OIL & GAS
- I got an ‘A’ in this class!!
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 &
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 will be found above oil, oil found above water.
g. Summary: Requirements for formation:
1. Source of hydrocarbons – dead critters
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
1 Barrel = 43
b. Natural Gas à measured in MCF
(i) MCF = 1,000 cubic feet
NOTE: We are really after the energy that oil creates = BTUs
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
(ii) Another person cannot extract minerals on the land w/o
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
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
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
(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
(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
(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
Eliff v. Texon Drilling
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
(ii) Rule: Duty to exercise ordinary care to
avoid injury or damage to property of
(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
c. Limits on how much you can take from reservoir
(i) MER – maximum efficient rate…rate allocated
to the well, how much you are allowed to pull
out of the ground.
d. Wronski v. Sun Oil – Example of how violation of
statute will void ROC protection. Statute limited # of
wells that may be drilled to 1 well per 20 acre tract and
production limited to 75 barrels a day. Sun Oil
overproduced…held liable for conversion
(i) Rule – (willful trespasser) = liable for enhanced
value of oil at time of conversion w/o deduction
for expenses or for improvements by labor
(ii) (Innocent trespasser) = liable only for value of
oil undisturbed, entitled to set off the reasonable
cost of production.
(iv). Ownership of Extracted Oil/Gas (Limit on ROC)
1. Real Property – when in ground
2. Personal Property – once in control out of ground
Ownership = comes to surface + control
RULE: ROC does not apply once you convert to personal
(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
being taken from TX reservoir and transported
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
3. If you have a Blowout = ROC applies b/c don’t
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
(ii) On Exam: Must state that there is still
some cushion gas which is still “real
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
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
(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
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
g. Gets royalty interest (% of revenues, incurs 0%
of cost of development)
h. Lessee – gets 100% working interest + net
i. Bonus: Company pays mineral owner, just to gain
a working interest…lessor gets to keep no matter
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.
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
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
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!!!)
D. Production Payment
a. Where Lessee gets another party (Bank) to finance production
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
VI. Conveying Title to Minerals
a. Conveyances of mineral interests are REAL PROPERTY.
A. Requirements for Validity
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)
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
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
3. No Warranty – Doesn’t say anything, no warranty clause in the
deed…BUT, statutorily you still get the “After acquired
doctrine” benefit. (Hardly ever seen in Oil/gas)
4. Quitclaim – “I give you what I have, but I’m not sure what I
have.” These are in oil/gas business for small pieces of
property. NOTE: Don’t have benefit of After-Acquired
D. Mineral Interest v. Royalty Interest
1. Simply state “This is a mineral interest” OR “This is a Royalty
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?
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
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
(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.)
1. existing use
2. alternative commonly used in
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
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
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
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
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.
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
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
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
(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
(iv) RULE: An accounting must be made to the
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
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
(iv) Lessee must pay RI at risk of dry hole + 30% to
(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
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
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
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
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
(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
(v) Failing to share signup bonus w/ non-
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/
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)
(vii) Process = Royalties and bonus are paid into escrow
account…interest earned on account goes to Life
Tenant. Remainderman gets his share when Life
(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” –
(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.
(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
(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
(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.
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.
1. Trustee – has management power (right to lease
2. Beneficiary – receives benefits (only collects benefits)…
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
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
Mutuality of Obligation (both sides must do something
(iv) Competent parties
(v) Subject matter
(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
(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
gives lessor = bonus,
Consideration for right to develop = bonus,
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
2. The LEASE
a. Granting Clause
(i) Sets forth the right that mineral owner grants to lessee (rt to
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
(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
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
(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
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
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
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
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
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.
(i) wants lease to revert back so he can re-lease it
(ii) does not want “holding lease by production”
(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
(ii) Satisfies lessee’s need to have option but not obligation to
(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
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.
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 on eve of 3 year anniversary of Primary Term.
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
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
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.
1. Well capable of PIPQ (must file well completions test
2. If make SIR payment
3. in X amount of days
4. Extends lease for another year…(giving time to connect
5. Must be done in good faith (good faith effort to establish
(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
(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
2. Cessation of Production
3. Continuous Operation Clause
4. Dry Hole
5. Shut-in Royalty
7. Force Majeure
k. Royalty Clause – (Lessor) – sect. 4
(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
(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
(ii) Lessee can subtract cost of transportation from lessor’s
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
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.
(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,
(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
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
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
(i) What is left out of a lease, may be covered by an Implied
XI. Implied Covenants
(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
2. Duty to Protect against Drainage (What a RPO would do)
a. Requirements: (Lessor must show)
(i) Must be Substantial Drainage (amt worth
(ii) Must show that an Offset well would be
profitable OR some type of Administrative
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
(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-
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
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
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
(i) Wants small legal distance
(ii) Put in lease, a clause that expressly negates
implied covenant to protect
(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
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
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
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
(iii) NOTE: if drilled to different strata …then its
constitutes an exploratory well.
1. Must have successful exploration well
2. Development well = Same Reservoir +
3. Relatively nearby horizontally +
(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
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
d. RULE: if lease expressly states number
of wells to be drilled…then implied
covenant to reasonably develop does not
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
stated duty to further explore.
a. Had Large leasehold…but Sun Oil was
only developing a small field w/in the
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!!!
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.
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
(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
(iv) General Rule: Damages will be lessor’s
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
(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
(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
(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
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
(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
(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
c. IDEA: Prevent overdrilling by spreading out wells and prevent drilling
every couple of acres
(i) Distance from lease line and other wells
(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
(iii) Wells must be located far enough from boundary lines & one
another to prevent excessive drainage
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
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
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
(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”
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.
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
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.
(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
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
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
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
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
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.