I am an oil and gas lawyer in Houston with roots in East Texas.  I was born and raised in Jasper, Texas and have family ties still in the area.  I have been an oil and gas lawyer for ten years.  I started out representing operators, but have since devoted myself to representing landowners and doing my part to educate the masses on their legal rights.  I've started with educating my own family.  We own acreage in East Texas and South Texas, but I was surprised to learn that nobody had a clue how much acreage we owned, who the acreage was leased to, or what was going on with our property.  My parents, aunts and uncles were just collecting royalty checks treating it as "mailbox money."  Through my representation of oil companies, I came to learn that my family was not much different than most royalty owners.  The average royalty owner in Texas is a 65 year old widow.  When compared to the resources, knowledge and expertise that an oil company has, royalty owners are typically at a huge disadvantage when it comes to protecting their interests.  Our Texas Supreme Court ignores this reality, and over the past 15 years has continually sided with oil companies in litigation, which has increased the burdens on royalty owners to protect themselves.  So I am posting this Primer on Texas Oil & Gas Law to provide an overview of some of the basic rights every royalty owner should know they have.  This is not intended to be legal advice.  This is simply a recitation of existing law in Texas.  If you have questions, please do not hesitate to contact me or a lawyer you trust.  Here is a link to my website  http://www.wattbeckworth.com/elmore.htm.

 

I.          Basic Principles

 

A.  Mineral Estate is often severed from surface estate

 

Five attributes of mineral estate

  1. Right to develop
  2. Right to lease
  3. Right to receive bonus payments
  4. Right to receive delay rentals
  5. Right to receive royalty payments

Altman v. Blake, 712 S.W.2d 117, 118 (Tex. 1986); Day & Co. v. Texland Petroleum, 786 S.W.2d 667, 669 n. 1 (Tex. 1990); French v. Chevron U.S.A. Inc., 896 S.W.2d 795, 797 (Tex. 1995)

 

Oil and gas lease is a fee simple determinable, with possibility of reverter in the lessor/mineral owner.  Cherokee Water Co. v. Forderhouse, 641 S.W.2d 522, 525 (Tex. 1982).  Oil and gas lease vests title to minerals in the lessee for so long as the lease is kept in force.  W. T. Waggoner Estate v. Sigler Oil Co., 19 S.W.2d 27 (1929).

 

B.  Rule of Capture

 

Mineral owner acquires title to minerals he produces from his land, even if such minerals migrated from adjacent lands.  Imagine an oil reservoir as an underground pool that extends from your land across the lease line to your neighbor’s land.  If you drill a well into that reservoir, you have the right to produce all of the oil, even that which is located under your neighbor’s land.

 

C.  Essential Terms of Oil and Gas Lease

 

1.  Habendum clause – description of “primary term” and “secondary term”- primary term is the stated months or years in the lease - secondary term comes into effect after the expiration of the primary term, but only if drilling, production or other operations are taking place as more specifically described in the lease (every lease is different in this regard).   Example:

Unless sooner terminated or longer kept in force under other provisions hereof, this lease shall remain in force for a term of three (3) years from the date hereof, hereinafter called “primary term”, and as long thereafter as operations, as hereinafter defined, are conducted upon said land or with no cessation for more than ninety (90) consecutive days, or as long thereafter as oil or gas is produced from said land by lessee.

 

2.  Royalty clause

 

The lessor’s royalty is equal to his share of production, free of production costs.  See Heritage Resources, Inc. v. Nationsbank, 939 S.W.2d 118 (Tex. 1996), reh’g denied, 960 S.W.2d 619.   Production costs may include the costs of 3D seismic, drilling costs, testing or reworking a well, or secondary recovery operations.  Reasonable post-production costs are typically deducted from royalty, such as severance taxes, costs of compression, treating or transportation.  See id.

 

Royalty clause may be based on a fraction of the “posted price” for oil, or “market value at the well” or “amount realized by lessee.”  Market value is the price negotiated between a willing seller and willing buyer.  See Exxon Corp. v. Middleton, 613 S.W.2d 240, 246 (Tex. 1981).  Market value is determined either by analyzing comparable sales or taking the amount realized by the lessee and netting out post production costs (i.e., “net-back”) to get to a value at the mouth of the well.  Heritage Resources, Inc. v. Nationsbank, 939 S.W.2d at 122-23.

 

3.  Pooling provision

 

Oil and gas leases contain a clause that grants lessees the right to pool leases together to form a unit.  The pooling power must be exercised in good faith.    See Elliott v. Davis, 553 S.W.2d 223, 226 (Tex. Civ. App. - Amarillo 1977, writ ref’d n.r.e.); Amoco Prod. Co. v. Underwood, 558 S.W.2d 509, 512 (Tex.Civ.App. - Eastland 1977, writ ref’d n.r.e.).  Lessors can negotiate maximum unit sizes so as to protect against dilution of their royalty.  If lessors are included in a unit, their royalty is recalculated to their proportionate share of the entire unit production.  If the lessor’s royalty in his lease is 1/8th, and 50 acres under his lease is included in a 640 acre unit, his royalty is equal to 1/8th of 50/640ths of production.

 

Every lease should contain a vertical and horizontal Pugh clause to protect the interests of the lessor. Such a clause results in a severance of the pooled and non-pooled portions of the leasehold such that the lease acreage and depths outside the pooled unit are not maintained by drilling or operations on the pooled unit. SMK Energy Corp. v.Westchester Gas Co., 705 S.W.2d 174, 176 (Tex.App.—Texarkana 1985, writ ref’d n.r.e.). 

 

The Texas Supreme Court recently held that if a lease contained within a unit terminates, the lease nevertheless remains part of that unit.  If the terminated lease is a drillsite tract, the lessor is treated as a cotenant and owes his proportionate share of production and post-production costs.  See Wagner & Brown v. Sheppard, 282 S.W.3d 419 (Tex. 2008).

 

II.        Implied Covenants of Oil and Gas LesseeAmoco Production Co. v. Alexander, 622 S.W.2d 563, 567 (Tex. 1981). - these are implied oblgiations the courts have placed on lessees.  Express provisions of a lease will control, and many lessees attempt to include express provisions that disclaim or nullify these implied covenants.  One needs to read a lease carefully before signing.

 

A.        Applicable Standard is Reasonably Prudent Operator

 

B.        Covenant to Develop

 

There is no requirement outside the express terms of the lease that the lessee drill an initial well.  A lessee may obtain a lease to hold and prevent its competitor from leasing acreage nearby.  The lessee either executes a paid-up lease or pays annual delay rentals to maintain the lease.  However, once the first well is drilled, the lessee must drill such additional wells to develop the property as a reasonably prudent operator would under the same or similar circumstances, taking into consideration the interests of both the lessor and the lessee. Clifton v. Koontz, 160 Tex. 82, 325 S.W.2d 684, 693-94 (Tex. 1959); Lenape Resources Corporation v. Tennessee Gas Pipeline Company, 925 S.W.2d 565, 572 (Tex. 1996).  The lessee has no duty to develop without a reasonable expectation of profit to it. Pickens v. Hope, 764 S.W.2d 256, 270 (Tex. App.—San Antonio 1988 writ denied).  

 

C.  Covenant to Protect Against Drainage

 

The obligation to protect the lease has been described as “the duty of the lessee to drill an offset or additional well, if, considering the cost of same and the probable profit therefrom, he would have been doing what an ordinarily prudent person would have done under the same circumstances.” Texas Pacific Coal and Oil Co. v. Barker, 117 Tex. 418, 6 S.W.2d 1031, 1036 (Tex. 1928); Amoco Production Company v. Alexander, 622 S.W.2d 563 (Tex. 1981).  Further, the reasonably prudent operator standard includes an independent requirement that the drainage be substantial before lessor can maintain a cause of action. Good v. TXO Production Corp., 763 S.W.2d 59, 61 (Tex. App.—Amarillo 1988, writ denied); Clifton v. Koontz, 160 Tex 82, 96-97, 325 S.W.2d 684, 695-96 (1959). 

 

D.  Covenant to Market

 

This covenant includes the duty to produce and market, to operate with reasonable care, to use modern methods of production and development and to seek favorable administrative action.  Amoco Production Company v. Alexander, 622 S.W.2d 563, 567 (Tex. 1981). The most common dispute arising under this covenant is the implied duty to market.  The lessee has the duty to “exercise good faith in the marketing of gas”. Amoco Production Company v. First Baptist Church of Peyote, 579 S.W.2d 280, 287 (Tex. Civ. App.—El Paso 1979, writ ref’d. n.r.e.) per curiam 611 S.W.2d 610 (Tex. 1980).  A lessee’s primary goal is to maximize profits.  Some lessees attempt to pass on unreasonable post-production costs by virtue of net-back method of accounting, which can result in less than market price.

 

III.       Royalty Reporting Statute

 

Lessees are required to provide certain information to royalty owners on every royalty check stub.  Texas Natural Resources Code §91.502.  If the royalty owner wants additional information, he can make written request to the lessee, who has 60 days to respond.  Id. at §91.504.  If the lessee fails to provide the requested information, the royalty owner may file suit and recover court costs and attorney’s fees.  Id. at §91.507.

 

IV.       Surface Use and Damages

 

The mineral estate is dominant over the surface estate.  See Harris v. Currie, 176 S.W.2d 302 (Tex. 1944).  As such, Texas courts have long defined the mineral owner’s right to use the surface as follows:

 

(1)        The mineral owner may only use the surface as reasonably necessary to develop the underlying minerals;

(2)        In using the surface, the mineral owner must act with due regard for the rights of the surface owner; and

(3)      The mineral owner must act non-negligently in the way and manner of use.

 

Brown v. Lundell, 344 S.W.2d 863,866-67 (Tex. 1961); General Crude Oil Co. v. Aiken, 344 S.W.2d 668, 671 (Tex. 1961); Sun Oil Co. v. Whitaker, 483 SW.2d 808 (Tex. 1972).

 

Under the accommodation doctrine, surface owners must demonstrate that: 1) their use preexisted the mineral owner's conflicting use; 2) the preexisting use is their only reasonable means of developing the surface; and 3) the mineral owner has other options that a) would not interfere with the surface owner's preexisting use, b) are reasonable (including economic reasonableness), c) are practiced in the industry on similar lands put to similar uses, and d) are available on the premises. Getty Oil Co. v. Jones, 470 S.W.2d 618 (Tex. 1971); Sun Oil Co. v. Whitaker, 483 S.W.2d 808 (Tex. 1972); Tarrant County Water Control & Improvement District No. One v. Haupt, Inc., 854 S.W.2d 909 (Tex. 1993).

 

V.        Investigation into Lessee’s Compliance with Covenants

 

Most of the claims brought by royalty owners are for breach of the express or implied covenants of the oil and gas lease governed by the four year statute of limitations.  Typically lessees do not provide their royalty owners with technical information supporting the lessee’s decisions concerning drilling activities, or lack thereof.  Over the past fifteen years, the Texas Supreme Court has eroded the protections afforded royalty owners by the "discovery rule" which acts to delay the running of statute of limitations on claims until such time that the claimant discovered or should  have discovered the claim through the exercise of reasonable diligence.  This places an ever increasing burden on royalty owners to educate themselves about the lessee’s operations and compliance with the oil and gas lease express and implied provisions.   

In order to investigate into a lessee’s operations and compliance with the lease, royalty owners typically will need assistance from experts, such as a geologist or petroleum engineer.  There is information publicly available on the website of the Texas Railroad Commission relating to individual wells and operators. 

http://www.rrc.state.tx.us/ 

  • Available Maps – Public GIS Map Viewer for O&G Data

http://www.rrc.state.tx.us/forms/maps/index.php

  •   Drilling Permits and Production Data

http://www.rrc.state.tx.us/data/online/index.php

 

The Texas Supreme Court has held on more than one occasion that one source of information is the lessee, and therefore, royalty owners should make written requests to their lessee for information concerning their operations. 

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Tags: covenant, develop, drainage, primer, royalty

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Comment by Ben Elmore on August 3, 2011 at 9:25am

I expect they will begin operations on the new well before shutting down the old well.  That way they meet the cessation of operations provisions of the leases (which I assume the leases have, and I assume the leases are beyond their primary terms).  Those leases that are released and not included in the new unit would be entitled to a new lease, bonus, royalty, etc... (again assuming they are beyond the primary term).  Bigger question is did the old oil well trickle enough to produce in paying quantities and hold the leases in the unit?

Comment by Krkyoldhag on August 3, 2011 at 1:58am

Situation: In a 640 acre unit with leases held by a "trickle" of production from old oil well.

Drilling company plans a new well in part of the unit  but might be shutting down the old well and releasing the leases in the unit except for the ones in area of the proposed drilling, and putting these two leased acreages into another unit.

Why would they do this?  If they shut down the well who's only purpose was to hold these leases wouldn't that release all the leases in that unit?  Would that mean that drilling company would have to negotiate a new lease with the owners of those acres they propose to drill on?

The only reason I can see (and does not explain why they releasing the other tracts) is that the unit is not wide/long enough to drill a shale well.

I suppose I will know this came about when I see a well go up on horizon and get my release. 

Comment by Ben Elmore on February 20, 2011 at 10:00am
Teacher, friend me and I am happy to discuss your situation separately. Thanks.
Comment by little ole 1st grade teacher on February 20, 2011 at 2:55am
I was leased but the lease expired back in 2010 and no company has offered to lease my property.
Comment by little ole 1st grade teacher on February 20, 2011 at 2:54am

How would you know whether the RULE of CAPTURE is happening on your property? 

I have wondered about this since I have wells all around my property but am not a part of any of the units that are close by to my property.

Comment by PamelaC on December 31, 2010 at 9:52pm

Ben,

 

Thank you so much for your help Monday. This post is very helpful also.

 

Pamela

Comment by Love Horizontals on December 29, 2010 at 5:02pm

Great summary.  Thank you for posting.  Royalty owners have been duped by oil co's and leases for years for decades by not knowing what they dont know....and then when they figure it out the courts reconstrue the meanings.  The games the oil co's are playing with the royalty owners can get very confusing. 

What is your general take on royalty based upon oil companies who enter into contracts to "hedge" or fix the price (within a range) for the gas to be delivered in the future?  Are there any court decsions  out there on it?  Obviously hedges work because each side minimizes risk in the market.  It is good for the oil co because they can plan and fullfill drilling committments and drill even when the spot price drops to a level that otherwise would not be economically feasible to drill.  It is also good for the ultimate buyer of the contract (like a utility co) because their expense for the fuel is known and they do not risk operations subject to rapid increases in price.  However if the market price fluctuates outside of the contract price range... one party benefits and one party loses relative to who "bet" right on the market. 

But what if a Lessor who was in a favorable negotiating position was sucessful in negotiating (effectively his own hedge) where he could never be paid less than market, but could be paid more than market if the Lessee negotiated a favorable contract (hedge contract or otherwise)- a royalty clause where Lessee was obligated to pay Lessor the "greater of" market or the amount "realized" by the Lessee in the sale of the gas.   Obviously, this is a favorable negotiation provision to the benefit of Lessor since the Lessee could actually lose money on the Lessor's undivided percentage of the gas sold if the Lessee bet wrong on the market with its hedge contracts.  (Ex: Lessee contracts in a hedge to sell with range of $3.00 to $4.50 and market price goes to $5.00.  If Lessee "bets" wrong on market with his hedge, he had a loss of $.50 on the 25% royalty portion owed to Lessor.)

 

This type of lease provision would seem important for royalty owners in the event of situations where oil co's argue it is not economically feasible to drill certain wells when the price of gas is at certain levels. 

Example: Not feasible if gas is less than $4.80. Gas is at $3.20.  However oil co has hedge contract with minium price of $5.00 so due to oil co's gas contract it IS economically feasible and oil co drills, but pays royalty owner based upon $3.20 and not the $5.00 they actually realized from the production - oil co realizes a GAIN of $1.80 on 100% of production, not just their 75%.   

It seems without some protection in the lease a royalty owners minerals would be developed and royalty owner paid for gas at what is otherwise an infeasible market price......instead of leaving it in the ground to be developed & produced at a feasible price.  Obviously if the royalty owner were to benefit from the price of the sale of gas the same as the oil co, then it would be good for the royalty owner to see his minerals developed same as the oil co....but if it doesnt make economic sense for the oil co to sell below a certain price, it seems the same would be true for the royalty owner.  

 

   

Comment by GoshDarn on December 28, 2010 at 3:05pm

Ben:

 

Thanks for taking the time to post this info.  Good stuff.

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