User:Lexchis/Unitization

In the history of the oil & gas industry, the Law of Capture led to overdrilling and premature loss of reservoir pressure. An example was the Spindletop field (discovered in *1909) in Beaumont, Texas, where a *majority of the estimated total oil reserve was left in the ground.

As a result, the concept of unitization *arose, and has become the predominant legal structure governing the exploitation of oil & gas reserves. When a producing field is discovered, it may be unitized, under the control of a state oil and gas board. The unit includes all acreage underlaid by any part of the producing geological stratum. Royalty owners and producers in the unit must vote to approve unitization. Usually a supermajority of royalty must approve.

Every owner of royalty in the unit is entitled to a pro-rata share of the total *royalty due from production in that unit. The fractional share due to each royalty acre is termed its *tract factor, i.e. its fraction of the total producing unit. When oil and/or gas is produced, the total royalty is calculated, from all producing wells within the unit, then distributed based on the royalty acreage multiplied by tract factor.

The tract factor for a given acre incorporates geological data such as the vertical and horizontal extent, porosity, and permeability of the reservoir stratum underlying that acre. Thus the royalty due to a given acre may be more or less than the fraction of the unit area represented by that acre.

Note that royalty is a cost of goods for the producer: it must be paid before any profits are paid out to investors. (*Severance tax must be paid even before royalty). Typical royalty in domestic US production is between ⅛ and ¼ of production. Nominally, royalty is payable in kind, for instance, in barrels of oil. However, almost universally, royalty is paid in cash based on the well-head price. A royalty owner must sign a Division Order, which consents to a specified fractional ownership, before receiving royalty payment.

Royalty may be due to the owner of the mineral rights, or the rights to a future royalty stream may have been sold, akin to a factoring arrangement. Royalty may then be split up and sold in pieces.

After royalty is paid, and other operation expenses covered, the producer of each well may pay any remaining profits from that well to the investors in the well. Investment in drilling and production is called *working interest. Working interest holders cover all drilling and production costs, and bear any liability exposure associated with well production; royalty interest holders are not liable.

Most states also specify a minimum spacing for wells: typically, 40 acres for oil, and 640 acres for gas. Exceptions may be approved by the oil and gas board. Note that a producing field does not necessarily have to be unitized. In such a case, royalty calculation is based solely on the fraction of acreage owned.

Examples
A well is drilled on a 40-acre unit. It is not unitized. Mr A owns ¼ undivided royalty under 10 acres of the unit. One month’s production is sold for $100,000, net of severance tax. What is the royalty due to Mr A?

Answer: ¼royalty times (10 acres / 40 acres) times $100,000 = $6,250

A unitized field covers 80 acres. Mr A owns 20 undivided royalty acres at ¼ royalty. Geological analysis has determined that 30% of the reservoir volume lies under Mr A’s acreage. One month’s production is sold for $100,000, net of severance tax. What is the royalty due to Mr A?

Answer: first, calculate the tract factor. Since a quarter of the acreage contains 30% of the reservoir, the tract factor per acre of Mr A’s holdings is 30%/25% = 1.2. The royalty due is then ¼ royalty times 1.2 times (20 acres / 80 acres) times $100,000 = $7,500