cite as 27 energy & min. l. inst. ch. 7 (2007) chapter … · tion as it applies in the eastern...

Chapter 7

Compulsory Pooling and Unitization with an Emphasis on the Statutory and Common Law

of the Eastern United StatesBruce M. Kramer

Maddox Professor of LawTexas Tech University School of Law

Lubbock, TX

Synopsis

§ 7.01. Introduction ............................................................................. 224[1] — Basic Terminology ............................................................. 224[2] — Historical Antecedent ........................................................ 225

§ 7.02. The Statutory Framework in the Eastern States .................. 233§ 7.03. Common Problems Attendant to Compulsory Pooling ....... 237

[1] — Who May Apply? ............................................................... 237[a] — Broad Statutory Provisions ..................................... 237[b] — Owners or Operators .............................................. 238[c] — State Conservation Agency .................................... 239

[2] — Who Is Entitled to Notice? ................................................ 240[a] — Special Problem Areas ........................................... 242

[3] — Options Afforded Non-Consenting Owners .................... 247[a] — The Free Ride Approach ....................................... 249[b] — The Surrender of Working Interest Approach ................................................................ 250[c] — The Risk Penalty Approach .................................... 252

[4] — The Effective Date of the Order ........................................ 255[5] — The Non-Consenting Unleased Mineral Owner .............. 256

§ 7.04. Compulsory Unitization .......................................................... 259[1] — Introduction ........................................................................ 259[2] — Consent Requirements ...................................................... 260[3] — Unit Area ............................................................................ 263[4] — Participation (Allocation) Formula .................................... 265

§ 7.05. Administrative Law Issues Relating to Compulsory Pooling and Unitization ........................................................... 266

[1] — Introduction ........................................................................ 266 [2] — The Related Doctrines of Exhaustion of Administrative Remedies and Primary Jurisdiction .......................................................................... 267[3] — The Collateral Attack Doctrine .......................................... 268

CITE AS27 Energy & Min. L. Inst. ch. 7 (2007)

ENERGY & MINERAL LAW INSTITUTE

§ 7.01. Introduction.The oil and gas industry has been in existence for something less than

150 years.1 Government regulation of the oil and gas industry, including the enactment of compulsory pooling and unitization statutes has been in existence for only a slightly shorter period of time.2 This chapter will present the historical context of modern compulsory pooling and unitization regula-tion as it applies in the Eastern United States,3 as well as how those states have dealt with such issues as unleased mineral owners in both pooling and unitization, the terms under which a compulsory or forced pooling order will deal with non-cooperative owners, the effective date of the pooled unit or unitized area, the participation formula used in compulsory unitization, the minimum number of consenting owners needed to issue a compulsory unitization order and the judicial review of both pooling and unitization orders.

[1] — Basic Terminology. To be consistent, as used in this chapter, the terms “unitization” or “unit

operations” will refer to the consolidation of mineral, leasehold or royalty

1 The drilling of the Drake well near Titusville, Pennsylvania in 1859 is considered the “birth” of the modern oil and gas industry, although there are published reports of an oil spring existing in Allegany County, New York as early as 1833 and a productive oil well in Washington County, Ohio that may have been drilled as early as 1814. See 1 Bruce M. Kramer and Patrick H. Martin, The Law of Pooling and Unitization § 1.01 (2006)[hereinafter Kramer and Martin]; Eugene Kuntz, A Treatise on the Law of Oil and Gas §§ 1.4-1.6 (1987)[hereinafter, Kuntz Treatise].2 See 1 Kramer and Martin, supra note 1 at § 1.01. See generally, A.B.A., Legal History of Conservation of Oil and Gas (1939). Professor Summers identifies Pennsylvania as adopting conservation statutes in 1878, New York in 1879, Ohio in 1883 and West Virginia in 1891. 1939 A.B.A. History, op cit. at 1 (n.1). Michigan began its conservation regulation of oil and gas development in 1909, at a time when oil and gas production in the state was sporadic at best. Id. at 75-77.3 While the author declines to define the “eastern” in the title, this chapter will generally limit references to eastern oil and gas development to states physically located east of the Mississippi River, although Louisiana, for various reasons, will not be considered an “eastern” state.

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COMPULSORY POOLING AND UTILIZATION

interests covering all or a portion of a common source of supply.4 Compul-sory unitization involves the use of the state police power to compel owners of mineral interests, working interests and royalty interests to consolidate their separately owned estates over all, or a portion of, a common source of supply. On the other hand, “pooling” or a “pooled unit” will refer to the joining together of small tracts or portions of tracts for the purpose of having sufficient-acreage to receive a well drilling permit under the relevant state or local spacing or drilling laws and regulations.5 Compulsory pooling refers to the use of the state police power to combine separately-owned interests within a designated spacing and/or drilling unit. Compulsory pooling arose largely in the context of the development of state spacing and/or drilling regulation while compulsory unitization arose as one means to achieve the conservation of oil and gas, prevention of waste and protection of correlative rights objectives of state conservation laws.

[2] — Historical Antecedents.The earliest attempts to apply a compulsory pooling regulatory regime

arose in two cities in Kansas.6 In one case the compulsory pooling require-ment was a condition precedent to getting a well spacing permit but in the other the applicant could seek a permit but would be required to force pool the other interest owners once the drilling permit was issued.7 Municipal compulsory pooling ordinances were reasonably common in the mid-con-tinent area.8 The first state compulsory pooling statutes were enacted in

4 1 Kramer and Martin, supra note 1 at § 1.02. For other definitions see 8 Patrick H. Martin and Bruce M. Kramer, Williams & Meyers Oil and Gas Law 1175-76 (2006)[hereinafter Williams & Meyers]; Robert Sullivan, Handbook of Oil and Gas Law 368 (1955).5 1 Kramer and Martin, supra note 1 at § 1.02. See also 8 Williams & Meyers, supra at 820-21. The term communitization is not in wide use in the eastern United States because it refers to the pooling of interests where one of those interests is owned by either the federal government or a federal oil and gas lessee. 2 Law of Federal Oil and Gas Leases, § 18.01[2].6 A.B.A., Legal History of Conservation of Oil and Gas 55-56 (1938).7 Id.8 Oklahoma City adopted an ordinance in 1929, followed by other Oklahoma cities shortly thereafter. A.B.A., Legal History of Conservation of Oil and Gas 391-97 (1948). In

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New Mexico9 and Oklahoma10 in 1935. The New Mexico provision simply stated:

The pooling of properties or parts thereof shall be permitted, and, if not agreed upon, may be required in any case when and to the extent that the smallness of or shape of a separately owned tract would, under the enforcement of a uniform spacing plan or proration unit, otherwise deprive or tend to deprive the owner of such tract of the opportunity to recover his just and equitable share of the crude petroleum oil and natural gas in the pool; . . . All orders requiring such pooling shall be just and reasonable, and will afford to the owner of each tract in the pool the opportunity to recover or receive his just and equitable share of the oil and gas in the pool . . . .11

The municipal compulsory pooling ordinance of Oxford, Kansas was the first such provision challenged as being unconstitutional. In Marrs v. City of Oxford,12 the court rejected the challenges. Under the Oxford ordinance only one well could be drilled on any city block. In addition, all royalty owners within that block were entitled to their share of production in proportion to their holdings within the block. Other working interest owners within the block, who were otherwise denied an opportunity to drill because of the well-spacing limits, were given the right to receive a proportionate share of the production if they tendered to the permit holder their proportionate share

1935 the City of South Houston, Texas, adopted a compulsory pooling ordinance. See Tysco Oil Co. v. R.R. Comm’n, 12 F. Supp. 195, 202 (S.D. Tex. 1935). See generally, Williams, “Compulsory Pooling and Unitization of Oil and Gas Rights,” 15 Sw. Legal Fdn. Oil & Gas Inst. 223 (1964).9 1935 N.M. Laws Ch. 72. The New Mexico statute is analyzed in 1938 A.B.A. History, supra at 106-07, 289-302.10 1935 Okla. Sess. Laws, Ch. 59. The Oklahoma statute is analyzed in 1938 A.B.A. History, supra at 209-210.11 1935 N.M. Laws Ch. 72.12 Marrs v. City of Oxford, 24 F.2d 541 (D. Kan. 1928), aff’d, 32 F.2d 134 (8th Cir. 1929), cert. denied Ramsey v. City of Oxford, 280 U.S. 563, 573 (1929).

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of the drilling and operating expenses.13 The court rejected both the takings and substantive due process claims made by the plaintiffs.

Regulatory takings jurisprudence in 1929 was in its infancy. The court’s analysis was somewhat superficial regarding the takings claim merely finding that the restrictions on the individual’s property interest were not so severe as to amount to a regulatory taking. In other words, the regulation in the words of Justice Holmes “did not go too far.” The substantive due process claim was more fully discussed, including an analysis of how the conservation of oil and gas was a valid objective under the city’s police power. The court analo-gized compulsory pooling to municipal zoning and relied on the Supreme Court’s recent affirmation of the constitutionality of zoning to buttress its conclusion the compulsory pooling was likewise constitutional.14 If zoning served a valid governmental objective so did compulsory pooling because they both served to stabilize property values. The court also emphasized the public safety issues involved in regulating oil and gas wells in urban areas. Finally, the court noted that the ordinance protects the correlative rights of all of the parties by its compulsory nature. All of the working interest and royalty owners are given an opportunity to share in the production from the pooled unit well where such an opportunity would have been denied under the well spacing regulation.15

Whether well spacing regulation without a variance or exception pro-vision or a compulsory pooling provision would withstand constitutional scrutiny has only been raised in one state, California, and the answer was that it would not. In Bernstein v. Bush,16 the California Supreme Court in-

13 Marrs, 24 F.2d at 541-42. Requiring cooperative or joint development was not necessarily a new concept at the time of the Oxford ordinance. The Supreme Court of the United States had upheld the validity of several state and sub-state regulatory programs that required joint or cooperative development in drainage, irrigation and surface stream dam projects. See e.g., Fallbrook Irrigation District v. Bradley, 164 U.S. 112 (1896); Head v. Amoskeag Mfg. Co., 113 U.S. 9 (1885). See generally, Williams, supra note 8.14 See Village of Euclid v. Ambler Realty Co., 272 U.S. 365 (1926).15 Marrs, 32 F.2d at 140.16 Bernstein v. Bush, 177 P.2d 913 (Cal. 1947).

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validated a well spacing regulatory program because it provided for neither exception permits nor compulsory pooling because the non-drilling parties were not given the opportunity to participate in the drilling operations. After the statute was amended to authorize the compulsory pooling of interests within a spacing unit, the statute was upheld.17

In Patterson v. Stanolind Oil & Gas Co.,18 a royalty owner whose interest was force-pooled within a 10-acre drilling unit attacked the constitutionality of this compelled sharing of the royalties with non-drillsite royalty owners. The constitutional claims were a combination of regulatory takings and substantive due process.19 The court focused mostly on the governmental interests in preventing waste and protecting correlative rights. Those interests clearly fall within a State’s police power. The royalty interest owner’s share of royalties had been reduced but that reduction amounted to a restriction or qualification of the property interest and not a confiscation. As such there was no violation of the due process or taking provisions of either the United States or Oklahoma constitutions.20

In Sylvania Corp. v. Kilborne,21 the compulsory pooling statute in New York was upheld against a challenge by a working interest owner. Two working interest owners each drilled two wells in wildcat territory that led to the state conservation agency hearing to determine minimum well spacing for the field. There were two orders issued, the first setting a minimum well spacing of 160-acres for each unit as well as providing for “integration” if there were two or more owners within the unit, and a second order which deleted the “integration” provisions. The field was divided into 14 units. Sylvania and Wyckoff had, prior to the order, drilled two wells each in four different units as was eventually created by the agency. In three of the four units both parties owned a fractional share of the working interest. They

17 Hunter v. Justice’s Court, 223 P.2d 465 (Cal. 1950).18 Patterson v. Stanolind Oil & Gas Co., 77 P.2d 83 (Okla. 1938), appeal dismissed, Patterson v. Stanolind Oil & Gas Co., 305 U.S. 376 (1939).19 Patterson, 77 P.2d at 85-86. See also Croxton v. State, 97 P.2d 11 (Okla. 1939).20 Patterson, 77 P.2d at 89-90.21 Sylvania Corp. v. Kilborne, 271 N.E.2d 524, (N.Y. 1971).

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could not agree on development for the remainder of the field and Wyckoff then filed a motion seeking compulsory pooling of the respective interests of Wyckoff and Sylvania. Sylvania argued that the 2500 foot limitation on the drilling of wells contained in the farmout agreement executed between the parties constituted a voluntary pooling of their interests. The agency disagreed and issued a compulsory pooling order to protect the correlative rights of the parties. The order also designated an operator for the wells in the three units with divided ownership.

The court had no difficulty finding that both the spacing and pooling regulatory programs were constitutional, relying on the many cases that had upheld such programs in other jurisdictions.22 Clearly the prevention of waste and the protection of the correlative rights of the various owners over a common source of supply were valid police power objectives. The court rejected the claim that the 2500-foot limitation amounted to a vol-untary integration or pooling of the parties’ interests and was the best way to protect the correlative rights of the parties. Noting that the compulsory pooling statute then in existence in New York required that voluntary or compulsory pooling may only occur after the creation of a spacing unit, the court concluded that the pre-spacing order agreement cannot constitute a pooling or integration of their interests.

In Ohio, however, the retroactive application of the well spacing and compulsory pooling statutory provisions was found to be unconstitutional in Burtner-Morgan-Stephens Co. v. Wilson.23 The lease executed prior to the adoption of the statute did not authorize the lessee to pool and called for non-apportioned royalties. The royalty owner asserted that by virtue of the compulsory pooling order, the contractual limitations on the right of the les-see to dilute its royalty was impaired. The court concluded: “. . . R.C. 1509.27 may not be retroactively applied to determine distribution of royalties that are provided for in an oil and gas lease that was entered into and recorded

22 See e.g., Hunter Co. v. McHugh, 11 So. 2d 495 (La. 1943), appeal dismissed Hunter Co. v. McHugh, 320 U.S. 222 (1943); Anderson v. Corp. Comm’n, 327 P.2d 699 (Okla. 1958), appeal dismissed Anderson v. Corp. Comm’n, 358 U.S. 642 (1959).23 Burtner-Morgan-Stephens Co. v. Wilson, 586 N.E.2d 1062 (Ohio 1992).

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prior to the enactment of the statutory provision.”24 Similar arguments had been made in many of the cases upholding compulsory pooling statutes and had been rejected.25 It would lead to the inability of the legislature to adopt many forms of conservation regulation and attempt to apply it to existing leases. As the author has said elsewhere: “Adjustments to private rights is the essence of the exercise of the powers of conservation agencies. It would allow private contractual rights to frustrate the valid public objectives of preventing waste and protecting correlative rights.”26

Compulsory unitization, unlike compulsory pooling, is not driven by a separate governmental regulatory program, but is driven by such factors as petroleum geology and basic economic principles. Starting in the 1920s, mainly through the efforts of Henry L. Doherty, a petroleum engineer, the nation was made aware of the many benefits that would flow from the unitized operations of oil reservoirs.27 Mr. Doherty, through a concerted effort aimed at the leaders of the oil industry, the federal government and state governments, argued for governmental intervention for the purpose of mandating unitized development. Included in his recommendations was the enactment of legislation giving the federal government the power to compel unitization.28 In 1929, the Section of Mineral Law of the American Bar Association issued a policy statement endorsing the concepts of both voluntary and compulsory unitization legislation.29 The A.B.A. Section also

24 Id. at 1065, citing Ohio Const. art II, 28.25 See Hunter Co., 11 So. 2d 495 (La. 1943); Patterson, 223 P.2d 465 (Cal. 1950); Marrs, 24 F.2d 541 (D. Kan. 1928). Similar impairment of contract arguments have been unsuccessfully made in surface use legislation that clearly changes both the express and implied easements that arise from a severance of the mineral estates. See Bruce M. Kramer, “The Legal Framework for Analyzing Multiple Surface Use Issues,” 2 Hous. Envtl. & Energy L. & Pol’y J. __ (2006)(forthcoming).26 Kramer and Martin, supra note 1 at 3-12.27 See Robert Hardwicke, Antitrust Laws, et al. v. Unit Operation of Oil and Gas Pools 1-13 (rev. ed. 1961).28 Id. at 33. There was substantial opposition to Mr. Doherty’s efforts to enact compulsory unitization legislation. Id. at 14-31.29 54 Rep. A.B.A. 739-740 (1929). The Section’s report is discussed in Maurice Merrill, “Stabilization of the Oil Industry and Due Process of Law,” 3 S. Cal. L. Rev. 396 (1930). Professor Merrill noted that both California and New Mexico had already enacted voluntary unitization legislation. Id. at 398.

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developed a model compulsory unitization statute because it had determined that voluntary unitization would not receive widespread support in the near future.30

The A.B.A. model would allow a majority of the working interest own-ers in a common source of supply to petition the government for an order compelling the non-consenting owners to join in a cooperative plan of devel-opment that had been agreed to by the majority owners. The petition would have to show that the cooperative plan would both conserve hydrocarbons and protect the correlative rights of both the working interest and royalty interest owners.31 The model provided for notice and a public hearing that would be followed by an order to compel the non-consenting parties to join the unitized plan of development that would come under the control of an “operators” committee, rather than a single unit operator.32 Finally, the state conservation agency would be authorized to suspend individual leasehold drilling or other obligations pending the final approval of the order.33

There was little activity regarding compulsory unitization in the 1930s. Nonetheless the groundwork for the eventual adoption of the first compulsory unitization statutes in the 1940s took place in that earlier decade with the creation of the Interstate Oil Compact Commission (IOCC) in 1935.34 A 1942 report of the legal committee of the IOCC contained a model compulsory unitization statute.35 The first compulsory unitization statute was adopted by Oklahoma in 1945, after being first proposed in 1941.36

30 54 Rep. A.B.A. at 749-50.31 Id. at 763-65.32 Id.33 Id. at 768-69. Shortly after the 1929 A.B.A. Report was published the Mid-Continent Oil & Gas Association issued a report that also encouraged unitization but not compulsory unitization. Handbook on Unitization of Oil Pools (1930-Mid-Continent Oil and Gas Ass’n).34 Kramer and Martin, supra note 1 at § 3.02[2].35 Robert Hardwicke, supra note 27 at 99-100. IOCC Quarterly Bulletin, Vol. 1, #2 (July 1942).36 Kramer and Martin, supra at note 1 § 3.02[2]. 1945 Okla. Sess. Laws 162-170 codified at Okla. Stat. Ann. tit. 52, §§ 286.1 et seq. The Oklahoma compulsory unitization statute is now codified at Okla. Stat. Ann. tit. 52, §§ 287.1 et seq.

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In Palmer Oil Corp. v. Phillips Petroleum Co.,37 non-consenting owners challenged the compulsory unitization order issued with regard to the West Cement Medrano Unit both on a per se and as applied basis. The statute contained some of the provisions in both the A.B.A. and IOCC models, including the creation of an operators committee. Plaintiffs argued that the statute was invalid because it did not require the Oklahoma Corporation Commission to find, as a condition precedent to the creation of the unit, that the purposes of the conservation legislation would be better served with a compulsory unitization order than with a different type of conservation order. The court found that the statute clearly required the Commission to make findings that the purposes and objectives of the statute would be carried out by the specific order.

Plaintiffs asserted that the creation of an operator’s committee would, in effect, constitute an improper delegation of legislative power to a private committee run by the majority owners. While the committee has broad pow-ers to develop and produce, its powers do not go to the creation of the unit which is solely in the hands of the Corporation Commission. The royalty owners who were not part of the consent requirement argued that their ex-clusion rendered the process unconstitutional. The court rejected that claim noting that once a legislative body makes a determination to exercise its police power to protect the public health, safety, morals or general welfare, it may do so without seeking the consent of the individuals who are affected by the regulatory program.

Regarding the “as applied” attack, the court concluded that it would not take a heavy-handed role in reviewing the validity of the attack. In the para-digm of “hard look” versus “soft glance” models of judicial review, the court clearly falls within the “soft glance” model and says it is inappropriate for a court to substitute its judgment for that of the Commission and that the party challenging the validity of an individual order has to bear a heavy burden of proof to show that the order was unreasonable or discriminatory.38

37 Palmer Oil Corp. v. Phillips Petroleum Co., 231 P.2d 997 (Okla. 1952), appeal dismissed Palmer Oil Corp. v. Amerada Petroleum 343 U.S. 390 (1952).38 Palmer Oil Corp, 231 P.2d at 1007.

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Compulsory unitization statutes were enacted in many of the major oil-producing states in the next two decades so that today only Texas of the major producing states remains without a compulsory unitization statute. In the eastern states it appears as if both Pennsylvania and Virginia lack a compulsory unitization statute dealing with units that go beyond the size of spacing or drilling units.39

§ 7.02. The Statutory Framework in the Eastern States.Alabama adopted its basic oil and gas conservation statutory scheme,

including well spacing and compulsory pooling in 1945.40 The compulsory pooling statute was also enacted in 1945.41 The compulsory unitization statute was adopted in 1945, expanded to cover more than secondary operations in 1957, and extensively amended in 2000.42 Florida also adopted its basic oil and gas conservation statutory scheme, including well spacing and compul-sory pooling in 1945.43 The compulsory unitization statute was also adopted in 1945 and has been amended some 4 times since then.44 Georgia also adopted its basic oil and gas conservation statutory scheme, including well spacing and compulsory pooling in 1945.45 The compulsory pooling provi-sions are contained in the same provision dealing with the creation of drilling

39 See Robert A. Bradley, Oil, Gas and Government—The U.S. Experience 206-07 (1996) where a chart is provided showing the adoption of compulsory pooling and unitization statutes on a state-by-state basis.40 Ala. Stat. §§ 9-17-1 et seq. There is a recent “popular” history of oil and gas activities in the Deep South that describes the efforts of those involved in oil and gas drilling and production activities. Alan Cockrell, Drilling Ahead: The Quest for Oil in the Deep South 1945-2005 (2005).41 Ala. Code § 9-17-13 (2006). The text of all of the conservation statutes can be found in Kramer and Martin, supra note 1, Volumes 4-5.42 Ala. Code §§ 9-17-80 through 9-17-88. See also State Oil & Gas Board v. Seaman Paper Co., 235 So. 2d 860 (Ala. 1970).43 Fla. Stat. Ann. §§ 377.25-377.27 (West 2006). See also Smacko, Ltd. v. Jordan, 469 So. 2d 860 (Fla. Dist. Ct. App. 1985).44 Fla. Stat. Ann. § 377.28 (West 2006).45 O.C.G.A. §§ 12-4-40 et seq. (O.C.G.A. §§ 43-701 et seq.).

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units.46 Somewhat uniquely, the Georgia compulsory unitization provision is located in the same statutory section as the well spacing and compulsory pooling provisions and is given the label of “operation units.”47

Illinois adopted its basic oil and gas conservation statutory scheme, including well spacing and compulsory pooling, in 1941, although the compulsory pooling provision was amended substantially in 1945.48 The compulsory pooling statute has been amended several times since 1941 and was recodified in 1989.49 The origins of the compulsory unitization statute are not clear but it has been in force since the 1940s.50

While Indiana has a long history of conservation regulation dating back to the 1890s, the adoption of the compulsory pooling statute apparently oc-curred in 1947, although with the recodification of its statutes in 1995, there is not an easy way to trace back the history of the enactment of the statute.51 As with Georgia, the compulsory unitization provisions are combined with the compulsory pooling provision as the statute allows the compulsory integration of separately owned interests in an established drilling unit or within a pool or part of a pool.52 Kentucky was a relative latecomer to the adoption of a compulsory pooling statute through its 1960 enactment of such a statute.53 The compulsory unitization statute was adopted in 1994.54

46 O.C.G.A.. § 12-4-45.47 O.C.G.A. § 12-4-45.48 225 Ill. Comp. Stat. 725/1 et seq.49 225 Ill. Comp. Stat. 725/22.2. See Newkirk v. Bigard, 485 N.E.2d 321 (Ill. 1985), cert. denied 475 U.S. 1140, reh’g denied, 477 U.S. 909 (1986).50 225 Ill. Comp. Stat. 725/23 et. seq. See John O. Schofield, Inc. v. Nikkel, 731 N.E.2d 915 (Ill. Ct. App. 2000); Shelton v. Andres, 462 N.E.2d 549 (Ill. Ct. App. 1984), aff’d 478 N.E.2d 311 (1985); Belden v. Tri-Star Prod. Co., 435 N.E.2d 927 (Ill. Ct. App. 1982).51 Ind. Code §§ 14-37-9-1 et seq. (1988).52 Ind. Code § 14-37-9-1 (1988).53 Ky. Rev. Stat. Ann. §§ 353.610, 353.630, 353.640, 353.650 (2006). See Howard v. Kingmont Oil Co., 729 S.W.2d 183, (Ky. Ct. App. 1987); Rice Bros. Mineral Corp. v. Talbott, 717 S.W.2d 515 (Ky. Ct. App. 1986).54 Ky. Rev. Stat. Ann. § 353.645 (2006).

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Michigan adopted its basic oil and gas conservation statutory scheme in 1929. The well spacing and compulsory pooling provisions were adopted in 1937, amended thereafter and recodified in 1994.55 Michigan has one of the lengthier compulsory unitization statutes that was also part of its recodifica-tion efforts in 1994.56 Mississippi adopted its basic oil and gas conservation statutory scheme in 1932. The State Oil and Gas Board, however, while it had the power to adopt drilling and/or spacing unit regulations, did not have the power to force pool separate interests until 1948.57 Because of the problems caused by having no compulsory pooling power, Mississippi courts adopted the unique equitable pooling doctrine.58 The compulsory unitization statute was initially adopted in 1964 with substantial amend-ments occurring in 1972.59

New York adopted its well spacing and compulsory statute in 1972, amending it in 1982 to grandfather a number of wells out of the statutory program and has further amended the statute in 2005 to deal with issues arising out of some recent administrative decisions and litigation.60 The

55 Mich. Comp. Laws § 324.61513 (1994). See Traverse Oil Co. v. Chairman, Natural Resources Comm’n, 396 N.W.2d 498 (Mich. Ct. App. 1986); Manufacturers Nat’l Bank v. Director of Dep’t of Natural Resources, 362 N.W.2d 572 (Mich. 1984).56 Mich. Comp. Laws §§ 324.61701-324.61738 (1994).57 Miss. Code Ann. § 53-3-7 (1948). See Pursue Energy Corp. v. State Oil & Gas Bd., 524 So. 2d 569, (Miss. 1988); Corley v. Mississippi Oil & Gas Bd., 105 So. 2d 633 (Miss. 1958).58 Kramer and Martin, supra note 1 at § 7.02[1].59 Miss. Code Ann. §§ 53-3-101 to 53-3-119. See Rogers and Gault, “Mississippi Compulsory Field-Wide Unitization,” 44 Miss. L. J. 336 (1973) and Custy and Knowlton, “Compulsory Field-Wide Unitization Comes to Mississippi,” 36 Miss. L. J. 123 (1965). See also Texas Pacific Oil Co. v. Petro Grande, Inc., 328 So. 2d 660 (Miss. 1976); Palmer Exploration, Inc. v. Dennis, 730 F. Supp. 734 (S.D. Miss. 1989), aff’d 896 F.2d 552 (5th Cir. 1990).60 N.Y. Env. Cons. Law §§ 23-0501 et seq. (McKinney 2006). See Sylvania Corp. v. Kilborne, 271 N.E.2d 524 (1971) aff’d 271 N.E.2d 524 (N.Y. 1971); Western Land Serv., Inc. v. Dep’t of Envtl. Conservation, 798 N.Y.S.2d 714 (Sup. Ct. 2004); Caflisch v. Crotty, 774 N.Y.S.2d 653 (Sup. Ct. 2003). The Caflisch decision is criticized by the author in Kramer and Anderson, “The Rule of Capture—An Oil and Gas Perspective,” 35 Envtl. L. 899, 928-930 (2005).

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compulsory unitization statute was adopted in 1972, amended in 1981 and further amended in 2005.61

North Carolina adopted its compulsory pooling statute in 1945.62 North Carolina does not have a compulsory unitization statute.

Ohio adopted its well spacing and compulsory pooling statute in 1965.63 The compulsory unitization statute was also adopted in 1965.64 While Pennsylvania, like Indiana, has a long history of oil and gas conservation regulation, the modern well spacing and compulsory pooling statute was adopted with the passage of the Pennsylvania Oil and Gas Conservation Law in 1971.65 Pennsylvania does not have a compulsory unitization statute.

Tennessee adopted its oil and gas conservation statutes in 1943 and added well spacing and compulsory pooling provisions in 1984.66 Tennessee del-egates authority to its Oil and Gas Board to statutorily unitize interests in a volumetric or surface poolwide unit. This is probably the shortest compulsory unitization statute in the United States.67 Virginia adopted its current form of well spacing and compulsory pooling regulation in 1982 with the enact-ment of the Oil and Gas Act.68 In 1990, a specific provision was added to the compulsory pooling statute dealing with problems concerning coalbed methane gas wells.69 Virginia, like North Carolina and Pennsylvania, does not have a compulsory unitization statute.

61 N.Y. Env. Cons. L. §§ 23-0901 et seq. (McKinney 2006).62 N.C. Gen. Stat. §§113-392, 113-393 (2006).63 Ohio Rev. Code Ann. §§ 1509.24 to 1509.27 (West 2006). See generally, Emens and Lowe, “Oil and Gas Conservation Law—The First Ten Years (1965-75),” 37 Ohio St. L. J. (1976). See Columbia Gas Transmission Corp. v. Zeigler, 83 Fed. Appx. 26 (6th Cir. 2003); Northampton Bldg. Co. v. Sharon Township Bd. of Zoning Appeals, 667 N.E.2d 27 (Ohio Ct. App. 1996), aff’g, 671 N.E.2d 1309 (1996); Johnson v. Kell, 626 N.E.2d 1002 (motion overruled 623 N.E.2d 567 (1993). 64 Ohio Rev. Code Ann. § 1509.28 (West 2006).65 52 Pa. Stat. Ann. §§ 406-409, 507 (West 2006). See Appeals of Pennzoil Co. & Westrans Petroleum, Inc., 69 Pa. D & C 122, 1974 WL 42920 (Pa. Environ. H. Bd. July 26, 1974).66 Tenn. Code Ann. §§ 60-1-106, 60-1-202 (1984).67 Tenn. Code Ann. § 60-1-202(N) (1984).68 Va. Code Ann. §§ 45.1-361.17 through 361.26 (1997).69 Va. Code Ann. § 45.1-361.22 (1997).

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West Virginia, by far, has the longest and most complex series of oil and gas conservation statutes of all of the 50 states. A well spacing and compul-sory pooling statute was adopted in 1994 that applies to coalbed methane gas wells.70 There is a separate well spacing and compulsory pooling statute for shallow gas wells that was also adopted in 1994.71 There are also well spacing and compulsory pooling provisions for other types of wells.72 The compulsory unitization statute was also adopted in 1994.73

§ 7.03. Common Problems Attendant to Compulsory Pooling.

[1] — Who May Apply? In most circumstances it will be a lessee/working interest owner who

will apply for a compulsory pooling order. It may be the working interest owner on the proposed drill site tract or under certain circumstances it may be the working interest owner on an adjacent tract that seeks to “muscle-in” to an existing drilling or spacing unit. There may be circumstances, however, where royalty owners, unleased mineral owners or the state conservation agency may be the party seeking to force pool several owners within the confines of a drilling or spacing unit.74

[a] — Broad Statutory Provisions. Both Mississippi75 and Louisiana76 provide that any “interested per-

son” may seek a hearing. Unless the statute or regulations define the term “interested person” narrowly, which is not the case in either Mississippi or

70 W. Va. Code §§ 22-21-15 to 22-21-20. See generally, Note, “Oil and Gas Regulatory Consideration for Coal, Oil and Gas Operators in West Virginia: Selected Issues,” 99 W. Va. L. Rev. 493 (1997). See Energy Dev. Corp. v. Moss, 591 S.E.2d 135 (W. Va. 2003).71 W. Va. Code §§ 22C-8-9 to 22C-8-17 (1994).72 W. Va. Code §§ 22C-9-7 et seq. (1994). See Powers v. Union Drilling, Inc., 461 S.E.2d 844 (W. Va. 1995).73 W. Va. Code §§ 22C-9-8 to 22C-9-11 (1994).74 Kramer and Martin, supra note 1 at § 11.02.75 Miss. Code Ann. § 53-1-29 (2006).76 La. Rev. Stat. Ann. § 30:6(F) (2006).

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Louisiana, it would appear that almost anyone who has an interest in produc-tion would be able to request a compulsory pooling order. It is problematic whether a surface owner who does not have an interest in production, but clearly is interested in the location of the well, may institute a compulsory pooling procedure under this broad statutory language.77

[b] — Owners or Operators.A number of compulsory pooling statutes limit to “owners” or “opera-

tors” the power to seek a compulsory pooling order. Illinois, for example, defines an “owner” as “any person having an interest in the right to drill into and produce oil or gas. . .”78 Ohio takes a similar approach limiting to “own-ers” the right to seek a compulsory pooling order79 and defining an owner as “the person who has the right to drill on a tract or drilling unit, to drill into and produce from a pool, and to appropriate the oil or gas produced therefrom . . .80 New York, which has a similar definition of the term “owner,”81 has interpreted that term in a somewhat bizarre fashion. In Caflisch v. Crotty,82 the court, in dicta, clearly mangles the definition of the term owner in a way that causes substantial confusion.83 The Roper tract is subject to a “no-drill” oil and gas lease held by Caflisch. It comprises some 0.30 percent of a spac-ing unit that was not created until after the well was drilled on an adjacent tract. In dealing with the argument that Caflisch and another plaintiff were not owners within the terms of the compulsory pooling order, the court says: “Neither petitioner ‘has the right to drill’ in the Gregory Drilling Unit since neither was granted a permit, the lease held by petitioner Caflisch does

77 The term “interested person” has been held to include overriding royalty owners in the context of a compulsory unitization procedure as was authorized by Alaska statutes. Allen v. Alaska Oil & Gas Conservation Comm’n, 1 P.3d 699 (Alaska 2000).78 225 Ill. Comp. Stat. 725/21.1 (2006).79 Ohio Rev. Code Ann. § 1509.27 (West 2006).80 Ohio Rev. Code Ann. § 1509.01(K)(West 2006).81 N.Y. Envir. Cons. L. § 23-0301 (McKinney 2006).82 Caflisch v. Crotty, 2 Misc.3d 786, 774 N.Y.S.2d 653 (Sup. Ct. 2003).83 See Kramer and Anderson, supra note 60 at 928-930 for a critique of Caflisch.

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not permit it, and, apparently, neither petitioner controls enough-acreage to qualify for a drilling permit.”84 This is a fundamental error in defining the term owner. The fact that a person owning the property right to produce oil and gas does not have sufficient acreage to qualify for a drilling permit does not deprive that person of his status as the owner of the right to drill. Even a lessee with a no-drill clause has the right to produce the oil and gas, but just not from a surface location on the leased-acreage. No-drill leases are common with federal oil and gas leases and occasionally appear in private fee leases where small-acreage tracts are being leased. The lessee clearly has the common law privilege to drill, subject of course to the exercise of the police power by the State. The New York court’s notion that only a party with a drilling permit is an “owner” would drastically limit the number of people who could seek compulsory pooling orders and give substantial power to those lessees who control larger tracts of land.

[c] — State Conservation Agency.A number of states have express provisions giving the state conservation

agency the power, on its own motion, to seek a compulsory pooling order.85 With the Georgia compulsory pooling statute, it is unclear whether a private party can seek a compulsory pooling order while the Virginia statute is more typical in that it empowers both private parties and the state conservation agency to seek such an order. Kentucky provides somewhat ambiguously for the state conservation agency to issue a compulsory pooling order where separate tracts are located in a drilling unit, but does not specify who can initiate the application for such an order even though it requires the operator to show that it has secured the consent of the owners of at least 51 percent of the interests in the proposed pooled unit.86 The consent provision is quite

84 Caflisch, 774 N.Y.S.2d at 656-57.85 See e.g., O.C.G.A. § 12-4-45 (2006); Va. Code Ann. § 45.1-361.20 (2006).86 Ky. Rev. Stat. Ann. § 353.630 (West 2006). The Kentucky statute defines an operator in terms of persons owning the privilege of drilling for oil and gas with a specific reference to unleased mineral owners and a specific exclusion of royalty owners. Ky. Rev. Stat. Ann. § 353.510 (West 2006).

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unusual for a compulsory pooling statute while it is almost universally re-quired for a compulsory unitization order.

[2] — Who Is Entitled to Notice?When answering this question as to both compulsory pooling and

compulsory unitization orders there are several different levels that are nec-essarily involved. At the lowest level are the notice requirements imposed by the state conservation agency, typically adopted through its rulemaking power. These requirements can be specifically tied to a compulsory pool-ing or unitization order and/or hearing or can be generally imposed for any type of agency hearing and/or order. At the intermediate level there may be state statutory requirements for notice. As with agency notice requirements, these may be specific to the compulsory pooling and/or unitization process or may be general as through a state administrative procedure act. For ex-ample, Mississippi has a statutory notice form that must be sent out by the operator to all interested persons before the agency has jurisdiction to issue a compulsory pooling order.87 Other statutes more typically just require the agency to provide notice and a hearing before issuing a compulsory pooling order.88 The Indiana compulsory pooling and unitization statute does not provide for a notice and hearing before the issuance of any order but does reserve to the conservation agency the power to “determine any dispute that arises under this chapter.”89

At the broadest level there are state and/or federal constitutional con-straints on the type of notice one must provide. Obviously a compulsory pooling order affects property rights and if an adjudicatory or contested case procedure is being used, then due process requires notice reasonably calculated under all of the circumstances to apprise interested parties of the pendency of the action.90 The Supreme Court of the United States has

87 Miss. Code Ann. § 53-3-7(2)(c) (2006).88 225 Ill. Comp. Stat. Ann. 725/22.2 (2006). See also Ala. Code § 9-17-13 (2006). 89 Ind. Code §§ 14-37-9-2, 14-37-9-4 (2006).90 Greene v. Lindsey, 456 U.S. 444 (1982); Mullane v. Central Hanover Bank & Trust Co., 339 U.S. 306 (1950). See generally Kramer and Martin, supra note 1 at § 11.04.

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recently given some guidance as to the type of notice required before prop-erty interests may be taken or affected. In Jones v. Flowers,91 an owner of some real property seized and then sold for failing to pay ad valorem taxes argued that the Due Process Clause required the state to send more than just two certified letters to the house being seized before they could sell the home.92 While actual notice is not constitutionally required under the Due Process Clause,93 what meets the Mullane standard of “notice reasonably calculated, under all the circumstances, to apprise interested parties of the pendency of the action and afford them an opportunity to present their objections,”94 has been a matter of some conflicting state and federal court decisions.95 The Supreme Court, however, does not provide a definitive test of what types of additional steps must be taken to satisfy the Due Process Clause where the government is aware that the notice sent was not received. The only standard provided by the court is the state “should have taken additional reasonable steps to notify Jones, if practicable to do so.”96 This requires a court to inquire as to the practicability of any alternatives, if there are any alternatives. In this case the court finds that there are alternatives, including the sending of a regular mail notice for which a signature is not required. It appears as if the court will look to what other states are doing to set the standard of what may be reasonable. In the context of pooling and/or unitization orders, the Due Process Clause may be the basis for setting up a national norm of notice based on the actual practices being presently used by state conservation agencies. Failure to provide notice to a party entitled

91 Jones v. Flowers, 126 S. Ct. 1708 (2006).92 The first notice was sent by certified mail in April 2000 and returned “unclaimed.” The second notice was sent in 2002, prior to the actual sale, and was likewise returned “unclaimed.” In addition, notice by publication in the Little Rock, Arkansas newspaper of general circulation was also provided in 2002. The home was located in Little Rock. Jones, 126 S. Ct. at 1712-13.93 Dusenbery v. United States, 534 U.S. 161 (2002).94 Mullane, 339 U.S. at 314.95 See cases listed in Jones, 126 S. Ct. at 1712-13.96 Id. at 1718.

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to notice may render the order void as to that party and thus not subject to the collateral attack doctrine.97

In Katter v. Arkansas Louisiana Gas Co.,98 the well operator proposing a pooled unit sought to force pool an undivided ½ interest in the mineral estate on a 38.5-acre tract of land. The Katter family had resided in Beirut, Lebanon since the 1940s. The Katters, pursuant to the order, were given three options, including a default option if they did not respond to the notice. The agency mailed a notice of the hearing and the election alternatives to the last known address of the Katters, care of the American Embassy in Beirut. By the time the Katters responded, the time for the election had passed. The Eight Circuit, however, found that the attack on the validity of the order and its default election option was an impermissible collateral attack on the order. The court rejected the claim that the order was void as to the Katters’ interest because of the lack of notice in part based on an estoppel theory because the Katters had apparently waited to file their action until the well had been drilled. There are, however, a number of cases finding that if the notice requirements of the Due Process Clause are not complied with, the order is void as to that party.99

[a] — Special Problem Areas.Should a top lessee be entitled to notice that a compulsory pooling hear-

ing will be held affecting the lands subject to the top lease? A trial court in New York found that a top lessee lacked standing to challenge a unitization after it had been implemented, but on appeal, the Appellate Division reversed,

97 The three dissenting justices (Justice Alito did not participate in the case), would have found that the state’s action in this case comported with the requirements of the Due Process Clause. Jones, 126 S. Ct. at 1721-23.98 Katter v. Arkansas Louisiana Gas Co., 765 F.2d 730 (8th Cir. 1985).99 Moore Oil Co. v. Snakard, 150 F. Supp. 250 (W.D. Okla. 1957), remanded for further proceedings on joint motion of the parties, 249 F.2d 318 (10th Cir. 1957); Day v. State Corp. Comm’n, 341 P.2d 1028 (Kan. 1959), opinion modified, 345 P.2d 651 (Kan. 1959).

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but did not directly address the issue of standing and/or notice.100 The cases did not directly deal with the issue of notice since the unitizations appear to be voluntary in nature, but the trial court concluded that the top lessee could not challenge their validity in a lawsuit. The Appellate Division, on the other hand, concluded that the top lessee had standing to challenge the exercise of the pooling power for breach of the good faith duty because the leases were beyond their secondary term and unless the pooling was effective the leases would terminate for lack of production in paying quantities. Most statutory definitions of an “owner” or “operator” require that party to have the power to explore and produce hydrocarbons.101 A top lessee does not have the power to produce oil and gas since its interest is in the nature of a springing executory interest which in the absence of consent by the owner of the present possessory estate cannot drill.102

If the notice is insufficient as to one party is the order that follows void or voidable as to the party not receiving notice or to the party or parties who may have actually received proper notice? As noted above, two cases suggest that as to the person who did not receive notice the order is void.103 In Walker v. Cleary Petroleum Corp.,104 the court found that the notice given by the Alabama Oil and Gas Board was constitutionally defective as to the plaintiff, but did not find that the order was void on its face. The court found, on the specific facts of the case, that notice by publication to a person known to be a maritime seaman violated the Due Process Clause. The plaintiff owner did

100 Envirogas, Inc. v. Consolidated Gas Supply Corp., 465 N.Y.S.2d 141 (N.Y. Sup. Ct. 1983), affd in part and rev’d in part on other grounds, 469 N.Y.S.2d 499 (N.Y. App. Div. 1983).101 See e.g., N.Y. Envir. Cons. Law § 23-0101(11) (2006); Va. Code Ann. § 45.1-361.1 (1982).102 The Rules of Procedure of the Louisiana Comm’r of Conservation specifically exclude the top lessee from the definition of an “owner.” Kramer and Martin, supra note 1 at 11-10 (n.24).103 Moore Oil Co. v. Snakard, 150 F. Supp. 250 (W.D. Okla. 1957); Day v. State Corp. Comm’n, 341 P.2d 1028 (Kan. 1959).104 Walker v. Cleary Petroleum Corp., 421 So. 2d 85 (Ala. 1982).

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not sue the Oil and Gas Board but instead sued the pooled unit operator for what appears to be trespassory claims. The court did not discuss the issue of the apparent collateral attack on the validity of the order, where the Board had made a specific finding that notice had been properly sent to all owners of interests subject to the forced pooling order. Instead it merely invalidated the order as it applied to the plaintiff and awarded nominal damages since the operator had tendered the plaintiff’s share of production, less his share of expenses in drilling the well, to the plaintiff.105

Will actual notice cure any defect in providing notice whether by publica-tion or by attempted personal delivery? The majority rule appears to be that a party who has received actual notice of the hearing cannot complain that the statutory or administrative notice provisions are unconstitutional.106 In Ohio Oil Co. v. Porter,107 several parties challenged the creation of drilling units. Under then existing Mississippi law notice by publication was suf-ficient to provide notice of the drilling unit hearing. Because the plaintiffs actually participated in the hearing, the court concluded: “They are therefore not in a position to complain that they were not afforded ample notice of the meeting.”108 A person who appears at a hearing probably cannot complain about any Due Process violations, but may be able to persuade the conser-vation agency to grant an extension or postpone the hearing until proper notice and time to prepare for participation has been given the party who

105 Other cases finding an order issued without proper notice invalid solely as to the party who did not receive notice include, Harry R. Carlisle Trust v. Cotton Petroleum Corp., 732 P.2d 438 (Okla. 1986), cert. denied sub nom Oklahoma Corp. Comm’n v. Harry R. Carlisle Trust, 483 U.S. 1021 (1987); Application of Koch Exploration, 387 N.W.2d 530 (S.D. 1986).106 See e.g., Brown v. Sutton, 356 So. 2d 965 (La. 1978); Superior Oil Co. v. Beery, 64 So. 2d 357 (Miss. 1953); Ranola Oil Co. v. Corp. Comm’n, 460 P.2d 415 (Okla. 1969); Application of Koch Exploration, 387 N.W.2d 530 (S.D. 1986); R.R. Comm’n v. Graford Oil Corp., 557 S.W.2d 946 (Tex. 1977).107 Ohio Oil Co. v. Porter, 82 So. 2d 636 (1955).108 Id. at 638.

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is protesting the lack of notice.109 Finally, in certain circumstances a court may find that under the affirmative defenses of estoppel or laches, a party may be prevented from asserting lack of adequate notice, although there are limitations on the use of such defenses where the lack of notice ostensibly violates constitutional norms.110

Is notice by publication sufficient? After Jones v. Flowers, continued reliance solely on notice by publication may be questionable. Most Due Process cases are decided on an ad hoc case-by-case basis rather than with a blanket statement that notice by publication is always invalid. In Walker v. Cleary Petroleum Corp.,111 a landowner argued that notice by publica-tion of a compulsory pooling hearing was a constitutional violation. At that time the Alabama State Oil and Gas Board rules only required notice by publication in newspapers of general circulation in Montgomery and Mo-bile, and where the proposed order would affect a parcel of land, notice by publication in a newspaper of general circulation in the county where the land was located.112 Relying on the general language of Mullane that notice must be reasonably calculated under all of the circumstances to apprise the interested parties of the pendency of the action, the court concluded that the plaintiff’s whereabouts were known and that notice by publication would not likely apprise him of the hearing. In fact the Board all but conceded that they knew that the plaintiff was a merchant seaman and would not likely be notified by the published ads. The court does not invalidate the Board rules authorizing notice by publication, but merely finds that as to this plaintiff notice was constitutionally infirm.

109 Kramer and Martin, supra note 1 at 11-121 (n.33).110 See e.g., Katter v. Arkansas Louisiana Gas Co., 765 F.2d 730 (8th Cir. 1985); Hutchison v. Pan American Petroleum Corp., 388 F.2d 111 (10th Cir. 1968); Tara Oil Co. v. Kennedy & Mitchell, Inc., 622 P.2d 1076 (Okla. 1981).111 Walker v. Cleary Petroleum Co., 421 So. 2d 85 (Ala. 1982).112 Id. at 86.

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Many of the issues relating to an attack on a state conservation agency order based on lack of notice were analyzed in In re Abandonment of Wells Located in Illinois v. Department of Natural Resources (DNR).113 DNR issued an order finding that certain permits allowing injection wells had been abandoned. The permit owner claimed that the order was void ab initio because DNR had failed to provide her with notice of the hearing that led to the issuance of the order. Under Illinois law, where a person’s right or interest in life, liberty or property is affected, due process requires that the person be served with adequate notice and be afforded an opportunity to be heard. The administrative regulations relating to permit revocations require DNR to give written notice through either personal service or certified mail.114 Complying with these notice requirements is a jurisdictional prerequisite for DNR’s exercise of its statutory power to revoke the permits. Because it is a matter of jurisdiction, the fact that the plaintiff did not file this action as a direct appeal of the issuance of the orders does not preclude her from challenging the order collaterally.115 There was a factual issue as to whether DNR provided notice through certified mail, so the court remanded the case back to resolve the factual issues. The court, however, went further and anticipated Jones v. Flowers by stating that certified mail may not comport with the Due Process Clause in every circumstance. If certified mail is not likely to reach the recipient and other means are reasonably available, then the agency may have to attempt to provide notice in another manner.

Can a notice for a hearing be invalid if the state conservation agency changes and/or expands the subjects to be discussed at the hearing? In Traverse Oil Co. v. Natural Resources Commission,116 the proponent of an 80-acre spacing and compulsory pooled unit challenged the Commission’s

113 In re Abandonment of Wells Located in Illinois v. Dep’t of Natural Resources, 796 N.E.2d 623 (Ill. App. Ct. 2003), appeal denied 807 N.E.2d 975 (Ill. 2004).114 In re Abandonment of Wells Located in Illinois, 796 N.E.2d at 626.115 Id.116 Traverse Oil Co. v. Chairman, Natural Resources Comm’n, 396 N.W.2d 498 (Mich. Ct. App. 1986).

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decision to create a 40-acre unit asserting in part that the Due Process Clause restricted the Commission’s power to issue an order that was not contained within the notice provided the parties prior to the hearing. While accepting the general proposition that the notice must reflect the subject-matter of the hearing, the court found that on the facts of the case, the applicant was put on actual notice that the Commission might consider creating a 40-acre and not an 80-acre unit, because that issue had been raised in a series of pre-hearing conferences with the affected parties. The Commission was not deprived of its jurisdiction to issue a compulsory pooling order to the number of acres listed in the notice where the evidence showed that a smaller pooled unit would comply with the statutory requirements for compulsory pooling.

[3] — Options Afforded Non-Consenting Owners.One of the driving forces, other than the rule of capture, behind the

adoption of compulsory pooling statutes, is the law of co-tenancy. Under the prevailing view, one co-tenant of the mineral estate has the power to explore for and produce oil and/or gas without the permission and over the objection of the other co-tenant.117 While giving the drilling co-tenant the right to produce hydrocarbons, the general rule also requires the drilling co-tenant to account to the non-drilling co-tenant for the revenue attributable to the non-drilling co-tenant’s share of production less the non-drilling co-tenant’s share of the costs of drilling. The key is that the non-drilling co-tenant is never liable for any out-of-pocket costs so that if the well is a dry hole or a marginal producer that never achieves payout, the non-drilling co-tenant gets a free ride. After payout, the non-drilling co-tenant becomes a silent, risk-free partner of its respective share of the profits from the successful well. It must be noted, however, that two eastern states, Illinois and West Virginia do

117 Williams and Meyers, supra note 4 at § 504 (2006); Howard Williams, “The Effect of Concurrent Interests on Oil and Gas Transactions,” 34 Tex. L. Rev. 519, 520 (1956). See generally, Prairie Oil & Gas Corp. v. Allen, 2 F.2d 566, 571 (8th Cir. 1924); Gerhard v. Stephens, 442 P.2d 692 (Cal. 1968); P & N Inv. Corp. v. Florida Ranchettes, Inc., 220 So. 2d 451 (Fla. Dist. Ct. App. 1969).

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not follow the general rule on co-tenancy, giving each co-tenant a veto right over the exploration and production of hydrocarbons.118 Without compulsory pooling a non-consenting co-tenant may create substantial economic disin-centives to drill for oil and gas because of its free ride status. It is unlikely that a person desirous of drilling a well would bear 100 percent of the risk for only 50 percent of the profit where there was a co-tenant owning a 50 percent interest in the minerals. The drilling co-tenant would be forced to “carry” the non-drilling co-tenant under the common law rules. Thus where ownership of mineral interests is balkanized producers became supporters of compulsory pooling legislation in order to either overcome the veto power of co-tenants or the “carried” status of co-tenants. In some cases, however, the victory achieved in enacting compulsory pooling legislation was Pyrrhic in nature because the compulsory pooling statute authorized or mandated that non-consenting owners be “carried” without penalty.

There are three principal approaches by which a state conservation agency may deal with non-consenting working interest owners.119 The first is the free ride or “carried” approach, the second is the surrender of working interest approach and the third is the risk penalty approach. Some states allow for the non-consenting party to elect from one or more of the approaches listed above or elect to participate in the costs of drilling the well. In some states the approach or approaches are mandated by statute, while in others the statutes are silent or merely require that the compulsory pooling order be “just and reasonable” or afford each owner the opportunity to recover their fair share of the hydrocarbons. In states without statutory mandates, the state conservation agency may choose from the three approaches listed above or allow an election to be made.120

118 See Zeigler v. Brenneman, 237 Ill. 15, 86 N.E. 597, 600-01 (1908); South Penn Oil Co. v. Aught, 71 W. Va. 720, 78 S.E. 759 (1913).119 See Bruce M. Kramer, “Compulsory Pooling and Unitization: State Options in Dealing with Uncooperative Owners,” 7 Utah J. of Energy L. & Pol’y 255 (1986); Kramer and Martin, supra at ch. 12.120 Kramer and Martin, supra note 1 at ch. 12.

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[a] — The Free Ride Approach. This approach essentially mirrors the common law approach. A non-

consenting working interest owner is allowed to be carried, in that it does not pay any of the drilling or other costs out of pocket but is carried until the well achieves payout at which time the non-consenting owner begins to share pro rata in the profits from this well. Alabama,121 Florida,122 Indiana123 and North Carolina124 follow this approach. This approach in effect requires the operator to give an interest-free loan to the non-consenting working interest owner with the only source of payment of the loan, production after well payout.125 The Alabama statute is typical in that it allows the operator to recover actual expenditures, but not to exceed what are reasonable costs out of first production.126 In addition, the operator is entitled to recover an amount to cover a “reasonable charge for supervision.”127 Florida goes a little further by authorizing the operator to have a lien on the leasehold estate of each separately owned tract contained within the pooled unit.128 This lien is analogous to the operator’s lien created by the joint operating agreement to secure the payment of the costs of drilling. Other states provide for a lien not only against the leasehold estate but against the production of oil and gas in order to secure the payment or crediting of the pro rata costs against the non-consenting working interest owner.129 There is little incentive for non-

121 Ala. Code § 9-17-13 (2006).122 Fla. Stat. Ann. § 377.27 (West 2006).123 Ind. Code § 14-37-9-3 (2006).124 N.C. Gen. Stat. § 113-393 (2006).125 Some eight other states authorize the free ride approach. See Bruce M. Kramer, “Compulsory Pooling and Unitization: State Options in Dealing with Uncooperative Owners,” 7 Utah J. of Energy L. & Pol’y 255, 262 (1986).126 Ala. Code § 9-17-13(c)(2006).127 Id.128 Fla. Stat. Ann. § 377.28(e)(1)(West 2006).129 See e.g., Alaska Stat. § 31.05.100(c)(2006); Ariz. Rev. Stat. Ann. § 27-505(A)(2006); Nev. Rev. Stat. § 522.060(3)(2006).

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consenting working interest owners to enter into a joint operating agreement in free ride states because when and if they are force pooled they will be getting their share of the profits from the well, if any, without bearing any of the risk of a dry or marginally-productive well.

[b] — The Surrender of Working Interest Approach.This approach requires the non-consenting working interest owner to

either participate by agreeing to pay up front its pro rata share of the ex-penses of the drilling operation or in the alternative to assign or surrender the working interest to the operator with compensation in the form of a cash bonus and/or an overriding royalty interest. In addition, it is also typical for their to be a third option given, namely the use of a risk penalty where the non-consentor chooses not to want to either pay the up front costs or transfer away its working interest. Oklahoma has the most extensive jurisprudence on this approach, which was adopted by the Corporation Commission because the compulsory pooling statute merely requires the pooling order to give the non-consenting owners their “just and fair share of the oil and gas.”130 The constitutionality of requiring an election and a possible forced sale was upheld in Anderson v. Corporation Commission.131 In light of the recent Supreme Court decision relating to the power of eminent domain132 and the changing membership of the Supreme Court, the forced sale option might not pass constitutional muster in the future since the state is requiring a pri-vate owner to sell its property interest to another private owner, ostensibly to prevent waste and to conserve natural resources.

Other states that provide for this approach as part of an election given the non-consenting working interest owners include Arkansas,133 Illinois,134 and

130 Okla. Stat. Ann. tit. 52, § 87.1(e)(West 2006).131 Anderson v. Corp. Comm’n, 327 P.2d 699 (Okla. 1958), cert. denied 358 U.S. 642 (1959).132 Kelo v. City of New London, 545 U.S. 469 (2005).133 Ark. Code Ann. § 15-72-304(b)(4)(West 2006).134 225 Ill. Comp. Stat. Ann. 725/22.2 (West 2006).

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West Virginia.135 The surrender option may be either a permanent transfer or for a limited period pending recoupment of costs with an additional sum fixed by the state conservation agency. Where an election is offered the non-consenting working interest owners, there is often litigation regarding the notice, the election period and the default option that will invariably be stated on the notice should the non-consentor not meet the deadlines for making the election. In Newkirk v. Bigard,136 the owners of a half mineral interest in a 30-acre tract challenged a compulsory pooling order that had created two 20-acre drilling units. The working interest owner in petitioning the state conservation agency for the order requested that the non-consentor be given the option of surrendering his interest or participating in the costs of drilling pursuant to the Illinois statute. The non-consentor was given notice of the hearing but he did not attend. The pooling order required the non-consentor to participate in the costs of drilling on the two units. Two years later, the non-consentor files a collateral attack on the order asserting it was ultra vires and unconstitutional. Neither the notice nor the order stated the time and manner in which the non-consentor could elect to participate in the unit and did not provide an equitable alternative to participation as required by the statute. While agreeing that the order was erroneous because the statute makes it mandatory to offer non-consenting parties options other than participation, the order was not void, but merely voidable. The non-consentor had notice of the hearing and chose not to attend or have his attorney or representa-tive present. Thus the agency had jurisdiction over the non-consentor and jurisdiction to issue the order. An erroneous order is not necessarily an order outside the jurisdiction of the agency. Here the non-consenting party needed to have filed a direct appeal of the order to challenge its validity.

135 W. Va. Code § 22C-9-7(b)(5)(2006)136 Newkirk v. Bigard, 485 N.E.2d 321 (Ill. 1985), cert. denied 475 U.S. 1140 (1986), reh’g denied 477 U.S. 909 (1986).

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[c] — The Risk Penalty Approach. The most widespread approach taken by state conservation agencies in

dealing with non-consenting working interest owners is to impose a “risk penalty” that allows the consenting party or parties to not only recoup the pro rata share of their actual and/or reasonable exploration and develop-ment costs, but also some amount above and beyond the fixed costs. The amount of the risk penalty may be fixed by statute, may be limited to a range of percentages or may be imposed by the state conservation agency at its discretion. For example, the Michigan compulsory pooling statute provides in parts that all orders “be upon terms and conditions that are just and reasonable, and will afford to the owner of each tract in the pooling plan the opportunity to recover or receive his just and equitable share of the oil and gas energy in the pool . . . without unnecessary expense . . .”137 Yet the state conservation agency’s policy is to afford the non-consenting working interest owner an election to participate or be carried with a risk penalty to be determined by the agency. In Traverse Oil Co. v. Chairman, Natural Re-sources Commission,138 the Commission’s regulation authorizing that elec-tion was challenged. The court did not endorse the Commission’s regulation as being authorized by the statute, but assumed it was valid. It nonetheless invalidated the Commission’s application of its regulation imposing a risk penalty to non-consentors because the regulation on its face only allowed such penalties to be imposed after the pooling order was entered. In this case the party seeking the pooling order had already drilled the wells without the participation of the non-consenting parties and thus the Commission was without authority to impose the risk penalty.

Mississippi, on the other hand, provides in its compulsory pooling statute for risk penalties ranging from 100 percent for the cost of newly-acquired surface equipment to 250 percent of the costs and expenses of drilling, reworking, deepening, plugging back, testing or completing the well.139

137 Mich. Comp. Laws Ann. § 324.61513 (West 2006).138 Traverse Oil Co. v. Chairman, Natural Resources Comm’n, 396 N.W.2d 498 (Mich. Ct. App. 1986).139 Miss. Code Ann. § 53-3-7(2) (2006).

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In Waller Brothers, Inc. v. Exxon Corp.,140 the constitutionality of the risk penalty provision was challenged. Prior to seeking a compulsory pooling order, Exxon, the operator, sought to have the non-consentors voluntarily assign their interests or execute a “farmout” agreement. Plaintiff chose not to accept the offers and did not participate in the hearing whereby the Board ordered its interest force pooled and subject to the statutory risk penalty for drilling and operating costs as well as for “alternate charges.” While most of the opinion discusses the issue of accord and satisfaction, the court upholds the compulsory pooling statute and its risk penalty provisions against a vague due process challenge. The emphasis is on the role of the risk or nonconsent penalty to “ensure that nonparticipating owners do not benefit from the suc-cessful outcome of risks they do not take.”141 Without a risk penalty provision there would be no economic incentive to enter into a voluntary agreement and working interest owners would take advantage of the common law free ride doctrine to share in the profits and bear none of the risks.

When applying a risk penalty provision a recurring problem is determin-ing what costs can the penalty be applied to. In Wright v. State Oil & Gas Board,142 the issue involved the chargeable costs where an unsuccessful unit well was re-worked to become a successful well at a shallower depth. Shell sought a compulsory pooling order for a 640-acre unit to drill a well to test a formation located at about 20,000 feet. Wright owned nearly 20 percent of the working interest and did not consent. The well was drilled and encountered some productive reservoirs at 12,000 feet, but found no oil and gas at the target formation level. A second Board order was sought to test the shallower formation with a 320-acre unit with a new well. The second well was successful at the 10,500 foot level and Shell sought to re-form the first pooling order to shrink the unit to a 320-acre unit. Shell then sought to charge Wright with its proportionate share of the costs of drilling

140 Waller Bros., Inc. v. Exxon Corp., 836 F. Supp. 363 (S.D. Miss. 1993), aff’d 20 F.3d 469 (5th Cir. 1994).141 Waller Bros., Inc., 836 F. Supp. at 371 quoting from Bennion v. ANR Prod. Co., 819 P.2d 343, 348 (Utah 1991).142 Wright v. State Oil & Gas Board, 532 So. 2d 567 (Miss. 1987).

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to the deeper formation. While the Board agreed with Shell’s position, the Mississippi Supreme Court disallowed those drilling costs because there were, in effect, two different stratum involved in the two orders so that the first order could not be “reformed” to deal with the shallower stratum from which hydrocarbons were being produced. The statute does not allow the non-consentor to be charged with the costs of drilling a dry or marginally-productive well which was essentially what the Board was ordering Wright to do by charging him the costs of drilling to the deeper stratum.143

As with other types of accounting issues, determining what are “de-velopment and operation” costs, to use the Mississippi compulsory pooling statutory language, is not always easy. In Pursue Energy Corp. v. State Oil and Gas Board,144 the unit operator sought to withhold revenue from the non-consentors that compensated the operator for the interest expenses incurred to financing the drilling operations. The Board agreed with the unit operator that such expenses were reasonable, necessary and actually incurred during the development and operation of the unit well. The Board was charged by the statute to determine the appropriate costs that may be charged to the non-consentors.145 Nonetheless the court took a reasonably “hard look” at the Board’s interpretation of the statute even under the “soft glance” arbitrary and capricious test to determine that interest expenses incurred by the unit operator could not be charged to the joint account.146 The court found that interest expense was a cost of doing business but not a necessary cost of drilling a well. Carried owners subject to a risk penalty should not bear the costs incurred by the business decision of the operator to use borrowed funds, rather than internally-generated funds to drill a well proposed by the operator.

143 In accord, Huffco Petroleum Corp. v. Massey, 834 F.2d 540 (5th Cir. 1987).144 Pursue Energy Corp. v. State Oil and Gas Bd., 524 So. 2d 569 (Miss. 1988).145 See also Superior Oil Co. v. State Oil & Gas Board, 220 So. 2d 602 (Miss. 1969).146 The arbitrary and capricious scope of judicial review of Board decisions was adopted in Superior Oil Co., 220 So. 2d 569; and California Co. v. State Oil & Gas Bd., 27 So. 2d 542 (Miss. 1946).

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New York also follows the risk penalty approach by statutory mandate, allowing a risk penalty of twice the non-consenting owner’s share of appro-priate costs.147 The constitutionality of imposing a risk penalty out of unit well revenues was upheld in Sylvania Corp. v. Kilborne.148 The New York statute defines the “risk penalty” as “the percentage applied to well costs to reimburse the well operator for the risk involved with the exploration for and development of a well . . .”149 It also allows the party subject to a risk penalty to end its status as a carried party by paying the full amount of what it owes. This would seemingly allow a carried party to wait until drilling is near completion and then pay well costs at a time when it is better able to determine the risks of a dry hole. The New York statute also provides an extensive definition of what constitutes “well costs” that are subject to recoupment and imposition of the risk penalty.150 The Ohio compulsory pooling statute gives to the state conservation agency the power to impose a risk penalty of up to double the share of the costs incurred by the unit operator.151

[4] — The Effective Date of the Order. The effective date of the order can affect the maintenance of leases and/or

term interests as well as the allocation of production between the parties. Issues arise where a state conservation agency attempts to make its pooling order retroactive to a date earlier than the date the order is actually issued. In addition, in states where there are separate spacing and pooling orders required, issues arise as to whether it is the spacing order or the pooling order that effectively combines the interests and allows for an allocation of production and/or costs to the parties who are subject to both orders. Few problems arise whether the actual drilling of the well follows both the issu-

147 N.Y. Envir. Cons. L. § 23-0901(3)(McKinney 2006).148 Sylvania Corp. v. Kilborne, 271 N.E.2d 524 (1971).149 N.Y. Envir. Cons. L. § 23-0901(3)(a)(4)(McKinney 2006).150 Id. at § 23-0901(3)(a)(5).151 Ohio Rev. Code. Ann. § 1509.27 (West 2006).

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ance of the spacing and/or pooling order. A problem may arise where the drilling of the well antedates either the spacing or pooling order. One way to resolve this issue is for the agency to make the order effective on the date of application, rather than on the date the order is actually issued.152

There is no clear-cut rule on whether courts will accept the “retroactive” dating of the effective date of such orders. For example, Texas generally does not allow a pooling order to be effective prior to the date of its actual issuance since it affects vested property rights.153 In Oklahoma, on the other hand, where the entry of a spacing unit automatically pools the royalty and unleased owners, the Oklahoma Supreme Court has found that a pooling order may relate back to the date of entry of the original spacing order.154 In Alaska, a compulsory unitization order was upheld that was made effective as of the date of application.155 In Utah, a pooling order was found to be invalid after it was made retroactive to the date of first production because until a valid spacing order was in place, the common law rule of capture doctrine could not be overturned.156 But in Nebraska a pooling made retroactive to the date of first production was valid even in the absence of a spacing order.157

[5] — The Non-Consenting Unleased Mineral Owner.Many state compulsory pooling statutes are silent on how unleased

mineral estate owners are to be treated.158 An increasing number of states,

152 Kramer and Martin, supra note 1 at § 13.03.153 See e.g., American Operating Co. v. R.R. Comm’n of Texas, 744 S.W.2d 149 (Tex. App. 1987, writ denied); Buttes Resources Co. v. R.R. Comm’n of Texas, 732 S.W.2d 675 (Tex. App. 1987, writ ref’d n.r.e.).154 Ward v. Corp. Comm’n, 501 P.2d 503 (Okla. 1972); Wood Oil Co. v. Corp. Comm’n, 268 P.2d 878 (Okla. 1954); Wood Oil Co. v. Corp. Comm’n, 239 P.2d 1023 (Okla. 1950).155 Allen v. Alaska Oil & Gas Conservation Comm’n, 1 P.3d 699 (Alaska 2000).156 Cowling v. Bd. of Oil, Gas and Mining, 830 P.2d 220 (Utah 1991); see also Hegarty v. Bd. of Oil, Gas & Mining, 57 P.3d 1042 (Utah 2002).157 Farmers Irrigation Dist. v. Schumacher, 194 N.W.2d 788 (Neb. 1972), but cf., Ohmart v. Dennis, 196 N.W.2d 181, (Neb. 1972).158 See e.g., Ind. Code Ann. § 14-37-9-2, 14-37-9-3 (West 2006); Ky. Rev. Stat. Ann. § 353.640 (West 2006).

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however, have adopted what I called the “7/8-1/8 solution.”159 These states essentially convert an unleased mineral estate into a lease from the owner to herself with the reservation of a 1/8th royalty. Thus, the unleased owner is treated as both a working interest owner who must participate in the expense of drilling the well and a royalty interest owner who is entitled to the royalty share out of first production.160 Unleased mineral owners meet most, if not all, of the statutory definitions of owners under compulsory pooling statutes because they possess the right to explore for and produce oil and gas.

New York has had some trouble with its compulsory pooling statute and what to do with unleased mineral owners. In Caflisch v. Crotty,161 the court and the underlying agency decision reflect a misunderstanding of the nature of the ownership of oil and gas. Although the lands in question were subject to an oil and gas lease, the agency and the court treat the lands as being unleased because the lease contained a no development clause. Initially the lessee is treated as a party not having the right to drill the well even though the no development clause could be rescinded by the parties at any time.162 The lessor is also treated as not having the power to develop the premises although the length of the lease is not given and the lessor could, jointly with the lessee, rescind the development restriction and authorize the drilling of a well. The court then concludes that the then-extant compulsory pooling act does not deal with the entitlement of an unleased mineral owner to participate in a pooling order. The order awarding the lessor a 1/8th royalty for its pro rata share of production from the unit but freezing out the lessee is hard to understand. What is also hard to understand is the court’s rationale that the order is justified by the rule of capture. The rule of capture, without the ap-

159 Bruce M. Kramer, “Compulsory Pooling and Unitization: State Options in Dealing with Uncooperative Owners,” 7 Utah J. of Energy L. & Pol’y 255, 278-79 (1986).160 See e.g., 225 Ill. Comp. Stat. Ann. 725/22.2(g)(West 2006); Ohio Rev. Code Ann. § 1509.27 (2006).161 Caflisch v. Crotty, 774 N.Y.S.2d 653 (Sup. Ct. 2003).162 N.Y. Envir. Cons. L. § 23-0101(11) (McKinney 2006).

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plication of the state regulatory regime, clearly would allow the owners of the small tract to drill a well to avoid drainage. The state regulatory regime, however, restricts that right so that after the spacing unit order and the compulsory pooling order, that right may not be exercised. The correlative rights of the pooled owners are protected by allowing them to participate, in some way, in the pooled unit well. The agency’s and court’s decision is clearly inappropriate. As I and my co-author have stated elsewhere:

The problem with New York conservation practice runs deeper than this particular holding. Under New York practice, spacing units are not created until after a well is drilled, and the shape of each unit must be separately justified on the basis of geology and reservoir characteristics. This can result in a non-uniform pattern of spacing units. Of course, pooling cannot occur until the spacing unit for a well has been established. This means that parties . . . are pooled after the well is drilled, and they may not be given a prior opportunity to participate in the drilling of the unit well.

This New York practice turns spacing and pooling policy on its head and actually serves to limit the rule of capture more than is customarily the case under the conservation practices of other states. While following survey lines might not be workable in New York owing to metes-and-bounds land descriptions, units could still be formed on a largely uniform pattern as is customary in many states. In addition, owing to the New York Practice of having to geologically justify each unit, pooling prior to drilling is not practically possible.

In most other states, whether spacing is determined for the entire reservoir immediately after its discovery, . . . or is determined on a unit-by-unit basis, spacing units follow a uniform pattern . . . New York conservation officials should

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establish spacing units prior to the drilling of development wells, and also allow pooling prior to development . . . .163

There is some problem with the 7/8-1/8 solution, namely that in today’s marketplace the royalty reserved in an oil and gas lease is likely to be greater than 1/8th. Yet the unleased owner is essentially forced to accept terms that might not be deemed reasonable under current market conditions. At one time it was thought that the unleased owner should receive the average, but not less than 1/8th, of the royalties committed to a compulsory pooled unit, but the clear prevailing view in the United States is to fix the royalty at 1/8th for unleased mineral owners.164 At least one state, Colorado, does not give the unleased owner a cost-free royalty share, but instead treats the unleased owner as an 8/8th working interest owner.165

In Arkansas and Virginia, unleased mineral owners are given several options, including leasing and/or selling the minerals to a participating work-ing interest owner, staying unleased and participating in the costs or staying unleased and paying the appropriate risk penalty by being carried.166

§7.04. Compulsory Unitization.[1] — Introduction.As suggested earlier, compulsory unitization involves the use of the

state police power to compel owners of mineral interests, working interests and royalty interests to consolidate their separately owned estates over all, or a portion of, a common source of supply. Unlike most voluntary pooling arrangements that occur through the execution of a joint operating agree-

163 Bruce M. Kramer and Owen L. Anderson, “The Rule of Capture—An Oil and Gas Perspective,” 35 Envtl. L. 899, 930-31 (2006).164 Professor Ernest Smith some 40 years ago dealt with that issue when Texas adopted its Mineral Interest Pooling Act and provided for the 7/8-1/8 solution. Ernest Smith, “The Compulsory Pooling Act,” 44 Tex. L. Rev. 387, 405-06 (1966).165 Colo. Rev. Stat. § 34-60-116(7)(c) (2006).166 See e.g., Lindquist v. Arkansas Oil & Gas Comm’n, 2000 WL 696414; 2000 Ark. App. LEXIS 442 (May 31, 2000)(unpublished opinion); Va. Code Ann. § 45.1-361.21(C)(7) (2006).

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ment between the cost-bearing interest owners and the exercise of a pooling power contained in an oil and gas lease, most voluntary unitization agree-ments require the assent of both working and royalty interest owners. Only in the Rocky Mountain region do oil and gas leases contain clauses giving the lessee the power to unitize the royalty interest. Typically, the voluntary arrangement will entail two agreements, the unit agreement executed by both cost-bearing and non-cost bearing interests and the unit operating agreement executed solely by cost-bearing interest owners.167 There are many common threads that appear in the various compulsory unitization statutes, although reference must not only be made to the statutory requirements but to the rules and/or regulations of the state conservation agency.

[2] — Consent Requirements.One such common thread which exists in almost all of the states is the

requirement that the proponent or applicant for a compulsory unitization order show that they have the consent or approval of a minimum percent-age of working and/or royalty interest owners before the state conservation agency may order the nonconsenting owners to be bound by the terms of the relevant unit agreement and unit operating agreement. Can a state opt to not have a minimum consent requirement as Alaska appears to do?168 In the one case that dealt with this issue the answer appears to be that there is no constitutional requirement for a minimum consent provision and that the state may compel unitization over the objection of every owner in order to prevent waste, protect correlative rights and conserve natural resources. In Palmer Oil Corp. v. Phillips Petroleum Corp.,169 the then-extant Oklahoma compulsory unitization statute imposed a minimum consent requirement of 50 percent of the working interest owners and also authorized a veto by 15

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167 See Kramer and Martin, supra note 1 at ch. 17.168 Alaska Stat. § 31.05.110 merely requires all parties to be invited to join the unit.169 Palmer Oil Corp. v. Phillips Petroleum Corp., 231 P.2d 997 (Okla. 1951), dismissed for want of a substantial federal question sub nom., Palmer Oil Corp. v. Amerada Petroleum Corp., 343 U.S. 390 (1952).

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percent of the working interests. The royalty interest owners’ consent was not required and they argued that their property rights were being deprived without due process of law. The Oklahoma Supreme Court rejected that claim, finding instead that the Legislature was free to distinguish between working and royalty interest owners for purposes of giving the Corporation Commission the power to compel the unitization of an area. The key issue was whether compelling any interest owner complies with the Due Process Clause, not whether the state can set forth conditions precedent to the exer-cise of that power. Because compulsory unitization serves important public purposes the state is free to authorize a state conservation agency to utilize the procedure imposing such requirements as it deems appropriate under the circumstances.

Many early compulsory unitization statutes set the minimum consent requirement at 75 percent.170 Tennessee has a 50 percent consent require-ment,171 Kentucky has a 51 percent requirement,172 while New York has a 60 percent consent requirement.173 Ohio’s minimum consent level is 65 percent174 while Alabama has a 2/3rds consent requirement.175 Mississippi used to have a very high 85 percent minimum consent requirement but has recently lowered the level to 75 percent.176

An initial question is who gets to consent or withhold consent so that the non-consenting owners may be subject to the compulsory unitization procedure. Almost all of the states require consent from both working in-terest and royalty interest owners.177 How are the votes to be tallied? There

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170 Ark. Code Ann. § 15-72-309 (2006); Fla. Stat. § 377.28(4)(1995); Mich. Comp. Laws § 324.61706 (1994); W. Va. Code § 22C-9-8(4)(1988).171 Tenn. Code Ann. § 60-1-202 (1992).172 Ky. Rev. Stat. Ann. § 353.645 (1990).173 N.Y. Envir. Cons. L. § 23-0901(6)(McKinney 2006).174 Ohio Rev. Code § 1509.28(B)(West 2000).175 Ala. Code § 9-17-84 (2000).176 Miss. Code Ann. § 53-3-109 (1988).177 See e.g., Ala. Code § 9-17-84 (2000); Fla. Stat. § 377.28 (1994); Miss. Code Ann. § 53-3-109 (1988); Ohio Rev. Code § 1509.28 (West 2000); W. Va. Code § 22C-9-8 (1998).

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are several options including surface-acreage, cost factors and production factors.178 Mississippi specifically refers to the surface-acreage contribu-tions of each of the working interest owners179 but since it is likely that the allocation formula will be based on other factors, the surface-acreage voting rights methodology may misallocate the voting power. A relatively small-acreage owner sitting atop the thickest part of the reservoir is given less power than the owner of larger tracts that may possess fewer hydrocar-bons. The use of a cost factor as the determinant for consent only refers to working interest shares and would not apply to royalty interests. Costs will be shared according to the terms of the unit agreement and unit operating agreement and will be based on the agreed-to participation formula which allocates decimal shares to each tract included in the unit.180 The use of a production factor which looks to the allocation of production, not costs, will encompass both the working interest and royalty interest owners within the proposed unit.181 Again, the revenue sharing will be based on the par-ticipation formula contained in the unit agreement which should reflect the respective contributions of the included tracts. Overriding royalty interest owners create a problem and a number of states expressly disclaim the right of any such owner to participate in the consent process.182

A number of states require that consent be shown as of the date the petition is filed seeking compulsory unitization.183 Other states, including Michigan,184 allow for the consent to be achieved within a fixed time period after the initial hearing on the order. Michigan allows for a 12-month delay in getting consent while other states allow for only a six-month month delay. What is the status of the compulsory unitization order after it has been is-

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178 Kramer and Martin, supra note 1 at § 18.02[4][b].179 Miss. Code Ann. § 53-3-107 (1987). 180 See e.g., Okla. Stat. Ann. tit. 52, § 287.5 (2006); Wyo. Stat. Ann. § 30-5-110(f) (2005).181 See e.g., La. Rev. Stat. Ann. § 30:5(C)(1992).182 La. Rev. Stat. Ann. § 30:5 (1992); Miss. Code Ann. § 53-3-107 (1988).183 Ark. Code Ann. § 15-72-305 (1994); La. Rev. Stat. Ann. § 30:5(C)(1992).184 Mich. Comp. Laws Ann. § 324.61706 (West 1995).

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sued but the consent requirements have not been met? In an Oklahoma case, the court found that since consent is required the order cannot be effective until such time as the minimum consent requirement is satisfied, essentially postponing the implementation of the order until the later date.185

[3] — Unit Area.All of the compulsory unitization statutes authorize the unitization of all,

or a portion of, a common source of supply. Because of the power to unitize a portion of a common source of supply issues may arise with the initial designation of the unitized area as well as with subsequent enlargement or shrinkage of the area. Determination of unit boundaries is initially set by the proponents of the compulsory unitization. Boundary lines therefore may be affected by the existence or non-existence of geophysical data, the ownership of the tracts, the consent or lack thereof by the owners, the amount of unleased acreage, the scale and uniformity of oil and gas development and differing interpretations of the underlying geophysical data. The constitutionality of a compulsory unitization order only covering a portion of a common source of supply was upheld in Spiers v. Magnolia Petroleum Co.186

Where the limits of the reservoir are not fully known, problems may exist regarding the “edge” tracts which border the proposed unit.187 In Phillips Petroleum Co. v. Stryker,188 owners of edge tracts who were not included in the compulsory unit sued the unit operator asserting that the unit was draining oil and gas from their tracts. The $26 million judgment against Phillips was reversed, however, based on the court’s finding that the

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185 Eason Oil Co. v. Corp. Comm’n, 535 P.2d 283 (Okla. 1975).186 Spiers v. Magnolia Petroleum Co., 244 P.2d 843 (Okla. 1952).187 See William F. Carr, “Compulsory Fieldwide Unitization,” 49 Rocky Mtn. Min. L. Inst. 21-1 (2003)(describing in detail the problems that can arise from the inclusion or exclusion of edge tracts in a compulsory unit).188 Phillips Petroleum Co. v. Stryker, 723 So. 2d 585 (Ala. 1998). The author was one of a group of oil and gas academics who submitted an amicus brief on behalf of the Mid-Continent Oil and Gas Association in support of the position taken by Phillips Petroleum in this case.

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drainage claim was essentially a collateral attack on the Board order setting forth the unit area boundary. A similar problem that may arise is whether there should be buffer zones around the unit which may include barren-acre-age. It would seem that inclusion of areas known to be barren of oil and gas would violate the provisions of most compulsory unitization statutes and thus would be grounds for reversal of the compulsory unitization order.189 Where the evidence is contradictory the decision of the state conservation agency should be entitled to substantial deference when judicial review of the order is sought.

Another problem with compulsory unitization statutes is that they sometimes require that the unit area must be defined by lands shown to be productive by drilling or development. With secondary recovery or opera-tional units that might not be a problem but with developmental units the entire common source of supply might not have been drilled on, or clearly defined, by the existing wells. It is not necessary that each drilling and/or spacing unit included within the unit area be drilled upon before such tract can be included.190

A common problem with voluntary unitization is whether the participa-tion formula should be changed upon the expansion or contraction of the unit area. Since the participation formula contained in the unit agreement and unit operating agreement will be incorporated into the compulsory unitization order, if there is a change in the unit area boundaries, there will be a concomitant change in the allocation of unit production. Where unit boundaries are changed, it is clear that tract allocations will likewise be changed to reflect the addition or subtraction of tracts to the unit. The effect of the expansion of the Citronelle Unit in Alabama is discussed in State

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189 See State Oil and Gas Bd. v. Brinkley, 329 So. 2d 512 (Miss. 1976). See also Carr, supra note 187 at 21-9 to 21-10. In a compulsory pooling order situation, the Michigan court found that one could not force pool known barren-acreage and include that acreage in the participation formula. Mfrs. Nat’l Bank of Detroit v. Director, Dep’t of Natural Res., 362 N.W.2d 572 (Mich. 1984), prior cases reported at 320 N.W.2d 403 (Mich. Ct. App. 1982); 270 N.W.2d 550 (Mich. Ct. App. 1978).190 Panhandle Eastern Pipe Line Co. v. Corp. Comm’n, 285 P.2d 847 (Okla. 1955).

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Oil and Gas Board v. Seaman Paper Co.191 The Board in the Citronelle Unit expansion approved the negotiated enlargement and the change in the participation formula that had been included within the unit agreement and unit operating agreement.192

[4] — Participation (Allocation) Formula. Typically in a voluntary unitization the most contentious issue is how to

determine the proper allocation of unit production to each of the included tracts. While some states such as Oklahoma193 provide a detailed laundry list of factors that the state conservation agency must consider in approving the allocation formula, most states merely require that the formula be fair, just and/or equitable.194 In most cases the state conservation agency will defer to the participation formula agreed to by the consenting parties as the best evidence of what is fair and reasonable. The fact that a different formula might lead to a fairer or more equitable result does not necessarily mean that the formula agreed to by the state conservation agency is invalid. Because each reservoir is unique there are no set formulae that may be universally applied.195

Litigation regarding the propriety of participation formula has been limited to Arkansas, Kansas, Oklahoma and Wyoming. The one common thread in these cases is that the courts have taken a very deferential view regarding their role in reviewing the agency decision approving a particular participation formula. In many of these cases the participation formulas were multi-faceted with different weight being given to different factors.196

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191 State Oil and Gas Bd. v. Seaman Paper Co., 235 So. 2d 860 (Ala. 1970).192 See also Cornelius v. Arkansas Oil & Gas Comm’n, 402 S.W.2d 402 (Ark. 1966).193 Okla. Stat. Ann. tit. 52, § 287.4(b) (West 1995).194 See e.g, Ky. Rev. Stat. Ann. § 353.652(c)(1996)(just and equitable share); Miss. Code Ann. § 53-3-103 (1972)(fair and reasonable); W. Va. Code § 22C-9-8(a)(3)(1998)(just and equitable share).195 Williams and Meyers, supra note 4 at § 920.196 See Williams v. Arkansas Oil & Gas Comm’n, 817 S.W.2d 863 (Ark. 1991); The Trees Oil Co. v. State Corp. Comm’n, 105 P.3d 1269 (Kan. 2005); Hatlestad v. Petrocorp, Inc.,

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The “soft glance” approach reflected in the Gilmore case where the plaintiff challenged the order creating a fieldwide unit. The proponents of the order had squeaked by the 75 percent minimum consent requirement by proffering consent from 75.89 percent of the working interest owners. The field was ap-proximately 18 miles long by 3 miles wide, encompassing some 31,000 acres with 177 producing wells. There were at least 80 separate working interest owners. In the voluntary negotiations that led up to the compulsory unitiza-tion petition, the parties considered 71 different participation formulae. The parties eventually agreed to a 10 factor test that included 1. usable wells; 2. first six months’ production; 3. peak rate; 4. wellbore net feet; 5. last three months’ production; 6. last six months’ production; 7. remaining primary reserves; 8. ultimate recovery; 9. General Land Office (GLO) developed porosity-acre-feet; and 10. GLO porosity-acre feet.197 Because the parties had engaged in lengthy and difficult negotiations to end up where they did, the court felt that it was particularly appropriate to defer to the agency deci-sion, especially in light of the benefits that would accrue from approving the unitization order.

§ 7.05. Administrative Law Issues Relating to Compulsory Pooling and Unitization.

[1] — Introduction.As a general matter, issues relating to judicial review, standing and

other administrative law problems are best resolved on a state-by-state basis. Almost every state has some type of general administrative procedure act in addition to specific statutes that may relate to oil and gas conservation agency decisions and/or rules or regulations. While there are clearly similarities

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928 P.2d 295 (Okla. 1995); Bingaman v. Corp. Comm’n, 421 P.2d 635 (Okla. 1966); Trout v. Oil & Gas Conservation Comm’n, 721 P.2d 1047 (Wyo. 1986); Gilmore v. Oil & Gas Conservation Comm’n, 642 P.2d 773 (Wyo. 1982).197 Gilmore, 642 P.2d at 775. The court inconsistently lists 10 factors but their respective percentages do not add up to 100 percent and otherwise in the opinion refers to 11 factors as being agreed to by the parties.

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between state administrative law principles, the author is hesitant to make overarching general statements regarding such principles.198

[2] —The Related Doctrines of Exhaustion of Administrative Remedies and Primary Jurisdiction.

The United States Supreme Court provided a short summary of these two doctrines when it said:

The doctrine of primary jurisdiction, like the rule requiring exhaustion of administrative remedies, is concerned with promoting proper relationship between the courts and administrative agencies charged with particular regulatory duties. ‘Exhaustion’ applies where a claim is cognizable in the first instance by an administrative agency alone; judicial interference is withheld until the administrative process has run its course. ‘Primary jurisdiction,’ on the other hand, applies where a claim is originally cognizable in the courts and comes into play whenever enforcement of the claim requires the resolution of issues which, under a regulatory scheme, have been placed within the special competence of an administrative body; in such a case the judicial process is suspended pending referral of such issues to the administrative body for its view.199

Failure to exhaust one’s administrative remedies, as may be required by statute, acts to deprive the court of jurisdiction to hear an appeal of an administrative decision.200 The primary jurisdiction doctrine, on the other hand, presumes that both the agency and the court have jurisdiction over the subject-matter of the dispute. There is no simple way to predict when

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198 This principle is reflected in the organizational scheme for the Pooling and Unitization treatise that divides up the judicial review materials on a state-by-state basis. Kramer and Martin, supra note 1 at § 25.06[1]-[22].199 United States v. Western Pacific R.R., 352 U.S. 59, 63-64 (1956).200 See e.g., Scales v. State, 563 N.E.2d 664 (Ind. Ct. App. 1990); White v. Shepherd, 940 S.W.2d 909 (Ky. Ct. App. 1997); Donald v. Amoco Prod. Co., 735 So. 2d 161 (Miss.

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a court will apply the doctrine and defer a decision pending the agency’s order.201 Some reasons given the courts who decline to apply the doctrine include where the issue sought to be adjudicated is inherently judicial in character, where the agency cannot give adequate relief to the complaining party, or where there is no potential for a conflict between the decisions of the court and the agency.202

[3] — The Collateral Attack Doctrine. An important doctrine developed to prevent indirect assaults on agency

adjudicatory decisions is the collateral attack doctrine. As defined by an Oklahoma court: “A collateral attack on a judicial proceeding is an attempt to avoid, defeat, or evade it, or to deny its force and effect in some manner not provided by law; . . .”203 The state conservation agency need not be a party to the subsequent litigation in order for a party to assert the collateral attack doctrine.204 The only quite limited exception to the collateral attack doctrine occurs where the original order is deemed to be void ab initio.205

Where parties are outside of a unitized area and claim that their lands are being drained by production activities occurring inside the unit, the Alabama Supreme Court determined that the suit constituted an impermis-sible collateral attack on the agency order creating the unit and setting forth

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1999); North Buncombe Ass’n of Concerned Citizens v. Rhoeds, 394 S.E.2d 462 (N.C. Ct. App. 1992), appeal dismissed, 397 S.E.2d 215 (N.C. 1990).201 See Kendra Oil & Gas, Inc. v. Homco, Ltd., 879 F.2d 240 (7th Cir. 1989) where the court declined to apply the doctrine in a dispute between an allegedly illegal production of oil in violation of Illinois Mining Board regulations.202 See e.g., Marshall v. El Paso Natural Gas Co., 874 F.2d 1373 (10th Cir. 1989); Wronski v. Sun Oil Co., 279 N.W.2d 564 (Mich. Ct. App. 1979).203 State ex rel. Comm’rs of Land Office v. Corp. Comm’n, 590 P.2d 674 (Okla. 1979). See also James W. George, “The Preclusive Effect of Oil and Gas Regulatory Orders in Subsequent Litigation,” 49th Oil & Gas Inst. Ch. 9 (Matthew Bender 1998).204 See Brown v. Alice-Sidney Oil Co., 343 So. 2d 745, (La. Ct. App.), writ denied 344 So. 2d 1056 (La. 1977); Newkirk v. Bigard, 485 N.E.2d 321 (Ill. 1985); Steen v. Quaker State Corp., 785 N.Y.S.2d 551 (N.Y. Sup. Ct. 2004); Cahill v. Harter, 716 N.Y.S. 2d 447 (N.Y. App. Div. 2000).205 Mullins v. Ward, 712 P.2d 55 (Okla. 1985).

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its boundaries.206 A similar result was reached in Mize v. Exxon Corp.,207 where the Board made findings that the unit area encompassed all of the productive limits of the common source of supply.208

A suit challenging the effectiveness of a compulsory pooling order as it affected the deep rights of a working interest owner was treated as a collateral attack against the agency order and disallowed.209 In applying the collateral attack doctrine, Oklahoma has had difficulty overcoming the dichotomy between private actions and public regulatory actions given the nearly-universal reality that state conservation agencies are not given the power to adjudicate private law matters such as title and contract interpreta-tion issues. Since agencies lack the power to resolve an implied covenant claim, can such an action truly be a collateral attack on an agency order? A good example of this dilemma is raised where a party asserts that the lessee has breached its duty of unitizing or pooling in good faith under a leasehold pooling clause after the state has issued an appropriate order. In Amoco Production Co. v. Heimann,210 the court found that the agency order finding that the unitization was fair and protected correlative rights as was required by the statute, essentially precluded the plaintiffs from asserting a breach of the duty of good faith owed to them by the lessors. While using language more appropriate for traditional collateral estoppel analysis, the Ninth Circuit was essentially saying that the common law breach of implied duty to pool in good faith action was an impermissible collateral attack on the agency decision finding the unitization plan fair and reasonable as to all of the non-consenting parties.

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206 Phillips Petroleum Corp. v. Stryker, 723 So. 2d 585 (Ala. 1998).207 Mize v. Exxon Corp, 640 F.2d 637 (5th Cir. 1981).208 But cf. Sheffield v. Exxon Corp., 424 So. 2d 1297 (Ala. 1982)(drainage claim not a collateral attack on drilling unit or pooled unit order).209 Frost v. Gulf Oil Corp., 119 So. 2d 759 (Miss. 1960). See also Waller Bros., Inc. v. Exxon Corp., 836 F. Supp. 363, (S.D. Miss. 1993), aff’d 20 F.3d 469 (5th Cir. 1994).210 Amoco Prod. Co. v. Heimann, 904 F.2d 1405, (10th Cir.), cert. denied 498 U.S. 942 (1990).

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cite as 27 energy & min. l. inst. ch. 7 (2007) chapter … · tion as it applies in the eastern...

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