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 OilExample 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 1st anniversary of

                                        lease.

                                    b. Primary term – usually 3 years

                                    c. Must drill by end of 1st 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 3rd 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 WarrantyDoesn’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

 

            A. Requirements to Establish Adverse Possession

           

                        1. Must hold Open & Notorious manner

                        2. Continuously and Uninterrupted for entire SOL period

                        3. Exclusive for limitation period

                        4. TX does not require Color of Title.

 

            B. Fundamental Principles

           

                        1. Once you meet limitation period, you get title

                        2. If mineral estate is not severed from Surface estate, then adverse

                            possession of surface gives you title to the mineral estate.

                       

                                    a. HYPO: O owns surface estate…X owns mineral estate…

                                        A adversely possesses by farming the land for limitation

                                        period.  à A will only get title to surface if meets the 3

                                        requirements.

                                    b. HYPO: if O owned both surface and mineral à A gains

                                        title to mineral estate also.

 

                                    c. HYPO: O owns unsevered mineral + surface…A begins

                                        adversely possession…then O conveys mineral to X. à A still

                                        gets  both mineral and surface.  RULE: in TX, mere paper

                                        transfer does not stop adverse possession.  X must do something

                                        after receiving conveyance.  POLICY: want to encourage

                                        development of minerals.

                                                (i) X should drill a well, exploration, etc.  in order to gain

                                                     control of mineral estate

                                    d. SOL = usually 15-20 years

                                    e. If adverse possessor drills a dry hole, and leaves equipment there

                                        and comes back later…statute says SOL continues to run

                                        (considered continuous use).

                                    f. Only need to be on a mineral estate in manner in which mineral

                                       owners usually are.

                                   

                                    g. HYPO: Have 1,000 acre mineral estate…you drill a well using

                                        40 acres…it produces for the time period.  RULE: In TX, you

                                        get the entire 1,000 acre mineral estate even though you only

                                        used 40 acres.

 

                                    h. HYPO: Adverse possessor drills well on 1,000 acre mineral

                                        estate…well is drilled only to strata containing oil…further

                                        down is uranium, etc.  RULE: Adverse possessor gains title to

                                        all of the mineral estate, regardless of how far he drills down.

 

                                    i. SUMMARY:

                                                1. Adverse possession of mineral works just like surface.

                                                2. Adv Possess. of severed estate will not earn you mineral.

                                                3. Adv. Poss. of nonsevered estate will earn you mineral.

                                                4. To adv. poss. mineral estate, you must do something to

                                                    develop the minerals.

                                                5. If only develop small portion of mineral estate, you gain

                                                    title to entire mineral estate.

           

                                    j.  Drilling permits don’t require proof of title, they assume you

                                        have title…they believe this is a private action, not for them to

                                        deal with.

 

IX. Joint Ownership

 

            NOTE: Mineral estate can be owned both concurrently & successively

                          It can be split b/t an equitable estate and a legal estate.

 

            1. Concurrent Ownership

 

                        A. 3 Types of Concurrent ownership

 

                                    1. Tenancy in Common

                                                a. An undivided interest in the property à “undivided ¼

                                                    interest”

                                                b. A co-tenant cannot adversely possess the land of another

                                                    co-tenant.  HOWEVER, may be possible if you tell other

                                                    party you are taking the land and they allow it.  If other

                                                    co-tenant says “NO”, then his rights kick in.

                                                c. Co-tenants rights:

                                                            (i) Co-tenant has to account to other co-tenant any

                                                                 revenues;

                                                            (ii) Each co-tenant has same amt of rights to

                                                                  develop the mineral estate.

                                                            (iii) If one co-tenant wants to develop and other

                                                                   does not…TX RULE (MAJ): No permission

                                                                   required from other co-tenant “if one wants to

                                                                   drill, then he can”.

 

                                                d. Rules of Co-tenancy:

                                                            (i) Developing party = Participating party

                                                            (ii) Nondeveloping party = Non-participating party

                                                                  b/c does not want to develop

                                                            (iii) Any co-tenant can develop w/o permission of

                                                                   other co-tenant.

                                                            (iv) RULE: An accounting must be made to the

                                                                   non-participating co-tenant.

 

                                                e. Prairie v. Allen

                                                            (i) Allen was tenant in common w/ Bob…Allen had

                                                                 a 1/10th interest and Bob had a 9/10th interest.

                                                            (ii) Bob wanted to develop the mineral by leasing to

                                                                  Prairie Oil.  Allen did not want to develop.  Bob

                                                                  can lease to Prairie w/o Allen’s permission.

                                                            (iii) Allen is a non-participating co-tenant.

                                                            (iv) RULE: Must account to the non-participating

                                                                  co-tenant of any revenues…and they are not

                                                                  responsible for the costs…but once the costs are

                                                                  recouped by the lessee, they are entitled to the

                                                                  % of their original co-tenant % of revenues.

                                                            (v) RULE: Mineral interest owner (Prairie Oil) has

                                                                 the right to recoup their expenses (costs) before

                                                                 the non-participating co-tenant can claim any

                                                                 revenues

 

                                                f. HYPO: Ted and Fred own undivided interest in land. 

                                                   Fred has a 1/10th interest and Ted has a 9/10th interest. 

                                                   Ted wants to develop and lease to Oil co.  Fred does not.

                                                   Fred is a non-participating co-tenant.  Oil company offers

                                                   a 20% RI.  Ted’s original stake in the property amounts

                                                   to 90% therefore Oil co now has a 90% interest.  Fred has

                                                   a 10% interest.  Ted’s 20% RI will come out of Oil Co’s

                                                   90%.  The cost of the well is $1 Million.  Fred will get

                                                   nothing from the revenues until Oil co recoups the 1

                                                   Million cost and pays Ted his 20% RI.  So, Fred won’t

                                                   receive a dime until Oil Co. makes 1.18 million.  That’s

                                                   b/c Ted’s RI payment will be 20% x 90% = 18% of 1

                                                   Million…which is $180K.

 

                                                g. HYPO: Suppose have 70% undivided interest…and            

                                                    other co-tenant has a 30% interest.  You want to lease

                                                    the mineral estate. 

                                                            (i) Lessee will incur the costs

                                                            (ii) Lessor will want to know the costs

                                                            (iii) Lessee has a working interest + net revenue

                                                                   interest

                                                            (iv) Lessee must pay RI at risk of dry hole + 30% to

                                                                   non-participating co-tenant

                                                            (v) As the non-participating co-tenants share

                                                                  increases, the less likely lessee will decide to

                                                                  take on the lease…b/c it will reduce his

                                                                  revenues.

                                   

                                                            (vi). Remedy:

                                                                        1. Try to get other co-tenant to ratify lease

                                                                                 a. he then becomes RI owner

                                                                                 b. But his share will come out of the RI

                                                                                     offered.  So, if owned 10% interest

                                                                                     in land, 10% 0f 20%RI. 

                                                                                     (10% x 20% = 2% RI).

                                                                                 c. 2% good if well is does not produce

                                                                                     much…get RI before co recoups

                                                                                     costs.

                                                                                 d. Better to keep original 10% if know

                                                                                     well will produce a large amt.

                                                                        2. Seek to Partition per TX §23.001

                                                                        3. Seek Partition by Sale – sell all of it…

                                                                            and one co-tenant buys all of it.  (Popular

                                                                            in TX).

                                                                        4. TX RULE: If co-tenants cannot agree...

                                                                             AS A MATTER OF RIGHT, the

                                                                             participating co-tenant can partition by

                                                                             sale (force sale of whole property).

 

                                                h. Executive Right / Non-executive owners

                                                           

                                                            1. Is the Right to develop.

                                                                        (i) Person w/ executive right has right to

                                                                             develop.

           

                                                            2. Each Co-tenant has right to develop

                                                            3. Co-tenant can, by deed reserve the executive

                                                                 right to develop to another family member…and

                                                                 give mineral interest to you…so only person that

                                                                 can develop is the one w/ executive right.

                                                            4. HYPO: O grants mineral interest to A but

                                                                reserves executive right.  O is the only person

                                                                who can develop the mineral interest.

                                                                        (i) O = Executive

                                                                        (ii) A = Nonexecutive

                                                           

                                                            5. Problem: Nonexecutive’s mineral interest is

                                                                worthless if Executive does not want to develop.

                                                            6. Solution: Duty of “Utmost Good Faith and

                                                                Fair Dealing Standard of care Executive owner

                                                                owes to Nonexecutive owner.

                                                                        (i) If you fail to lease estate that is being

                                                                            drained;

                                                                        (ii) If fail to enter into a lease when it is

                                                                              possible to do so (depriving           

                                                                              nonexecutive of revenue); OR

                                                                        (iii) If Executive develops the property

                                                                               personally when it was possible to lease

                                                                               it and gain more money for non-exec.;

                                                                        (iv) If fails to share the royalties by any sort                                                                                      of means (i.e, negotiate overriding

                                                                               royalty);

                                                                        (v) Failing to share signup bonus w/ non-

                                                                              exec.

                                                                 Then non-exec has a cause of action against exec

 

                                                            7. RULE: If someone comes to you w/ a reasonable

                                                                 lease, you have to take it so that non-exec can

                                                                 enjoy the interest (Only when have Exec/

                                                                 Non-exec situation).

 

            2. Successive Ownership

                       

                        A. Life Tenants & Remaindermen

           

                                    1. Life tenant – has freehold interest for his lifetime.

                                        Remaindermen – Owns the Corpus of the estate

 

                                    2. Problem: If life tenant wants to develop, remainderman has

                                        cause of action for “waste”.  If remainderman develops, life

                                        tenant has cause of action for “trespass”.

 

                                    3. Solution: (TX)

                                                (i) Both Life tenant AND Remainderman are required to

                                                     sign the lease.  (Remainderman ratifies lease)

                                                (ii) Unless otherwise agreed upon…the proceeds are

                                                      broken up into Income and Corpus

                                                (iii) Life Tenant gets all that is considered Income.

                                                (iv) Remainderman gets all that is considered Corpus.

                                               

                                                (v) Income = Delay Rentals (considered rent)

                                                (vi) Corpus = Bonus (investment in the whole = corpus)

                                                                       Royalties

                                                (vii) Process = Royalties and bonus are paid into escrow

                                                        account…interest earned on account goes to Life

                                                        Tenant.  Remainderman gets his share when Life

                                                        Tenant dies.

 

                                    4. Analysis:

                                                (i) Look to see when life tenancy was created

                                                            a. if lease was in effect before and at time life

                                                                tenancy was created = Life tenant gets everything

                                                            b. If lease created after life estate is established =

                                                                Remainderman gets bonus, royalty interest placed

                                                                into escrow…interest goes to life tenant…delay

                                                                rentals go straight to life tenant.

                                                (ii) Look at lease…if there is something in writing stating

                                                      that remainderman gets everything…language controls.

                                                (iii) If no language, then use “Open Mine Doctrine” –

                                                       Moore v. Vines

                                                (iv) Once the lease that is in effect at time life estate ends...

                                                       a subsequent lease voids the “Open Mine Doctrine”.

 

                                    5. Problem: If you cannot find the remainderman to sign the lease.

                                                (i) Tex Property Code = If made a diligent search for him…     

                                                     then Can go ahead and drill…but put funds in escrow.

                                                (ii) Exception – If property being drained, then life tenant

                                                      does not have to search for remainderman…can go

                                                      ahead and drill to defend mineral estate…BUT, still

                                                      has to put funds in escrow.

           

                                    6. Moore v. Vines

                                                (i) H& W leased Tract A and B…W died leaving life estate

                                                     to H.  Lease ended…H subsequently leased the property

                                                    again.  Remainderman sued for their share of profits.

                                                (ii) RULE (TX): If there was an open mine (lease) on the

                                                      mineral estate (producing well, or mineral estate under

                                                      lease) then the life tenant gets everything…b/c it must

                                                      have been the intention of the testator to give

                                                      everything to the life tenant.

                                                (iii) However, in this case, the first lease expired after the

                                                       the creation of life tenant…subsequent leases will

                                                       not get benefit of open mine doctrine.  Must pay to

                                                       remainderman.

                                                (iv) Open Mine Doctrine: “To open the land to search for

                                                       mines of minerals, is waste – a detriment to the

                                                       inheritance…BUT, if the mines were open BEFORE

                                                       the life estate is created, it is not waste for tenant to

                                                       continue to drill…b/c it is a mere annual profit from

                                                       the land.”

                                                (v) Summary: Don’t have to divvy up Delay Rentals,

                                                      Royalties or Bonus if the lease was in effect at time

                                                      life tenancy was created.  After life tenancy is created

                                                      you have to divvy up w/ the remainderman.

 

                        B. Trusts

 

                                    1. How it works:

                                                (i) Trust splits up the estate into:

                                                            1. person who gets MANAGEMENT (trustee);                                                                            AND

                                                            2. person who gets BENEFIT (beneficiary)

 

                                    2. Why use Trust accounts?

                                                (i) to prevent beneficiary from being careless w/ property.

 

                                    3. Parties

                                                1. Trustee – has management power (right to lease

                                                                    minerals)

                                                2. Beneficiary – receives benefits (only collects benefits)…       

                                                                           cannot manage.

 

                                    4. TX Trust Code

                                               

                                                a. §113.012 (Rights of Trustee):

                                                            1. Right to enter into mineral transactions (leases)

                                                            2. Trustee does not have to get permission of

                                                               beneficiary (as opposed to having to get

                                                               permission of remainderman by life tenant)

                                                            3. If trust states otherwise, then language of trust

                                                                controls

           

                                                b. §113.007 (Divvy of Proceeds):??? :Look in Suppl!!!

                                                            1. 72.5% of bonus & royalties goes to beneficiary

                                                            2. 27.5% goes to subsequent beneficiaries.

                                                            3. All delay rentals (income) go to beneficiary

                                                                100% of them.

 

X. OIL/GAS Lease

 

            1. In General

           

                        a. General Rule: Lessee (oil/gas company) writes the lease b/c they want                                        the minerals.  Most of the provisions will be for the benefit of lessee.

 

                        b. Goals of Lessee:

                                    1. Wants OPTION, not obligation to develop over specified term.

                                                a. option b/c there is tendency to lease before finding out if

                                                    minerals are there.  Want to lease before some other

                                                    company does…and if there are no minerals, then don’t

                                                    want to develop.

                                                b. Specified term b/c need time to explore, get money.

 

                                    2. Establish production + maintain lease + cost free for as long as it

                                        is economically viable.

                                                a. TX à Production = Sales…you are not producing until

                                                    selling and making money.

 

                        c. Lease = Deed + Contract

                                    1. Contract Requirements:

                                                (i) Legal Consideration;

                                                (ii) Mutuality of Agreement

                                                (iii) Mutuality of Obligation (both sides must do something
                                                (iv) Competent parties

                                                (v) Subject matter

 

                                    2. Deed

                                                (i) it’s a conveyance b/c Lessor transfers title to mineral

                                                     estate to lessee

                                                (ii) Lessee has right to use land, but also has right to take

                                                      the minerals

                                                (iii) Lessee’s rights are not limited to term of years…they

                                                      are limited to how long the well produces

                                                (iv) Lessee’s rights are not exclusive…has to share surface

                                                       w/ surface owner.

                                                (v) Lease creates a Fee Simple Determinable in minerals.

                                                      (Fee Simple but w/ automatic termination at occurrence

                                                       of stated event). à Once production stops.

                       

                                    3. Summary: Deed b/c lessor transfers title to minerals…Contract

                                         b/c lessor bargains for certain benefits (RI, bonus, DDR)

 

                        d. The Transaction:

                                    1. Lessor conveys over right to develop – loses this right

                                    2. Lessee gives lessor = bonus, DDR, RI

                                    3. Consideration for right to develop = bonus, DDR, RI

                                    4. Primary term = time to establish production à about 3 yrs

                                    5. Secondary term = once establish production, get to keep lease

                                    6. Lessee pays: 100% costs, gets 100% of return – RI

                                    7. Lessor gets: RI, has no risk, bonus, DDR…does not have to do

                                        anything.

 

            2. The LEASE

 

                        a. Granting Clause

                                    (i) Sets forth the right that mineral owner grants to lessee (rt to

                                         develop)

 

                                    (ii) Requirements:

                                                a. Must identify size of interest granted

                                                b. Must identify substances covered

                                                c. Must identify the land that is covered

 

                                    (iii) Should identify w/ specificity

                                                a. Problem: if say for “development of oil/gas and other

                                                    minerals” à lessee can develop uranium…even though

                                                    you wanted oil.

                                                b. So, if want to limit to oil/gas à Say “oil, gas and other

                                                    hydrocarbons.”

                                    (iv) If want to limit lessee to develop only one level of strata

                                                a. Can limit lessee to depth & geographically

                                                b. Can limit them horizontally and vertically.

                                    (v) So, lawyer should tell lessor that he can restrict lessee in

                                          the kinds of minerals mined + area in which he develops.

                                    (vi) RULE: If you don’t place restrictions in granting clause, it is

                                           assumed that you leased everything to the center of the earth.

 

                        b. Mother Hubbard Clause

                                    (i) To sweep up SMALL contiguous pieces of land that were left

                                        out of the Granting clause

                                    (ii) Purpose: to cover surveying flaws

                                    (iii) Requirements:

                                                1. Small parcels that were left out of granting clause

                                                2. Must be contiguous w/ the land (adjacent)

 

                                    (iv) NOTE: If parcel is BIG, then does not get included.

 

                                    (v) 5 Counterveiling principles that limit what a lessee can do

                                               

                                                1. Lessee’s use of surface estate must be reasonable.

                                                            a. Has to be use towards development of minerals

                                                            b. Cannot build icehouse & serve beer.

                                                2. Use has to be in accord w/ the Accommodation Doct.

                                   

                                                3. Activities have to be for Benefit of the minerals under

                                                    that particular leased land.

                                                            a. Have easement over surface for the minerals

                                                                under that surface estate.

                                                            b. Can build roads, pipeline, etc.

                                                            c. HYPO: Lessee has well on Tract A, he can build

                                                                pipeline on Tract A.  Lessee has lease on Tract B,

                                                                à Lessee cannot extend pipeline from tract A

                                                                onto Tract B.  Pipeline on Tract A is for benefit

                                                                of minerals on Tract A, NOT tract B.

                                                                        (i) Could seek to get B’s permission.

                                                            d. HYPO: Lessee has well on Tract A and Tract B.

                                                                 Lessee cannot lay continuous pipeline and carry

                                                                 A’s gas over B’s land.

 

                                                4. Activities have to fall in Accord w/ terms of the lease.

 

                                                5. Has to be in accord w/ applicable statutes, ordinances

                                                    and RR commission rules.

 

                        c. Habendum Clause (favors lessee)

                       

                                    (i) States Primary Term + Secondary Term

                                    (ii) Idea: Once production is established, want to hold lease.

                                    (iii) TX: to hold a lease, Production must be PIPQ

                                                a. PIPQ = profit, no matter how small, that exceeds

                                                    operating expenses.

                                    (iv) Lessor worried that lessee will “hold by production”…should

                                           seek to restrict in granting clause.

                                    (v) Lessor wants small Primary Term

                                    (vi) Lessee wants larger Primary Term

 

                                    (vii) Clifton v. Koontz (2 step Test) - PIPQ

                                                a. Clifton leased to oil co w/ primary term of 10 years. 

                                                    He claimed that lease terminated b/c for several months

                                                    the well was not making a profit.  Clause in lease stated

                                                    that upon cessation of production…get 60 days to

                                                    re-establish production.

                                                b. Rule: If well pays profit, even small, over operating

                                                    costs, it produces in paying quantities, even though it

                                                    may never repay its costs and enterprise as a whole may

                                                    prove to be unprofitable.

                                                c. Factors for determining PIPQ:

                                                            (i) price which lessee is able to sell minerals

                                                            (ii) relative profitableness of other wells in area

                                                            (iii) operating & marketing costs of lease

                                                            (iv) net profit & lease provisions

                                                            (v) reasonable period of time under circumstances

                                                            (vi) whether lessee is holding for mere speculation

                                                d. Test:

                                                            Prong 1: If over a certain time frame, operating

                                                                        revenues from the well are exceeding

                                                                        operating expenses…then As a Matter of

                                                                        Law…you have PIPQ (get to keep lease)

                                                                                 a. Revenues = Net Royalty Interest

                                                                                     (Royalties paid out) + Overriding

                                                                                      Royalty interests (lessee hires

                                                                                      another party to do something)

                                   

                                                                                 b. Expenses = Key is “Regularity”

                                                                                     à Taxes; Labor costs (ex: paying

                                                                                      someone to examine well, etc);

                                                                                      Repairs; Pumping costs

                                                                                    à NOTE: Capital Costs are NOT

                                                                                     included!!! (i.e., bonus, Cost to drill

                                                                                     well; Replacing equipment;

                                                                                     completing well à things that occur

                                                                                     only ONCE!!)

 

                                                                                 c. Lessor has burden of proof!!!

 

                                                            Prong #2:  RPO Standard. 

                                                                        a. Answer to Prong #1 is à Negative profits

                                                                        b. If a RPO who expected to make profit

                                                                            would continue to operate…THEN keep

                                                                            lease.

                                                                        c. Operator must not be speculating à

                                                                           knowing there are minerals, but just

                                                                           holding property until value goes up???

                                                                        d. EX: market right now is $10 barrel but

                                                                            operator knows there have been times that

                                                                            price was $40…could hold onto lease.

                                                e. Lessor:

                                                            (i) wants lease to revert back so he can re-lease it

                                                            (ii) does not want “holding lease by production”

 

                                                f. Lessee:

                                                            (i) wants to maximize profit

                                                            (ii) more time to rework well

 

                                                g. HYPO: Suppose have 2 wells, on same lease, same

                                                    lessor + same lessee…One of the wells fails the 1st prong

                                                    …the other well passes the 1st prong…but together, they

                                                    both fail the 1st prong.  What do you do?

                                                            (i) Gas Ridge v. Suburban Agricultural Products

                                                                 150 F.2d 363 (1945)

 

                        d. Drilling Delay Rentals (Savings Clause)

 

                                    (i) You are in secondary term once you drill well and have

                                         production.

                                    (ii) Satisfies lessee’s need to have option but not obligation to

                                          develop.

                                    (iii) May pay DDR before the 1st anniversary during Primary term.

                                    (iv). This extends time to do something for another year.

                                    (v). Can do this for each year in the primary term

                                    (vi) Considered RENT

                                    (vii) By eve of 3rd year, you have to either establish production or

                                            begin drilling a well.  (By 3rd year, must do something)

                                    (viii) Problem: Lessor wants a SHORT Primary Term

                                                               Lessee wants LONG Primary Term

                                    (ix) NOTE: Way of restricting Lessee à

                                                a. In granting clause…or stipulate minimum dollar amount                                                              for lessee to pay in order to stay in lease. 

                                                b. In last paragraph of DDR clause à insert a “Release”

                                                    provision = Lessee can give a portion of land back to

                                                    Lessor and not have to pay DDR…Allows Lessee to

                                                    release pieces of mineral estate that doesn’t want…

                                                    Lessor can then lease it to others.

                                    (x) Requirements for DDR:

                                                1. Must be paid at Proper Time

                                                2. To proper person

                                                3. In proper amount

                                                X. Under CL, if any one is violated, then lease terminates.

                                                Y. Today, if problem is rectified w/in 30 days OR if

                                                     payment is made late, and lessor accepts it…lease

                                                     continues.

                                                Z. RULE: If payment is Late, To wrong person, or Not in

                                                    proper amount à Lessor has to give Lessee notice.

                                   

                        e. Cessation of Production Clause (Savings) – Sect. 6

 

                                    (i) Must have PIPQ to get benefit of.

                                    (ii) Situation: Have PIPQ… then have mechanical problems…

                                          causing you to have to cease production…clause allows lessee

                                          to go for period of time, w/ no production, and lease continues.

 

                                    (iii) Requirements:

                                                1. Must establish PIPQ

                                                2. Then can use Sect. 6

                                                3. Have 60-90 days to get production re-established

                                                4.  If so, then keep the lease

                                                5. Lessor Must give NOTICE to Lessee that he knows

                                                    lessee has gone beyond the 60-90 day period…and

                                                    lessee has time to cure it.

           

                                    (iv). HYPO: suppose you drill a dry hole à Cannot use Cessation

                                            of production b/c have not established PIPQ. + Cannot use

                                            continuous operations clause b/c out of Primary Term

 

                        f. Continuous Operations Clause

 

                                    (i) Anniversary date passes & lessee does not establish production.

                                         Production = Sales.

                                    (ii) As a Matter of Law à you can invoke the continuous

                                         operations clause “as long as you are out there operating, w/o a

                                         break in operation (say 60 days), you can continue to hold lease.

                                    (iii) It does not matter when you start…it can be on the last minute

                                          of midnight on eve of 3 year anniversary of Primary Term.

                                    (iv). Requirements

                                                1. Must be Activity on the lease;

                                                2. Designed to complete a productive oil/gas well

 

                                    (v) What constitutes Operations?

                                                1. Clearing land for drilling rig.

                                                2. Things designed to complete a productive oil/gas well.

                                    (vi) What does not constitute Operations?

                                                1. Drilling a water well rig…b/c must be designed to

                                                    complete oil/gas well.

 

                                    (vii) Special Note: You don’t have to actually complete well…the

                                            operations must simply be designed to complete oil/gas well.

 

                                    (viii) Further: If start drilling on eve of 3rd year…can use

                                             continuous operations clause…then if establish PIPQ…

                                             and then have problems…can use cessation of production

                                             clause.

 

                        g. Dry Hole Clause – (Savings) – sect. 6

 

                                    (i) If drill a dry hole à have 60 days to do something.

                                    (ii) don’t have to be continuously working during the 60 days

 

                                    (iii) Can wait until 59 ½ day to do something

                                    (iv) You can decide to move the well to another location.

 

                                    (v) Advantage: If drill dry hole, have 60 days to evaluate, then

                                         on the 59 ½ day you can move and start drilling in another

                                         location on lease…then get benefit of Continuous operations

                                         clause (as long as your doing something)

                                    (vi) Can go from drilling dry hole à 60 days à move à

                                           continuous operations clause à dry hole à 60 days à

                                           move à continuous operations clause.

 

                                    (vii) Reality – Don’t want to keep spending money if not going to

                                            pay out.

 

                        h. Shut-In Royalty Clause – (Savings) – Sect. 4

 

                                    (i) Applies to Natural Gas ONLY!!!

                                    (ii) Situation: have a well capable of PIPQ, but can’t sell b/c don’t

                                          have a pipeline hooked up.

           

                                    (iii) Requirements:

                                                1. Well capable of PIPQ (must file well completions test

                                                     proving PIPQ)

                                                2. If make SIR payment

                                                3. in X amount of days

                                                4. Extends lease for another year…(giving time to connect

                                                    to pipeline)

                                                5. Must be done in good faith (good faith effort to establish

                                                    sales)

 

                                    (iv) As a Matter of Law à SIR clause assumes lessee is making

                                           good faith effort to establish sales.

 

                                    (v) NOT GOOD FAITH = if pipeline is ¼ mile away (Close-by)

                                          and you are not doing anything

                                    (vi) Good faith = if pipeline is 20 miles away (far) then good faith.

 

                                    (vii) Clause does not apply to Oil b/c oil can be hauled by trucks to

                                             sell.

 

                                    (viii).  RULE: If have PIPQ + a pipeline à Don’t have to sell if a

                                                RPO would not do so.

                                                            1. ex: if RPO decides market conditions are not

                                                                good…then can make a SIR payment…extend

                                                                one year…must in good faith show market

                                                                analysis shows not good time to sell.

 

                        h. Pooling Clause – (Savings) – Sect. 5

 

                                    (i) Must have common reservoir

                                   

                                    (ii) Situation: Lessee A and Lessee B are drilling on a common

                                          reservoir…they can pool the leases.

 

                                    (iii) Effect: Whatever happens on A’s lease happens on B’s lease

                                            and vice versa. à If operations have begun on A’s lease…                                                       then operations have begun on B’s whether or not literally

                                            true. (protection against Primary Term deadline, etc.)

 

                                    (iv) Divvy Of Shares: Once pooled, each lease is equal…any

                                           royalties, expenses, or revenues are divided equally b/t

                                           leases…if there is no writing to contrary.

 

                                    (v). HYPO: A has ¼ Royalty…B has 1/5 Royalty…Each owns 100

                                           acres. (combined is 200 total)

                                                1. Calculation = 100/200 x ¼ x Production revenues                                                                       a. equals A’s share

                                                2. Calculation = 100/200 x 1/5 x Production revenues

                                                            a. equals B’s share

 

                                    (vi) Special Note: If lease was NOT pooled…and well was drilled                                                   on B’s land only…then A gets nothing.

                                                (i) TX is a non-apportionment state

                                    (vii) If leases NOT pooled…then revenues from that particular

                                            lease go only to that lessee.

 

                                    (viii) Why pool?

                                                1. Protect from drainage

                                                2. Allows lessee to hold lease w/o doing anything as long

                                                     as other lessee is working.

                                                3. Benefits Lessor who cannot get a drilling permit b/c his

                                                    acreage is too small.

                                                            (i) Hypo: A owns 40 acres…B owns only 10 acres

                                                                 …B may not be able to get drilling permit…so

                                                                 should pool (must have common reservoir)

                                                                        calculation (B) = 100 ba/day x ¼ x 10/50

 

                                    (ix) HYPO: A and B each have 10,000 acres…decide to pool…

                                           now have 20,000 acres total…drill one well on A’s land…

                                           well covers only 40 acres.

                                                (i) PROBLEM: One crappy well can hold the entire

                                                     20,000 acres by production.

 

                                                (ii) Solution: Tough Shit!!! à in TX, it is your god given

                                                      right to pool.

                                                            a. Unless the Lessor specifically negates pooling in

                                                                lease, it is presumed to allow pooling.

 

                                    (x) Limiting Pooling (lessor)

                                                1. Granting clause – limit acreage you will lease

                                                2. By using Pugh Clause – limit pooling to certain amt of

                                                    acreage.  Ex: “you can pool up to 640 acres”

                                                3.  If lease lapses w/ nonproduction, pooled acreage

                                                     continues under lease, rest reverts to lessor.

 

                        i. Force Majeure Clause (Savings)

 

                                    (i) Unforeseen Major Event

                                    (ii) Act of God/Gov’t

                                    (iii) Keeps lessee from operating

 

                                                a. Unforeseen = if floods regularly in that location, then not

                                                    unforeseen…it was foreseeable that it would flood

           

                                                b. God/Gov’t = earthquake, tornado, other natural disaster.

                                                            a. Gov’t = war breaking out.

                                                                        (i) NOTE: there is a difference b/t a statute

                                                                            on the books and war breaking out. 

                                                                                 Gov’t statute = NOT unforeseeable.

 

                                    (iv) Function: Tolls the lease for reasonable time

                                    (v) Lessee should give NOTICE to Lessor that Event has occurred

                                   

 

                        j. SUMMARY à 7 Types of Savings Clauses

                                    1. DDR

                                    2. Cessation of Production

                                    3. Continuous Operation Clause

                                    4. Dry Hole

                                    5. Shut-in Royalty

                                    6. Pooling

                                    7. Force Majeure

 

                        k. Royalty Clause – (Lessor) – sect. 4

 

                                    1. Rules:

                                                (i) Merchantable Gas/oil

                                                (ii) Option to sell on lease…or off lease

                                                            a. If sold off lease = sales price – transportation cost

                                                            b. If sold on, then market value at well

 

                                    2. HYPO: Have a mediocre well that produces 500 ba/d.  Lessor

                                        has 1/5 royalty.  How many barrels a day would be attributable

                                        to lessor?

                                                (i)  Ans: 100 barrels

                                                (ii) Money = 100 x 365 = 30,000 barrels/yr.

                                                            à If price per barrel = $35, then

                                                            à 30,000 x $35 = $1,050,000

 

                                    3. Typical Royalty = 1/8 à ¼

                                                (Avg = 1/5 – 1/6)

 

                                    4. NOTE: Royalties are free from cost of production

           

                                    5. Calculation =  Royalty fraction x barrels/day x price per barrel

 

                                    6. HYPO: If you sold gas for $5 NCF at market area…if costs $1

                                        NCF to get to market…its value is $4 at well

                                                (i) So, the $4 would be the value to use in calculating the

                                                     Royalty payment

                                                (ii) Lessee can subtract cost of transportation from lessor’s

                                                      royalty share.

 

                                    7. RULE: Whether you sell it at market or sell at lease…price you

                                        use to calculate RI is value at well.

                                   

                                    Gas Royalty Clause

                                                a. Unlike oil, lessor cannot take his royalty share of gas

                                                     production in-kind.

                                                b. It cannot be readily stored above ground…it must be

                                                    produced into a pipeline

                                                c. costs of making merchantable can be deducted from

                                                    the royalty share.

                                                            (i) have to take out the hydrogen sulfide, water, etc

                                                d. NOTE: this is unlike oil production, b/c oil can be

                                                    stored above ground and therefore, RI owner can

                                                    take his share in-kind and market himself.

                                    8. RULE: Natural gas has to be sold as Merchantable product.

 

                                    9.  Pineywoods

                                                (i) RULE: costs of making gas merchantable can be

                                                    deducted in Pro-rata share from Royalties…based on

                                                    market value at the well.

                                                (ii) Costs to make merchantable = treating costs,

                                                      conditioning costs.

                                                (iii) Shell had to turn “sour” gas into “sweet” gas to be

                                                       merchantable…BUT, they were subtracting these costs

                                                       from the K price (actual proceeds received), not the                                                                  price of market value at the well.  The K price was                                                                    lower than the market value at well…so they were                                                  screwing lessor out of money.

 

                                    10. If representing Lessor:

                                                (i) Place in lease that Lesee bears costs of conditioning.

 

                        L. Surrender Clause – Sect. 3

                       

                                    (i) Allows you to release the acreage

                                    (ii) Purely benefits lessee

                                    (iii)Allows him to release acreage he feels is not productive

                                    (iv) Advantage – less acreage he’ll have to protect against drainage

 

                        M. Offset Well Clause – Sect.7

 

                                    (i) Requires lessee to drill a well

                                    (ii) NOTE: granting clause only gives option to drill

                                    (iii) RULE: if well is produced in paying quantities on adjacent

                                           land…and drilled 500 ft + draining lease premises, then lessee

                                           MUST drill offset well…IF a RPO would drill

 

                                    (iv) RPO Standard:

                                                1. Must act in good faith

                                                2. As a competent operator (just have to be avg)

                                                3. With Due Regard for lessor’s interest (have to balance

                                                     your actions w/ lessor’s interest)

                                                            a. If take action that harms lessor’s interest, then

                                                                NOT RPO!!!

 

                                    (v) Analysis:

                                                1. Is Lessor being harmed?

                                                2. Am I acting as competent operator? (RPO)

 

                                    (vi) HYPO: Have a common reservoir…well drilled on adjacent

                                           land…draining reservoir…Does lessee have to drill offset

                                           well? – MUST decide if RPO would do so…Probably so.

 

                                    (vii) KNOW: when looking at implied covenants to protect against

                                            drainage…MUST look at in context of sect.7 (RPO)

 

                        N. Assignability Clause – Sect. 8

                                    (i) allows lessor/lessee to assign their rights

 

                        O. No increase in burdens clause – Sect.8

                                    (i) Context = If lessor assigns interest to others

                                    (ii) RULE: lessor may assign interest to others (ie., charity)

                                    (iii) PROBLEM: would mean that lessee would have to pay

                                          DDR + royalties to all interest holders.

                                    (iv) Solution: Clause allows lessee to say it increases his burden

                                           so he does not have to pay out to each interest holder…he can

                                           just pay to original lessor…then lessor has to divvy up and

                                           distribute to other interest holders.

 

                        P. Subrogation Clause – Sect. 9

 

                                    (i) Situation: Lessee steps into shoes of lessor

                                    (ii) Context: If lessor fails to make a payment such as taxes.

                                    (iii) Lessee can pay the taxes of lessor, to prevent loss of the land

                                           …then can deduct the taxes from the profits from well before

                                           calculating royalty share.

           

                        Q. Section 10 – If there is a breach

 

                                    (i) Lessor must give NOTICE to lessee of breach and allow lessee

                                         time to cure it.

 

                        R. Summary:  Know:

                                    1. Object of leasing operations

                                    2. Purpose of granting clause

                                    3. Habendum clause + how affects parties

                                    4. DDR payments

                                    5. Royalties – how clause works + not restricted on where you sell

                                        the gas.

                                    6. Administrative clauses

                                    7. If represent Lessee – what would you put in lease

                                    8. If represent Lessor – what to include + what to take out

                                    9. Know where clauses are + what they do

                                    10. EXAM Question = Express languages in lease

 

                        S. NOTE:

                                    (i) What is left out of a lease, may be covered by an Implied

                                         Covenant!!!

 

XI. Implied Covenants

 

            1. General:

                        (i) Designed to protect Lessor!!!

                        (ii) So leases are not 100 pages long.

 

            2. Why have Implied Covenants?

                        A. To cover Fundamental Uncertainties

                        B. Differing interests b/t lessor/lessee

                                    (i) Lessor wants option to drill…but may not have money

                                    (ii) Lessee wants payment…+ protection from drainage

                                    (iii) Express language of lease protects lessee!!

 

                        C. Types of Implied Covenants

                                    1. Implied in Law:

                                                (i) Obligation arises out of relationship of parties

                                                            a. One party might be stronger than other.

 

                                    2. Implied in Fact:

                                                (i) Obligation arises out of conduct of parties

                                                (ii) Based on Intent of parties

                                                (iii) NOTE: Easier to negate!!!

                                                (iv) KNOW: Oil/gas lease covenants are implied in FACT.

                                                            a. Allows lessee to negate implied covenants easier.

                                                            b. Lessee can do this by express language in lease.

 

                        D. What obligations are Implied?

                                                1. to protect against drainage

                                                                2. to reasonably develop leasehold

                                                                3. to market product (effort to get a good price, not best)

 

                                    1. NO Implied covenant to Drill a Test well.

                                                a. Lost w/ the advent of DDR clause.

                                                b. Lessor should place directly in the lease, that there is

                                                    an obligation to drill. + limit primary term + limit in

                                                    granting clause.

 

                                    2. Duty to Protect against Drainage (What a RPO would do)

 

                                                a. Requirements: (Lessor must show)

                                                            (i) Must be Substantial Drainage (amt worth

                                                                 pursuing)

                                                            (ii) Must show that an Offset well would be

                                                                  profitable OR some type of Administrative

                                                                  action

                                                                        a. If not profitable, no duty to drill offset

                                                                            b/c RPO would not do so.

                                                            (iii) Damages = Lost Royalties

                                                            (iv) NOTE: Paying DDR will not negate duty to

                                                                   protect against drainage!!!

 

                                                b. Special NOTE on Express Offset Clause

                                                            (i) Clause in lease that talks directly about drainage

                                                            (ii) Situation: “(1)If well is drilled w/in X amt of                                                                    feet from leaseline; AND (2) it’s draining…then

                                                                  have to drill offset well.”

                                                            (iii) NOTE: Only applies during Primary term…

                                                                   once in secondary term à Implied duty to

                                                                   protect against drainage begins.

 

                                                            (iv) HYPO: Well is drilled on adjacent land over a

                                                                   common reservoir…but is at a distance greater

                                                                   than expressed in clause…You have no duty to

                                                                   drill offset well.

                                                            (v) Lessee wants = smaller distance from

                                                                  leaseline.

                                                            (vi) Lessor wants = greater distance.

                                                            (vii) HYPO: clause states 500’ from leaseline…

                                                                    adjacent land well is drilled 700’ from

                                                                    leaseline…If in primary term, Express offset

                                                                    clause controls and no duty to drill offset well.

 

                                                            (viii) Exception ( Common Lessee)

                                                                        a. Have one lessee and 2 lessors

                                                                        b. RULE: have to treat each lessor as if

                                                                            only lessor (as an individual)

                                                                        c. Express Offset Clause will NEVER

                                                                            negate implied covenant do protect

                                                                            in this situation!!!

                                                                        d. Still have to show (1) substantial drainage

                                                                            (2) Offset would be profitable; (3) lessor

                                                                             has burden to prove.

 

                                                                        e. Amoco v. Alexander – Amoco had leases

                                                                            in same field w/ Alexander and other

                                                                            lessors (common lessee).  Field was a

                                                                            “water-drive” field (as oil is taken, water

                                                                            pushes oil upward to highest point). 

                                                                            Alexander owned a “down dip” lease…so

                                                                            as oil is taken from “up dip” leases,

                                                                            Alexander’s lease gets watered out faster

                                                                            (drainage).  Amoco was favoring the up-

                                                                             dip lease b/c lessor had a smaller RI.

                                                                                 1. Rules: Duty to protect from field-

                                                                                      wide drainage;

                                                                                 2. Lessee must act as RPO and seek 

                                                                                     Rule 37 permits to drill replacement

                                                                                     wells if drainage occurring.

                                                                                 3. Failure to act as RPO by not seeking

                                                                                     Rule 37 permits is liable for loss

                                                                                     caused by failure to drill.

                                                                           Rule 37 – in order to prevent waste…will

                                                                           grant exceptions to permit drilling w/in

                                                                           shorter distance than prescribed by RR

                                                                           commission.

                                                                                 4. Exemplary damages are not allowed

                                                                                     b/c must have a tort cause of action.

                                                                                 5. RPO standard applies to each

                                                                                     individual lessor.  (per lease basis)

                                                                                 6. Have to act w/ interests of your

                                                                                     lessor in mind as if it were your only

                                                                                     lessor.

 

                                                c. No duty to Inform Lessor of drainage!!!

 

                                                d. Profitable = Whether RPO would drill…NOT PIPQ

                                                            (i) PIPQ is a lower standard

                                                            (ii) An RPO would seek higher prices than PIPQ

                                                                        a. What kinds of revenues are being made

                                                                             in the area

 

                                                e. Lessee

                                                            (i) Wants small legal distance

                                                            (ii) Put in lease, a clause that expressly negates

                                                                  implied covenant to protect

 

                                                f. Lessor

                                                            (i) Wants Large legal distance

                                                            (ii) Express clause “no matter what term, you will

                                                                  drill certain number of wells.”

                                                                        a. Only works w/ wealthy lessors

                                               

                                                g. Advising Lessor

                                                            If being drained –

                                                                        1. Get copy of lease

                                                                        2. Check for Express Offset clause

                                                                                 a. Is lease in Primary Term?

                                                                                                Yes – Express Offset negates

                                                                                                           Implied duty to protect

                                                                                                BUT- if common lessee, then

                                                                                                          Express offset does not

                                                                                                          control.  Still have duty

                                                                                                           to protect

                                                                                                NO – Implied duty controls

                                                                                                            a. Substantial drain

                                                                                                            b. Offset profitable

                                                                        3. It’s expensive to prove this by hiring

                                                                            experts…so talk to lessee first

                                                                                 a. Might give you exploration records

                                                                        4. If litigate and win à get Royalties OR

                                                                            cancellation of lease + damages OR force

                                                                            lessee to drill offset.

                                                h. NOTE: Drainage is the easiest breach of covenant to

                                                    prove!!!  All others are hard to prove.

 

                                    3. Implied Covenant to Reasonably Develop

                       

                                                a. Requirements: (Lessor must show)

                                                            (i) Must obtain production first!!

                                                            (ii) Must show that further development of reservoir

                                                                 would be profitable for lessee

                                                            (iii) Profitable = what a RPO would do

                                                            (iv) That Lessee is acting imprudently (not as RPO)

                                                                        a. lessee is incompetent (financially or

                                                                            technically)

                                                                        b. lessee is speculating (knows he can hold

                                                                            the lease and come back and drill later…

                                                                            not looking out for lessor’s interest)

                                                                        c. How to show?

                                                                                 1. drilling nearby (RPO would drill)

                                                            (v) IF lessor proves this, then Lessee has to drill a

                                                                   development well.

 

                                                b. Development well vs. Exploratory well

                                                            (i) Exploratory well is the first well you drill.

                                                            (ii) The next well that is drilled nearby + in same

                                                                  reservoir + to same depth (strata) = development

                                                                  well.

                       

                                                            (iii) NOTE: if drilled to different strata …then its

                                                                   constitutes an exploratory well.

                                                            (iv) Summary:

                                                                        1. Must have successful exploration well

                                                                        2. Development well = Same Reservoir +

                                                                        3. Relatively nearby horizontally +

                                                                            vertically

                                                            (v) NOTE: there is no implied covenant to explore.

 

                                                c. Advise Lessor

                                                            (1) If in negotiating stage of lease

                                                                        (i) Put in lease à Continuous Development

                                                                             clause + Retained acreage clause

                                                                                 a. “once you drilled development well,

                                                                                      w/in 90 days you have to drill

                                                                                      another well…if don’t, then lease

                                                                                      lapses, BUT you retain the well that

                                                                                      was drilled + 160 acres”

                                                                                 b. If lessee drills another well, gets

                                                                                     additional 90 days to drill 3rd well…    

                                                                                    and so on.

                                                                        (ii) Allows lessee to release land + lessor to

                                                                              be able to re-lease land.

                                                                        (iii) Advise lessor to look into financial

                                                                               strength of lessee

                                                                                 a. If not strong à use these clauses.

 

                                                d. Express language in lease

                                                            1. Will control over any implied covenant

                                                                        a. so if have express language that negates

                                                                            an implied covenant, the language

                                                                            controls.

 

                                                            2. Gulf v. Kishi

                                                                        a. Gulf had 2 leases w/ Kishi…in lease #1,

                                                                            there was a clause which stated the

                                                                            12 wells were to be drilled…in lease #2

                                                                            which stated that 4 wells were to be

                                                                            drilled w/in a time period.

                                                                        b. Lessee proved that they had developed all

                                                                            of the required wells

                                                                        c. Kishi argued they had duty to reasonably

                                                                           develop further.

                                                                        d. RULE: if lease expressly states number

                                                                            of wells to be drilled…then implied

                                                                            covenant to reasonably develop does not

                                                                            apply.

 

                                                e. No duty to further explore!!!

                                                            1. Possible exception – Dictum in Clifton v. Koontz

                                                                        a. Where have large tracts of land, w/ very

                                                                             little drilling à duty to further explore

           

                                                            2. Sun v. Jackson – Shot down Clifton dictum that

                                                                stated duty to further explore.

                                                                        a. Had Large leasehold…but Sun Oil was

                                                                            only developing a small field w/in the

                                                                            lease.

                                                                        b. Ct held = We would be forcing lessees to

                                                                             drill in areas w/o knowing whether they

                                                                             would be profitable…We won’t do this!”

                                                                        c. RULE:  No implied covenant to explore.

 

                                                f. Lessors Remedy:

                                                            1. Limit acreage in granting clause

                                                            2. Put in lease à continuous development clause +

                                                                retained acreage clause.

 

                                    4. Implied Covenant to Market leasehold Production

                       

                                                1. Applies ONLY to NATURAL GAS!!!

                                   

                                                2. Issues:

 

                                                            a. Timing

                                                            b. Price

 

                                                3. General – If have gas well, lessor sells gas along w/

                                                    lessee’s b/c gas cannot be easily stored above ground…

                                                    have to send in pipeline…So we just give lessor his share

                                                    from the sale.

                                                            (i) lessor has to go along w/ lessee

                                                            (ii) Lessor dependent upon lessee to act in due

                                                                  regard for his interest

                                                            (iii) Lessor cannot sell the product himself!!!

 

                                                            (iv) Oil can be stored in above ground tanks…so

                                                                   lessor can take his share in-kind.

 

                                                4. Requirements:

                                                            1. Have to market production w/in Reasonable Time

                                                            2. AND at Reasonable Price

                                                            3. Acting in Due Regard for lessor’s interest

 

                                                5. Timing Issue:

 

                                                            (i) Shut-in cases:  Lessee might shut in well b/c

                                                                cannot connect to a pipeline.

                                                            (ii) If lessee speculating – knows that adjoining

                                                                  acreage has gas underneath…but does not

                                                                  want to connect the lessor’s well to pipeline

                                                                  b/c does not want to make it public knowledge

                                                                  that there is gas in this field…THEN he is

                                                                  NOT acting in Due Regard for Lessor and is

                                                                  in violation of Implied covenant to market.

 

                                                6. Pricing Issue:

                                   

                                                            (i) Must sell at a Reasonable price

                                                                        a. Does not mean Highest price.

                                                            (ii) What a RPO would sell for.

                                                            (iii) Must treat the individual lessor fairly!!!

 

                                                            (iv) Amoco v. First Baptist

                                                                        a. Amoco entered into long-term gas

                                                                            contract w/ buyer.  BUT, gas prices

                                                                            fluctuate.  At time of signing, the price

                                                                            was reasonable…but later, price was

                                                                            way below market value. 

                                                                        b. Amoco made deal w/ buyer under

                                                                            lease #1 that if buyer gives them a

                                                                            higher price…they would guarantee

                                                                            a price below market value for lease #2

                                                                            owned by First Baptist. 

                                                                        c. HELD: Violation of Implied duty to

                                                                            Market…Not acting in due regard for

                                                                            lessor #2 in getting reasonable price…

                                                                            which is Market value.

                                                                        d. Amoco had duty to sell at reasonable

                                                                            price…NOT a fiduciary duty to sell

                                                                            at highest price.

 

                                                                        e. Similar to Amoco v. Alexander: talked

                                                                            about drainage, & this talks about

                                                                           marketing (sales), analogous b/c lessee

                                                                           was doing prudent thing big-picture wise,      

                                                                           but on lease by lease basis he was not

                                                                           acting w/ due regard to his individual

                                                                           lessors….lessors relied on Amoco.  

           

                                                            (v) Reasonable = Market value

 

                                                7. Remedies for breach of covenant to market

           

                                                            A. Failure to market in reasonable time

                                                            (i) Lessor (Baptist) will ordinarily claim that lease

                                                                 has ended.

                                                            (ii) If claim brought in Primary term, lessor will ask

                                                                  ct to exercise equity powers to cancel lease.

                                                            (iii) If claim brought after Primary term, lessor’s

                                                                   theory will be that lease has terminated by its

                                                                   own terms b/c of lessee’s failure to secure

                                                                   PIPQ.

                                                            (iv) General Rule: Damages will be lessor’s

                                                                   remedy.

 

                                                            B. Failure to market at reasonable price

 

                                                                        (i) Damages will be remedy if prove that

                                                                             lessee sold at less than fair price

                                                                        (ii) Fair market value of gas when delivered

                                                                              = reasonable price.

 

                                    5. NO implied covenant to Drill a Test well!!!

 

                                                (i) Under lease, there is no express obligation to drill a test

                                                     well.

                                                (ii) There is no implied obligation to drill a test well.

                                                (iii) DDR came into play …so no need for obligation.

 

                                    6. HYPO: Lease (Edge of Nowhere) produces unmerchantable gas

                                         w/ 9% CO2….it’s on “Y” sand…the gas needs to be treated. 

                                         Pete says he will lay pipeline…he’ll set a treating plant…costs

                                         $10 Million…and for every NCF bad luck produces…will

                                         deduct 50 cents from NCF for Pete, and if Bad Luck doesn’t

                                         pay $13 Million dollars at the end of 3 years, he’ll take the 50

                                         cents MCF that have been paid. 

                                                It’s 1.5 years before Bad luck thinks about drilling on these

                                        other leases.  Bad Luck starts drilling all these wells all over the

                                        place on Treece’s lease & it’s a dry well.  Bad Luck drills again

                                        on Treece’s land & strikes oil; turns out its in “A” sand…which

                                        is good…and doesn’t produce as much CO2.

                                                Our boy Treece looks at this and gets his royalty statement,

                                          and he looks at it and says “you know, this doesn’t look right;

                                          there’s a deduction in there of 50 cents of NCF. 

                                                Paulsen decides he should get upset also.

 

                                          What would you look at if Treece came into your office?

                                                1. Express language of lease

                                                            (i) Treece’s gas does not have to be treated.

                                                            (ii)If you look at it, he doesn’t have the obligation,

                                                                 he’s paying for something he’s not using;

                                                            (iii) Look at pipeline, benefits really are to Treece,

                                                                   b/c w/o Paulsen, he would be unable to sell his

                                                                   gas.

                                                            (iv) What might Bad Luck argue? Treece has this

                                                                   much production b/c of Paulsen…he would not

                                                                   be getting this much money if not for Paulsen

                                                                   pipeline.

                                                            (v) Think about the development = it took Bad luck

                                                                  1.5 years to get started (not usual).  Because its

                                                                  a long pipeline, you have to build a plant.  Look

                                                                  at the deal = For every NCF that Bad luck puts

                                                                  through pipeline, he gets 50 cents deducted…of

                                                                 which he can deduct before calculating the

                                                                  royalty share.

 

                                                2. Next, Analyze Implied Covenants

                                                            (i) Bad luck has incentive to drill b/c he can deduct

                                                                 his 50 cents from lessors share.

                                                            (ii) Question: Is he acting w/ due regard for lessor?

                                                                        a. It depends.

                                                                        b. On the other lease, he has a duty to

                                                                            protect against drainage.

                                                                        c. On Treece’s lease, there is no drainage.        

                                                            (iii) If representing Treece:

                                                                        a. Might argue from Implied Marketing

                                                                            standpoint, we have a treating plant that

                                                                            treats gas, therefore Treece shouldn’t pay

                                                                            & gets whole amount of RI.

                                                            (iv) NOTE: this is one of those cases where there’s

                                                                   not going to be 100% win…there will be some

                                                                   compromise

                                                            (v) From Bad Lucks’ persepective, they don’t think

                                                                  they did anything wrong…they argue they are

                                                                  the ones w/ the risk…and they are operating w/

                                                                     due regard for lessor’s interests.

                                   

                                                3. NOTE: This is what will be on the exam, and that is

                                                    how you analyze it…Don’t just jump to first answer

                                                    that pops in your head…have to look at everything

                                                    that is going on.

                                                            (I) express language

                                                            (II) Implied Covenants

 

XII. State Regulations

 

            1. Purpose of State Regulations (enforced by RR Commission)

           

                        a. To Prevent Waste – Duty to all citizens of TX not to squander our

                            minerals;

                                    (i) Idea = Spread wells out + prevent drainage + cut down number

                                         of wells + cut down waste

                                    (ii) Basically = want to cut down # of wells in order to maximize

                                          recovery from reservoirs.

 

                        b. To Protect Correlative Rights

                                    (i) Correlative rights – When have a common reservoir…every

                                        mineral owner has right to his fair share as long as he doesn’t

                                        damage the reservoir

                                    (ii) Drilling too many wells may harm the reservoir à decrease

                                          pressure.

 

                        c. IDEA: Prevent overdrilling by spreading out wells and prevent drilling

                            every couple of acres

                                    (i) Distance from lease line and other wells

                                    (ii) Acreage

                                    (iii) Statewide Rules = spacing rules and density rules

 

            2. Statewide Rules

 

                        a. Statewide Rule 37 (Spacing Statute)

                                    (i) Spread well out = Idea

                                    (ii) Prevents overdrilling by limiting # wells that can be drilled in

                                          given area.

                                    (iii) Wells must be located far enough from boundary lines & one

                                           another to prevent excessive drainage

                                    (iv) Exceptions:

                                                a. To protect correlative rights of owners against drainage

                                                    (see small tract owner problem)

                                                b. To prevent waste of oil/gas.

 

                        b. Statewide Rule 38

                                    (i) Must have at least 40 acres of mineral estate for each well

                                         drilled.

 

                        c. Exception well permit (option) à Small tracts

                                    (i) Problem – Owners of “small tracts” (ones w/ less than 40 acres)

                                        …do not have enough acreage to have even one well.  So if

                                        being drained, cannot get permit to drill offset well.

                                    (ii) Solution – RRC can grant an exception well permit…an

                                          exception to Rules 37 & 38.

 

                                    (iii) Requirements (Must show):

                                                1. The well is necessary to protect correlative rights

                                                            a. Show there is a common reservoir & you need

                                                                to protect it from drainage.

                                                            b. W/o drilling well, you couldn’t recover

                                                                 hydrocarbons (your share).

                                                2. Must show that your tract is NOT a voluntary

                                                    subdivision.

                                                            a. Cannot be a small tract that was created after an

                                                                oil/gas was discovered in the area;

                                                            b. Cannot be a small tract that was created through

                                                                 an oil/gas lease;

                                                            c. Cannot be a small tract that was created w/ intent

                                                                of circumventing the spacing & density rules

                                                                37 & 38.

                                                            d. BASICALLY – cannot be created for purpose of

                                                                oil/gas production.

                                    (iv) Time period

                                                1. Permit good for 2 years.

 

                        d. Century Well Doctrine (option) à Small tracts

                                    (i) If cannot get an Exception well permit, might be able to get a

                                        Century Well permit.

 

                                    (ii) Century Well – The small tract was not formed as a voluntary

                                          subdivision à it was formed from an original Large “parent”

                                          tract

                                                a. Take all of the voluntary subdivisions and piece together

                                                     the original “parent tract”….on that tract only allowed

                                                     ONE century well…goes to first person to apply for it.

 

                                    (iii) Idea: Allowed to drill one well on parent tract.

                                                a. Only one well can be drilled on entire parent tract.

                                                b. The Permit for the one well will be granted to the

                                                     first person to apply for permit.

 

                        e. SUMMARY:

                                    1. Seek Drilling Permit à Rules 37 & 38 (RRC)

                                    2. If Small tract à Seek Exception well permit

                                    3. If cannot get Exception well à Seek Century well permit

 

                        f. Production Allowables

 

                                    1. Problem – Under exception well doctrine…a small tract owner

                                        can drill a well on his small piece of the common reservoir and

                                        drain an adjacent owners well that is close by.  So, we have now

                                        gone from small tract owner being drained à large tract owner

                                        being drained by small tract.

 

                                    2. Analysis: Goal is to prevent waste…so don’t need these 2 wells

                                        so close together.

 

                                    3. Solution = Production allowables

 

                                    4. The state wants to maximize the amt of oil/gas produced

                                                a. State doesn’t look at where wells are located;

                                                b. Only at how can we get max amt of oil/gas

 

                                    5. MER – Maximum efficient rate

                                                a. State figures out what the MER is per the field.

                                                b. State says everybody gets an “allowable”

 

                                    6. Allowable = your contribution to the reservoir

 

                                    7. Example: Small 10 acre tract…next to 300 acre tract…have

                                        common reservoir.  State calculates the MER to equal 1,000

                                        barrels a day.

                                                a. Large tract allowable = 300/310 x 1,000 barrels a day

                                                b. Small tract allowable = 10/310 x 1,000 barrels a day

 

                                    8. Problem: Small tract owner will get less profit…his well costs

                                        as much as the large tract well…but he will get smaller

                                        allowable…will take him more time to recover the cost of his

                                        well.

                                                a. So, even small tract owners can get exception well

                                                    permits…exception wells can be unprofitable to produce

                                                    b/c of their allowables.

                                                b. Lessee may not agree to drill under this problem

                                                c. Ct is more concerned w/ waste than correlative rights…

                                                    b/c correlative rights don’t make money.

 

                                    9. Summary:

                                                (i) If advising small tract owner

                                                            a. must have common reservoir

                                                            b. Seek drilling permit 37 & 38

                                                            c. Seek Exception Well permit b/c correlative rights

                                                                necessary

                                                            d. BUT, advise that even if get exception well,

                                                                he may be subject to allowables…which may

                                                                make it unprofitable to even drill a well…will

                                                                take longer to recoup drilling costs.

 

XIII. End of Well Life (Once no longer PIPQ)

 

            1. Duty To Plug Well

                       

                        a. TX – Have duty to plug well.

                       

                        b. Plugging process:

                                    1. Must have a cement plug at well bore and top of reservoir

                                    2. Must plug every level that you perforate.

                                    3. Must plug at every level that you produced from

 

                        c. Statewide Rule 14

                                    1. One year after operations have ceased, well must be plugged.

                                    2. Condition on getting drilling permit à that you plug well.

 

                        d. Who has duty to Plug?

                                    1. Operator – person in charge of well is primarily responsible

                                    2. Working interest owner – if operator cannot be found or has

                                         gone out of business.  Has liability even if never set foot on

                                         the lease.

                                    3. RRC – Default

                                                a. If cannot find operator or working interest owner

                                                b. RRC will plug, then go after the liable parties.

                                                c. If they have to do this, you will likely never get another

                                                    permit to drill.

                       

                        e. Who does not have duty to Plug?

                                    1. RI owners & Surface owners

                                                a. Even if derived a benefit from well, legislature says they

                                                    are not responsible.

                                    2. Subsequent lessees

                                                a. If have old well on lease at time of subsequent lease

                                                b. TX says no obligation to plug prior wells.

                                                c. BUT, if representing lessor, may want to place

                                                    condition in lease that subsequent lessor has to

                                                    plug.

 

                        f. Abandoning the Well (Procedure)

                                    1. Have to give NOTICE to RRC that you are plugging well.

                                                a. Must make sure your plugging procedure comports to

                                                    RRC procedures

                                                b. Cannot just go to Home Depot and buy cement and do it.

                                    2. Have to give NOTICE, 5 days prior to plugging to surface

                                        owner and all affected parties.

                                    3. Have to submit a report to RRC w/in 30 days after plugging

                                                a. must show how much cement used, etc.

 

                                                b. WHY? b/c it negates your liability if you followed the

                                                    RRC procedures and it leaks.

 

                        g. Costs of plugging

                                    1. Fairly cheap…but cost more the longer you let it go…b/c of

                                        possible cave-ins, etc.

                       

                        h. Why plug?

                                    1. Prevent leakage into water tables

                                    2. Metal casings have “Naturally Occurring Radioactive Material”

                                        where the rocks have adhered to the metal.

 

            2. Equipment Removal Clause

                       

                        a. In lease language = usually have 1 year to remove equipment

                        b. If not removed in 1 year after abandonment, then belongs to mineral

                            interest owner.

                        c. If representing mineral interest owner

                                    1. place clause in lease that conditions a penalty on lessee if leaves

                                        junk equipment on property.

                                    2. Also, always want to make sure that the operator is reputable b/c

                                        want them to plug and get equipment off land.