How a greener, more efficient way to extract oil was phased out

Almost everything we encounter in our day-to-day lives is created with some type of extracted oil or bitumen. And it’s no guarded secret that oil extraction is complicated, wasteful, and unambiguously terrible for the environment.

From its first discovery and inception, commercial oil and gas extraction has and continues to suffer enormous production externalities. These externalities stem from the nature of the resources: oil and gas are fluid and migrate from areas of high pressure to areas of low pressure within the subterranean reservoir.

Often, the reservoirs span across multiple productive leases, meaning no single firm holds sole rights to the entire reservoir. Rights to the resource are informed by the “rule of capture,” which means that producers can drain resources lying beneath another firm’s land without any liabilities, as long as the oil well is located on their own property.

In other words, legal ownership of the resource does not begin until the resource is extracted, or “captured.” These conditions characterize a classic common-pool resource that is both rival and non-exclusive.

Firms race to build as many wells as it takes to extract as much oil as possible in the shortest amount of time possible. The result is over-extraction and overly hasty extraction, leading to a huge wasting of both resources and capital equipment, as well as environmental damage.

Can anything be done to mitigate some of this damage?

Unitization — a different type of reservoir operation management.

Oil field unitization refers to a single firm being designated as the sole unit operator to develop the oil reservoir as a whole, but where each firm contributes to capital and operating costs while sharing in profits based on their stakes.

So instead of having subdivided tracts of land where firms race to build wells and extract, there is typically only one well per reservoir, and one operator that controls the production.

There are huge benefits to oil field unitization.

According to Wiggens and Libecap, unitization raises field rents by increasing oil recovery and reducing production costs when compared with common pool production. Production life of unitized reservoirs should be longer and production volume should be tilted towards the future.

Studies have shown that unitization works, through enhanced oil recovery and more efficient production schemes. In such cases, unitization can be said to be pareto-improving, where efficiency gains make all parties better off.

The idea isn’t new, either. As early as 1916, the U.S. Bureau of of Mines called for the unitization of U.S. Oil Fields.

But by 1947, it was found that only 12 fully unitized fields existed, out some 3000 sampled fields.

Prior to 1966, statutory unitization was decreed for in 4 out of 5 Canadian provinces where freehold mineral rights were of importance. In 1966, the Saskatchewan law was amended to include voluntary unitization, and eventually the “compulsory” form became largely unused (in fact, it was perhaps not-so-compulsory after all).

As of June 2013, Crescent Point Energy’s oil pool at Leitchville North, SK, was the first unitized field in Saskatchewan in about 20 years. Apart from the leftover active units, unitization barely still exists in Canada today.

What caused its phasing out?

In short, a lack of strict compulsory unitization legislation.

Voluntary unitization is extremely rare, as there are risks involved, and profit-hungry oil giants that want to minimize such risks.

Imperfect and asymmetrical information lies at the root of unitization’s contractual failure.

A rift in information prevents agreement on lease values and hold-out strategies of firms to increase their share of unit rents. A key feature of unitization negotiations is the division of net revenues. The profit sharing formula results in a permanent share assignment, because reservoir dynamics and relative lease production potential are “fundamentally altered” under unitization.

Under unitized management, some wells are plugged and others are converted to gas injection to maintain subterranean reservoir pressure. As well, altered pressure in various parts of the field changes oil migration patterns. These changes in the dynamics of oil production mean that share negotiations cannot be reopened to adjust for new contingencies, so there remains a degree of uncertainty and risk to signing a unit agreement.

Saskatchewan and Alberta’s voluntary application process for unitization has effectively killed its prospects. Despite the efficiency benefits, firms can’t stand to face risks and uncertainty without the force of law.

One can only hope that as new innovations arise that have demonstrable environmental and economic benefits, legislators will wield a stronger hand.

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