Capture and Release?

Petroleum has been one of the most peculiar “minerals” (in a legal sense) owing to its existence as a fluid; only groundwater faces similarly bizarre legal contortions. (If you want all the details, read Finders, Keepers by Terence Daintith.) The development of laws that were forward looking for conventional oil and gas development are now causing heartburn in unconventional development.

Recall that originally, you could drill straight down and hit an oil pool and oil might come out all on its own. The oil that came up could be coming from neighboring lands. Courts decided, using (of all things) the common law pertaining to capture of wild animals, to decide that this was OK.  If you “captured” that wild oil, it was yours to keep; hence, this is called the rule (or law) of capture.  This was utterly different than the decisions reached on other mineral rights that didn’t move around.

The result of the rule of capture was an insane style of production.  Each landowner wanted to get the most oil, and they wanted to preserve the oil under their land.  So they would drill as close to the land’s boundaries as possible and go as fast as possible in the hopes of extracting resources from neighboring lands and preventing loss of their own reserves. The result overall was a decrease in the total production from many oil fields as reservoir pressures decreased rapidly while at the same time maximizing surface damage.  The pictures of forests of derricks at, say Spindletop in Texas or Signal Hill in Southern California arose from this.

 

The rules were largely left to states, many of which started to introduce unitization laws that tried to remove the incentive to extract everything in the craziest manner possible. Colorado, for instance, has such a law. The basic idea is that if a field starts to be produced, all the mineral rights holders will gain from the extraction in some proportion. For this to work, some rights holders can’t stop the proceedings: if one mineral rights holder’s objections would prevent drilling and production, then all the other rights holders would be losing their mineral rights to some degree. So there is some measure usually applied.  Here in Colorado, all it takes is one rights holder to say they want to produce to trigger the unitization process, thus leading this to also be called “forced pooling”–you might not have wanted your oil and gas to be extracted, but you are forced into the pool so that others can get theirs.

Unhappily, this makes no sense with the latest unconventional resources.

It is because the reason the resources are called unconventional is that they are locked in the rocks in ways that the conventional oil and gas reservoirs were not.  If I drill on my land and frack my drill hole, I will only get oil (or gas) from the volume that was fractured.  I won’t be draining my neighbors’ oil unless my fractures cross property lines, something that is mostly under the control of the operator. So, unlike traditional oil and gas development, there is no “capture” the way there was in the past. Arguably this rule should be ditched for unconventional resources.

Mind, this is not the position of the oil and gas industry, which finds these rules beneficial. Of course ditching the rule would complicate unconventional development.  Right now, get one rights holder to agree to develop and the industry can go in and drill–and slant drill under neighboring lands.  Unlike old rule of capture restrictions, in a unitized field you can slant drill into the resource under neighboring lands, and this has by and large been a good thing as it reduced the number of drill pads and the overall surface disturbance associated with petroleum exploitation. If the forced pooling rule were dropped, then the geometry of horizontal drill holes would have to conform to the geometry of rights holders who agreed to development. This would require somewhat more negotiation with rights holders and could result in some drill pad locations becoming subeconomic. And you know what?  This is totally fair.

Right now, if someone holds the mineral rights for an acre of land and wants to develop his or her oil and gas, a company can come in and claim the field extends out into hundreds of surrounding acres of land. Now the value of the oil and gas under that one acre is certainly subeconomic–it isn’t worth that much, but using that acre to crowbar open the surrounding lands can make it economic to drill and frack and recover the oil or gas from that one acre along with all the neighbors.

If unitization rules were dropped for unconventional development, things would get a lot more complex–but they would in turn be fairer to the rights holders. That one acre holder would not get anything from that mineral right if all the neighbors said they didn’t want development simply because that one acre wasn’t worth it. The neighbors could hold out for a better paycheck, or they could say they wanted to hold out for some amount of time thinking the value of their oil or gas would be more down the road–it doesn’t matter why, it just means that they are free to exercise their mineral rights when and how they choose to.

Conversely, if a lot of rights holders wanted to develop and there was a small parcel that didn’t, that one parcel would not block development of anything other than their small parcel. At worst, this would complicate a drilling plan; it shouldn’t prevent exploitation of the parcels willing to drill. [Of course, when you figure in restrictions on drill pad location, it is possible that development in an area can only be done from one surface location, and if that was the parcel declining to participate, things do get messy, but that is why you write laws very carefully, so as to anticipate these complications].

There is an irony in the legal decisions that originally controlled the American oil industry were counterproductive and unfair to rights owners for conventional resources, but that the eventual imposition of smarter and fairer rules for conventional oil are in fact counterproductive for rights holders of unconventional oil and gas resources. It seems like we are always behind the curve…

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