One question that I am repeatedly asked lately is what are Allocation Wells and how is royalty calculated in one for division order purposes? So, I thought I would answer those questions in this month’s newsletter and begin a series about this important current topic. For this month’s newsletter, we’ll answer these questions beginning with what is an allocation well?
What is An Allocation Well?
An allocation well is a type of horizontal well that allows a lessee with a 100% working interest in two or more adjacent tracts to drill a well that traverses (and produces from) each tract. For a lessee, one benefit of an allocation well is that no pooling authority is required even though each tract may be owned by different lessors (mineral owners).
What’s the difference between an Allocation Well and a Production Sharing Agreement (PSA) Well?
First, it’s important to recognize that often attorneys may use the term Allocation Well to refer to both Allocation Wells and PSA wells, but there are distinct differences. Second, both the Allocation Well and the PSA well are designations of the Texas Railroad Commission (RRC), the administrative body in Texas tasked with regulating railroads and other transportation carriers like pipelines, and thus oil and gas. A PSA is an agreement between the parties that specifies how production is to be allocated.
The RRC requires 65% of all interest owners to agree to a PSA before it will approve a permit for a PSA well. Often, this is difficult or impossible to attain. The RRC granted the first Allocation Well permit in 2010 to Devon. Devon attempted to secure a PSA from its interest owners but lacked the requisite 65% approval. Nevertheless, Devon still applied for the permit but labeled the well as an Allocation Well and the RRC approved the permit. With that was born the Allocation Well which required no approval (as in ZERO) from interest owners. So, in an Allocation Well, there is no PSA and no requirement of approval by the interest owners.
How are Royalties Calculated in an Allocation Well?
First, let’s look at how royalty is calculated in traditional pooling to fully comprehend the distinction in the two formulas. In a pooled unit, royalty payments are calculated based on a tract participation actor (TPF). The TPF formula is the number of the lessor’s lease acres included in the unit as the numerator and the total number of acres in the unit as the denominator:
Instead of a TPF, in an allocation well, royalty payments are calculated based on an allocation factor. That is, a formula is used that purports to quantify what production is attributable to each tract. Typically, that formula is productive lateral length of the horizontal wellbore on lessor’s tract(s) as the numerator and the total horizontal wellbore length as the denominator.
Total horizontal wellbore length
Why Isn’t Pooling Required if there is different ownership in different tracts?
According to the RRC, the reason pooling is not required in an Allocation Well is that a horizontal well is treated as a vertical well for purposes of the oil and gas lease. In other words, under the terms of a typical lease, a lessee has the option to drill a vertical well on any tracts he’s leased, even if the tracts are adjacent to one another. A horizontal well is treated as if it’s a vertical well so that, even though it can traverse lease lines, each tract is treated as if it holds a single vertical well.
Stay tuned for next month’s newsletter when we’ll have even further discussion on Allocation Wells.
Reference Sources and Suggested Reading
- Allocation Wells in the Permian Basin, presented to the Rocky Mountain Mineral Law Institute in Santa Fe NM – July 20-22, 2017 by Michael E. McElroy, McElroy, Sullivan, Miller & Weber, LLP, Austin, Texas
- Ernest E. Smith, Applying Familiar Concepts to New Technology: Under the Traditional Oil and Gas Lease, a Lessee Does Not Need Pooling Authority to Drill a Horizontal Well That Crosses Lease Lines, 3 Oil & Gas, Nat. Resources & Energy J. 553, 569 (2017).
- Clifton A. Squibb, The Age of Allocation: The End of Pooling As We Know It?, 45 Tex. Tech L. Rev. 929, 948 (2013).
- Browning v. Luecke 38 S.W.3d 625, 647 (Tex. App. – Austin, 2000). PLAINTIFFS’ ORIGINAL PETITION FOR JUDICIAL REVIEW in the 53rd District Court, Travis County. Monroe Properties , Inc. et al. vs Railroad Commission of Texas, No. D-1-GN-18-001111.
- Bret Wells, Allocation Wells, Unauthorized Pooling, and the Lessor’s Remedies, online at https://www.baylor.edu/law/review/doc.php/271080.pdf
- Doug J. Dashiell, Allocation Wells/Production Sharing Agreements/Pooling, Oil, Gas & Energy Resources Law (October 2015)
- POOLING WITHOUT POOLING: THE HISTORY OF PSA AND ALLOCATION WELLS IN TEXAS Lance B. Joiner, Joiner Law PC League City, Texas www.joiner-law.com