Tuesday, August 2, 2011

When is a hydraulically fractured well "complete?"

The expiration of an oil and gas lease's primary term does not necessarily release all non-producing lands. This can be so even when the lease contains a Pugh Clause. Typically, most leases contain savings provisions that extend the lease beyond the primary term when the lessee “continuously prosecutes” drilling operations. A sample of this saving provision from the Producer's 88 lease form is as follows:

Subject to the other provisions herein contained, this lease shall remain in force for a term of ____ years from this date (herein called "primary term") and as long thereafter as oil and gas, or either of them, is produced from the above described land or drilling operations are continuously prosecuted as hereinafter provided. "Drilling operations" includes operations for the drilling of a new well, the reworking, deepening or plugging back of a well or hole or other operations conducted in an effort to obtain or re-establish production or oil or gas; and drilling operations shall be considered to be "continuously prosecuted" if not more than 180 days shall elapse between the completion or abandonment of one well or hole and the commencement of drilling operations on another well or hole. If, after the expiration of the primary term of this lease, oil or gas is not being produced from the leased premises but lessee is then engaged in drilling operations, this lease shall continue in force so long as drilling operations are continuously prosecuted; and if production of oil or gas results from any such drilling operations, this lease shall continue in force so long as oil or gas shall be produced from the leased premises. If after the expiration of the primary term of this lease, production on the leased premises should cease, this lease shall not terminate if lessee is then prosecuting drilling operations, or within 180 days after each such cessation of production commences drilling operations, and this lease shall remain in force so long as such operations are continuously prosecuted, and if production results therefrom, then as long thereafter as oil or gas is produced from the leased premises.

Even a Pugh clause does not ordinarily defeat these savings provisions. The function of the Pugh clause is to prevent the lessee from holding non-producing lands with a single production unit. It does not prohibit the establishment of production and holding of lands by savings provisions.  The typical Pugh clause reads as follows:

If at the end of the primary term, a part but not all of the land covered by this lease, on a surface acreage basis, is not included within a unit or units in accordance with the other provisions hereof, this lease shall terminate as to such part, or parts, of the land lying outside such unit or units, unless this lease is perpetuated as to such land outside such unit or units by operations conducted thereon or by the production of oil, gas or other minerals, or by such operations and such production in accordance with the provisions hereof.

Note that not only does the typical Pugh clause not conflict with the "continuously prosecuted" savings provisions, but it acknowledges the possibility that the lease may be perpetuated beyond the primary term by those very savings provisions.

In a bid to test these savings provisions, a large Colorado landowner argued that a "completion" was an ambiguous term in the savings provisions. That is, it the completion date could be the date on which the well cased and perforated or the date on which the well was hydraulically fractured. The case of Bledsoe Land Company, LLLP v. Forest Oil was decided on June 23, 2011. See the opinion at http://scholar.google.com/scholar_case?case=3498925303401075223.

To understand the landowner's argument, a little background on completion is instructive. A conventional oil and gas reservoir has its own energy to force the migration of oil and gas to the surface (“up hole”). Completion is a simple matter of drilling the well, setting production casing, and perforating the production casing. The perforations are the holes in the casing that allow oil and gas to flow from the reservoir rock into the casing. The casing is the pipe that contains the oil and gas on its way up to the surface. The reservoir releases its energy without any further stimulation allowing the oil and gas to flow up hole. There is, therefore, an argument that "completion" means what it does in the conventional sense--the setting and perforation of production casing.

With tight gas and oil found in shale formations, it takes more than the setting and perforation of production casing to recover the oil or gas because there is no readily available reservoir energy. The producer must create cracks in the formation to release the formation's energy so that the oil and gas to flows up hole. The producer accomplishes this with hydraulic fracturing. Using thousands of pounds of pressure, the producer forces a cocktail of chemicals, sand, and water through the production casing perforations. The force applied to the water breaks the formation apart and the sand props these fractures open so that oil and gas can flow up hole.

In Bledsoe, the landowners' acreage was being held beyond the primary term by continuous operations with 180 day continuous drilling savings provisions. The lessee commenced a subsequent well 184 days past the casing of the first well and 197 days past the perforation of the casing in the first well, but only 176 days after the hydraulic fracturing of the first well. The landowner won at the trial level, with trial court declaring the term “completion” to be ambiguous. After reviewing the extrinsic evidence, the trial court found that “completion” meant the setting and perforation of production casing.

The appeals court in Bledsoe overturned the trial court’s ruling that the term “completion” was ambiguous. Citing to a number of authorities that the ordinary accepted usage in the oil and gas industry of the word “completion” meant the well was “capable or ready to produce gas,” the court reasoned that term was meant in its ordinary and accepted meaning in the oil and gas industry. As a result, the completion date occurred after the hydraulic fracturing treatment rather than on the date the casing was set and perforated, keeping the lease alive for the drilling of a subsequent well.

The Bledsoe decision has application for leases in unconventional oil and gas areas where hydraulic fracturing is the norm. In Arkansas, the decision may provide some secondary authority for similarly worded leases. Additionally, the case may serve as secondary authority that “completion” as used in the statutory Pugh Clause should occur upon the hydraulic fracturing treatment rather than upon the setting and perforation of casing.

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