Opinion ID: 1307933
Heading Depth: 2
Heading Rank: 2

Heading: may the authority to terminate a compulsory unit be delegated to the owner of the working interest?

Text: The final issues are whether the Corporation Commission erred in ruling that the unit would continue until the working owner, Misco, terminated it, and whether the Corporation Commission improperly delegated to the working interest owner the authority to determine when unitization would terminate. We will consider these together. The purposes of the compulsory unitization act, as set forth in K.S.A. 55-1301, are to prevent waste, to further the conservation of oil and gas, and to protect the correlative rights of persons entitled to share in the production thereof. The Corporation Commission did not make specific reference to these purposes in its order of June 1982 denying petitioners' request that the unit be terminated. Instead, the Corporation Commission's order is based upon the provisions of the Plan of Unitization that provide for termination. As shown above, those provisions give the power to terminate to Misco, since it owns all of the working interest. Its witnesses established that Misco believes that unit operations are feasible and in fact necessary to the ultimate recovery of the hydrocarbons underlying the unit. The commission held that because Misco determined that unitized substances could still be produced in paying quantities and that there was still production from the unit, the order for unitization must remain in effect until Misco or some subsequent working interest owner makes contrary determinations, under the provisions of the Plan of Unitization. The district court went further and held that the Plan of Unitization was contractual and binding upon the surface (royalty or mineral interest) owners and their successors in interest, and that the unit must continue until the working interest owner determines otherwise pursuant to the plan. The original Plan of Unitization was not a contract between all of the royalty and mineral interest owners and all of the working interest owners. Approximately 19% of the royalty and mineral interest owners and a smaller portion of the working interest owners did not agree to that plan. Unitization was forced upon those people in 1968 under the original proceeding conducted pursuant to K.S.A. 55-1301 et seq. The Plan of Unitization, however fair in its provisions as to the workings and operation of the unit, is not a contract which may be enforced against those interest holders who did not agree to its terms and who were included in the unit against their will. The unit in this case is not one created by contract; it is one imposed by the Corporation Commission under authority of law. Both the Corporation Commission and the district court denied dissolution of the unit solely because of provisions in what they viewed as the contract. But by no stretch of the imagination can the unwilling interest holders be considered parties to a unitization contract. Only the Corporation Commission can impose unitization upon unwilling interest holders and then only pursuant to the statutes designated above. As Chief Justice Schroeder observed in his dissent in Mobil Oil Corp. v. Kansas Corporation Commission, 227 Kan. 594, 610, 608 P.2d 1325 (1980), [T]he Commission's authority to compel unitization is governed strictly by statute. (Emphasis in original.) After notice and hearing, if the unit application complies with all statutory requirements and if the commission makes the required findings, the commission may order unit operation and compel unitization on the non-signing 25% royalty owners. Though they are bound by the unitization order, the non-signing owners cannot be compelled to sign a contract. In this case, the commission's original order provides that the unitization should continue so long as unitized substances are produced in paying quantities and as long as unit operations are conducted.... The phrase, in paying quantities, has a generally accepted meaning in oil and gas cases. It refers to the production of sufficient quantities of oil or gas to yield a profit to the lessee over its operating expenses, even though the drilling costs, or equipping costs, are never recovered and even though the undertaking as a whole may result in a loss to the lessee. See Pray v. Premier Petroleum, Inc., 233 Kan. 351, Syl. ¶ 5, 662 P.2d 255 (1983), and Texaco, Inc. v. Fox, 228 Kan. 589, 593, 618 P.2d 844 (1980). The petitioners apparently agree that Misco is producing oil in paying quantities, i.e., that the twenty-four barrels of oil a day, when sold at the current market price, produce sufficient revenue to pay Misco's operating expenses and yield a profit. The original order also provides that operations shall continue as long as unit operations are conducted.... Unit operations do not appear to be defined either by statute or by prior case law. Does the mere production of a few barrels of oil from one well on a unitized acreage and the payment and division of the resulting royalties among all of those interest holders who have some right thereto constitute unit operations? If, for example, Misco could pay its operating expenses and perhaps even make a small profit from one well producing two barrels a day, and thus establish that it was recovering oil in paying quantities, and if at the same time it divided the royalties therefrom among the myriad owners of royalty interests in the 5800 acres comprising the Nichols unit, would such activity constitute unit operations? We think not. Unit operation is said to represent development and operation of an oil pool as a unit. It involves the consolidation or merger of all of the interests in the pool and the designation of one or more of the parties as operator. This method of development will permit the location of wells so as to secure the most scientific use of the natural reservoir energy in the production of oil and gas by primary recovery methods. See Campbell v. Fields, 229 F.2d 197, 199, 200 (5th Cir.1956). It would also include the location of both induction and production wells so as to secure the most scientific use of artificial energy in the production of oil and gas by secondary or tertiary recovery. Unit operation must mean not only the process of unitizing the area, centralizing management, pumping a few wells, and dividing the royalty proceeds according to schedule; it must also mean the good faith operation and prudent development of the unit. The Supreme Court of Arkansas, in Christmas v. Raley, 260 Ark. 150, 539 S.W.2d 405 (1976), held that the implied covenant to develop applies to unitized oil operations even when unitization is compulsory, and breach of that covenant is a ground for dissolution of the unit and cancellation of the leases. We agree. Kansas, like Arkansas, has long recognized that there is imposed by law upon an oil and gas lessee an implied covenant to reasonably develop the lease. This covenant is measured by the reasonably prudent operator test. See K.S.A. 55-223; Rush v. King Oil Co., 220 Kan. 616, 627, 556 P.2d 431 (1976); Shaw v. Henry, 216 Kan. 96, Syl. ¶¶ 1, 2, 531 P.2d 128 (1975); Stamper v. Jones, 188 Kan. 626, 631, 364 P.2d 972 (1961); Renner v. Monsanto Chemical Co., 187 Kan. 158, 166, 167, 168, 354 P.2d 326 (1960); Baker v. Huffman, 176 Kan. 554, 271 P.2d 276 (1954). In King Oil we said: Under the implied covenant of reasonable development when oil in paying quantities becomes apparent and the number of wells to be drilled on the lease is not specified, there is an implied obligation on the lessee to continue development of the leased premises by drilling as many wells as reasonably necessary to secure the oil for the common good of both the lessor and the lessee. Syl. ¶ 1. Under the prudent operator test the lessee must continue reasonable development of the leased premises to secure the oil for the common advantage of both lessor and lessee and may be expected and required to do that which an operator of ordinary prudence would do to develop and protect the interests of the parties. Syl. ¶ 3. The owner of an individual tract has the right to expect his lessee to prudently develop that tract under an oil and gas lease. When, however, the tract becomes unitized by order of the Corporation Commission, operations conducted pursuant to the order of the Corporation Commission providing for unit operations constitute a fulfillment of all the express or implied obligations of each lease.... K.S.A. 55-1306. We hold that the implied covenant to develop, measured by the reasonably prudent operator test, applicable to lessees of individual leases, is equally applicable to the operators of unitized leases. The Corporation Commission has statutory authority to amend or modify its unitization orders, and to terminate unit operations. K.S.A. 55-1305. It is the regulatory body which has expertise in the field, which has competent staff advisors, and which may employ consultants when that becomes necessary. K.S.A. 55-1309. The commission is in the best position, when called upon to do so, to determine whether unit operations upon statutorily unitized oil and gas leases are being carried on in good faith and whether the unit is being prudently operated and developed. When applications are filed with the commission to terminate a unit, the critical issue is whether unit operations were those of a reasonably prudent operator at the time the application was filed. Such a determination must be made if the correlative rights of all parties entitled to share in the production are to be protected. It is the duty of the Corporation Commission to protect those rights. Has the operator in this case exercised good faith and has it operated and developed the entire unit as a prudent operator would? The plat of the 5800 acres in this unit discloses that there is not one well on the west 2880 acres, not one well on the north 1240 acres, not one well on the south 1200 acres. Assuming that the pilot injection project in the northeastern portion of the unit pushed the oil in more than one direction from the location of the initial injection wells, would prudent operation require attempts at production in directions other than southeast of the pilot project? Would prudent development of the unit require at least some attempt to test available production to the north, west or south of the original pilot project? Once the pilot project was abandoned, would a prudent operator have attempted another pilot water injection project in some other location on the unit? Is it prudent for an operator of a unit this large to sit for ten years pumping six wells  five of them clustered together  while leaving large areas untried? Are the six wells now being pumped adequate to produce the oil underlying the entire 5800 acres, much of which is over a mile from the nearest well? Does such an operation prevent waste, conserve oil and gas and protect the correlative rights of all of the persons entitled to share in the production from this unit? The Corporation Commission did not address these or like issues in its final order in this proceeding; rather, it based its denial of dissolution solely upon the original Plan of Unitization, allowing the present operator sole discretion to determine whether or not this unit shall continue. This resolution by the Corporation Commission is not in the public interest, is not authorized by statute, and cannot be viewed in any sense as protective of the interests of those persons who are entitled to share in the production of this unit except one  the holder of the working interest. The Corporation Commission cannot delegate its statutory authority and responsibilities to the owner of the working interest. Voluntary termination by the working interest owner is but an alternative method of termination. That alternative remains open to the working interest owner under the Plan of Unitization and under the Corporation Commission's order of May 24, 1968. However, the Corporation Commission remains the ultimate authority and may terminate compulsory unitization if it determines that unit operations are not being carried on in a prudent manner, or that the purposes of the act, as set forth in K.S.A. 55-1301, cease to be served. The judgment is reversed and this case is remanded to the district court with directions to remand the matter to the Corporation Commission for further proceedings consistent with this opinion. HERD, J., not participating.