OIL & GAS

Prof. Strausser

(Spring 2004)
- I got an ‘A’ in this class!!

ORIGIN of

I. Organic Theory

a. Process = anaerobic bacteria à organic matter à hydrogen & carbon (Kerogen – ooze) à increased pressure, increased temperature à natural gas + crude oil

- Crude Oil à Forms at 150°

- Natural Gas à Forms at 300°

b. Porosity – void spaces in sand grains where kerogen breaks down into gas &

oil.

c. 3 types of Rock:

1. Igneous – volcanic; granite

2. Metamorphic – slate, marble

3. Sedimentary – sandstone, limestone (Needed for oil/gas accumulation)

d. Hydrocarbons – molecules of hydrogen & carbon (may be gas or fluid)

e. Density: lighter hydrocarbons migrate higher.

Gas will be found above oil, oil found above water.

Gas

Oil

Water

f. Accumulation

1. Bend

2. Fault

g. Summary: Requirements for formation:

1. Source of hydrocarbons – dead critters

2. decomposition

3. porous rock – for hydrocarbons to accumulate

4. temperature & pressure

NOTE: if have these, likelihood that reservoir may contain oil/gas

II. Exploration & Production of Hydrocarbons

a. Exploring subsurface

1. Seismic technology (sound waves to investigate)

a. Use geophones (records soundwaves)

b. Soundwaves travel at different velocities through materials of

different density à travel slower through more dense material;

faster thru less dense material (slower thru water than oil)

c. Geophones used to determine density and shape

2. Location = place where you decide to drill

b. Drilling a Well

1. Fluids move from high to low pressure – so by piercing reservoir, the

oil will rise.

2. Process: drilling rig taken to location à connect drilling bit to series of

connecting pipe à chews thru the strata à circulating “drilling mud” to

keep the drill bit cool & it creates “hydrostatic pressure” to prevent oil

from just shooting upward “blow out”. à run piping called “casing”

down hole to release the oil (pipe is perforated by using a gun which

opens up the pipe allowing oil to escape).

3. Determining what’s down there:

a. take core sample

b. Run an electric log – measures conductivity of rock (resistivity

of rock) – less dense has greater resistivity???

4. Measurement of Oil & Gas

a. Oil à measured in barrels

(i) 1 Barrel = 43 U.S. gallons

b. Natural Gas à measured in MCF

(i) MCF = 1,000 cubic feet

NOTE: We are really after the energy that oil creates = BTUs

Problem: Drill well…how much will well produce? = “Drainage area”

1. Oil wells drain about 20 acres

2. A gas well will drain about 80 acres

3. Want to know the “Drainage radius” à A = Πr2

So, if have area of 80 acres (43,560 sq. ft.) = Πr2…then r = 1050

III. The Petroleum Family

1. Hydrocarbons – Oil/Gas are made of hydrocarbons

a. Have energy + heat value (will burn)

b. Manufacturing value – can combine to make other materials (i.e. nylon)

2. Components of Oil/Gas

a. Natural Gas = Mostly Methane (CH4)

b. Crude Oil = Paraffins + Aromatics (i.e., benzene) + Naphenes

c. Other ingredients = Carbon dioxide, Nitrogen (don’t burn), Hydrogen,

Sulfide (can create sulfuric acid) à want to remove this stuff.

d. NOTE: Oil/Gas sales fall under Art. 2 à have to be merchantable à

so have to remove all the crappy ingredients.

IV. Migration Problem

1. Ownership in Place Doctrine – Landowner owns all substance, including oil

& gas, which underlie his land. Such ownership is qualified, however, in the

case of oil and gas, by the operation of the law of capture. If the oil and gas

depart from beneath the owned land, ownership in such substances is lost.

(i) The property owner owns everything w/in the boundary lines

vertically downward

(ii) Another person cannot extract minerals on the land w/o

trespassing.

a. Unless landowner conveys mineral estate away, the ownership in title

has absolute ownership in severalty…oil/gas and coal are considered a

part of the realty (real property)… “He owns all the minerals under his

land”.

b. Fugacious – Oil/gas are fugacious…they migrate…therefore, if

adjacent landowner drills well on his own property and oil/gas migrates,

OIP doctrine does not apply.

(i) Migration is only a problem if have a common reservoir.

(ii) Drainage = when extracting, some of the oil/gas comes from

beneath another’s land.

c. OIP doctrine would apply if somebody came onto landowners property

directly and drilled a well.

d. Del Monte v. Last Chance Mining Co. (1898) – Δ followed a vein of

silver and lead-bearing ore it was mining…beyond the western

boundary of its mining claim and under Π’s mining claim.

(i) RULE: OIP = the owner of the fee of the soil owns all below

the surface, limited by the extent of the surface rights.

(ii) NOTE: this applies b/c Δ crossed the boundary line of Π’s

property.

e. Don’t use OIP w/ Oil/Gas – Policy = We want to encourage the

development of these minerals.

2. Rule of Capture (TX uses)

a. ROC = The landowner who extracts oil/gas from beneath his land

acquires absolute ownership of those extracted substances even though

they may be drained from beneath the land of another;

(i) Owner may appropriate these minerals w/o being liable to

adjacent landowners.

(ii) After the oil has migrated to adjacent land, title of former

owner is now GONE.

(iii) Remedy: Self-help, drill own well (Offset well) to prevent being drained.

b. NOTE: HOWEVER, if the well bore is drilled at a slant and is

bottomed under the neighbor’s land, the oil or gas produced from the

well belongs to the owner of the land under which the well is bottomed.

c. Limits on Rule of Capture:

(i) Correlative Rights Doctrine – “Each owner of land that are in

a common source of supply (common reservoir) has privileges

as against the other owners that he has the right to take as much

of the common source as long as he does not injure the common

source of supply.” (limits how many wells can be drilled in a

common reservoir).

(a) Injury = by poking too many holes in the reservoir or

poking in wrong place of reservoir bringing in water.

(ii) Correlative rights doctrine: limits 2 areas of ROC…(1)

Conduct; and (2) Ownership

(1) Conduct – ROC does not protect you if you:

a. Trespass – by drilling well directly on another’s

land; or by drilling a directional well that bottoms

out under another property.

(i) note: directional wells are not illegal, but

can be.

(ii) Must obtain a drilling permit – have to

show where you are going to drill and

where the drill went.

b. Violate a Statute or Ordinance – if your methods

used to drain are prohibited by statute or

ordinance – no protection by ROC.

(i) People gas v. Tyner – used nitroglycerin

to increase the fractures…nitroglycerin

was against city ordinance.

(ii) EXAM QUESTION: Whether

using hydrofracing to enlarge the well

is trespassing if you know it will enlarge

the wings beyond the property line and

underneath adjacent landowner’s.

c. Negligent Conduct

(i) Eliff v. Texon Drilling Co. – Texon was

negligent in drilling on a common

reservoir…Texon’s well blew out…and

caused other wells including Eliff’s to

crater and blow out…they did not use

drilling mud.

(ii) Rule: Duty to exercise ordinary care to

avoid injury or damage to property of

others.

(iii) Policy – prevent waste.

(iii) State Regulations (RR commission)

a. Policy DCR = prevent physical & economic waste.

b. Well Spacing and Density Rules

(i) RULE 37 = Every well has to be at least 467 feet

from the nearest property line/leas line +

1200 feet from other wells.

(ii) RULE 5 = Need permit to drill

a. must show registered surveyor

b. must show proposed location

c. distance from propty line

d. distance from other wells.

(iii) RULE 38 (Density) – Must have 40 acres to

drill.

c. Limits on how much you can take from reservoir

(i) MER – maximum efficient rate…rate allocated

to the well, how much you are allowed to pull

out of the ground.

d. Wronski v. Sun Oil – Example of how violation of

statute will void ROC protection. Statute limited # of

wells that may be drilled to 1 well per 20 acre tract and

production limited to 75 barrels a day. Sun Oil

overproduced…held liable for conversion

(i) Rule – (willful trespasser) = liable for enhanced

value of oil at time of conversion w/o deduction

for expenses or for improvements by labor

(ii) (Innocent trespasser) = liable only for value of

oil undisturbed, entitled to set off the reasonable

cost of production.

(iv). Ownership of Extracted Oil/Gas (Limit on ROC)

1. Real Property – when in ground

2. Personal Property – once in control out of ground

Ownership = comes to surface + control

RULE: ROC does not apply once you convert to personal

property.

(i) Champlin Exploration v. Western Bridge (1979) – Champlin (refiner) took steps to recover leaking refined hydrocarbons by digging trenches on premises to recover and trap hydrocarbons. (Operator) brought suit seeking declaration as to who owned the substances…

arguing that hydrocarbons that escape, even though previously refined are subject once again to law of capture.

(ii) RULE: Once oil/gas is extracted from earth, it becomes

tangible, personal property. RULE: If oil should escape from a well, tank, or pipeline, the owner may lose possession BUT retains title UNLESS the oil/gas is abandoned.

(iii) Natural Gas Storage

1. Texas American Energy v. Citizens – Gas was

being taken from TX reservoir and transported

to Kentucky and injected into a depleted

depleted reservoir. Held: it was personal

property b/c removed and refined…personal

property falls under Art. 9 of UCC.

(i) RULE: If you extract the mineral,

maintain control, and then reinject into

ground…it remains personal property.

(ii) Integrity of reservoir must be maintained

(iii) Salt domes are ideal for this.

(iv) See handout on Natural Gas

(v) if integrity is not maintained and it

migrates, it becomes real property again.

(vi) Injecting into reservoirs is done to

handle peak demands in winter +

allows to continue production w/o

having to plug the well.

2. Hypo: there are 2 wells owned by 2 different

entities. Gas escapes from A’s well on way up to

surface…gas migrates to B’s well bore, and B

extracts it. ROC applies b/c gas was not under

A’s control.

3. If you have a Blowout = ROC applies b/c don’t

have control.

4. Cushion Gas problem: There is always some

residual gas left in a reservoir (native gas). By

injecting gas into reservoir, you get a mixture of

“foreign + native” gas.

(i) RULE: You have to account for the

cushion gas and pay the mineral rights

owner his % share of cushion gas

extracted.

(ii) On Exam: Must state that there is still

some cushion gas which is still “real

property.”

5. SUMMARY: Know TX Amer Case!!!

(i) How gas is secured

(ii) How it’s personal property covered by

Art. 9 of UCC

(iii) Discuss how there is still cushion gas, which is real property, which has to be

accounted for and paid to mineral rights

owner.

V. How you can Own Minerals

1. Possessory Interests

A. Mineral Interest

(i) Mineral estate = (1) Oil/gas and other minerals that are located

in the subsurface…AND (2) the right to search for, develop and

produce them.

(ii) Severance from Surface Estate

a. Can sever mineral estate from surface estate

b. Can sever and carve out your mineral estate from a

previous mineral estate à

1. horizontal severance – b/t 2 subsurface strata. 2. vertical severance – dividing straight down into halves.

c. You can convey mineral interests

d. You can retain and convey your interests in different

minerals. (i.e., can convey oil but retain uranium).

(iii) 4 incidents of a Mineral Estate (defines a mineral estate).

1. Right to use surface to develop the mineral estate –

a. TX, mineral estate = Dominant estate

b. Policy = want to develop the minerals

c. Right to use surface is inherent (implied).

d. Mineral owner gets implied easement

e. Restriction = Can only use easement to develop

the minerals + Only use amt of land necessary to

develop the minerals.

f. Don’t have to ask surface owner permission.

2. Right to develop (incur costs & retain profits) w/ regard

to minerals.

a. Have right to develop, drill wells

3. Right to alienate (Executive Right)

a. Right to transfer these rights

b. Have right to transfer: right to develop, incur

costs, and profits (Oil lease).

4. Right to Retain Lease Benefits

a. Get someone else to develop

b. Lease to exploration & production companies

c. These companies incur costs of development

d. They get to keep profits but pay royalty interest

e. Mineral interest owner loses right to develop and

right to come onto Surface owners property.

f. RULE: Only one person can have right to

develop!!!

g. Gets royalty interest (% of revenues, incurs 0%

of cost of development)

h. Lessee – gets 100% working interest + net

revenue interest.

i. Bonus: Company pays mineral owner, just to gain

a working interest…lessor gets to keep no matter

what happens.

2. Non-Possessory Interests

A. Leasehold Royalty Interest

a. Lessor get this in return for relinquishing his right to develop.

b. Loses his right to lease, right to use surface

c. Doesn’t have to pay cost of production (0%) working interest

d. Can convey a portion of his royalty interest to another.

e. RULE: you cannot have a royalty interest and a mineral interest.

Once you take Royalty interest, you forfeit your mineral interest.

Working interest

a. Lessee gets 100% working interest

b. Incurs 100% of cost of development

Net Revenue Interest

a. Lessee gets this…it’s 100% - % royalty interest.

b. Ex: Royalty interest is ¼ or 25%...Net revenue interest is 75%.

Drilling Delay Rentals

a. Lessor gets this…if lessee does not drill by the 1^st anniversary of

lease.

b. Primary term – usually 3 years

c. Must drill by end of 1^st year…if not, must pay DDR.

d. Can pay DDR to keep lease active but, if do not drill by end of

primary term, it reverts back to lessor.

e. If PIPQ is established before end of primary term, then

secondary term kicks in…and lease stays active for as long as

PIPQ continues.

B. Non-participating Royalty Interest

a. Royalty interest paid to a person that takes no part in the lease.

b. He simply bought the lease or was given it.

c. The non-participating royalty interest is taken out of the original

Royalty interest…it does not affect the working interest or net

revenue interest. It comes out of Lessor’s Royalty interest.

d. HYPO: Paulson has ¼ RI…he decides to give ½ to charity…this

½ comes out of his ¼…So, each get 1/8 Royalty interest. The

charity is now a non-participating RI owner.

e. NOTE: Lessee can convey away part of its working interest to

another company…these 3^rd party companies are called à

Non-operating working interest owners.

f. Operator – person in charge of drilling.

(i) can only have one operator!!!

C. Overriding Royalty Interest (LOOK UP!!!)

a.

D. Production Payment

a. Where Lessee gets another party (Bank) to finance production

costs

b. If Lessee short on cash…go to bank…take the prospect to the

energy lending VP…who looks at it to determine whether they

would like to invest in the prospect.

c. NOTE: Banks can charge 30% interest rate b/c its not subject to

the usury laws b/c dealing w/ sophisticated customers.

d. Once production is established, RI owner always gets his share

and rest goes to bank until the loan is paid off…then lessee gets

to keep the rest.

e. EX: Paulsen has 25% RI…BP has 75% Net Revenue Interest +

100% working interest. BP goes to Bank and seeks deal. They

offer BP $1 Million + 30% interest rate…so will owe $1.3

Million. Well comes in at $100K per month. Divided = first

$25K goes to RI owner (Paulsen)…$75K goes to Bank as a

(production payment). Once Bank paid back, BP gets $75K.

f. Advantages: (1) Don’t have to pay development costs; (2) if drill

a “dry hole” – Lessee is not liable for the money…Bank takes

loss.

VI. Conveying Title to Minerals

1. Conveyances

a. Conveyances of mineral interests are REAL PROPERTY.

A. Requirements for Validity

Deeds

1. Must be in Writing

2. Must be Delivered by G’or to G’ee

3. Must contain granting words – identify G’or and G’ee

4. Must describe the estate

5. Must be properly executed

NOTE: Good idea to notarize it, so you can record it, which will

place others on notice.

B. Deeds (in general)

Clauses (Handout)

1. Granting Clause - States the following:

a. Who G’or/G’ee is

b. Describes interest conveyed (Should be detailed)

2. Habendum clause – States following:

a. “To have and to hold”

b. Describes type of interest G’ee is receiving

c. Describes term (length of time)

d. Who it’s going to and what is going

e. Always follows granting clause

3. Warranty Clause

a. How strong the G’or warrants that he has what

he says he has.

b. General Warranty deed (best kind) – affords you

max amt of protection à G’or guarantees that he

owns and will Defend against all others on behalf

of G’ee à Get benefit of iron-clad assurance +

“After Acquired Title Doctrine” = if G’or attempt

to convey to you something he did not have title

to…if later he gains title, it goes to you. à

You also get damages.

4. Subject- To Clause (LOOK UP!!!)

C. Types of DEEDS (Handout)

1. General Warranty (Best Kind) – Oil/Gas does not have this

kind of deed!!!

2. Special Warranty – (Oil/gas has this kind) Warrants that to the

best of My knowledge, b/c of the chain of title, this is my

property.

a. If give special warranty deed to someone to develop

minerals…but interest actually belonged to another…

the well that is drilled will be considered a “trespass

well”.

3. No Warranty – Doesn’t say anything, no warranty clause in the

deed…BUT, statutorily you still get the “After acquired

doctrine” benefit. (Hardly ever seen in Oil/gas)

4. Quitclaim – “I give you what I have, but I’m not sure what I

have.” These are in oil/gas business for small pieces of

property. NOTE: Don’t have benefit of After-Acquired

Doctrine.

D. Mineral Interest v. Royalty Interest

1. Simply state “This is a mineral interest” OR “This is a Royalty

Interest”.

a. NOTE: You have a bundle of rights w/ a mineral interest

BUT, only have limited rights w/ a Royalty interest.

E. Who Signs a Deed?

1. G’or Only

F. Who Signs a lease?

1. Lessor/Lesee

a. On a Gas lease – only lessee signs lease!!

KNOW DEEDS, TYPES, LANGUAGE…Difference b/t Quitclaim v.

General Warranty for example.

VII. Mineral Estate/ Surface Estate Conflict

1. Legal Effect of Horizontal Severance

a. Severance of surface estate from subsurface (mineral estate).

A. Adverse Possession

RULE: Can adversely possess mineral estate by adversely

possessing surface estate…ONLY if there is no severance of

surface estate from mineral estate.

2. Use of Surface by Mineral Owner

A. Dominant/Servient Estate Doctrine

TX – Mineral estate is Dominant…Surface is servient

a. Dominant has implied easement

B. Rights of Mineral Estate Owner

1. Has implied easement to use as much of surface as needed to

develop the minerals.

2. Can conduct seismic tests

3. Build oil storage tanks

4. Can build roads

5. Can use your water

6. Can put up drilling rigs, clear your land, and make it flat

7. Can do all this w/o your permission

8. Mineral Owner has NO obligation to fence in the drilling

operation.

9. No duty to restore the location (common law)

C. Restrictions on Mineral Owner’s Surface Use

1. The Accommodation Doctrine

a. Hunt Oil v. Kerbough – “reasonable use” à having due

regard for the surface owner.

b. Getty v. Jones (KNOW!!!) – landmark case…changed

the way TX thought about surface use. Set forth the

Accommodation doctrine:

(1) Where there is only one manner of use (have

no other choice)…LESSEE has right to pursue

this action regardless of surface damage.

(2) Where there is (i) an existing use by the surface

owner which would be otherwise precluded or

impaired; (ii) the surface owner has burden of

showing the reasonableness of surface use.

(means that if there is an alternative for lessee to

use that is commonly used in the industry, then

mineral interest owner has to use it.)

SUMMARY:

1. existing use

2. alternative commonly used in

industry.

3. Surface owner has burden.

NOTE: it is only where there an alternative is

available that Accommodation Doctrine is allowed.

c. Sun Oil v. Whitaker – KNOW!!! (Added another

requirement to Accommodation doctrine).

1. Sun was mineral owner…and used water from

Whitaker’s well to inject into his oil well.

Whitaker argued that he had preexisting use that

would be harmed if Sun used the well.

2. HELD: Mineral owner has dominant estate.

3. RULE: The 2 elements of Accommodation

doctrine have to be met + the reasonable

alternative must be available on the leasehold

premises

4. Can’t require mineral owner to get alternative

from source that is off the leasehold premises.

d. Accommodation Doctrine Today:

1. Surface interest owner can take advantage of

Statewide Rule 76: (Balances rights of mineral

owner vs. surface owner)

2. Usually only Wealthy developers get to take

advantage of this rule.

3. (1) Surface tract must be 640 acres; (2) In a

county which contains at least 400k inhabitants

OR in an adjacent county that has at least 140k

inhabitants which is adjacent to county w/ 400k

inhabitants OR barrier isle; (3) Must be

subdivided for residential, commercial use (will

not get benefit if for personal use); (4) Must be

provisions allowing 80 acres for mineral rights

(80 acres can be several 10 acres tracts set aside

equaling 80 acres).

4. RULE: Mineral owner’s use must be reasonable

…If the use is unreasonable (use too much land,

in the wrong place to develop minerals, deer

hunting), then the whole mineral estate easement

goes away.

5. TEST: Is the use reasonable? à YES à

Accommodation doctrine applies

2. Express Restrictions on Mineral Estate

a. Cannot just rely on the Accommodation doctrine…must

go to court to prove that you get benefit of doctrine.

b. When advising lessor…make sure you place conditions

on oil lessee…such as reparation of damages

c. Mineral owners use of surface must be reasonable…if

not, you lose mineral estate easement.

3. Livestock and Barnyard Critters

1. Livestock are subject to the Place of injury rule. (TX)

a. Mineral interest owner (lessee) has no duty to

fence in their operation, UNLESS there is a lease

restriction requiring them to do so.

b. You owe no duty to livestock owner, except not

to injure the livestock intentionally (can’t shoot

them)

c. If the livestock are injured b/c of something you

do outside of the lease boundaries, you are liable.

(If harm occurs in an area outside of the area of

operation, you are liable…but if harm occurs in

the area of operation, you are not liable…unless

you did so intentionally.)

XIII. Adverse Possession