Oil and Gas – Fall ‘06, Prof. Jones
Michael D. Jones
713 652 4068
1. Introduction to Oil and Gas
1. Five Phases of the Business
1. Upstream Processing
2. Downstream Processing
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
1. explore & produce
2. executive right
4. delay rental
II Law of Capture and Private Ownership
1. Law of Capture:
1. Oil comes from rock – sedimentary 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 porous, 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. Ideas of drilling: radial drainage, and oil pours into pressure sink that you create by drilling a hole. Soon the pressure wave builds up, moving the oil from all directions to the bore.
4. 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 center of the Earth underneath the property. 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. Ohio Oil (1897): Ohio Oil drilled a serious of the wells 20 feet around Kelly’s property. They are draining Kelly’s property. Kelly asks for TRO. Court said once he extracts the oil it is his
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.
You can’t convert real property. But, when oil is removed from soil, it becomes a personal property, which is convertible.
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, meaning they can go and do likewise, i.t. drill, too, on their property.
1. Property rt of ownership – do what you want w/ land as long it is lawful
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
6. ROC lead to unfortunate results. Every person is going to build a derrick on his property. Together with splitting the property, it will lead to extremely inefficient extraction, overdrilling. Eventually, it will lead to regulations. In TX, you need 40 acres to drill a well, and 467/1200 feet spacing.
1. Ownership of Extracted Oil and Gas (Exceptions from ROC)
1. Champlin Exploration – gas in its natural state is subject to the rule of capture but once it is severed, it becomes a personal property of… unless it is abandoned.
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. Texas American: oil or gas becomes personal property when produced, ownership is not lost by mere loss of possession, reinjection.
1. Since it is personal-you have security, falls under the UCC and you file with the secretary of State (for real property that would be a county clerk)
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 – Hammonds KY only
2. TX-rule of capture does not apply to reinjected gas at all – but in KY it does until they overturn Hammond
3. Once gas is severed it is personal and not real property. It is not subject to the rule of capture – Texas(Lone Star Gas Co v. Murchison, (Tex. 1962.)
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.
The owner of the surface has to give permission, unless there is still oil – then – mineral owner permission.
Humble oil has a burden of proof to show that there was indeed X1/y left.
Correlative rights –
2. Exceptions to the ROC: 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
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 (see Ch 4. Tresspass)
2. Geo Viking: Tex-Lee Operating Co sued Geo Viking for Dmgs under DTPA for improperly performed fracing. Sand Fracing -pump in sand w/fluid sand gets in the cracks to keep cracks open and increase flow. Viking improperly sand frac the well and lost large quantities of oil. Issue: on the measure of Dmgs, P wanted to include the amount of oil it would have recovered from underneath the neibouring tracts, had the fracing been performed properly. Holding: Fracing under the surface of another’s land constitutes trespass. Rule of Capture does not give you a right to commit trespass. Dms limited to the loss of production from reservois within the lease boundaries.
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 was exceeding its allowables for 150,000 barrels. 1/3 of this illegally produced oil was drained from the P’s property.
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. Doctrine of Correlative Rights
3. Doctrine of Correlative Rights -parties having a property interest in the oil out of the common reservoir have a legal right to develop, however each owner has a duty not to engage in any activity injuring the common reservoir. Such as:
i. Drilling too many wells
ii. Drilling wells in imprudent locations and
iii. Producing at too high a rate
3.a Eliff v. Texon Drilling Co. (1948): Texon negligently drilled a well, causing a well to blow out, crate & ignite. Eliff’s property was adjacent, and a large amount of gas & distillate was drained from beneath his property as a result of blow out. Eliff sued Texon, asking for Dmgs for the drained gas & distillate. TX Sup Crt affirmed, holding: the law of capture was limited by the correlative rights doctrine, which protects owners from negligent or wasteful operations that injure or destroy the common source of supply.
1.mile 640 acres in Sq mile
II. Conservation: Modifying and Limiting the Rule of Capture
1. Regulating Drilling, Well Completion and Plugging
Larson v. Oil & Gas Conserv. Comm.: Violation of correlative b/c did not make the right findings- WY did not have § to prevent waste.
Larson owned royalty interest, in TX they are not entitled to notice under rules of RR Commission
2. State wide spacing patterns-normally 40 acres (§19 of TAC)
a. Field rules – Supersede state wide rules
b. When staff receives application, there is hearing w/public notice (30 days) so that anyone that wants to can be heard
i.Commission conducts the hearing with a hearing examiner
ii.Hearing examiner hears evidence and makes finding and determines approval
iii.These findings are a recommendation to commissioner
iv.Commissioners will most likely put these into law.
c. The losing party can appeal to Travis County District Court for everything except appeal of forced pooling
i.Dist. Ct will review the record made in administrative arena – usually substantially affirming what the hearing court stated
ii.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)
iii.This process is a state thing – Congress does not get involved.
RR Commission v WBD Oil & Gas Co:
Statewide Rules: 467 feet from the lease line, 1200 feet apart
Special Field Rules:
Appeals from RR Commissions goes to the Dist Crt of Travis Co by Statute.
Standard of review: judicial (contested case), not legislative (rule making)
3. Well Spacing Exceptions
a. Exceptions justified for two reasons
i. To protect the correlative rights of owners against drainage or
ii. To prevent waste of oil and gas
b. Pattie: Correlative Rts. Supercede conservation as long as no waste
i. 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
ii. Implied power to protect correlative rights- reviewed De Novo.
c. Exxon Corporation v. RR Comm’n: to prevent waste of oil, get R. 37 exception when unusual res./other conditions, Must have:
i. Good Faith, not subterfuge to get around § requirements
ii. Need to prevent waste or confiscation (econ., phys, or other)
1. Court allows production to prevent physical waste
2. Forms of physical waste
a. Open pit storage
b. Most frequent-if I can’t recover my way it will never get to the public.
Exxon argued that they did it just to violate the rule, but Crt did not buy that argument.
Initial BHP (bottom hole pressure) suggested that there was not big difference, and Exxon had nothing to worry about.
iii. 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
delay rentals, being aware of the mistake, and does not notify the payor of the wrong amount, he is later estopped to assert that the lease has terminated.
4. Kincaid: “bona fide attempt to pay or tender” is enough for lease NOT to be terminated. And there was a renewal provision, extending a primary term for another 5 years. In 1980, they were considering paying FT, but not ED (they had a dry hole). For FT, they put the wrong name on the check. ED did not accept, the lease should terminate, but “bona fide attempt”: “Contra preferentum”: here the lessor is the drafter, usually – the lessee, the Oil Co.
5. Brannon v. Gulf States Energy Co (1977): p. 163 Revivor: if you cash the check deposited late, you revived the lease.
6. “Commencement of Production” Within one year from AD, or after four years of paying delayed rentals, you have to “commence operations for drilling” – Don’t have to be actually drilling a well unless specifically stated. Watch the lease language. If “commences operations”, then building a road satisfies (especially in Louisiana, which is swampy). But, if lease says “production”, TX follows the minority rule – if discovered, have a reasonable time to drill.
Breaux: O&G lease signed on March 18, 1966 with a primary term of 1 year. Clause ”Lease terminates unless the Lessee “commences operations for the drilling of the well, or pays delay rentals. On March 16 or 17, 1967 Lessee stared building a board road ti the well location, on March 18 it was completed. Issue: Whether the Lessee “commenced operations for the drilling of the well” during the primary term? Holding/Rule: actual drilling is unnecessary to “commence” a well; substantial surface preparations are sufficient to considered “commencement”, such as making and clearing a location, delivering equipment to the well site, and the like, provided that such preliminary operations are continued in Good Faith continuance and with due diligence until well is actually spudded in.
Par 6 Supplement Lease: After a year barrier has passed, per our supplement lease he has to continue, and cannot stop for more than 90 consecutive days.
3. 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 term of lease (how the lease will begin & end) sets period of time for which rights given in the granting clause will extend. Possible to last forever F/S determinable
1. Two Types
(1) “Unless” – widely used “unless delay rentals paid or production, K terminates”
(2) “Or” – either pay delay rental or produce – Must bring Ct. action to terminate lease
· “Primary term”: a fixed term of years during which the lessee has the right, w/o any obligation, to operate on the premises. The shorter, the better for royalties. Used to be 10 years, now 3-5 mostly. If lease starts 8/31/06, 5 years expires 8/31/11. If lease does not expire on 8/31/11, secondary term starts.
· Secondary term – extended period of time for which rights are granted to the lessee once production is obtained
Problem (Where is the money going?):
Applewhite 40/160 x 1/5 = 5%
Adams ½ 80/160 x 1/5 = 5%
Willette ½ 40/160 x 1/5 = 5%
Gordon 20/106 x 1/5 = 2.5%
Meng 20/106 x 1/5 = 2.5%
Overriding Royalty Interests:
Whitte = 1.75%
Conoco 73.00% – NRI
Cheyenne Resourses v. Criswell: lease repudiation.
Facts: Darrell Criswell, Freda Criswell, and Elsie Criswell signed an oil & gas lease with Cheyenne Resources, it’s primary term expiring on February 7, 1984. The jury determined that Cheyenne *104 did commence a well on the property on or before February 7, 1984, and was engaged in drilling operations on February 7, 1984. It also found that drilling operations ceased on March 17, 1984, because on March 14 or 15, 1984, Darrell Criswell posted a sign on the gate to the leased premises notifying Cheyenne Resources or its assignees that its oil and gas lease had expired with instructions to contact the Sheriff of Eastland County. Darrell Criswell testified concerning the sign.
Trial Crt found: Based on answers to special issues, judgment was entered declaring that the lease had expired, that the Criswells take nothing against Cheyenne, and that Cheyenne take nothing against the Criswells. Cheyenne appeals.
Appeal Issue: Cheyenne urges a single point of error contending that:
The trial court erred in refusing to grant Appellant’s Motion to Disregard Finding on Special Issue and for Judgment and in granting judgment for Appellees declaring that the oil and gas lease in favor of Appellant had expired, for the reason that the uncontroverted evidence establishes as a matter of law that the actions of Appellees constituted “repudiation” of Appellant’s title to its oil and gas lease….
App Crt judgment: We reverse and render.
Rule of Law: Where lessors under oil and gas leases notified lessees by letter that the leases had terminated, and the lessees discontinued their efforts to continue development of the leases on receipt of the letter, lessors were not entitled to relief of cancellation and lessees were entitled to a declaration that the leases were in full force and effect for a specified term from the date of the judgment and as long thereafter as oil or gas were produced from the land thereunder.
ii. Production in paying quantities:
Cliffton v. Kuntz:
If Revenue > Op. costs, then we have production in paying quantities
“In Paying Quantities” – Clifton v. Kuntz – means commercial quantities, if RPO (reasonable prudent operator) would continue to produce for profit and not for speculation in the manner in which the well in question was operated. Doesn’t have to be paying out every month. There was not a cessation of production, which would invoke different rules.
(1) If Revenue exceed operation costs? if the well pays a profit, even small over operating expenses, it produces in paying quantities, though it may never repay its costs (drilling & equipment costs), and the enterprise in whole may prove improfitable. Profitability = operating revenues – operating costs
Costs not included: capital costs (drilling & equipment), depretiation, overriding royalties.
For costs included, see Jones hypo (Olsen well)
If they are, go to the 2nd prong
(2) RPO. would continue to produce for profit and not for speculation in the manner in which the well in question was operated. Only if the answers to both prongs are negative, lease terminates.