Lessors of Two Evils

In 1901, the discovery of Spindletop oil field kicked off the oil industry we know today. Drillers raced to extract as much as they could as quickly as possible, even from tiny plots of land, leading to an overabundance of wells. Using too many wells on an oil field is costly, since it limits the amount of oil that can be extracted and increases the cost to extract any that remains.

In response to the overcrowding of wells, most states passed laws that, in effect, required drillers to assemble a minimum amount of acreage before drilling. Developers found it difficult to acquire enough land through voluntary contracts with landowners, leading to the opposite problem: under-drilling. To correct for the over-correction, at least 39 oil and gas-producing states have passed forced pooling laws.      

Under forced pooling, once drillers acquire some minimum threshold of the acreage requirement, they can force remaining holdout landowners to sign over their mineral rights. Predictably, landowners in states with such laws are outraged. They claim forced pooling strips them of bargaining power and property rights. Often, drillers use the threat of forced pooling to coerce landowners to sign contracts, even before meeting the acreage threshold. And landowners that refuse to sign can be penalized with extra costs, called risk penalties.

Only one top oil and gas-producing state has not enacted a forced pooling law: Texas. Landowners there proclaim pride at this, citing individual liberty and a wildcatter spirit. Yet, possibly as a consequence, Texas has more wells that are more densely packed than many other states.

So on one hand, we know from prior research that wells in states with forced pooling laws, like New Mexico, are more profitable than wells in states without such laws, like Texas. However, forced pooling has been accused of wresting bargaining power away from landowners.

How do we evaluate this trade-off between well productivity and landowner bargaining power? One way is to look at the leases the landowners negotiate. In my new working paper, I compare three key leasing outcomes (royalty rates, bonus payments, and concessions from drillers) for Texas leases, which are not subject to forced pooling, and New Mexico leases, which are. I find that landowners contracting under forced pooling fare better in two of the three dimensions, royalty rates and concessions, and no worse in the third, bonus payments.

Forced pooling laws seem to offer landowners a slightly larger percentage of the profits and significantly more protections. At the very least, these results make it difficult to argue that forced pooling makes landowners worse off, as the widespread criticism suggests.

This post highlights research presented at the Northeast Workshop on Energy Policy and Environmental Economics, hosted this year at the University of Pennsylvania.

Rachel Feldman

Doctoral Student, Georgetown University

Rachel Feldman is a Ph.D. candidate in economics at Georgetown University. Her research focuses on energy and environmental economics, specifically in the oil and gas and renewable energy industries.