Kohlman, Application of

• Decision Date: 20 March 1978
• Docket Number: No. 12082,12082
• Citation: 263 N.W.2d 674
• Parties: Application of Paul KOHLMAN from the Board of Natural Resource Development.
• Court: South Dakota Supreme Court

Page 674

263 N.W.2d 674

Application of Paul KOHLMAN from the Board of Natural

Resource Development.

No. 12082.

Supreme Court of South Dakota.

March 20, 1978.

Donn Bennett of Mueller & Bennett, Belle Fourche, for appellants Depco, Inc. and Hanover Planning Co., Inc.

E. D. Mayer of Riter, Mayer, Hofer & Riter, Pierre, for respondent Paul Kohlman.

William J. Janklow, Atty. Gen., Pierre, for respondent Bd. of Natural Resource Development.

ZASTROW, Justice.

This is an appeal from the judgment of the circuit court modifying the compulsory pooling order of the Board of Natural Resource Development.

On August 13, 1973, the Board of Natural Resource Development for the State of South Dakota (Board) entered an order establishing an oil and gas spacing unit known as Buffalo Field. This field is comprised of the land area described as Section 19, Township 23 North, Range 5 East of the Black Hills Meridian, Harding County, South Dakota. This spacing unit is a short section bordering on the North Dakota-South Dakota line and contains slightly in excess of 400 acres. This spacing unit was created at the request of one of the owners of oil rights in that area, namely, Depco, Inc., the appellant herein. The owners of natural resource rights in this land area are Paul Kohlman, respondent, who holds the oil and gas lease on a 40-acre tract located in the extreme southeast corner of the spacing unit, and Depco, Inc., and its partner, Hanover Planning Co., Inc. (hereinafter collectively referred to as Depco), who control the oil and gas leases on the balance of 371.68 acres in the spacing unit. Establishing this area as a spacing unit necessarily limited the number of wells in that unit to one. Kohlman made no objection to the spacing unit order of August 1973, entered by the Board.

Following the establishment of the spacing unit, Depco indicated a desire to drill a well therein, and for maximum recovery potential desired to place the drill site on the 40-acre tract leased by Kohlman. The parties attempted to negotiate a voluntary arrangement regarding the payment of drilling expenses, the sharing of the proceeds, and all other requirements necessary between the owners of the land in the spacing unit, pursuant to SDCL 45-9-30. All attempts to a voluntary agreement failed; thereafter, Depco applied under SDCL 45-9-31 to the Board for a compulsory pooling order.

Pursuant to that application, notice of hearing was given and a hearing was held on April 11, 1974. Oral testimony was given by Depco's officers and Kohlman; following the hearing, written briefs were submitted by both parties. On May 29, 1974, the Board entered its Pooling Order No. 1-74, the order in dispute in this appeal. The order gave Kohlman the option of prepaying Depco a proportionate share of the estimated costs of drilling the well, or:

"b) That the operator (Depco) is hereby authorized to withhold the following costs and charges from production:

The pro rata share of reasonable well costs attributable to each nonconsenting working interest owner who has not paid his share of estimated well costs within 30 days from the date the schedule of estimated well costs is furnished to him. As a charge for the risk involved in the drilling of the well, 100 percent of the prorata share of reasonable well costs attributable to each nonconsenting working interest owner who has not paid his share of estimated well costs within 30 days from the date the schedule of estimated well costs is furnished to him. Such charges shall be exclusive of a royalty of not more than 1/8 of production occurring to the royalty owner."

This type of provision is referred to in the oil and gas industry as a "compensation for risk," "risk compensation," "risk bonus," or "risk penalty." It is intended to relieve the nondrilling interest owner from having to advance his proportionate share of the drilling costs but provide extra compensation from production (if oil is found) to the drilling party who has advanced the entire drilling costs and who would absorb the entire cost of a "dry hole."

The trial court held that the Board has exceeded its statutory authority in providing for the risk compensation and ordered the pooling order modified to delete subdivision (b).

The issue in this appeal is whether or not the Board is authorized to provide for "risk compensation" in a compulsory pooling order under SDCL 45-9-33.

SDCL 45-9-32 sets the requirements of a compulsory pooling order as follows:

"Each such pooling order shall authorize the drilling, equipping, and operation of a well on the spacing unit; shall provide who may drill and operate the well; shall prescribe the time and manner in which all the owners in the spacing unit may elect to participate therein; and shall make provision for the payment by all those who elect to participate therein of the reasonable actual cost thereof, plus a reasonable charge for supervision and interest."

SDCL 45-9-33 provides that alternatives are to be given to those working interest owners who elect not to participate in the risk and cost of drilling prior to production. The alternatives are stated in SDCL 45-9-33 as follows:

"If requested each such pooling order shall provide for one or more just and equitable alternatives whereby an owner who does not elect to participate in the risk and cost of the drilling and operation of a well may elect to surrender his leasehold interest to the participating owners on some reasonable basis and for a reasonable consideration which if not agreed upon, shall be determined by the board, or may elect to participate in the drilling and operation of the well, on a limited or carried basis upon terms and conditions determined by the board to be just and reasonable." (emphasis added)

The question of a nonparticipating, working interest owner sharing in the risk of drilling the well is discussed in 5 Summers, Oil and Gas, § 974:

"The majority of compulsory pooling statutes whereby royalty and working interest ownerships are force pooled on the basis of drilling and spacing unit areas require the drilling party, if other working interest owners do not elect to participate, simply to carry non-drilling interest owners at his risk. If successful in obtaining production, he then may recover proportionate actual outlays for drilling, completion costs and cumulative expenses prior to participation by the non-drilling parties. * * *

"To put it mildly this is an unattractive arrangement from the standpoint of the party taking the drilling risks. Not all states follow it. * * *

"What makes the shoe pinch in these situations of forced pooling for the drilling of a well is the case of a working interest owner who wishes to drill despite that the drilling and spacing unit is located at a considerable distance from established production because the primary term of his lease is running out. On the other hand, another working interest owner who will be subjected to the compulsory procedures may have a considerable period of time remaining in his lease and prefer to await drilling developments by others instead of participating in a hazardous stepout drilling venture." 5 Summers, Oil and Gas, § 974, pp. 122-124.

The Summers treatise lists New Mexico, Texas, Arkansas and Oklahoma as those statutes which do not allow the nonparticipating owners a "free ride." New Mexico, ¹ and Texas, ² have specific statutory provisions which set the maximum that their respective administrative agencies may impose as risk compensation in addition to the proportionate share of the well costs. Arkansas ³ provides that the Board may impose an "additional sum" with no limit nor any indication that the sum represents a risk compensation.

Depco relies upon the judicial interpretation of the Oklahoma statute, which is similar to South Dakota's statute, as authority for the imposition of a risk penalty by the Board.

Oklahoma Statutes Annot. 52, § 87.1(d) provides:

"All (compulsory pooling) orders * * * shall be upon such terms and conditions as are just and reasonable and will afford to the owner of such tract in the unit the opportunity to recover or receive without unnecessary expense his just and fair share of the oil and gas. * * * Such pooling order of the Commission shall make definite provisions for the payment of cost of the development and operation, which shall be limited to the actual expenditures required for such purpose not in excess of what are reasonable, including a reasonable charge for supervision."

Depco cites Holmes v. Corporation Commission, 1970, Okl., 466 P.2d 630; Anderson v. Corporation Commission, 1957, Okl., 327 P.2d 699; Wakefield v. State, 1957, Okl., 306 P.2d 305; Superior Oil Co. v. Oklahoma Corp. Commission, 1952, 206 Okl. 213, 242 P.2d 454; and Youngblood v. Seewald, 1961, 10 Cir., 299 F.2d 680, as those cases which have recognized the authority of the Oklahoma Corporation Commission to impose risk compensation under O.S.A. 52, § 87.1(d).

Only Holmes involved the imposition of a risk compensation in a compulsory pooling order by the commission. The protestant in that case did not challenge the authority of the commission to set risk compensation, but rather attacked the 250% Risk compensation as excessive and thus an abuse of discretion by the commission. The amount of risk compensation was upheld by the Oklahoma Supreme Court.

The other cases involved corporation commission orders which gave the nondrilling owners...