Oil and Gas - Spring ‘01, Prof. Reed
1. Introduction to Oil and Gas
1. Five Phases of the Business
1. Upstream Processing
1. Exploration
2. Production
2. Downstream Processing
1. Transport
2. Manufacturing
3. Marketing
2. Horton’s Rule: Literal interpretation of a document - strong in TX
3. Correlative Rights: When more the 1 person has right to reservoir must protect them
II Law of Capture and Private Ownership
1. Law of Capture:
1. Concepts:
1. Oil comes from rock - sedementary rock (limestone) permeable - the gut of the organism has positive buoyancy when they die they lose this and sink to the bottom. The guts inside the exoskeleton rot and decay and create oil and gases.
2. Rocks are pourous, if pores are connected then the rock has porosity (30% is good)- the pores must have oil or it is dry hole. If there is oil then it is producer. Poor communication = low permeability
3. European law - govt owns the mineral under the land (hence royalty), TX had this rule from 1840-1895
2. Ownership Prior to and at Extraction
1. Del Monte Mining: (OLD rule) whoever has the fee of soil owned all from the heavens above the surface to the core below. Early on, oil was considered fugacious (constantly moving).
2. Note: Mining lode claims - the owner of the lode has the right to mine all veins lodes and ledges throughout the entire depth.
3.
Kelly v.
1. Rule of capture - there is no liability for capturing oil and gas that drains from another’s land. The owner of the tract acquires title to the oil and gas that he produces. It is a rule of non-liability.
1. if land owner drills on his or her land- bottoming the well in accordance w/laws then land owner owns all production no matter where they bottom out.
2. Others who are drained are deemed covered by self-help
1.
Property rt of
ownership - do what you want w/ land as long it is lawfu
1. The gov’t can claim the property by power of imminent domain
2. If it is mine I can use unless the gov’t takes it and pays me for it
4. If the land owner has a well, drills and produces in accordance w/laws then he owns all the production.
5. Rule of capture modifies the ownership in place theory-the owner of the well does not own the oil underneath, he merely has the exclusive right to capture it
1. Ownership of Extracted Oil and Gas
1. Champlin Exploration - gas in its natural state is subject to the rule of capture but once it is captured it remains the property of the one who captured it until it is abandoned, once captured - oil is personalty.
1. Can lose title via abandonment
2. In order to abandon property it takes:
1. An intent to abandon (forgetting is insufficient)
2. Corroborated by some physical act that confirms intent
3. Rule of Capture does not apply to oil and gas after it has been severed
4. Oil spills are now covered by act of 1990.
2.
1. Since it is personal-you have security, falls under the UCC
2. When gas is reinjected it remains personal property.
1.
If it is reinjected back into the ground and escapes -
then it is subject again to the rule of capture -
2.
TX-rule of capture does not apply to reinjected gas at
all - but in KY it does until they overturn
3.
Once gas is severed it is personal and not real
property. It is not subject to the rule of capture -
3. Humble Oil v. West: when a land owner re-injects gas into a reservoir before all the native gas is extracted ( not liable for royalty interest on the injected gas but are for the native gas) - BOP is on the injector to show how much native gas remained
3. TX RR commission administers law for oil and gas, Barrell of Oil = 42 gal.
2. Conduct Permitted in Extraction Process
1. People’s Gas v. Tyner: Rule of capture includes the right of artificial increase in the flow, however can be liable in tort. Here, they were shooting the well
1. Tort theory- private nuisance interferes w/right to enjoy property
1. Merely making a well flow more than it normally would is not a coa b/c of the theory of self-help
2. Rules
1. Majority-permitting a lessee to sweep oil from under property of a neighbor by evasive techniques is beyond the rule of capture
2. Minority-conducting secondary recovery methods can be liable to adjoining mineral owners that are drained of oil and gas on a theory of nuisance or trespass
3. TX-rejects liability for nuisance or trespass where drained party refused a fair proposal to participate in enhanced recovery program if state conservation agency has approved program
3. Distinguish -
1. nuisance-interfering w/right to exclusive enjoyment of land v.
2. trespass-interfering w/land owner’s exclusive possession right
4. Trespass resulting in Production
1. All wells in TX are to be straight wells unless prior approval
2. Did the trespasser act in good faith or bad
1. Good faith - when they unknowingly came upon the land- liable for the value of the oil produced, but may charge costs against owner
2. Bad faith-knowingly committed the trespass and liable for total production of the well not allowed to offset cost
2. Viking: Rule of Capture - does not give you a right to commit trespass. Here, there was well w/low permeability and want to increase permeability.
1. Trespass resulting in no production will be held liable for damages to the perceived value of the mineral estate (TX)
1.
Damages are equal to the amount of the lost
bonus payment the mineral interest owner could have collected from a potential
lessee prior to the dry hole
2. Sand Fracing -pump in sand w/fluid sand gets in the cracks to keep cracks open and increase flow
1. Improperly sand frac the well and lost large quantities of oil
3. P brought negligence action b/c received less oil: P won
1. No right to sand frac on neighbor’s property - trespass
3. Wronski v. Sun Oil: Rule of capture-limited to allowable amount so everyone can have a to have fair chance/share to recover a fair share of oil
1. Sun Oil got more barrels than “allow” right and drained the neighbor.
1. By exceeding allowable Sun Oil interfered w/neighbors right to his fair share - and this is more important
2. Rule of Capture does not protect those that overproduce
1. Sun Oil was effectively producing neighbor’s oil = conversion
2. Max. Efficient Ratio (MER) - Comm’n can limit spacing + daily production of individual wells
3. OK - first to make conservation decisions w/allowable amounts
1. Champlin-USSC upheld conservation regulations-2 purposes:
1) Prevent/combat waste (upheld in Champlin) and
2) Protect correlative rights -Constit. DP rt.(def. - Rts./duties of all landowners in the common source/supply, balancing rts. Of all interested parties
2. Rule of Capture (review): personalty after severence, rt to drain other land
1. Doesnt Apply
1. When Trespassing, unless violating conservation rules
2. When injuring reservoir
2. Not Applicable to:
1. Oil after Production
2. O/G after Reinjection
3.
Limited by:
1. Conservation Power
1) To prevent waste
2) To protect correlative rts
2. Fair Chance/share Rule
3. Other Notes:
1) Can artificially increase flow, but may be tort action
3. Doctrine of Correlative Rights -parties having a property interest in the oil have a legal right to develop, however each owner has a duty not to engage in any activity injuring the common reservoir. Such as:
1. Drilling too many wells
2. Drilling wells in imprudent locations and
3. Producing at too high a rate
3. Conservation: Modifying and Limiting the Rule of Capture
1. Regulating Drilling, Well Completion and Plugging
1. Larson v. Oil & Gas Conserv. Comm.: Violation of correlative b/c did not make the right findings- WY did not have § to prevent waste
2. State wide spacing patterns-normally 40 acres (§19 of TAC)
1. Field rules - Supersede state wide rules
2.
When staff receives application, there is
hearing w/public notice (30 days) so that anyone that wants to can be heard
1. Commission conducts the hearing with a hearing examiner
2. Hearing examiner hears evidence and makes finding and determines approval
3. These findings are a recommendation to commissioner
4. Commissioners will most likely put these into law.
3. The losing party can appeal to Travis County District Court for everything except appeal of forced pooling
1. Dist. Ct will review the record made in administrative arena - usually substantially affirming what the hearing court stated
2. Reviewing Admin findings and orders. 2 grounds of contention
1. The order violates a statute or the constitution and
2. The order is not supported by substantial evidence in the record (far more common)
3. This process is a state thing - Congress does not get involved.
3. Well Spacing Exceptions
1. Exceptions justified for two reasons
1. To protect the correlative rights of owners against drainage or
2. To prevent waste of oil and gas
2.
Pattie:
Correlative Rts. Supercede conservation as long as no waste
1. The courts and conservation agencies have generally allowed a well to be drilled to offset drainage when A will be drained by B b/c the well spacing provision does not allow A to get the oil under her property
2. Implied power to protect correlative rights- reviewed De Novo.
3. Exxon Corporation v. RR Comm’n: to prevent waste of oil, get R. 37 exception when unusual res./other conditions, Must have:
1. Good Faith, not subterfuge to get around § requirements
2. Need to prevent waste or confiscation (econ., phys, or other0
1. Court allows production to prevent physical waste
2. Forms of physical waste
1. Open pit storage
2. Most frequent-if I can’t recover my way it will never get to the public.
3. Unusual Circumstances
1. TXSC- order permitting producer to recomplete producing well to a shallower formation, though drilling a new well in that location would not have been permitted - but b/c the legal location would not have been economically feasible
3. Production Control - production allowable rules
1. Daily, weekly or monthly limits on production of oil
2. Maximum efficient ratio (MER) proration - limits imposed to prevent overly fast production of a reservoir
3. Market Demand Proration - determining market demand in the next month-market can’t set price or over production will result
4. Proration Unit - acreage assigned to well to determine allowable
5. Allowable - Amt. Of O/g allowed to produce over a given period, may be determined by acreage, depth of well, net acre feet of reservoir below proration unit, open flow capacity + other factors
6. Historically, RR Comm’n gives disproportionately larger allowables to small tract owners, changed w/ Normanna & Halbouty
7. Many formations contain the type of production where there are some solutions in the oil and if you produce too fast that causes the gas to come out of the solution “bubble”, when that happens the oil is much thicker and cant go through the pours
4. Regulating Production and Marketing
1. Pickens v. RR Comm: Large owners must have a fair chance to recover, division of allowables was according to depth of prod. & Mkt. Need
1. The pressure of the oil will move the thin oil owners out and thick oil owners won’t get anything
2. In effect here if you take the field wide allowable (1 mill barrels a day) and allocate 50% based on surface acres then the thin owners will get just as much as the thick owners in allocation
1. Court upholds the 50/50 rule to even allowables
2.
1. Correlative rights yield to preventing waste - if they did not too much gas would rise into the air and not be captured
2. Almost always - except here - it is possible to reach a compromise b/t correlative rights and prevention of waste
1. Here the court said that we have to choose b/t the two to prevent waste (def. TNRCC § 85.046)
2. Well operators must cease production when exceed the ratios to prevent waste and maintain reservoir pressure
3. Reservoirs
1. Secondary recovery-if salt water pumping is feasible another 25% can be recovered
2. Tertiary recovery-using a detergent instead of salt water - the detergent not only pushes but washes the oil out
4. Oil and Gas Leases:
1. Lessee wants the Rt, not the obligation to drill and explore for oil b/c doesn’t know if going to want to drill or if there is anything to drill, may just want to prevent others from drilling. Also, wants Rt. to keep lease as long as prod.
1. I can let the lease go if i decide to - if I have an obligation then I can’t
2.
Habendum Clause - “lease shall continue in
force for a primary term of five years, and so long thereafter as oil or gas is
produced from the lease premises” -
establishes how the lease will begin & end
1. Possible to last forever - F/S determinable
1.
Lessor has a Possibility of Reverter
II The Oil and Gas Lease
1.
Granting
Clause: spells out the rights the mineral interest owner grants to lessee
1. Introduction
1. This gives the lessee the right to search for, develop and produce oil from the leased premises w/o imposing an obligation to do so
2. Hunt Oil: Mineral lease holder left mess on surface and surface owner wants it cleaned
1. Rule- surface is the subservient holder and the mineral owner is the dominant.
2. Rule - the lessee has an implied easement to use the surface of the land in such a way and at such locations as may be reasonably necessary to obtain minerals
3. Accommodation Doctrine: where there is an existing use by the surface owner which will otherwise be precluded or impaired, and where there are alternatives available to the lessee whereby the minerals can be recovered, rule of reasonable usage of the surface may require adoption of that alternative
1. Must be reasonable use
2. Servient owner’s burden to prove unreasonable use, under doctrine
1. Pre-existing use by surface owner
2. That is now impaired
3. There is a reasonable alternative avail. on that property
3. For purpose of obtaining minerals under land
4. In accordance with the terms of the lease, and
5. In accordance with applicable statutes, ordinances, rules and regs
4. Exceptions to this rule
1. If facts above exist on lease-mineral owner must use this alternative
2. No jurisdiction has an implied duty of clean-up, except AK
3. Many states now have statutes limiting the rights of the mineral owner - Not in TX
1. Mineral owner is limited by environmental tort: negligence , strict liability, abnormally dangerous, property damage, trespass, molecular trespass nuisance
2.
1.
Subsidence of the rock and surface - very rare from oil
- 1978
3. Habendum Clause - establishes term of lease, Producer’s 88 is common name for lease form.
1. Two Types
1. “Unless” - widely used, unless delay rental paid or production, K terminates
2. “Or” - either pay delay rental or produce - Must bring Ct. action to terminate lease
2. Delay rental clause - operates as an amendment to habendum. Allows lessee to defer drilling for one year if payment is made to lessor or lessor’s rep. (Bank)
1. Problems
1. Untimely Payment - Normal Rule - if payment is not timely, lease is lost, but lessee must give “fair warning” of changes in address, etc... also, if lessor (consciously) accepts late payment the lease continues. Note, most leases include a good faith attempt to pay clause that allows an erroneously addressed or $ amount payment to be corrected w/i 30 days after notice (by lessor) of the problem
2. Third Party as Recipient - usually bank, put clause in to deal w/bank as proper agent. Also, a clause that says if placed in mail by due date, payment is timely is common.
3. “Commencement of Production” - Breaux - Don’t have to be actually drilling a well unless specifically stated. Watch the lease language. If “commences operations”, then building a road satisfies. But, if lease says “production”, TX follows the minority rule - if discovered, have a reasonable time to drill. Factors for “commencement of operations”
1. Surface prep (substantial), i.e., building a road
2. Good Faith continuance and due diligence
3. Until well is spudded in
4. “In Paying Quantities” - Clifton v. Kuntz - means commercial quantities, if RPO would continue to produce for profit and not for speculation = paying quantities. Doesn’t have to be paying out every month.
1. Factors
1. Look at well’s history
2. Time of year
3. Expert witnesses
4. Future expectations (in that well)
5. Costs associated (don’t include capital costs, just operating)
2. “Operating Profits” - Pshagoda - disregard capital expenditures when looking at commercially profitable. Factors for Oper. v. Capital
1. Is it predictable
2. Is it recurring
3. Size of the cost - may be important
4. Nearness in time to drilling (closer = more like capital)
5. Is ii an upgrade to increase the length of well’s life or raise production
6. For habendum, profitability = operating revenues - operating costs
5. Lease, lessee has working interest (historically 7/8, but all costs of production)
1. Habendum -sets period of time for which rights given in the granting clause will extend- contains two parts
1. Primary term - a fixed term of years during which the lessee has the right, w/o any obligation, to operate on the premises
2. Secondary term - extended period of time for which rights are granted to the lessee once production is obtained
2. Delay Rental Payment Clause - obviates any implied covenant to drill test well
1. Lease will terminate sooner if the lessee fails to drill unless you pay
2. Good faith attempt to pay delay rentals holds the lease if as soon as notified you pay (30 days)- no attempt made then no excuse
3. Actual Production or Capability of Production
1. Stanolind Oil & Gas Co. v. Barnhill - Habendum clause
1. If lessee doesn’t produce in commercial quantities w/i 5 yrs then expires
2. Majority - actual production is required to extend into a second term. It implicitly requires marketing also b/c there is no point on production if it cant be marketed - Strict application (4 corners rule)
3. This habendum said it must be producing not just discovered-effectively shortening the lease term lease
1. Finished drilling and be producing on the last day of the lease
4. Suppose they drill in third year of five year primary term-but they don’t produce - they discover. Do they have to pay the delay rental?
1. No, but if last day and you are not producing you lose the lease.
5. Acceptance of delay payment then exception applied
6.
Can not be de minimus-would RPO continue
production for purposes of making a profit, not
speculation.
2.
Pack v.
1. Oil and gas lease will not terminate at the end of the lease as long as oil discovered - actual production not necessary, though discovery requires completion, capability of production and good faith effort to produce
2. MN, WY, KY and TN follow this rule as to gas but not as to oil
3. Temporary cessation due to mechanical errors - the lessee has a reasonable time to restore production- if K silent = QoF
4.
“Operations” as Substitute for “Production:” (Savings Clause) makes drilling operations the equivalent
of prod, provides constructive production when there is none
1.
1. Lessee cannot complete a well begun prior to the end of the lease as a dry hole and then spud another well
2.
Well
Completion Cl - (30/60 cl) Lease will terminate
when drilling operations commenced during primary term are completed, unless
some lease language extends it.
3. If clearly had production and it ceases how long do you have to restart?
1. Here, sixty days b/c it is within the lease - strict interpretation
2. O&G attorneys went to fix habendums to add operation and production
1. If lease says operations instead of production then no use for 30/60 day clause (may save the lease by giving 30/60 days for operations, etc...) not widely used now if “operation” is in habendum, but still have them
2. What qualifies as “operations”
1. Has to be doing something- just sitting there is not operating
2. Liberal construction in favor of lessee-if term not defined in K
3. If you do define the term - for any of the following . . .
1. Disadvantage-stuck w/definition
2. Definition in example lease calls for physical operation on the lease premises-no language regarding marketing operations-this is not enough
3. Would a market definition fly-yes, like the OK rule
3. Rule- If prod. habendum, must have 30/60; if operation, then not.
5. Force Majeure Clause: (superior force) enables lessee to preserve the lease when circumstances beyond his control prevent him from operating. Strictly construed
1. Perlman v. Pioneer- Whenever, as a result of any cause reasonably beyond lessee’s control and lessee is thereby prevented from compliance, lessee shall not be liable for damages
1. If prevented from complying w/obligation time ceases until 60 days (or whatever is demanded by the K) after the end of the force majuere
2. This does not protect against termination of lease for failure to produce, failure to pay, or any other duty/legal obligation (must be more)
1. Clause doesn’t expressly provide for extension of the lease w/o operations or production
2. Ex- inability to obtain steel to drill b/c of war. Can lessee get out when K for four wells and only enough for two? No, very strict interpretation (#124)
3. Ex- same thing but lost the lease b/c no force majeure lease
1. Must have one & it must also provide for an extension of time
4. Don’t need a broad one if you have a broad shut in clause
6. Shut-In Royalty Cl: lease will be maintained if well capable of production is shut-in
1.
Freeman
v. Magnolia: Magnolia paid at end of term-discovered during the
term. Waited four months after discovery
to make royalty payment
1. Rule - When shut in royalty clause does not specify the time that the payment is due, payment is due before the well is shut in
2. Shut-in Clause: a well is shut in b/c the lessee is unable to market they can only be made on wells that are capable of producing in paying quantities - can not be made on uneconomic wells or for speculating
1. A grace period of 90 days after shut-in cl. and annually after that = different result- as long as payment is w/i the ninety-days
3. – Shut in date is Important –
1. If producing it’s the day the valves are turned off
2. If not producing = date when testing of well suggested prod. in paying quantities (probably), due before end of primary period
3. Now, most Ks make this payment due w/i 90 days
4. Broad shut in clause-“for any reason and applies to any well”- can hold lease against force majeure and others by paying royalty
5. Shut-in payments belong to royalty owners, not like rent
2. Implied Covenants in the Oil and Gas Lease: All states say these are implied in Fact, So they may be K’d around (limit/negate). Remedy is das., unless not adequate remedy TX will give an alternative decree = ultimatum (fix w/i X days or terminated), also these interests may be divisible, TX App. Cts are split.
1. Introduction - Nature and Classification of Covenants: Three types
1. Develop the Premises - seek add’l production, not cvt. to explore
2. Protect the Leasehold - drill offsets to prevent drainage
3. Manage & Administer (& Mktg.) What a RPO would do under circumstances
4. Brewster -if the lessee breaches then he owes damages
1. This is a promise - breach does not cause the lease to expire (ordinarily)
2. Condition on the title -no obligation to pay but causes title to terminate
3. Are the covenants implied in fact or law?
1. Fact (TX) - as though they were written in the lease, suit on covenants is an action in K and sometimes has a different SOL
1. Most cts have held implied in fact and held in K
2. TX you can’t get punis for breach of implied covenant
2. Law - then action in tort and covered by tort SOL, (US S. Ct.)
1. If implied in law - then there would be serious doubt on whether you could expressly negate one of the covenants
2. Implied Covenant to Protect from Drainage: may obligate the lessee to protect even where no production-lessee may choose whether to drill but does not extend to permitting drainage (goes back to waste)
1. Amoco - Alexanders contend that Amoco had accelerated process by plugging wells on their lease and increasing production on Amoco up-dip leases. Alex contends that Amoco slowed prod. on down dip lease
1. TXSC- Amoco had obligation to protect against drainage
2. TXSC found three broad implied covenants:
1. Develop the premises (wildcat is a hit expect development of others) a second or subsequent well
2. Protect the lease - having to deal w/drainage
3. Manage the lease - RPO. This is the catch all. Duties of the operator are:
1. Drilling replacement wells
2. Reworking existing wells
3. Additional wells
4. Seeking field wide regulatory action
5. Rule 37 exceptions
6. Seeking voluntary unitization and
7. Seeking other available administrative relief
3. Always consider capital and operating expenses (RPO would)
4. Covenant to explore? Not in TX, Jackson
1. Other states added- purchased the right to an exploratory well- reason for delay clause
2. In TX, usually done w/a continuation clause, (says drill continuously, finish one + start another w/i X days or lease terminated)
5. What are das for failure to drill well?
1. Give lessor royalty she would have received
6. If remedy at law is inadequate ask the court for equity
3.
Implied Cvt to Develop (reas.) Or Drill is a QoF
depending on circumstances
1. Elements of Proof
1. Productive oil or gas extends under the leased mineral estate
2. Lessee has reasonable expectation of profit for additional wells
3. Lessee is not proceeding at a diligent rate of development
4.
Superior Oil
v.
1. Rule - Must give notice, then demand further development. If they fail w/i a reasonable time to drill you can terminate - if a RPO would have drilled
1. You must do this before you file the lawsuit
2. Can put a clause in the lease that failure to drill gives the option to terminate, but makes it mostly unmarketable
5. Most suits on breach of implied covenant are for failure to drill the well
1. TX always gives lessee an opportunity to correct
2. Remedy is damages if we can drill as opposed to cancellation
4. Implied covenant to explore-that the lessor has failed to explore undeveloped areas rather than failure to develop known deposits (this is rejected by TX)
1. Elements of Proof -Exploratory well should be drilled b/c probability of profit
2.
1. Ct held that there is no covenant to explore and this is the only way to get Sun to drill a well
2. They had info regarding land but no wells on the 9000 acres
1. TX/OK, no cvt to explore distinct from cvt to develop
5. Implied Covenant to Manage/Market: Gen’l Rule- lessee must market the leasehold production w/i a reasonable time after discovery and at reasonable price
1.
1. OK held a delay of eight years before marketing was reasonable b/c was impure and there were no pipelines
2. Even if there was a pipeline, purchaser may be reasonable to wait for better deal
3. Reasonable price actually means best price available
4. Remember in OK rule is if you discovered w/i primary term then will allow marketing in second term
1. In TX, if no shut in clause and only habendum then the lease would have terminated
6. Payment / Value
1. 1/8 of the market value, provided that if the gas is sold the royalty shall be 1/8 of the proceeds received
1. Some say at time of the K (lease) & some say at the field (wellhead) TX
2. Adding Value to the Production - If you process the gas anything at all that raises the value gets rid of the proceeds clause (5th cir.) - key - put in a cl stating “whether or not the gas has been processed or treated” = make it as broad as possible
3. Absent something in the lease changing it, this term means market value at the mouth of the well -
4. if there is no market value at the mouth of the well (oil) then you truck and it is recognized that the cost of transporting the oil - is charged against the lessor’s royalty as are any costs of marketing, treating, etc...
5. Gas may be different if long term K, note the difference b/t amount received v. Mkt price (look at K & circumstances)
6. Proceeds clause - royalty based on whatever you get when you sell gas - even though in a long term contract and price is higher or lower
1. When you sign, it’s not limited to sale in the field and if the sale is at the tailgate (plant) then proceeds clause may not apply
2. Class form-sold and in revision for a future form
1. Sold means sold w/o processing
2.
Should state whether before or after any
processing
2. Mkt. Value = value at mouth of the well
3. Pre-Production costs = payed by lessee
4. Post production costs = attributable to lessor in proportion to ownership, unless K language to the contrary, a minority CO, KS, OK say treating is part of making marketable & not chargeable to lessor
5. Products clause - used to keep costs from going against lessor/royalty owners, i.e., extraction costs of removing gas from oil. Rarely in lease (must add-in)
1. Common carrier has to serve all customers and publish rates according to volume and distance
2. The deeper the well the greater the likelihood to find very rich gas-distillate and condensate-these are specific liquids that are in solution w/gas - can siphon them out as liquids and sell (propane and butane)-what kind of royalty for these liquids?
3. If extraction occurs at or near the lease, cts find someone to give royalty owner money-but if nothing is in the lease about it (products clause stating she gets free of costs of extraction) she will have to pay her share of the extraction costs.
4. Gas buyer will pay price based on having to take the liquids out
5. TXSC refused to publish - case stated that get mkt price even if higher or lower
1.
Handle this by putting language into the
proceeds clause
6. Variations on this:
1. Gas Lines are now Common Carriers (normally a person in business has the right to pick customers) - common carriers have no right whatsoever to pick/choose customers - they must serve everybody who pays the published rates. The spot market determines the market price
7. Take or Pay Clause (makes lease bankable) What if the lessee is locked into a low price from long ago - market value is whatever the lessee can get for it (absent bad faith)
1.
2. OK as long as the lessee acted prudently and in good faith will adhere to the lessee contract price
3. T or P Cl.- lessor isn’t really a party, so if deal is struck b/t lessee and buyer - doesn’t give a Rt. to the lessor for part of the settlement. (2) reasons - (1) cl wasn’t intended for lesssor’s interest (for lessee), (2) royalties are for gas produced, T or P Cl settlements are for gas not produced
III Royalty
1. Costs of Production and Costs Subsequent to Production Distinction
1. Heritage Case: no deduction for transportation, Rule -Market value standing alone means NO deduction for transportation
2. Most rules in Ct- it’s more important to have the law settled than have it settled right
3. Take or Pay Clause: generally associated w/long term gas sales K obligating purchaser to pay for percentage of gas that the producer produces, whether or not actually taken
1. This is a quantity clause
2. Lessee sells gas getting certain price-provision tells the buyer how much cubic feet to take a day insuring a revenue stream and calculate revenue as a lessee
1. Inserted clause stating the buyer will take or pay for it if it does not take
2. It made this K bankable so the lessee could show a stream of revenue
3. Common law- unless a specific clause covering the situation “economic out clause,” the lessee says you are breaching and owe me 100K an hour so to keep the SOL from running against the lessee they must file suit - but if it goes to judgment then the gas co. will file chapter 11 and they won’t get anything.
3. Majority (tx) The royalty owner doesn’t share in take or pay
4. Minority -LA has theory where lessor/lessee enter joint enterprise agreement
2. Division Orders: a statement executed by all parties who claim an interest, stipulating how proceeds of production are to be distributed
1. Gavenda v. Strata: division orders are not Ks, & Cannot be used to cure title defects or amend leases
1. Language reserves to heirs a ½ non-participating royalty-ct says this off the top
2. attorney reserved 1/16 of the royalty - the division order did not work here
3. Bottom line: “of” was used & lessee isn’t protected when writing erroneous division order in its favor
2. Notes:
1. Division order is addressed to the buyer authorizing to run the oil or the gas and give the credit as follows - wildco 7/8 of 8/8, molly brown 1/8 of 8/8
2. Ex: molly sold some of her royalty (1/4) so now molly has 3/4 of 1/8 of 8/8 and royalty buyer 1/4 of 1/8 of 8/8
1. Assume ambiguity-then wildco will pay on original basis and division order can be cancelled
3. Royalty clause is a covenant, Not a condition on a title
1. If it were a condition - failure to pay properly would terminate the lease
2. If underpaid, remedy is to sue for amount should have been paid (K law)
4. Lessor remedies
1. UCC gives royalty owner a lien §9.319
2.
3. In common law - no right to attorney’s fees unless in K or in statutes so when suing under royalty could probably get attorney’s fees
4. Remedy - money, interest, attorney’s fees and a lien
IV Titles and Conveyances - Interest in Oil and Gas
1. Ownership & Abondonment
1. Bodcaw Lumber v. Goode: O/G mineral rt. is rt of possession it can’t be abandoned
1. Ownership in place - (TX, MS, NM) can continue to be the owner of the oil & gas (severe the surface from the minerals by reservation)- A freehold (L/E or better) or a Reservation can’t be abandoned. To obtain title, must be Adversely Possessed (for statutory time, only get what owner has)
1. Drilling/production of minerals invades mineral estate and begins AP.
2. No AP against a mineral interest that was severed before adversely possessed, until actual drilling (as against mineral holder)
3. Depends on time of AP & whether severed 1st, if not severed 1st AP runs against both (even if min. later severed)
2. Other states – (KS) modified ownership in place by reserving profit a prendre (like easement) right to explore, exploit minerals-a property right- but only difference is allows abandonment, so it is more like a lease
1. Difference is abandonment-a fee title it is not subject to abandonment
2. Oil and gas lease is not intended to last forever w/o production
3. Deed in minerals last forever-minerals can be severed from the surface
4. LA- no min. estate can exist apart from surface for > 10 yrs w/o prodt’n
2. Mineral = “in & under the land” / Royalty = “all that may be produced” Distinguished
1.
Altman v.
Blake (
1. Right to enter & drill
2. Right to execute lease- transfers rt to enter and drill to lessee
3. Right to receive bonus payments
4. Right to receive delay rentals
5. Right to receive royalty payments
2. Execution of a lease leaves mineral estate owner with:
1. Right to a royalty and delay rental
2. Right to use the surface
3. Receipt of a bonus
4. Possibility of reverter
3. Each stick is a property right and owner can divide them up
1. If no lease on the land she has ability to execute a lease or drill
2. If lease came first then it’s superior to royalty buyer, vice versa
4. Mineral Interest holder possesses the right to develop or lease and keep proceeds of a lease.
5. Royalty Interest lacks those rights, but has a right to a share of production free of costs
e. McSweyn: which is preferable depends on the circumstances
1. Even if it land never produces, the mineral interest has a substantial value b/c owner has right to lease and receive bonus and delay rentals
2. If there is production, a royalty interest is preferable b/c it is cost free
3. Elements of Conveyance- may describe more than grantor has-but just passes what he has:
1. Deed - Name and Identity of the grantor
2. Words of grant - Grant, sell and convey to ABC (or undersigned) (triggers implied warranties)
3. Grantee - to ABC, the name of the grantor can be the name of the signor
4. Description of the land - must be specific location
5. Signature - of parties
6. Delivery of Deed - delivery is presumed if recorded
7. Acknowledged - often used
4.
French
v. Chevron: bundle of sticks theory is literally interpreted. Deed conveying
royalty interest by granting fractional
mineral estate followed by reservations, conveyed a fraction of royalty,
not a fixed fraction of total production - negates the right to participate in
the leasing and bonus,
5.
2. Shared Ownership - Cotenancy
1. Law v. Heck Oil Co. - Minority Rule - Cotenant is entitled to have it remain in condition he sees fit, subject to cotenant rights. Cotenant can compel partition or sale.
1. If drainage, one small owner can stop a cotenant from entering and drilling
2. (WV, LA, IL, MI)-non-participating co-tenants have right to enjoin the interest when drills w/o permission - (with the exception of drainage)
1. If time isn’t ripe for injunction then won’t settle and will compensate
2. Prairie Oil and Gas v. Allen - Majority Rule (OK, TX)- Lessee becomes t-i-c and can use the land, they have right to operate w/o consent of other and over objections
1. Must compensate w/net profits - revenue rec’d less amount spent in obtaining.
1. Non-participating co-tenant will not receive any revenues until all costs are recouped - Capital & Operating Costs
2. Entering co-tenant takes the entire dry-hole risk.
1. Exception: when dry hole gives info for a second producing well
3. The non-participating co-tenant has no right to object to the development however the developing co-tenant must be careful not to deny the non-participating cotenant the right to independently develop - to do so would be an ouster and subject the co-tenant to trespasser liability
4. Co-tenant can ratify the lease and start obtaining royalties - directly or by just accepting a royalty payment
3. Earp v. Mid-Continent: Drill or Pay Cl. illustrates the principles of co-tenancy. Non-consenting gets nothing until payout. Here, may have entered into an operating agreement and probably made some $
4. Neely - Active co-tenant has rt. to protect prop. & get reimbursed, but not improve unless being drained.
5. Moseley: Partitioning, usually “in-kind”, not here had to sell. Try to get agreement even if have to checkerboard
6. Percentage Depletion - Tax scheme that ended in ‘60's, used to encourage drilling. Let royalty owners & lessees alleviate 27.5 % of GP from taxes, taken against cost basis
3. Life Estates, Successive Ownership & Non-Possessory Interests
1. Wellborn: Slander of Title suit. Life Tenant may NOT drill w/o agreement of remaindermen. UNLESS, there is drainage occurring (immediacy is important)
2. Methods of Distribution b/t Life Tenant & Remainderman
1. Open-mine doctrine: where there is an open mine on the property when the life tenancy is created the life tenant is entitled to all rents, bonuses & royalties
1. “Open” means when an oil and gas lease exist at the creation of the life tenant; the grant of the lease opens the mine
2. TX limits the doctrine to the term of the lease in existence when the life tenancy is created - the life tenant may not extend existing leases
3. If the oil and gas lease expire and wells are drilled as a result of a subsequent lease, life tenant does not get the open mine
4. If production on lease executed by dad - then the life tenant is entitled to the corpus for life and the remainder people have to wait until they die
5. Same thing is accomplished by the homestead exemption and the Uniform Principal Income Act.
2.
3. Common Law - Lease w/ life tenant and remainder person and who gets what
1. Delay rentals belong to the life tenant -
2. Right to make investment decisions
1. Unclear: one case says pay life tenant-let them fight it out!
2. Risky to pay the life tenant unless the remainder-person agrees
3. Only own % of title, Bank owns & you find an agricultural tenant in possession of the land (most of these are oral), law makes o/g lease superior to these at renewal
1. Usually use subordination release, lessee pays the tenant a modest sum of money to subordinate his lease to the o/g lease
2. If tenant has a five year lease - you have to get a subordination
1. Don’t do this and bank will enjoin drilling
4. Doctrine of Marshaling of Assets - If subordination from bank did not happen and Wildco is about to drill and hears about a foreclosure-if you get to court fast enough, before foreclosure, can have doctrine of marshaling assets applied
1.
Iin foreclosure, The
lessee has the right to have land sold subject to the lease and then if land
does not make enough money to pay loan, sell lease separately to raise the
money
2. Be wise, get subordinations before drilling
4. Terminable Interest
1. Archer County v. Webb: Shut-in payments do NOT extend a royalty deed that requires production to be effective (past primary term, even though separate from o/g lease) the appropriate way is to say this deed shall last as long as any other lease, etc...
4. Executive Rights in Mineral Interest: power to lease minerals
1. Mims v. Beall: Exec Rt. holder owes duty of utmost good faith, requiring the executive to acquire for the non-participating every benefit that he exacts for himself - std is appropriate sharing
1. A, executive, holds acts for B, non-executive -A owes B full fiduciary duty
1. Duty of care -degree of care a person of ord. prudence would exercise in conduct of their own affairs - no speculating
2. Duty of loyalty -No self dealing
3. NO Duty to subordinate personal interest to the estate’s interest
2. Utmost good faith only requires appropriate sharing plus no self dealing and any time this is labeled as a fiduciary duty add-it doesn’t require subordination
2. Mangus - TXSC held that a duty of utmost good faith that requires the executive to acquire for the non-executive every benefit that the executive gets for himself, and imposing exemplary damages on the executive for failure to meet std
3. Day v. Texland- rt to execute leases is prop right, doesn’t trigger RAP or pwr of atty
4. Dallapi: exclusive right to lease divorced from ownership interest in mineral estate is subject to the RAP. NOT the rule in TX
5. Hypo - Bean Brothers: can he execute oil and gas lease- case has not been overruled
1. Navy Bean gave Home Bean power of atty to sell and convey land
1. Do you sell all of the land if you execute an oil and gas lease - No
2. Does the power to sell all give the power to sale part - No
2. Powers of Atty are strictly construed
1. If want power to convey oil and gas lease must be expressly set forth -
3. If you want the power to pass to attorney - you have to expressly state
1. TX Trust act gave trustees power to execute
2. Must find complying statute and strictly adhere to it
6. Relinquishment Act 1919- for lands patented b/t 1905-1931, state reserved the minerals on all tracts sold.
1. Act gives power of soil owner to be agent of state to lease oil and gas
2. Compensation for services is half of the bonus, delay rental and royalty
3. 1869-95, State ceded all minerals to surface owners, but only applied to private owners. So, any land state sold from 1895-1931 state held min. interest.
4. Owes the state a fiduciary duty, must act in the best interest of the state. Owner has duty of appropriate sharing, self dealing can subject the owner to punitive das also the duty to subordinate personal interest to state’s interest
5. Meaning of “Other or Hard” Minerals and Named Substances
1. Moser v. US Steel Corp.:
1. Two tests:
1.
After
1. “Mineral” is determined by the ordinary/natural meaning of the word, regardless of whether parties knew at time of K
2. Mineral owner has right to take minerals even if removal causes destruction to the surface, but requires compensation to the surface owner for destruction, UNLESS the substance was specifically defined as a mineral (belonging to min. estate) in the grant or reservation
3. List of NON-Minerals adopted from CL (S.D. test)
1. Building stone
2. Limestone
3. Caliche
4. Surface shale
5. Water
6. Sand
7. Gravel
8. Near-surface lignite/coal (near-surface = 2-300 ft.)
9. Near-surface iron ore
2.
Prior to
1. The resource is at/near the surface (for hard min = 2-300ft), AND
2. Any reasonable method to extract the resource exists at the time of grant/conveyance (or thereafter), that would destroy all/part of the surface estate
2. Schwartz v. State - Moser does not apply when state reserves o/g & other minerals
1. 1960's new relinquishment act, now state gets 60% instead of 50% - covering coal, lignite, sulpher, pot ash, uranium, thorium and other minerals produced
3.
OK v.
4. NCNB v. West: to quiet title to [coal bed methane gas]
1. If it’s in the coal those who have the right to the coal have the right to the gas
2. If it has migrated out of the coal then the owner of the land owns the gas
6.
Conveyances
of Fractional Interest IN LAND, NOT
GEN’LY APPLICABLE TO LEASES
1. Averyt v. Grande: literal interpretation rule in granting cl. In DEED
1. Distinction made b/t land described and land conveyed
2. Deed that reserves a fraction of minerals Conveyed - it reserves a fraction of the mineral interest owned by the grantor at the time of conveyance
3. Deed that reserves a fraction of minerals Described - reserves that fraction of the minerals under the entire estate
2. Duhig - Overconveyance: occurs when a grantor deeds away and reserves in himself a larger fraction of the mineral interest than the grantor actually owns
1. Rule - where full effect can not be given both to the granted interest and to the reserved interest, the courts will give priority to the granted interest until the granted interest is fully satisfied - Look at what is conveyed, not what’s owned
2. NOTE: in the Duhig deed there was no mention of any other deed - if there was the result might change- for Duhig to apply there must be no reference to another deed (doesn’t apply to leases)
3. Construing Ambiguous Deeds - Conveyancing
1. Bundle of sticks theory - Look at granting cl to see what is conveyed, then look at what is negated (If negation cl describes mineral that would be in the conveyance)
2. Granting Clause: not only defines the property to be leased but also sets forth the rights given to the lessee in order to develop the mineral estate
3. Land described above - a reference to the metes and bounds in fee simple
4. Prefacing undivided interests are disregarded in construing a reservation
5. Duhig principle - (applies where no reference to other deeds-look at what is conveyed not what is reserved) A conveys to B reserving ½ of minerals and B conveys to C reserving ½ minerals - look at deed from B to C, what’s conveyed
6.
1. Protects the grantor against claims for breach of warranty b/c of outstanding lease, avoids the Duhig problem, and
2. Clarifies that grantee receives an interest in unaccrued rents and royalties under the lease
3. Court construes the “subject to” cl to prevail for revenues under existing lease and future leases
4. Proportionate Reduction Cl/Savings/Cut down Cl: if lessor owns less than entire F/S, royalties and rentals to be paid may be reduced proportionately
1. Authorizes lessee to proportionately reduce future lease benefits to the extent that title has failed.
2. Texas Co. v. Parks- failure to literally apply cut down cl caused lease terminat’n
1. Only triggered when lessor doesn’t have full f/s in land conveyed