COMMINGLING PRODUCTION FROM DIFFERENT DEPTHS

It is not uncommon to encounter situations where the leasehold ownership under a Lease varies, depending on depth.  One owner owns depths from the surface of the ground to a specific subsurface depth, or the base of a specific formation or zone, while another owner owns all greater depths.  (For the purpose of this example, it will be presumed that the royalty ownership is common at all depths.)

Historically, this may have given rise to each owner drilling a well on the Lease and producing from the depths owned.  Primarily for economic reasons, it may be determined that one well, completed in two different depths will adequately drain the formations owned by each owner.  The cost of drilling one well may be significantly less than drilling two separate wells.  If you own the shallow depths, you are looking at the marginal cost of drilling into and completing in the deeper depth.  If you own the deeper rights, you are looking at the marginal cost of completing in the shallow depth.

The questions that arise when such a proposal presents itself are:

1. Will the governing agency allow production from the two depths to be commingled.  Is a special permit needed, or amendment to field rules?

2. Who will be responsible for drilling, completing, and operating the well, and how will the costs of those activities be shared by the owners?

3. Upon a well being completed in both the shallow and deep depths, how will the production income be divided among the owners?

The answer to the first question depends on where you are and what state rules may apply.

The second question is typically addressed in a negotiated operating agreement.

The third question may be the most difficult to answer.  If there has been production in the area where the well is to be located, the parties may undertake a reservoir engineering study to determine the projected ultimate recovery of a separate well drilled, completed, and produced from the separate depths in which the proposed well is to be completed.  Presuming the parties can agree on the estimated ultimate recovery from each zone, those volumes can be added together and each zone then allocated a percentage of the estimated ultimate recovery.  Presuming agreement on this allocation, it is then necessary to reduce that agreement to writing so there will be no disputes as to the rights acquired or relinquished by each owner, recognizing that any party owning an interest at either the shallow or deep depth that is not a party to the agreement may later claim their percentage ownership in all production from the well.  What type of agreement will address this situation?  A form of Commingling Agreement to deal with this situation is included in Kanes Oil and Gas Forms available at www.Kanesforms.com.  If you encounter this situation, this form can be adapted to meet your specific transaction needs.