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Cross-Unit Horizontal Wells: Division of Interest Issues

A cross-unit horizontal well is one that begins in one pooled unit or non-pooled tract and ends in another pooled unit or non-pooled tract, but involves at least one pooled unit in its lateral path. The horizontal wellbore, or lateral as it is more commonly called, traverses more than one unit or large tract. Production from each pooled unit or non-pooled tract typically is measured by the ratio of the total feet of lateral in the horizontal well. The length of producing lateral is measured either from first take point (FTP) to last take point (LTP), or from penetration point to terminus.

There are three common issues that can come into play when the division order analyst begins analyzing documents to build the initial division of interest (DOI). These issues are not always present in a horizontal well, but occur often enough to deserve discussion. The three issues are (1) non-participating royalty interest (NPRI), (2) unleased mineral interest, and (3) entire unleased tract in the path of the wellbore.

Non-participating interests (NPRI) are discussed in the February 7, 2022 blog, “Common DOI Management Issues: Interest Types,” but additional information well be given here. Both NPRI types (explained in the earlier blog) have the same title restrictions for inclusion in, or exclusion from, the revenue DOI.

Courts have permanently decided that an NPRI owner is not bound by the pooling clause in the lease that includes the non-executive NPRI interest. If their path is outside the lateral path, in order to be entitled to revenues an NPRI owner must agree independently to pool their interest. Pooling the NPRI will proportionately reduce it by the size of the pooled area. An NPRI owner can agree to pool their interest in two ways. They may (1) sign a Ratification of Oil and Gas Lease ratifying the lease covering their NPRI interest, or (2) sign a Ratification of Pooled Unit. Each has different ramifications for the NPRI owner, and DOI setup by the division order analyst for future density wells, but either one will allow their inclusion in the revenue DOI for the well at hand.

If an NPRI interest is inside the lateral path (drill site area) the NPRI is entitled to be included in the DOI without any ratification. However, they are entitled to their 100% NPRI share of the portion of production being sold from their tract, calculated by length of producing lateral inside their tract(s) divided by total lateral length. For the portion of the lateral inside the tract to be considered a producing portion, it must contain at least one take point. If it does not, the tract is considered non-producing and again, the NPRI owner receives no revenues without a ratification of the lease that has been pooled, or the pooled unit itself.

The strongest issue with unratified NPRIs involves additional horizontal wells in the pooled unit, known as density wells, or in-field drilling. A new lateral positioned elsewhere in the unit could then exclude an unratified NPRI from that new well’s DOI. For this reason, the analyst should never copy directly the revenue DOI from the initial well to create the DOI for a subsequent well without making substantial modifications. This is true even if the wells were completed and turned to sales only days or weeks apart.

The next issue, unleased interests, is similar in nature to the NPRI issue. Like the NPRI, an unleased interest outside the horizontal well site is not entitled to any revenues for the life of the well. Likewise, an unleased owner may ratify the pooled unit and be included in the DOI regardless of location in the pooled unit.

The potential problem exists that each unleased owner in the unit area, regardless of location in the unit area, must be offered the opportunity to ratify the pooled unit when the horizontal well pays out. Quite often, unleased owners receiving the offer will ask to be leased instead. If such a lease is negotiated and signed, now the division order analyst must transfer the unleased owner’s APO decimal to the portion now owned as RI by the owner, and the remainder as net WI owned by the company. If the unleased owner becomes leased while the well is still paying out, the analyst must carve out the unleased decimal portion from the company’s BPO net WI. That small decimal must be divided into two parts, the royalty payable to the previously unleased owner, and the remainder belonging to the company as permanent net leasehold working interest. For this reason, many analysts are wise to set up the original revenue BPO DOI crediting the company with a net leasehold WI decimal, and a gross unleased WI decimal. A separate list of all unleased owners and their decimal interest is maintained as part of the original setup spreadsheet, for quick and easy reference.

If the lease is taken during the payout period, the landman must inform the analyst what effective date to use. Some companies will pay an owner a larger bonus agreed to cover royalties that would have been due from date of first sales to the effective date of the lease. Otherwise, the lease should state the date it was signed, but clearly state it is effective the date of first sales from the named well. The analyst must follow company policy, workflow procedures, and database instructions as to how to transfer the interest and pay retroactive royalties should the situation warrant.

The final issue is lease common of the issues being discussed here, but nonetheless is important for the analyst to know.

A horizontal lateral can cross from a leased, or partially leased, pooled unit or non-pooled tract, travel through a completely unleased tract, then terminate in another pooled unit or non-pooled tract. Legal issues outside the scope of this week’s blog aside, an operator is allowed to drill only on a tract if it is at least partially leased, or the operator has some other contractual agreement with at least one unleased owner to drill on the tract. Remember, a tract is not “drilled” unless it contains a take point. When no contractual agreement can be reached, the wellbore may travel through the unleased tract, but cannot extract any production from it—no take points. The mineral rights owner(s) in the 100% unleased tract will never be entitled to receive revenues for the life of the well.

When such a rare situation occurs, the section of lateral crossing the 100% unleased tract must be omitted entirely from the “total lateral length” of the horizontal well. The remaining lateral length with take points is distributed among the leased tracts or pooled unit, accordingly. Only in this way can 100% of the production revenues be distributed correctly among all owners entitled to receive them.

This last issue discussed here, of a 100% unleased tract lying in the path of a horizontal well lateral, is easily resolved in states with actively-used involuntary (forced) pooling statues, such as Louisiana and Oklahoma.

Next week’s blog will be “Basic Pooling Comparisons Between Texas, Louisiana, and Oklahoma Horizontal Wells.”

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