Member Article

Effective September 1, 2010, the Texas Railroad Commission issued new regulations for oil and gas operators related to inactive onshore wells and associated equipment pursuant to House Bill 2259¹ which dramatically changed requirements for extension of plugging obligations for inactive wells. Certain aspects of the regulations and the original law currently are under review, and amendments to HB 2259 are expected to be introduced in the current legislative session. Additionally, challenges to the Commission rulemaking under Statewide Rule 15 also may be raised.

Prior to September 1, 2010, in order to defer plugging obligations, the Railroad Commission only required that operators have a current Organization Report (P-5 form), a good faith claim to the right to continue to operate the well (and evidence for same if requested), and that the well and associated equipment was otherwise in compliance with state regulations. In addition, if the well was more than 25 years old, the operator also must conduct and provide evidence of a successful fluid level or hydraulic pressure test. After September 1, 2010, under much more rigorous standards (i.e., cost), an operator may seek statewide plugging extensions either on a blanket-statewide basis or on a well-by-well application. Failure to comply with the new requirements can result in the operator’s P-5 becoming “Delinquent,” and the Railroad Commission may begin to sever/seal the operator’s leases and wells.

Blanket Application for Extensions. Under the new regulations, in order to obtain a blanket extension to defer plugging inactive wells in the State, an operator must complete Form W-3X (Application for an Extension of Deadline for Plugging an Inactive Well) under one of the following options:

1.	The operator may plug or restore to active operation at least 10 percent of the number of inactive wells at their last Form P-5 annual renewal date (wells plugged or restored to activity need not have been among the operator’s inactive wells at the last Form P-5 renewal date; wells that more recently became inactive, or inactive wells that were acquired since the last renewal, also may be counted). The Commission may request additional information to verify that the operator has plugged or returned to active operation the required number of wells. Wells plugged by the operator in excess of 10 percent may be carried forward for the following year’s reporting obligation.
2.	An operator that is a publicly traded entity (note that the operator must be a public company; this option is not applicable if the operator is a subsidiary of a public company) may file with the Commission (i) a copy the federal documents it filed to comply with Financial Account Standards Board Statement No. 143, “Accounting for Asset Retirement Obligations,” and (ii) an original executed Uniform Commercial Code Form 1 Financing Statement, filed with the Texas Secretary of State, that names the operator as “debtor” and the Railroad Commission of Texas as “secured creditor” and specifies the funds covered by the documents in the amount of the “cost calculation” (described below) for plugging all inactive wells held by the operator.
3.	The operator may file a bond, letter of credit, or cash deposit in the amount equal to the lesser of (i) the “cost calculation” for plugging all of the operator’s inactive wells, or (ii) $2 million.

Whether or not the granting of a lien under Option #2 would default an operator’s negative covenant against granting liens on collateral under its Credit Agreement is academic given the confusion created under the language of this regulation. In short, the legal effect of Option #2 is unclear. Neither the Railroad Commission’s regulations nor HB 2259 identifies what “federal documents” are supposed to be attached to the application. Nor is it clear where one would find where such documents are filed “in compliance with FAS 143.” Moreover, the regulations do not conform with current provisions of the Uniform Commercial Code for creation and perfection of a lien (which would appear to be the intent of this provision). The intent of attaching a UCC filing with the Texas Secretary of State is unclear as (i) signatures are no longer required to file a UCC, (ii) the filing requirement does not require and the regulation does not otherwise establish a security agreement with the Railroad Commission, (iii) the proper location for filing against a debtor is its state of organization, so that only as to entities organized in Texas would a filing with the Texas Secretary of State be effective to perfect a lien against such entity, and (iv) no “collateral” to secure the deferred plugging obligation is described upon which a UCC financing statement would be filed to perfect against.

Option #3 represents a significant increase in the amount most companies currently have posted for statewide performance bonds, letters of credit, or cash deposits under Chapter 16, § 3.78 of the Texas Administrative Code, currently being either $25,000 for 1-10 wells, $50,000 for 11-99 wells, or $250,000 for 100 or more wells. Use of this option could absorb a significant amount of smaller independent operators’ available cash, or increase the amount such operator is required to borrow under its credit facility to either secure letters of credit or cash deposits. The effect on such operators will mean less capital available to drill, complete, and operate producing wells in Texas.

Individual (Single Well) Extension Application. As an alternative to the blanket application, compliance can be met on a well-by-well basis by filing the Form W-3X and including documentation under one of the following five options:

1.	an “abeyance of plugging report” in which an engineer or geoscientist certifies the future beneficial use of the well within a reasonable period (Rule 15(j)), along with a $100 fee per well;
2.	if the operator is not otherwise required to file a fluid level or hydraulic pressure test, the operator may perform such test (Form H-15), along with a $50 fee;
3.	post a bond with the Commission in the amount of the “cost calculation” for plugging the well (equal to the cost, calculated by the Commission for each foot of well depth plugged based on average actual plugging costs for wells plugged by the Commission for the preceding state fiscal year for the RRC district in which the inactive well is located);
4.	make an annual escrow fund deposit to be held in the Oil Field Clean Up Fund maintained by the Commission in an amount no less than 10 percent of the “cost calculation” for plugging the well; or
5.	a statement that the well is part of a Commission-approved Enhanced Oil Recovery (EOR) project.

Operators and other parties affected by HB 2259 and the Commission’s implementing regulations should stay apprised of legislative proposals for technical corrections as well as any challenges that may be raised at the Commission level to the new rulemakings implementing HB 2259.

If you have any questions, please feel free to contact one of the attorneys listed below.

Buddy Clark 713.547.2077 [email protected]

Michael J. Jewell 512.867.8513 [email protected]

Christopher S. Kulander 713.547.2067 [email protected]

 

Footnotes: 1 HB 2259 was enacted during the 2009 Texas legislative session. HB 2259 applies only to land wells (not to bay and offshore wells). A copy of the legislation as enacted can be found here.