Production sharing and allocation wells have been drilled in Texas for some time, and have been used almost exclusively for horizontal wells. (An allocation well is a horizontal well drilled across two or more lease lines without creating a pooled unit that includes the leases. A production sharing well is an allocation well for which production sharing agreements have been signed by mineral owners in all tracts that are crossed by the well.) However, the Texas Railroad Commission has never adopted a formal rule for issuing permits for these types of wells, by using the procedure in the Texas Administrative Code that all Texas agencies are supposed to follow when they want to adopt a new rule. The Administrative Code requires publication of proposed rules and opportunities for public comment before they are adopted. At first, the Commission approved a permit for these wells if the operator obtained signed production sharing agreements for at least 65% of the mineral owners. In recent years, the Commission began to approve permits for these wells even though no mineral owners had signed production sharing agreements.
In this case, two mineral owners in Karnes County, Texas, the Opielas, contested the granting of an allocation well permit by the Commission to Magnolia Oil & Gas. On May 12, 2021, the 53rd District Court in Travis County reversed an order of the Texas Railroad Commission denying the mineral owners contest. ( Elsie and Adrian Opiela v. Railroad Commission of Texas v. Magnolia Oil & Gas Operating Inc., Cause No. D-1-GN-20-000099). The Court held, in part, that “(t)he Commission erred in adopting rules for allocation and Production Sharing Agreement (“PSA”) well permits without complying with the requirements of the Administrative Procedure Act, Tex. Govt Code § 2001.001 et seq., and further erred in applying those rules by issuing well permits for the Audioslave A 102H Well (the “Audioslave Well”)”. The Court sent the case back to the Railroad Commission for “further proceedings consistent with this judgment.”
Texas oil and gas attorneys have been scratching their heads for some time at the Commission’s practice of granting permits for these types of wells without a formal rule. We don’t know whether the Railroad Commission will appeal this decision or not. If it does not, or if it does and the appellate court upholds the district court decision, what is the status of the many allocation and production sharing wells already drilled? Are they all void? Alternatively, are just the allocation wells permitted and drilled without mineral owner consent void? To be determined.
If you are presented with a production sharing agreement, consider it to be an amendment to your lease (because it will function as that) and have an oil and gas attorney review it for you. There are several substantial issues to be considered and negotiated in a production sharing agreement, and you should give it the same attention as the original lease.