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Oil and Gas
University of Illinois School of Law
Trott, Thomas George

Fall 2013

Professor Thomas Trott

Oil & Gas

Formation of oil & gas:

– Source of carbon and hydrogen that developed from the remains of land and sea life buried in the mud and silt of ancient seas

– Conditions which caused the decay or decomposition of these remains and the recombining of carbon and hydrogen to form a mixture of hydrocarbons that make up petroleum

– A porous rock or series of such rocks within which the petroleum was able to migrate and displace the water originally in the rock

– A local structure or trap, having a top layered seal, that forms a reservoir where petroleum has gathered.

Te formation of commercial oil and gas accumulation is produced from biological material altered over millions of years by heat and pressure

– Transformation occurs in sedimentary basins where pore and fracture spaces permit migration into areas in the rock where the less dense hydrocarbons rise through the water in the formation and are trapped by a rock type that does not allow further migration

Oil and gas are commonly found in sandstone, porous limestones and dolomites , from which they migrated to the reservoirs. The accumulation occurred as the underground rocks masses were in certain forms and shapes that halted the oil movement and caused the petroleum to be trapped and to gather in large quantities.

Oil and gas gather in the upper part of the trap because of the differences in weight of gas, oil and salt water. Gas is usually found in the highest part, oil and oil with dissolved gas is found next, and salt water below the oil. Often the pore spaces contain about 10%-50% salt water (Connate water).

Petroleum reservoirs: geological structures or traps to which petroleum has migrated and within which it has been trapped and has accumulated.

Reservoir Rock

– the ratio of the pore volume to the total rock volume is called porosity

– a good sandstone reservoir may have up to 30% porosity

– if the majority of the pores within a rock are interconnected, the rock is said to be permeable

Geologic types of reservoirs

– domes and anticlines

– fault traps

– unconformities

– dome and plug traps

– reef traps

– lens-type traps

– combination traps

For optimal development, some rock formations that serve as reservoirs require the use of specialized drilling techniques such as horizontal drilling or post-drilling process like hydraulic fracturing

– knowledge of the location of fractures zones derived by seismic reflection surveys is very important to maximize production from a single well

– contemporary hydraulic fracturing techniques: allow drillers t dramatically increase the permeability of the formation by forcing highly pressurized fluid into the rocks; the fluid fractures the shale layers and releases gas that could not be recovered by traditional drilling techniques


Ownership prior to extraction

The Role of Surface Boundaries:

– property rights associated with land rely upon surface boundaries to define and identify the rights

– the property interests will be defined by a grant or reservation of a stated interest within the tract of land described by some form of surface description

Del Monte Mining v Last Chance

Common law:

– whoever had the fee of the soil owned all below the surface

– owner of soil may convey his interest in mineral beneath the surface without relinquishing his title to the surface

– the possible fact of a separation between the ownership of the surface and the ownership of mines beneath that surface growing out of contract, in no manner abridged the general proposition that the owner of the surface owned all beneath

– Heaven to hell doctrine

o To whomever the soil belongs, he owns also to the sky and to the depths

– Extralateral rights doctrine

o the owner of a lode claim may exclusively mine all the veins, lodes and ledges throughout their entire depth, the top or apex of which lies inside

o doctrine extends the mining right beyond the staked boundaries of a lode claim

Describing surface boundaries

– Federal rectangular surveying system: surveys laid out from a

o principal meridian line, based upon lines of longitude,

o base lines , based upon lines of latitude

o Range lines, drawn at 6-mile intervals east and west of the selected principal meridian

o Township lines, drawn at 6-mile intervals north and south of the selected base line

o Each township is further subdivided into 36 numbered sections of 1 square mile each

o A standard section is 1 m ile by 1 mile

Ownership theories

2 fundamental theories: ownership in place and exclusive right to take

– Ownership in place theory:

o Landowner owns all substances, including oil and gas, which underlie his land

o Such ownership is qualified by the operation of the law of capture

§ If oil and gas depart from beneath the owned land, ownership in those substances is lost

– Exclusive right to take theory:

o Landowner does not own the oil and gas which underlie his land.

o He merely has the exclusive right to capture such substances by operation on his land

§ Once reduced to dominion and control, such substances become the object of absolute ownership, but until capture, the property right is described as exclusive right to capture

Rule of capture and ownership at extraction

Kellly v Ohio Oil Co.

– Kelly has a contract with Hasting (landowner) to operate the lands for oil in exchange for a royalty of the oil produced

– To drill an oil well near the line of one’s land cannot interfere with the legal rights of the owner of the adjoining lands, so long as all operations are confined to the lands upon which the well is drilled

– When a person has the legal right to do something, the motive with which it is done is immaterial

– The right to drill and produce oil on one’s own land is absolute, and cannot be supervised or controlled by a court or an adjoining landowner

– Ownership of oil exists while the oil stays within the land boundaries until it is raised to the surface, when it becomes the subject of distinct ownership. Separate from realty, and becomes personal property

o Once the oil is drawn out through a well, it becomes the property of the person who owns the well

– Under the rule of capture, the landowner who extracts oil or gas from beneath his land acquires ownership of the extracted substances even though they may have been drained from beneath the land of another

o This is so even when evidence discloses a portion of the oil or gas was drained from adjoining lands

Ownership of oil and gas after extraction

Champlin Exploration v Western Bridge

– An owner of refined hydrocarbons does not, ipso facto, lose title to escaped hydrocarbons unless it is shown by competent evidence that he has abandoned the same

– Ordinarily, a landowner, lessee or unit operator who brings hydrocarbons to the surface and reduces them to actual possession acquires absolute ownership of the substances,, subject to the operation agreement or lease

– Title to lost property does not vest automatically in its finder/capturer for our purposes; there must have been an abandonment by its previous owner

– If oil should escape from a well, tank or pipeline, the owner may lose possession but he retains title unless the oil is abandoned

– Once oil and gas is extracted from the earth, it becomes tangible, personal property and subject to absolute ownership

Texas American Energy v Citizens Fidelity Bank

– In those instances where previously extracted oil or gas is subsequently stored in underground reservoirs is capable of being maintained, title to such oil or gas is most lost and said minerals do not become subject to the right of the owners of the surface above the storage fields

o Such previously extracted oil or gas , thus stored, is goods under the UCC and the proper manner of encumbering an inventory of said minerals in storage is controlled by the UCC

Often gas is produced from its natural reservoir and moved to storage reservoirs that are located near the populated areas where it will be consumed

– This allows gas suppliers to economically meet peak seasonal demands without constructing larger capacity pipelines or storage facilities that are more expensive and dangerous than underground storage

– Ad coelum doctrine does not confer absolute ownership to the subsurface, but includes the right to exclude invasions that actually interfere with the property owner’s reasonable and foreseeable use of the subsurface

– When a landowner injects gas into a formation before all native gas is extracted, the injector does not become liable to royalty interest owners for royalty on the injected gas;

o however, the injector has the burden of proving the proportion of injected gas to native gas to compute the royalty due on the native gas at the time the gas was withdrawn from storage

o roy

the fee

o The fee often refers to the totality of all private rights in the land

o A fee owner owns: The surface, the airspace above the surface and everything beneath the surface in fee simple absolute, an estate which is alienable, devisable and inheritable

– Various kinds of interests in oil, gas and other minerals may be carved from the fee

– In general, these interests may be created and conveyed or reserved like other interests in real property

Mineral interest or rights:

– May be carved or severed from the fee interest

– Complete severance occurs when:

o the fee owner coveys his land, reserving the mineral estate, or when the fee owner conveys all of the mineral interest in his land by mineral deed

– Partial severance occurs when:

o fee owner conveys his land reserving part of the mineral interest or conveys part of the mineral interest in his land

o reservation or conveyance of

§ a fractional part of the mineral (1/2 of all minerals in land)

§ an interest in certain mineral (only gas)

§ a fractional part of certain mineral (1/2 of the oil in land)

– a common formulation divides the mineral interest into 4 incidents:

1. the right to access to and use the surface

a. the owner of a mineral interest owns the mineral rights described in the conveyance or reservation, together with the right to use the surface and subsurface as reasonably necessary for, develop, ad produce the mineral

b. these rights will be implied even if not expressed in severance instrument

2. the right to incur costs and to retain profits (the right to develop)

a. Working/Operating interest: one who has the rights to use the surface, incur the costs of development and retains the profits

b. Net profits interest: owner who has only a right to share in any profits of an operation

3. the right to alienate:

a. Executive right : a mineral interest owner right to alienate by transfer all or portions of the mineral interest to another

b. transfer may take the form of a mineral deed, a royalty deed, a mineral lease, etc

4. the right to retain the lease benefits

a. an oil and gas lease typically reserves certain lease benefits in the lessor

b. as consideration for executing and conveying the lease, the lessee pays the lessor an initial cash payment called a bonus.

c. Most leases also provide for periodic delay rental payments to the lessor prior to the development by the lessee

d. After development, the lessor may be entitled to shut-in royalty payments

i. Where gas is discovered but not yet produced or where production temporarily ceases

The oil and gas leasehold interest

– Similar to a mineral interest in that the lessee receives all incidents of the mineral interest except those specifically reserved in the lessor

o During the term of the lease, the lessee holds the rights to use the surface, incur costs and to retain profits (subject to the lessor’s benefits like royalties)

– The lessee owns the working interest/operating interest

– The lessor usually retains a right to bonus delay rental, shut-in royalty and production royalty

– The lessor also retains the possibility of reverter (upon expiration of lease, all incidents of the mineral interest revert to lessor)

– Because oil and gas leases are generally issued for a specified term of years and so long thereafter as oil or gas is produced in paying quantities,

o the lessee’s interest is often described as fee simple determinable or a profit of determinable duration

o The lessor is said to retain a possibility of reverter/reversion