The Austin Court of Appeals has ruled in Texas Railroad Commission et al v. Opiela, the dispute over a permit for a horizontal well under a Production Sharing Agreement.  We reported on the result in the trial court. Here are some highlights of the appeal.

Where did the 65% rule come from?

The court traced the Commission’s authority to a 2008 minute entry in which two of the three commissioners approved a permit while directing staff that wells that are permitted based on PSA’s should be approved when the operator certifies that at least 65% of the working and mineral interest owners in each component tract have signed a PSA.  That announcement did not say that multiple different PSA’s could be signed or that other documents, such as a lease pooling clause, could be the equivalent of a PSA for purposes of the 65% threshold.

Pooling and PSA’s

The court examined the relationship between pooling and PSA’s and determined that Magnolia’s assertion of right to drill under a PSA did not infringe on the anti-pooling clause in the Opiela lease. The Commission ignored the anti-pooling clause as irrelevant to the well permit.  The court concluded that a permit for horizontal drilling under a PSA is not pooling under Texas law and thus the Opiela lease’s anti-pooling clause was not implicated.

RRC authority over title questions

The court affirmed that Commission does not have the authority to adjudicate questions of title or rights of possession when it grants a drilling permit. The Commission’s conclusion that Magnolia made the requisite showing of a good-faith claim of right to operate the well rested on satisfaction of the 65% threshold that is not found in the Texas Administrative Code.

Is a PSA required?

The evidence showed that only 15.625% of the interest owners signed a PSA. The other written agreements Magnolia relied on included consents to pool and pooling ratifications. Substantial evidence did not support a finding that 65% of the interest owners signed a PSA.

Even while granting deference to the Commission’s expertise in regulating the industry, the court was not persuaded that a consent to pool can substitute for a PSA absent a good-faith showing that consents and the PSA’s call for the same sharing of production for a well across tracts that are not pooled. Magnolia did not so certify and the Commission did not make such a finding.

The definition of a PSA from the Commission’s 2019 Form P-16 allows proof of a PSA to include certification that 65% of interest owners have signed an agreement as to how proceeds will be divided. But Magnolia’s permit was based on applications predating that definition. Neither the form nor the instructions used to complete the application contained the expanded definition of the agreements that would make a 65% threshold.

The rulings

The court:

• reversed the trial court judgment that the Commission erred in concluding that it had no authority to review whether an applicant seeking a permit has authority under a lease or other relevant title documents
• reversed the trial court judgment that the Commission erred in failing to consider the pooling clause of the lease in deciding that Magnolia had a good-faith claim to operate the well.
• affirmed the trial court judgment that the Commission erred in finding that Magnolia showed a good-faith claim of right to drill the well.
• remanded the case to the Commission for further proceedings.

The dissent

Justice Kelly would conclude that an operator’s certification that the requisite owners from each tract have agreed on how production would be shared, when supported by signed agreements, is sufficient to show a good-faith claim to operate. Because royalty calculations are specific as to each lease, the exact share or method for dividing proceeds under any particular agreement is immaterial. He would resolve whether the 65% threshold standard complies with the APA.

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