## Facts

- NGC Energy Company and Mono Power Company each held a 25% working interest in a federal oil and gas lease administered by the Bureau of Land Management (BLM).
- Mono also held an interest in an adjacent lease located off the federal lease.
- BLM determined that a well on the adjacent lease drained gas from the federal lease.
- In the administrative record, BLM accepted that drilling an additional protective (offset) well on the federal lease to prevent drainage would have been uneconomic.
- Despite the uneconomic nature of an offset well, BLM assessed compensatory royalties against NGC and Mono for alleged breach of the implied covenant to protect the federal lease from drainage.
- BLM’s assessment relied on the view that, because Mono was a common owner across the federal and adjacent tracts, Mono had an absolute duty to unitize the tracts to prevent drainage; BLM treated failure to unitize as the breach.
- The BLM Colorado State Office affirmed the compensatory royalty assessment.
- NGC and Mono appealed the State Office decision to the Interior Board of Land Appeals (IBLA).

## Issues

1. Whether a working-interest owner with interests in both a federal lease and an adjacent lease has an absolute duty to unitize the tracts to satisfy the implied covenant to protect the federal lease from drainage.
2. Whether compensatory royalties may be imposed for failure to protect against drainage when drilling an offset well on the federal lease would be uneconomic.
3. Whether failure to unitize, without more, can constitute a breach of the implied covenant to protect against drainage sufficient to support compensatory royalties.

## Decision

- The IBLA rejected BLM’s theory that a common owner bears an absolute duty to unitize adjacent tracts as a condition of satisfying the implied covenant to protect against drainage.
- The IBLA treated the implied covenant to protect against drainage as governed by a reasonably prudent operator standard that accounts for economic feasibility.
- Given BLM’s acceptance that an offset well would have been uneconomic, the IBLA concluded the compensatory royalty assessment was not supportable on the record presented.
- The IBLA set aside the State Office/BLM assessment of compensatory royalties.

## Legal Principles

- The implied covenant to protect a federal oil and gas lease from drainage is evaluated under a reasonably prudent operator standard, including profitability and economic feasibility of protective measures.
- A lessee (or working-interest owner) is not required to take protective actions that a prudent operator would regard as uneconomic.
- Common ownership of interests in adjacent tracts does not create a per se or absolute obligation to unitize as the sole means of satisfying the implied covenant to protect against drainage.
- Compensatory royalties require a supportable finding of breach of the implied covenant; they are not warranted where the agency’s theory rests on an incorrect per se duty and the record shows protective drilling would be uneconomic.

## Conclusion

The IBLA overturned BLM’s compensatory royalty assessment for alleged drainage from a federal lease, holding that the implied covenant to protect against drainage turns on what a reasonably prudent operator would do in light of economics and does not impose an absolute duty on a common owner to unitize adjacent tracts.


NGC Energy Co. v. Mono Power Co., 114 IBLA 141 (I.B.L.A. 1990)