The effects of transaction costs on Northern Plains oil unitization agreements

Abstract

Under the rule of capture, petroleum production on reservoirs with numerous surface owners leads to significant economic waste from over-drilling and reduced total oil recovery. To mitigate the economic losses from rule of capture, private and regulatory solutions emerged to limit over-production on oil reservoirs. Among these solutions, contracts known as reservoir-wide unitization agreements lead to optimal reservoir development by allowing wells to be placed according to physical and economic conditions. While unit agreements allow for a first-best productive result, the costs of reaching contractual agreement can prohibit unit formation. This thesis examines the determinants of reservoir-wide unitization agreements. The general hypothesis is that increases in costs contracting decrease the likelihood of successful unit formation. A static well-choice model is used to analyze the factors affecting the firm's decision to join a unit. Variations on the model allow the well-choice decision to be derived under various regimes: sole ownership of the reservoir, rule of capture production, and contracting. The well-choice decision for each variation can then be used to determine the value of the reservoir for each regime. Using these values, the probability of unitization can then be linked to increases in the value of the reservoir when it is unitized and increases in the costs of negotiating agreements. Two primary predictions result: 1) as surface landholdings and subsurface physical reservoir properties become more heterogeneous, the probability of unit formation decreases, and 2) laws facilitating the unitization process increase the probability of unit formation. The primary empirical analysis uses probit regressions and case studies to examine data from oil reservoirs in the Northern Plains for the probability of unitization. The estimates indicate successful unitization occurs when surface ownership and reservoir properties are more homogenous, but also that legislation enacted to facilitate the unitization process has little impact on the formation of units.