed to by the royalty owner. If this happens, the mineral owner is effectively changed from a royalty owner to a working interest owner.

The force-pooled scenario does not consider what is called a Pugh Clause. This means the gas company can include some or the entire leased mineral into the unit. Imagine leasing 100 acres to the gas company and then having just 10 acres included in the unit. This omission would certainly leave the mineral owner with very little acreage in the unit and therefore less revenue. This would also mean that the acreage that is not considered in the unit would still be leased and not in the control of the mineral owner for many years to come.

Forced pooling generally limits the ability of mineral owners, particularly the small mineral owner, to negotiate a gas lease that is fair to them. These mineral owners, more often than not, do not have the finances required to compel the gas company to negotiate a fair lease. If the gas companies are able to force pool, these mineral owners may feel the agony of defeat before the negotiations even begin. Mineral owners, small or large, should have a level playing field when it comes to dealing with a gas company.

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