Avoiding Unintended Consequences Caused by Retained Acreage Clauses

Retained acreage clauses permit the lessee to retain acreage around a producing well in the event of a forfeiture of a lease.  Typically, retained acreage clauses become the subject of litigation when the lease contains a continuous drilling obligation and the lessee has ceased its drilling.  The retained acreage clause permits a lessee in that situation to retain a specific portion of the acreage surrounding a producing well and requires that the lessee release all acreage not subject to the retained acreage clause.

Frequently, retained acreage clauses in leases will specify the number of acres per well that an operator is entitled to retain after the continuous development program has ended.  However, many oil and gas leases tie the acreage subject to the retained acreage clause to the “field rules” for a given oil and gas field,[1] which may result in the retained acreage clause operating in way that it is contrary to the intent of the parties.  Recently, Texas courts interpreted retained acreage clauses and reached differing outcomes that were not contemplated by the parties.

First, in ConocoPhillips Co. v. Vaquillas Unproven Minerals, 04-15-0006-CV, Tex. App. LEXIS 8194 (August 5, 2015), the San Antonio Court of Appeals determined that the field rules governed a retained acreage clause in an oil and gas lease.  The retained acreage clause provided that the ConocoPhillips was entitled to retain “640 acres per gas well, except when field rules established by the governing authority provide otherwise.”  Id., at 3.  Specifically, the retained acreage clause provided:

“Lessee. . . agrees to . . . release . . . all portions of this lease which have not been drilled to a density of at least . . . 640 acres for each producing or shut-in gas well, except that in case any rule adopted by the Railroad Commission of Texas . . . for any field on this lease provides for a spacing or proration establishing different units of acreage per well, then such established different units shall be held under this lease by such production, in lieu of the . . . 640-acre units above mentioned . . . .”

Id., at 2-3.

Here, the applicable field rules provided for “different” sized units than the 640 acre units contemplated by the leases.  Specifically, the relevant field rule provided that no well shall be drilled closer than 467 feet to any property line, lease line or subdivision line, and no well shall be drilled closer than 1,200 feet to any well in the same reservoir on the same lease or pooled unit.  Id., at 7.  Although the spacing requirement did not expressly set a number of acres per well, Statewide Rule 38, 16 Tex. Admin. Code § 3.38, requires that the standard drilling unit for a gas field with a spacing rule of 467-1200, like the one here, then the minimum acreage requirement is 40 acres per well for both oil and gas wells. Id., at 9.  ConocoPhillips’s continuous drilling program ended on June 21, 2012, and ConocoPhillips claimed 640 acres for each gas well, not the 40 acres as provided in the field rules, was retained under the retained acreage clause.  Id., at 3.

The Court disagreed with ConocoPhillips and concluded that ConocoPhillips was entitled to retain only 40 acres per well, as provided by the field rules, despite 40 acres being far less than the 640 acres per well as contemplated by the lease.  Id., at 14.  As a result, ConocoPhillips was required to release an additional 15,351 acres to Vaquillas that was not retained by the retained acreage clause.  Id., at 11.

Second, in XOG Operating, LLC v. Chesapeake Exploration L.P., 07-13-00439-CV, Tex. App. LEXIS 9411 (September 2, 2015), the Amarillo Court of Appeals reached a different conclusion and determined that the retained acreage clause permitted Chesapeake to retain more acreage than the parties contemplated.  On June 1, 2003, Xeric Oil & Gas Corporation and Geronimo Holding Corporation assigned their interest in four oil and gas leases containing 1,625 acres to EOG Resources, Inc.  Id., at 2.  The assignment provided for a primary term of two years and incorporated retained acreage clauses, which, in part, provided:

“Upon expiration of … of this Assignment . . . all rights created hereunder shall terminate … and … revert to Assignor, save and except that portion of said lease included within the proration or pooled unit of each well drilled under this Assignment . . . The term, ‘proration unit’ . . . shall mean the area within the surface boundaries of the proration unit then established or prescribed by field rules . . . for the reservoir in which each well is completed.  In the absence of such field rules . . . each proration unit shall be . . . 320 acres of land . . . surroundings [sic] a well . . . .” (Emphasis omitted).  Id., at 2, 3.

During the primary term, Chesapeake (EOG’s successor) drilled six gas wells, five wells in the Allison-Britt Field, and one well in the Stiles Ranch Field.  Id. at 3.  The assignments terminated on May 30, 2005, and all rights under the leases reverted to XOG, “save and except that portion of said lease[s] included within the proration or pooled unit of each well drilled.”  Id., at 13, 14.

The field rules for the Allison-Britt Field stated that the maximum area of a “prescribed proration unit” was 320 acres.  Id., at 4.  The field rules further provided that any unit containing less than 320 acres is defined as a “fractional proration unit.”  Id.  There were no field rules or special orders applicable to the Stiles Ranch Field, and by contractual definition, the acreage retained by a given well within that field was 320 acres.  Id., at 16.  Under those rules, Chesapeake would have been permitted to designate 1,920 acres to its six wells.  However, Chesapeake did not designate proration units of 320 acres for its wells, but fractional proration units, totaling 802 acres for its six wells.

Chesapeake argued that the retained acreage clause permitted it retain 320 acres for each of its wells despite that it designated fractional proration units containing less acreage.  The Court agreed and explained that absent an express contractual agreement providing otherwise, a proration unit is defined as “the acreage assigned to a well for the purpose of assigning allowables and allocating production to the well” for regulatory purposes.  Id., at 11.  The Court determined that the retained acreage clause was clear that the parties specifically agreed to define a proration unit as the area within the boundaries of a proration unit “established or prescribed by field rules” or, in the absence of field rules then 320 acres.  Id., at 11.  Consistent with that interpretation, the Court concluded that the parties expressly agreed the assignee would retain that portion of the lease included in a “proration unit” for the Allison-Britt field, and a proration unit for a given well in that field was 320 acres.  Id., at 15.  The Court explained that Chesapeake’s fractional proration unit filings were irrelevant because the retained acreage did not contemplate fractional proration units.  Id.  Thus, Chesapeake was entitled to retain 320 acres for each of its wells despite that in its P-15 filings with the Railroad Commission Chesapeake designated fewer acres in its fractional proration units.  The total acreage Chesapeake was entitled to retain under the retained acreage clause exceeded the total acreage covered by the leases and and Chesapeake was entitled to retain the full 1,625 acres covered by the assignments.  Id., at 16.

Both the XOG and ConocoPhillips illustrate that courts are willing to apply the field rules to retained acreage clauses if the contract provides (however loosely) that the field rules are to control.  In both cases, the retained acreage clause operated to more or less acreage than contemplated by the parties because the retained acreage clause was tied to field rules.  Thus, it is critical to carefully define a retained acreage clause to avoid unintended consequences that may arise when parties rely on field rules to define the acreage subject to a retained acreage clause.

[1] Field rules are used to regulate well spacing and density provisions to promote the development in a field in such a way that the wells are not clustered together and damage the reservoir.  The Texas Railroad Commission regulates “field rules” under statewide rules, county rules, and/or special rules.