On Friday, June 30, 2023, the Third Court of Appeals in Austin issued its opinion in Railroad Commission of Texas, et al. v. Opiela.  The appeal was lodged by the Railroad Commission of Texas (“RRC”) and Magnolia Oil & Gas Operating, LLC (“Magnolia”) after the 53rd District Court in Travis County (“Trial Court”) determined the RRC inappropriately granted a drilling permit for a production sharing agreement (“PSA”) well.  The Appellate Court reversed the Trial Court order in part, affirmed in part, and remanded the matter to the RRC for further fact finding. A brief summary of the Trial Court’s holdings and the Appellate Court’s responses are set forth below:

Trial Court: The RRC erred in failing to consider the anti-pooling clause of the lease covered by the Audioslave A 102H Well (“Audioslave Well”) in deciding that Magnolia has a good faith claim to operate the well. The anti-pooling clause in the lease provides as follows:

Nothing contained herein shall authorize Lessee in any manner whatever to pool said land or any part of the same for oil, and for the production of oil from said land under this lease, and in the event oil is discovered on and under said land Lessor shall receive as his royalty the full one-eighth of all the oil produced and saved from said entire tract of land leased hereunder, as herein in Paragraph 3 provided.

It is important to note that the Opielas have never executed a PSA, and their arguments at trial were primarily related to the public policies surrounding pooling and horizontal wells.

Appellate Court:  The RRC did not fail to consider the anti-pooling clause.  The Appellate Court specifically held that production through a PSA well is not the same as pooling under Texas law, and, thus, the anti-pooling clause did not negate Magnolia’s good faith claim to the right to drill and operate the PSA well. The Appellate Court further clarified that the RRC’s handling of the permit in question was consistent with two previous RRC rulings where the same arguments were used.

Trial Court: The RRC erred in concluding it has no authority to review whether an applicant seeking a well permit has authority under a lease or other relevant title documents to drill the well.

Appellate Court: The RRC did not err by concluding that it had no power to adjudicate the applicant’s rights under a lease or other relevant title documents. The RRC was following the Texas Supreme Court’s holding that “[w]hen [the RRC] grants a permit to drill a well it does not undertake to adjudicate questions of title or rights of possession. These questions must be settled in the courts.”[1] Further, the RRC is similarly limited from adjudicating the validity of contractual agreements such as pooling agreements.[2]

Trial Court: The RRC erred in adopting rules for allocation and PSA well permits without complying with the requirements of the Administrative Procedure Act, Tex. Gov’t Code § 2001.001 et seq., and further erred in applying those rules by issuing well permits for the Audioslave Well.

Appellate Court: Unfortunately, the Appellate Court determined that the RRC’s rulemaking process was not determinative of the issues at hand and declined to discuss the issue further.

Trial Court: The RRC erred in finding that Magnolia showed a good faith claim of the right to drill and operate the Audioslave Well as a PSA well.

Appellate Court: The Appellate Court affirmed the Trial Courts holding that Magnolia did not provide sufficient evidence of a good faith claim to drill and operate the Audioslave Well through a PSA well permit. Both Courts discussed the existence and origin of the 65% threshold of executed PSA’s for the issuance of a drilling permit. The guidelines for the threshold were described in Texas R.R. Commission, Formal Commission Actions, Hearings Div., p. 3, Status #665639 (Sept. 9, 2008) as “wells that are permitted based on a production sharing agreement should be approved when the usual criteria are met and the operator certifies that at least 65% of the working and royalty interest owners in each component tract have signed the production sharing agreement. (emphasis added)” In the end, the evidence provided at the hearing in front of the RRC showed that only 15.625% of the interest owners on the Opiela tract signed a PSA, whereas another 49.437% executed instruments consenting to a pooled unit. Because pooling is not required to permit a PSA well, the Appellate Court concluded that, for permitting purposes, a PSA and a consent to pool are not equivalent.  Thus, substantial evidence could not be presented to show that the RRC’s own 65% threshold was ever met by Magnolia.

Allocation Well Alternative: Magnolia also requested the Appellate Court grant the permit as an allocation well or remand the action back to the RRC to determine whether the Audioslave  Well should be permitted as an allocation well.  The Appellate Court refused to grant a new permit but did remand the action back to the RRC.

This opinion is important for three reasons. First, the Appellate Court reiterated that horizontal wells may cross tract boundaries without pooling.  Second, the RRC is still not an arbiter of title or contract rights amongst applicants and challengers.  Third, the 65% threshold to qualify for a PSA well permit must be backed by substantial evidence. The primary complaint of the Opiela’s protest against the drilling permit issued by the RRC was that allocation and PSA wells are “pooling by another name” and, as such, were prohibited based on the language of the Opiela’s lease. The question of whether allocation and PSA well development is akin to pooling was not directly challenged in this appeal, as it was not clearly ruled on by the trial court, nonetheless, the Court of Appeals provided a very clear answer, at least for the moment.

[1] Magnolia, 170 S.W.2d at 191.

[2] See Railroad Comm’n v. Rau, 45 S.W.2d 413, 416 (Tex. Civ. App.— Austin 1931, writ dism’d) (cited by Kawasaki Motors Corp. USA v. Texas Motor Vehicle Comm’n, 855 S.W.2d 792, 799 (Tex. App.—Austin 1993, no writ)).

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