Manufacturers Nat. Bank of Detroit v. Director of Dept. of Natural Resources, Docket Nos. 69371

• Decision Date: 28 December 1984
• Docket Number: Docket Nos. 69371,No. 4,69372,4
• Citation: 362 N.W.2d 572,420 Mich. 128
• Parties: MANUFACTURERS NATIONAL BANK OF DETROIT, successor trustee, and Adeline K. Werp, Plaintiffs-Appellees v. DIRECTOR OF the DEPARTMENT OF NATURAL RESOURCES, acting as Supervisor of Wells, Defendant-Appellant and Shell Oil Company and Northern Michigan Exploration Company, Interested Parties-Appellants. Calendar420 Mich. 128, 362 N.W.2d 572
• Court: Michigan Supreme Court

Page 572

362 N.W.2d 572

MANUFACTURERS NATIONAL BANK OF DETROIT, successor trustee and Adeline K. Werp, Plaintiffs-Appellees v. DIRECTOR OF the DEPARTMENT OF NATURAL RESOURCES, acting as Supervisor of Wells, Defendant-Appellant and Shell Oil Company and Northern Michigan Exploration Company Interested Parties-Appellants.

Docket Nos. 69371, 69372.

Calendar No. 4.

420 Mich. 128, 362 N.W.2d 572

Supreme Court of Michigan.

Argued March 6, 1984.

Decided Dec. 28, 1984.

Byron P. Gallagher, Lynch, Gallagher, Lynch, Shirley, Martineau & Campbell, Mount Pleasant, for plaintiffs-appellees.

Frank J. Kelley, Atty. Gen., Louis J. Caruso, Sol. Gen., Terrence P. Grady, Russell

E. Prins, Asst. Attys. Gen., Lansing, for Director, Dept. of Natural Resources, as Supervisor of Wells, defendant-appellant Lands, Lakes & Leases Div.

Joseph H. Fields, Shell Oil Co., Houston, Tex., William H. Stephens, III, Northern Michigan Exploration Co., Jackson, George W. Loomis, Harvey J. Messing, Michael G. Oliva, Ronald W. Bloomberg, Loomis, Ewert, Ederer, Parsley, Davis & Gotting, Lansing, for interested parties-appellants Shell Oil Co. and Northern Michigan Exploration Co.

William R. Ralls, Ralls & Latterman, P.C., Lansing, for amicus curiae State Bar of Michigan Oil & Gas Law Committee.

Veryl N. Meyers, John M. De Vries, Mika, Meyers, Beckett & Jones, Grand Rapids, for amici curiae Wolverine Gas, et al.

BRICKLEY, Justice.

The questions in this case are whether the creation of a drilling unit by the Director of the Department of Natural Resources, in his capacity as Supervisor of Wells ¹, amounts to a pooling of the legal interests of those whose lands are within the unit, and, if so, whether the Supervisor of Wells may permissibly allocate the production royalties of the well to lands within the unit which are not underlain by oil or gas. We answer the first question in the negative and, therefore, do not reach the second question.

Plaintiffs ² have leased the oil and gas rights in their 80-acre farm to Shell Oil Company, retaining a 1/8 interest in the production as a royalty. They claim that the Supervisor of Wells, by establishing a 240-acre drilling unit, pooled their royalty interest with the interests of other royalty owners. Plaintiffs further claim that the Supervisor of Wells has ordered royalty payments to be made to all royalty holders on the basis of the relation that each royalty owner's surface acreage bears to the 240-acre drilling unit. Since it is undisputed that approximately 100 acres of the drilling unit are not underlain by the oil and gas pool, while most of plaintiffs' land in the unit is underlain by oil and gas, plaintiffs claim that their royalty has been reduced by the amount allocated to the owners of "barren" land. The Supervisor of Wells, Shell Oil Company, and the Northern Michigan Exploration Company (NOMECO), on the other hand, contend that the legal interests of the royalty owners within the unit were pooled by private action pursuant to the leases granting Shell Oil Company and NOMECO the oil and gas rights in the lands within the drilling unit. They also contend that royalties are being properly paid on a surface-acreage basis pursuant to those same leases. In a series of opinions, the Court of Appeals agreed with plaintiffs. We now reverse.

I

An overview of the statutes and regulations regarding the Supervisor of Wells' power over oil and gas is necessary for an understanding of this case.

The mission of the Supervisor of Wells is to prevent waste in oil and gas drilling. M.C.L. Sec. 319.1; M.S.A. Sec. 13.139(1), M.C.L. Sec. 319.5; M.S.A. Sec. 13.139(5). Waste is broadly defined to include the waste of oil and gas and gas pressure, unnecessary surface destruction, and, generally, anything that would tend to unnecessarily damage the above- or below-ground environment. M.C.L. Sec. 319.2(l ); M.S.A. Sec. 13.139(2)(l ). More particularly, the drilling of unnecessary wells is twice defined as waste. M.C.L. Sec. 319.2(l )(3); M.S.A. Sec. 13.139(2)(l )(3), M.C.L. Sec. 319.13; M.S.A. Sec. 13.139(13). In part, M.C.L. Sec. 319.13; M.S.A. Sec. 13.139(13) provides:

"The drilling of unnecessary wells is hereby declared waste as such wells create fire and other hazards conducive to waste, and unnecessarily increase the production cost of oil and gas to the operator, and thus also unnecessarily increase the cost of the products to the ultimate consumer".

To prevent unnecessary wells, and, therefore, prevent waste, the supervisor may establish drilling units. The establishment of a drilling unit prevents unnecessary wells because the size of the unit depends on the area that can be drained by one well, and only one well is allowed in a drilling unit:

"To prevent the drilling of unnecessary wells the supervisor, after conference and recommendation by the board, may fix a drilling unit for each pool. A drilling unit, as contemplated herein, means the maximum area which may be efficiently and economically drained by 1 well and such unit shall constitute a developed area as long as a well is located thereon which is capable of producing the economically recoverable oil or gas thereunder. Each well permitted to be drilled upon any drilling unit shall be located in the approximate center thereof, or at such other location thereon as may be necessary to conform to a uniform well spacing pattern as adopted and promulgated by the supervisor after due notice and public hearing, as provided in this act." Id.

Furthermore, no one may drill for oil and gas without applying for and receiving a drilling permit from the Supervisor of Wells. M.C.L. Sec. 319.23; M.S.A. Sec. 13.139(23).

When there is but one owner of all the land in the area the supervisor has designated as a drilling unit, that owner alone may simply apply for a permit to drill. If, however, different persons own the lands within the unit, problems arise. If an individual owner's land is smaller than the size of the drilling unit established for the oil or gas pool, the owner will be prohibited from drilling, unless unique circumstances would allow a well to be drilled on that land without waste. Therefore, so that the owners of land within a drilling unit can join together to apply for a drilling permit, there is the concept of pooling.

The term "pooling" has been defined as a term "properly used to denominate the bringing together of small tracts sufficient for the granting of a well permit". Williams and Meyers, 8 Oil and Gas Law, p 554. Private pooling agreements generally provide for the manner in which the production of the single well in the unit will be distributed to the landowners. See 8 Williams and Meyers, supra, pp 555-556. On the subject of pooling, M.C.L. Sec. 319.13; M.S.A. Sec. 13.139(13) provides:

"The pooling of properties or parts thereof shall be permitted, and, if not agreed upon, the supervisor after conference with and recommendations by the board, may require such pooling in any case when and to the extent that the smallness or shape of a separately owned tract or tracts would, under the enforcement of a uniform spacing plan or proration or drilling unit, otherwise deprive or tend to deprive the owner of such tract of the opportunity to recover or receive his just and equitable share of the oil or gas and gas energy in the pool. * * * All orders requiring such pooling shall be upon terms and conditions that are just and reasonable, and will afford to the owner of each tract in the pooling plan the opportunity to recover or receive his just and equitable share of the oil or gas and gas energy in the pool as above provided, and without unnecessary expense, and will prevent or minimize reasonably avoidable drainage from each developed tract which is not equalized by counter drainage. The portion of the production allocated to the owner of each tract included in a drilling unit formed by voluntary agreement or by a pooling order shall, when produced, be considered as if it had been produced from such tract by a well drilled thereon".

Additionally, the Supervisor of Wells has promulgated the following rules regarding pooling:

"The lessees or lessors, or both, of separate tracts or mineral interests which lie partially or wholly within an established drilling unit may pool or communitize such tracts or interests to form full drilling units and to develop such units in accordance with the provisions of these general regulations and any applicable order of the supervisor." 1979 AC, R 299.1204.

"The supervisor may require the pooling of tracts or mineral interests within a drilling unit when the owners of such tracts or mineral interests have not agreed, or do not agree, upon the pooling of said interests to form full drilling units in accordance with these general regulations and any applicable spacing order. Such compulsory pooling shall be done on a basis which will permit each owner of an interest within a drilling unit the right and opportunity to receive his just and equitable share of the production from the unit. Compulsory pooling shall be adopted by the supervisor only after public hearing as provided in R 299.2004, after conference with and recommendation by the advisory board, for the purpose of preventing waste, and to prevent the drilling of unnecessary wells." 1979 AC, R 299.1205(1).

II

The Northern Trend, a relatively narrow trend of Niagara rock, 12 to 23 miles wide, extends across the northern portion of the lower peninsula. Small areas of gas-bearing reefs (normally limestone formed by the bodies of marine animals surrounded by non-porous rock) are scattered throughout. The present case involves lands over the Grant 13-23N-12W Salina-Niagaran Formation Pool (Grant-13 Pool).

In 1968, appellant Shell Oil Company entered into from 10,000 to 15,000 oil and gas leases in the northern lower-peninsula area. Among those leases are the ones involved in the present case.

On April 25, 1968, plaintiffs leased...