Dealing with Missing Persons and Holdouts: Using Rule 37 and MIPA for Urban Gas Development Presented By: Eric C. Camp W HITAKER, C HALK, S WINDLE & S AWYER, LLP 301 Commerce Street, Suite 3500 Fort Worth, Texas (817) (direct line)

Introduction Units with hundreds of small tracts Drilling and completion costs of $2-4 million per well Laterals of up to 5,000 to 8,000 feet

Statewide and Field Rules Governing Horizontal Wells Statewide Rule 86: – Entire “horizontal drainhole” (portion of the wellbore in the correlative interval) must comply with Rule 37 spacing requirements Special Field Rules: – Only “take points” (perforated intervals) along the horizontal drainhole must comply with Rule 37 spacing requirements (adopted in Barnett, Haynesville, and Eagle Ford fields)

Rule 37 Statewide Rule 37: Wells must be at least 467 feet from property and lease lines Barnett Shale Special Field Rules: Wells must be at least 330 feet from property and lease lines 4

Rule 37 Exception Permits Will not allow an operator to drill through an unleased tract From 1919 – 2005, RRC granted 12,000 Rule 37 Exception Permits In the Barnett Shale formation alone, the RRC granted almost 3,000 Rule 37 Exception Permits through March 2,

Steps for Obtaining a Rule 37 Exception Permit 1.File a drilling permit with the RRC with a list of “affected parties” 2.RRC serves “affected parties” with Notice of the Application (1 st class mail, no plat, includes Notice of Intent to Protest) 3.Affected parties have 21 days to file their protests to the Application with the RRC 4.If no affected party protests or protestants waive their objections, RRC administratively grants the permit 5.If protest is filed, RRC schedules a hearing on the Application 6.At the hearing, Applicant bears the burden of proving it needs the exception permit to prevent waste or confiscation 7.If applicant wins, it gets the permit (good for 2 years) and can drill the well and pay affected parties nothing 8.If applicant loses, RRC will not hear another Rule 37 exception application for the same well absent “changed circumstances” 6

Preventing Waste Operator must show that: – The exception well will recover substantial O&G that wells in the field would not otherwise recover; AND – “unusual underground conditions” exist such that a closer spacing of wells is essential to recover additional O&G – The “unusual underground conditions” must be peculiar to the subject tract, as opposed to equally applicable elsewhere in the field 7

Preventing Confiscation Operator must show that without the applied for well, it will be denied a reasonable opportunity to recover its fair share of O&G currently in place under the lease Requires proving that: -Drilling a regular well would not afford the operator a fair and reasonable opportunity to recover its fair share of O&G currently in place; AND -The proposed irregular location is reasonable Denying a party a fair and reasonable chance to recover O&G under its property is “confiscation” 8

What about Economic Waste as Confiscation? “Economic waste” is when an operator seeks a Rule 37 Permit because producing the reserves from regular locations would be uneconomic Split in authorities on whether “economic waste” can be considered in Rule 37 preventing confiscation cases (Pre-August 2010 vs. Post-August 2010) 9

Recent Developments: Controversy with Economic Waste as “Preventing Confiscation The Frank Reed 117 Lease Case (RRC 1995), Green Gas Unit Case (RRC 2008), and Ramey Case (RRC 2009) – Economic Waste not a ground for granting a Rule 37 Exception Permit to prevent confiscation The Eden Eastside Case (RRC 2010), Carter SE Case (RRC 2010), and TWU B Case (RRC 2010) – Used economic waste as a ground for granting Rule 37 Exception Permits to prevent confiscation 10

Recent Developments: Urban Permitting Processes 1.File NPZ plat 2.Remove NPZ’s and send Rule 37 Notices 3.If protests, amend plat to have NPZ’s only around the protestants’ tracts 4.Repeat steps 2 and 3 11

Recent Developments: Proposed Changes to Statewide Rules 79 & 86 12

Recent Developments: Proposed Significant Changes to Statewide Rule 86 Allows NPZ wells RRC will treat NPZ wells as exceptions to Rule 37 and require a $200/NPZ/application fee “Deviation Box” Notice to affected parties by certified mail, return receipt requested with plat of proposed well Operators must contact district offices 24 hours before perfing a NPZ well and must submit perf logs for NPZ wells 13

MIPA Enacted in 1965 to protect small tract owners after the Normanna case invalidated prorationing formulas that favored small tract owners Smith & Weaver’s Texas Law of Oil & Gas “Traditionally, the MIPA has been construed … to protect small tracts rather than a broad act designed to protect correlative rights generally or as an act allowing owners of large tracts more flexibility in development” Plain language of the statute has no such limitations 14

Limitations on Invoking MIPA Does not apply to reservoirs discovered and produced prior to March 8, 1961 Oil unit can be no larger than 160 acres; gas unit can be no larger than 640 acres; with 10% tolerances allowed for both Tracts large enough to support their own standard well cannot be pooled together Can only pool acreage “that reasonably appears to lie within the productive limits of the reservoir” Does not apply to lands owned by the State of Texas 15

MIPA Requirements 2 or more separately owned tracts Lying within a common reservoir For which field rules have been established Separately owned interests are in an existing or proposed proration unit Interest owners have not agreed to voluntarily pool their interests At least one interest owner has drilled or proposes to drill a well within the proration unit The applicant must make a fair and reasonable offer to pool before submitting its MIPA Application 16

MIPA Unit Once Formed Cannot be modified or dissolved without consent of all mineral interest owners affected, except as necessary to enlarge the unit under MIPA’s muscle-in provisions Automatically dissolves (1) one year after effective date if no production or drilling has occurred; (2) six months after the completion of a dry hole; OR (3) six months after production ceases 17

Applicant’s Fair & Reasonable Offer to Pool TX SC: Offer must take into consideration those relevant facts, existing at the time of the offer, which would be considered important by a reasonable person entering into a voluntary agreement concerning oil and gas properties Debate over amount of the bonus when it varies greatly from leased tracts in the proposed unit Apparent Rule: Lease offer is “fair and reasonable” if the bonus and royalty are consistent with the prevailing market terms in the area at the time the offer was made 18

Size of a MIPA Unit Applied for Barnett Shale MIPA wells have varied from acres to acres for the cases where the RRC has issued a proposal for decision (RRC has approved unit sizes ranging from acres to acres) Examiners trying to include only acreage that can be “effectively and efficiently” drained from the proposed well (Commissioners have so far refused to adopt this standard) Texas Steel B case resulted in the RRC proposing a MIPA Unit that was 500 feet wide on either side of the wellbore. Operator withdrew the application because it was not interested in such a unit. 19

Economic Terms on Which Small Tracts are Pooled Very little statutory guidance – each owner gets “fair share” of production RRC’s formula: – No bonus – Prevailing royalty – Carried working interest for remaining interest – Zero Risk Penalty Is the RRC’s formula fair?

Multiple Wells in a MIPA Unit? Finley did not limit the Unit to a single well Rosen Heights: Limited to a single well Texas Steel B: Effectively limited to a single well because of the RRC’s re-drawn unit RRC’s rational for limiting MIPA Units to a single well is that it is only authorized to approve a MIPA Unit where necessary to prevent the drilling of unnecessary wells, prevent waste, and protect correlative rights

Conclusions Increased press coverage will likely lead to increased scrutiny of RRC decisions, possible legislative actions, and further RRC rule revisions Both Rule 37 and MIPA need to be revised to protect correlative rights and promote development – current system has too many problems and uncertainties for both operators and unleased mineral interest owners