(a) Obligation to drill an offset well. An offset well must be drilled on state property under the terms of this section whenever an encroaching well is completed unless one of the following conditions applies: lessee has properly pooled the state property with the property containing the encroaching well (see §9.81 of this title, (relating to Pooling and Unitizing State Property), the commissioner has granted written approval to allow payment of compensatory royalties in lieu of drilling an offset well (see subsection (c) of this section) or the commissioner has agreed that the encroaching well cannot be draining state hydrocarbons (see subsection (b) of this section). Failure to drill an offset well can result in the forfeiture of a lease or of a surface owner's agency rights under the Relinquishment Act.
  (1) Who is obligated. For any state property other than Relinquishment Act property, the lessee of the state property has the obligation to drill the offset well. For leased or unleased Relinquishment Act property, the surface owner, lessee, sublessee, receiver or other agent in control of the property has the obligation to drill the offset well.
  (2) Drilling the offset well. In addition to meeting the requirements found in §9.32 of this title, (relating to General Responsibilities of State Lessees) and §9.34 of this title, (relating to Drilling and Reworking Operations), an offset well shall also be drilled to a sufficient depth and in such a manner as to prevent drainage of oil or gas from state land.
  (3) When to begin drilling. The drilling operation associated with an offset well shall begin:
    (A) for Relinquishment Act lands, within 100 days of the date that the encroaching well first produces commercially (excluding test production); or
    (B) for other state properties, within 60 days of the date that the encroaching well first produces commercially (excluding test production).
(b) Agreement that no drainage of state hydrocarbons is possible.
  (1) Application. If the person obligated to drill an offset well is certain that an encroaching well cannot be draining the state property, he shall apply in writing to GLO staff at the address found in §9.32(c)(3)(A) of this title (relating to Required Activity Lessee Responsibilities). This application should include a full explanation of why applicant contends that no drainage of state hydrocarbons is possible and request the commissioner to agree with this contention.
  (2) Information/Data supporting application. With the application, the applicant shall submit any evidence, data, or information necessary to support the application and request, including geological, geophysical, economic, engineering, or production data from the encroaching well, and any other data regarding the state property, the encroaching well or any shut-in well located on the state property. Applicant shall submit additional evidence, data or information upon request of GLO staff.
  (3) Effect of reaching an agreement. If the commissioner, after reviewing all pertinent data and evaluating the GLO staff recommendation, agrees that the encroaching well cannot drain state hydrocarbons, then the commissioner will send a letter to the applicant as evidence of this agreement. This letter agreement will not prevent the state from claiming or collecting damages should later technology show that state hydrocarbons were drained or if the data submitted by applicant was false, inaccurate or incomplete.
  (4) Effect of failing to reach an agreement. If the commissioner, in his sole discretion, concludes that the state property may possibly be drained, then a letter will be mailed to applicant stating that the drilling of an offset well is required under the statutory provisions and any corresponding lease provision. Applicant will then be given the opportunity to seek the commissioner's approval to pay compensatory royalties in lieu of an offset well under subsection (c) of this section.
(c) Agreement to accept compensatory royalty in lieu of drilling offset wells.
  (1) Effect of reaching or failing to reach an agreement. If an agreement is reached with the commissioner under this section, the payment of a compensatory royalty will satisfy the obligation to drill an offset well on the state property involved. Reaching an agreement will not prevent the state from claiming or collecting damages should later technology show that additional state hydrocarbons were drained or if the data submitted by applicant was false, inaccurate or incomplete. If such an agreement cannot be reached and the state property cannot be pooled, an offset well must be drilled under the appropriate statutory provisions and any corresponding lease provisions.
  (2) Application. If the person obligated to drill an offset well desires to pay compensatory royalty in lieu of drilling it, he should apply in writing to GLO staff at the address found in §9.32(c)(3)(A). This application should include, at a minimum, an explanation of why applicant does not plan to drill an offset well (or to produce and market production if there is a shut-in well on the state property), why applicant cannot pool the state property with the property containing the encroaching well, and why the payment of a certain compensatory royalty will adequately protect the state's interests.
  (3) Information/Data supporting application. With the application, the applicant shall submit any evidence, data, or information necessary to support his application, including geological, geophysical, economic, engineering, or production data from the encroaching well, and any other data regarding the state property, the encroaching well or any shut-in well located on the state property. Applicant shall submit additional evidence, data or information upon request of GLO staff.
  (4) Mandatory terms of the agreement. If, after reviewing the pertinent data and evaluating the GLO staff recommendation, the commissioner is able to reach an agreement with applicant under this section, the agreement may contain additional terms at the commissioner's sole discretion but must contain the following provisions:
    (A) The amount of the compensatory royalty payment. The compensatory royalty on the state property burdened by the offset obligation shall be paid:
      (i) on the royalty rate set in the lease covering such state property or on a royalty rate set by the commissioner if such property is unleased Relinquishment Act land; and
      (ii) on the market value at the well of all production from the encroaching well unless the commissioner, in his sole discretion, agrees to reduce proportionately the compensatory royalty volumes based upon the amount of state hydrocarbons being drained as reflected by the data submitted by the applicant.
    (B) Special provisions if state property already has a shut-in well. If compensatory royalties are paid on state property that has a shut-in well and the annual total of these compensatory royalty payments is less than the annual shut-in royalty payment set in the applicable state lease, lessee shall pay additional compensatory royalty equal to the difference. Such additional compensatory royalty is due one year and 30 days from the date that the first compensatory royalty was due and annually thereafter on the same date.
  (5) Due date. Unless the agreement reached with the commissioner states otherwise, the first compensatory royalty payment (covering all past production from the encroaching well) is due by the last day of the month following the month in which the agreement was reached and, thereafter, compensatory royalties are due by the last day of each month and computed based on the encroaching well's production for the preceding month.

Source Note: The provisions of this §9.37 adopted to be effective January 7, 1999, 24 TexReg 146; amended to be effective August 9, 2009, 34 TexReg 5379