[co-author: Micheal Streitmann]
In Ammonite Oil & Gas Corp. v. R.R. Comm’n of Tex.,[1] the Texas Supreme Court held that the Railroad Commission (the “RRC”) did not abuse its discretion in denying a “muscle in” application under the Texas Mineral Interest Pooling Act (“MIPA”).[2]
Although seldom invoked when compared with other states, MIPA provides “stranded” mineral owners with a mechanism to compulsory pool – or muscle into – an adjacent unit.[3] In order to prevail under a MIPA action, the applicant must first make a fair and reasonable offer to pool voluntarily.[4] The commission must then determine that the pooling order would (i) avoid the drilling of unnecessary wells, (ii) protect correlative rights, and/or (iii) prevent waste.[5]
These thresholds are high enough that MIPA is sometimes described as “forced voluntary pooling” as opposed to true compulsory pooling.[6] However, once the thresholds have been met MIPA rulings are no exception to the general rule that courts will defer to agency decisions. To be overturned, a MIPA decision must be “arbitrary or capricious or otherwise characterized by an abuse of discretion.”[7]
Procedural Background
In this case, Ammonite Oil & Gas Corporation (“Ammonite”) took a riverbed lease from the State of Texas and sought to force the interest into EOG Resources’ (“EOG”) adjacent unit. When a pooling agreement was not reached with EOG, Ammonite applied for a forced pooling order under MIPA. The RRC denied Ammonite’s application because, in the Commission’s view, Ammonite failed to make a fair and reasonable offer and forced pooling would not prevent waste, protect correlative rights, or avoid the drilling of unnecessary wells. Ammonite appealed to a trial court, who denied their petition for review. The San Antonio Court of Appeals upheld the denial for review, and the Texas Supreme Court granted a petition to review the Court of Appeals’ decision.
Factual Background
Ammonite is a family business that focuses on acquiring State riverbed leases and stranded state tracts with the intent of pooling their interests.[8] The State of Texas owns the minerals beneath navigable riverbeds and leases its minerals through the General Land Office. Here, the State leased a tract to Ammonite in McMullen County beneath the Frio River in January of 2015.[9] EOG leased the land on each side of the river and permitted 16 new oil wells. Between April and October of 2015, Ammonite sent multiple letters to EOG proposing the formation of 16 pooled units which included the plats EOG used in obtaining their permits. EOG’s plats did not show that any of their wells would physically traverse or frac under the riverbed where Ammonite was leased.[10]
As with pooled units, the working interest owners were required to pay production costs. Ammonite’s solution was to pay production costs from their share of royalties and include a risk penalty of 10% “or such greater penalty as may be prescribed by the Railroad Commission if a MIPA case should have to be adjudicated before that agency.”[11] EOG rejected their offers because the terms of their leases prohibited them from accepting a voluntary-pooling offer and because they felt Ammonite’s offers were not fair and reasonable due to EOG’s wells not being able to reach the riverbed reservoir.[12]
After the pooling offer was rejected by EOG, Ammonite filed for a MIPA forced pooling order. The hearing was in January of 2017. At this time, each of EOG’s wells were completed though none were actually draining Ammonite’s tract.[13] EOG argued that Ammonite’s offers to pool were not fair and reasonable because the wells did not actually drain the riverbed minerals.[14] EOG’s expert witness explained that wells in the Eagleville (Eagle Ford-1) Field require immense capital investment and that the shale there has ultralow permeability which requires a fracture of the rock.[15] This practice demands horizontal drilling and hydraulic fracture stimulation techniques for commerciality, explained Smith. As such, the 10% risk factor was not fair and reasonable; rather, a 100% risk factor was appropriate according to Smith.
Finally, EOG’s expert testified that the minerals beneath the riverbed were not stranded. However, he did acknowledge that the difficulty and cost of extracting minerals beneath a meandering riverbed would require a more favorable economic climate.[16] The hearing examiners recommended approval of Ammonite’s pooling applications, but the RRC rejected their proposal for two reasons. The first reason was because Ammonite’s offer was not fair and reasonable.[17] The second was because forced pooling would not prevent waste, protect correlative rights, or avoid the drilling of unnecessary wells.[18]
The Supreme Court’s Decision
The first issue addressed by the Texas Supreme Court was whether Ammonite’s offer was fair and reasonable.[19] MIPA does not define “fair and reasonable,” and these measures are intended to allow flexibility. The decision is thus left to the Commission’s discretion, supported by substantial evidence. Here, the RRC found that Ammonite’s offer was not fair and reasonable, but based on its written opinion it was not exactly clear why.[20]
One possible basis for rejecting Ammonite’s offer to pool was that they did not provide survey data or a metes and bounds description of the riverbed to establish the precise acreage to be pooled.[21] Another possible basis for rejection was the proposed 10% risk penalty, an amount much lower than the 100% risk penalty available under MIPA. However, neither of these theories proved convincing to the Supreme Court.[22]
Instead, the court found that Ammonite’s offer to pool was not fair and reasonable because the offers were based on EOG’s wells as permitted.[23] It focused on the fact that EOG’s wells were not permitted to penetrate the tract beneath the Ammonite’s riverbed acreage and there was no evidence to suggest that Ammonite’s riverbed acreage would be drained. This meant that Ammonite would get to participate in production without actually contributing its minerals.[24] Thus, any “recoverable oil and gas that may exist beneath Ammonite’s lease [would] remain beneath its lease.”[25] This would, in essence, allow Ammonite to have its cake and eat it too.
In support of its decision, the court pointed to Railroad Commission of Texas v. Broussard – a case “scavenge[d] from the depths of our dusty law library,” per the dissent.[26] In Broussard, the RRC dismissed a pooling application because the evidence showed that the offerees’ wells were not draining the offeror’s minerals when the offer was made.[27] Section 102.017(a) of MIPA requires that pooling offers give each owner a chance to produce or receive their fair share.[28] The Court reasoned that the offer Ammonite made required them to produce nothing while diluting EOG and its lessors (even if just by a small percentage).[29]
The RRC, after determining that Ammonite’s offers were not fair and reasonable, went on to conclude that Ammonite’s offer to pool would not prevent waste or protect correlative rights. Ammonite contended that this case presented a narrow legal question: whether proof of drainage is required to obtain MIPA pooling to prevent waste.[30] Ammonite suggested that if proof of drainage is not required, then the location and completion of EOG’s wells leaves the minerals beneath the riverbed stranded.[31] The Court disagreed with their contention; instead, the court stated that the issue is whether the RRC could have concluded in this case that forced pooling would not prevent waste.[32] Ammonite contended their minerals were stranded because EOG’s wells did not reach the riverbed, so without forced pooling, the minerals would be stranded; however, Ammonite’s minerals were undisturbed because EOG’s wells were already producing and not draining or depriving Ammonite’s minerals.[33]
Ammonite argued that EOG should have proposed permitting their wells to drill into the riverbed but failed to show any authority requiring an operator to seek an exception for the purpose of preventing a neighbor’s tract from being stranded.[34] Doing so would result in the failure to maximize the production of the operator’s own minerals. Finally, Ammonite claimed that a pooling order would prevent waste by incentivizing EOG to drill new wells or rework existing wells to get the minerals beneath the riverbed tract.[35] Again, referencing Broussard, the Court stated that this was not unreasonable because nothing was drained at the time the offer was made.[36] The Court stated that this theory contravenes MIPA’s policy of avoiding the drilling of unnecessary wells.[37]
Justice Young’s Dissent
In a robust dissent, Justice Young reached the opposite conclusion, finding that the RRC had acted in an arbitrary and capricious manner.[38] Per the dissent, the drainage argument, while persuasive, was secondary to the issue of leaving minerals stranded. In fact, “[t]he lack of drainage is the very thing that allegedly makes the minerals here stranded. If they are stranded, they constitute waste. And if there is waste, then pooling may be mandatory. Drainage has never been required to establish waste.”[39] Justice Young would have thus remanded the case for further findings on exactly why the offer to lease was not fair and reasonable, and why the pooling did not prevent waste and protect correlative rights.[40]
Conclusion
This case may be, at its heart, another example of courts struggling to reconcile traditional reservoir law born in the era of vertical drilling with the modern realities of tight shale formations. The court begins its opinion by distinguishing drainage in a permeable formation into a vertical wellbore with that in an impermeable shale formation where the minerals only migrate a short distance through hydraulic fractures in a horizontal well. The Eagle Ford, for example, has “ultralow permeability,” and does not allow flow through the rock without fracture stimulation. The traditional rule of capture arguably begins to unravel when drainage becomes a legal fiction.
By requiring a MIPA applicant to show that the wells drilled on land which they seek to be pooled with are technically able to reach or drain the minerals below its tract, the courts may be attempting to account for the geological practicalities of the shale patch. An applicant would thus be best equipped to invoke MIPA when they can show that their minerals are actually being drained or fracked. Otherwise, an anomalous situation is created where a mineral owner is participating in production from a unit but there is no actual depletion of his minerals. The minerals would therefore remain “stranded” and unproduced with or without MIPA pooling. In that case the only thing “wasted” would be the opportunity for the State, or its lessee, to participate in revenue (i.e., to have its cake and eat it too).
From another perspective, this case asks the question of whether preventing waste and protecting correlative rights can outweigh the practical matter that minerals will remain under a riverbed during production. Do Ammonite and the State of Texas have a statutory right to participate in revenue even though their minerals are not actually being produced? This would appear to be production on paper only. As noted by the dissent, stranding minerals under the riverbed could be considered waste. Drainage, on the other hand, would speak more to protecting correlative rights. Regardless, this case appears to extract yet another tooth from the already toothless Mineral Interest Pooling Act.
References
[1] 2024 Tex. LEXIS 544 (2024).
[2] Tex. Nat. Res. Code §§ 102.001, et seq.
[3] Id. at § 102.012.
[4] Id. at § 102.013(b).
[5] Id. at § 102.011.
[6] See 2024 Tex. LEXIS 544 (2024), at 5.
[7] See. Tex. Gov’t Code § 2001.174(2)(F).
[8] 2024 Tex. LEXIS 544 (2024), at 3.
[9] Id. at 6.
[10] Id. at 7.
[11] Id. at 8.
[12] Id.
[13] Id.
[14] Id. at 10.
[15] Id. at 11.
[16] Id. at 12.
[17] Id. at 13
[18] Id.
[19] 2024 Tex. LEXIS 544 (2024), at 14.
[20] Id. at 16.
[21] Id.
[22] Id. at 17.
[23] Id.
[24] Id. at 18.
[25] Id. at 9.
[26] Ammonite Oil & Gas Corp. v. R.R. Comm’n of Tex., 2024 Tex. LEXIS 544 (2024) (Young, J., dissenting), at 50.
[27] R.R. Com. of Tex. v. Broussard, 755 S.W.2d 951, 952-54 (Tex. App.—Austin 1988, writ denied)
[28] Tex. Nat. Res. Code §§ 102.017(a).
[29] Ammonite, at 18.
[30] Id. at 22.
[31] Id.
[32] Id. at 23.
[33] Id. at 24.
[34] Id.
[35] Id. at 26.
[36] Id., citing Broussard, 755 S.W.2d at 953.
[37] Id. at 26.
[38] Ammonite Oil & Gas Corp. v. R.R. Comm’n of Tex., 2024 Tex. LEXIS 544 (2024) (Young, J., dissenting), at 33.
[39] Id. at 31.
[40] Id at 30.
