Integration necessary and no cause for concern for mineral owners

Occasionally, I receive questions from people who are upset because they got a letter from a lawyer for an oil and gas company stating that the oil and gas company applied to the Oil and Gas Commission to integrate their land. The letter includes a legal notice giving the date and time for a hearing along with instructions on how to notify the Commission of any opposition to the integration. The first reaction from most getting these letters is that they’ve been sued or the oil and gas company is taking something from them. Neither is the case, and being subject to an integration is no cause for concern.

The hearing before the Oil and Gas Commission is the culmination of months and sometimes years worth of work on the part of the oil and gas company. The company has to identify an area prospective for oil and gas, run title on the area, attempt to lease everyone in the area, and attempt to get all other companies with leases in the area to agree to the operation of the unit before going to the Commission. I will omit identification of the geology, and start with running title.

Running title is ordinarily a precursor to leasing and a must prior to integration. In order to know who owns the oil and gas, a company must check the land records at the county courthouse or in a private title plant. In some cases, oil and gas companies simply buy out a private title plant. This happened in a few instances in Fayetteville Shale Counties, allowing the plant owners to retire wealthy. The oil and gas company examines the title back to when the United States owned the land. Once they determine ownership, the companies send out landmen to make a lease offer to the mineral owner.

If the landowner and landman agree to a lease, the landowner is out of the integration process. The lessee becomes the only “interested party” in the integration. If the landowner says “no thanks” to the lease, the landman will haggle and persist for a time, sometimes until the landowner cuts off communication with the landman. At some point between negotiating and persisting, the company meets its obligation to make “reasonable efforts” to lease. There is no published case on how far a company has to go to lease, but it probably isn’t a high bar to clear. Once the company makes reasonable efforts to lease, the company (assuming it meets other requirements) may apply to the Oil and Gas Commission to “integrate” the unleased interest.

The term “integrate” is a polite term for “compulsory pooling.” The Oil and Gas Commission holds a power granted by statute to compel parties in a prospective oil and gas unit to come to an agreement as to how to share costs and revenues for the production oil and gas from the unit. The proceeding before the Commission is administrative in nature. Thus, nobody is being sued. The company seeking to operate the drilling unit is the “operator” or “applicant.” The unleased mineral owners and uncommitted working interest owners (other companies with leasehold interests) are “interested parties.” A lease mineral owner or not interested because the oil and gas lease effectively transfers the mineral owner’s interest to the control of the lessee.

A company seeking to integrate drilling unit must hold a majority leasehold acreage interest in the unit. They must prepare an application documenting their efforts to lease the unleased parties, documenting efforts to get other companies with acreage in the unit to agree to the operation of the unit, listing the drilling costs of the first well, listing the highest bonus and royalty it paid in the unit, and detailing the geological risk of drilling the well. The company gives notice of the pending integration to all interested parties by certified mail and by publication in the newspaper. Once the applicant submits the application and notice delivered, the company goes to hearing before the Oil and Gas Commission.

The hearings are usually uneventful. The company and its attorney will present the application to the Commission, and a landman representative of the company will be present to answer questions about the company’s acreage position in the unit and efforts to lease. The Commission usually has few questions for the company and will approve the application if it is in order.

Occasionally, a landowner will object or otherwise appear before the Commission at the hearing for one reason or another. The most common complaints are ownership disputes and surface use issues. The Commission has no jurisdiction to resolve either problem. The Commissioners will listen to the complaint, though they cannot take any legally binding action on ownership of surface use issues. I’ve seen this happen many times. Once the landowner finishes speaking, one of the Commissioners will explain why they cannot take action.

Sometimes, the landowner will bring an attorney. I’ve seen many times where an attorney unfamiliar with the Commission’s powers will make a number of arguments about the propriety of the proceeding. Perhaps the greatest misconception among general practice attorneys is that the Commission’s proceeding is an eminent domain proceeding. Pursuing this line of reasoning, they present arguments about the amount of compensation paid. An integration proceeding is not a “taking” under the Constitution. The proceeding is an exercise of police power by the state to prevent the drilling of unnecessary wells and the waste of a non-renewable resource.

Yet another angle taken by attorneys representing landowners is that the lease bonus and royalty stated by the applicant is not the highest paid in the section. The best known case of this is where the United States received $8,000 an acre for their acreage in a unit, and the landowner’s attorney argued that should be the highest bonus paid. The statute authorizing integration says the terms of the integration “shall be upon terms and conditions which are just and reasonable.” In that case, the attorney didn’t realize the “just and reasonable” applies to both the applicant and the unleased mineral owner. Most of Commissioners were appointed to serve because they are industry professionals. Because of their own experiences and their hearing of integration applications, they have extensive knowledge what bonus and royalty is reasonable. A common bit of industry knowledge is that leases from the United States are always sold at an extreme premium in producing areas. The Commissioners took this into consideration, and they chose to accept the applicant’s highest bonus and royalty rather than that paid to the United States.

The only points of dispute in an integration that are likely to make any headway with the Commission are deficiencies in the contents of the application or lack of a majority interest. If a landowner finds a deficiency, the applicant will move to amend the application or delay the proceeding until they can correct the deficiency. At best, this type of objection will simply buy the landowner a bit more time to find a better lease than what will be offered by the Commission. Theoretically, the landowner could object or dispute more technical things in the application such as the geological risk or the drilling costs, but doing so would require the retention of an expert such as a petroleum geologist or drilling engineer.

After the hearing, the Commission will enter and order setting forth the integrated party’s options. The applicant sends out a lease form and election letter to each unleased interest. The interested parties have 15 days after the order to make their election. For an unleased mineral owner, the options are to affirmatively accept the commission lease at the applicant’s highest bonus and royalty, do nothing and being deemed to accept the lease, participate in the well, or affirmatively reject the lease and be deemed “non-consent.” The choice to participate makes the interest owner a partner in the well. As a well partner, the interest owner must pay Joint Interest Billing Statements (JIBS) issued by the operator for well costs. For example, if well #1 costs $2,000,000 and the participating owner owns 64 acres out of a 640 acre unit, the JIBS for that owner for well #1 will be $200,000. The non-consent choice subjects the unleased mineral owner to a geological risk factor penalty of 300% to 600%. That is, the non-consenting interest gets all of the money attributable to the interest from the well, but has to forfeit 1 to 6 times the cost that would have been paid had the owner participated with the interest. In the example above, Well #1 would have to pay out 6 to 12 million before the non consenting interest sees their first payout. Typically risk factors are 300% to 400%.

Uncommitted working interest owners may either participate in the well or be non-consent. The same risk factor is imposed on non-consenting working interest owners as non-consenting mineral owners except that the royalty is paid out to the lessor and the remaining balance of the revenue goes to satisfy the risk factor.

Integration and oversight by the Oil and Gas Commission provides an important function. Without regulation, profit demands that everyone drill as many wells as possible as quickly as possible. In order to prevent the drainage by neighboring tracts, each and every landowner has an incentive to drill their own well. As a result, several expensive wells could drain one pool, scarring the surface estate of each Tract and decreasing the overall profitability of the enterprise by drilling unnecessary wells. Further, excessive wells decrease the reservoir pressure leading to lower overall recovery and the intrusion of fossil brine causing the resource to become less recoverable.

Landowners who are noticed for Integration should not be alarmed. Integration is a not a lawsuit, and nothing will be lost by being a party. Integration is fair and efficient means to give every interested party a fair share of production while minimizing economic waste, damage to the surface estate, and maximizing the overall recovery from the pool of oil or gas.

For more information about integration, consult the Arkansas Code in title 15, section 72 along with Arkansas Oil and Gas Commission Rule B-43.

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The above represents the opinion of the author and not of any organization or group to which the author may belong. This material is general information, and it is not intended to create any lawyer-client relationship. Neither the transmission nor receipt of this information is an offer to extend representation by the author. Any information, opinion, and comment provided herein should not be taken as legal advice or relied upon by the reader for any purpose. The author is licensed in the state of Arkansas. Commentary on cases and law from jurisdictions where the author does not hold license to practice are for demonstrative or scholarly purposes and do not represent the author is licensed or accepts cases in the applicable jurisdiction. If you are need of legal services, you should contact a licensed attorney in your jurisdiction.

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