Oil & Gas

Oil & Gas

Oil & Gas (Jones) Spring 2008

11Ch 1 Accumulation Ownership & Conservation

11Accumulation

11Law (Rule) of Capture and Private Ownership

11Rule of Capture

11Exceptions to Rule of Capture

11Champlain Exploration v. Western Bridge

11Texas American

11Geo Viking

12Trail Enterprise

12Statewide Spacing Rule in Texas

12Del Monte Mining & Milling v. Last Chance Mining & Milling (old law)

12Kelly v. Ohio Oil Rule of Capture allows boundary line drilling (old law)

12Radial Theory of Drainage

12Permeability

12Porosity

13Production Unit

13Humble Oil & Refining Co (HORCO now known as Exxon) v. West (extraneous gas)

13interstitial spaces

13Peoples Gas v. Tyner (fracing within boundary of own land is okay)

13Geo Viking v. Tex-Lee (fracing that crosses lease line is a trespass)

13Fracing

13Wronski v. Sun Oil (correlative rights - great black letter law) (1979 MI)

13Correlative Rights

13Correlative Rights Rule

14Elliff v. Texon Drilling (RoC exception; liability for negligent production)

14The Surface and Mineral Estates (The Bundle of Sticks in the ME)

14Mineral Estate Bundle of Sticks in TX

14Township

14Conservation

14Larsen (RRC is tasked with protecting correlative rights)

15Pattie

15Exxon v. RRC

15Bottom Hole Pressure

15Allowables

15Proration Units

15Pickens (100 rule)

15Denver Producing & Refining (RRC allocation of allowables must be reasonable)

15Ch 2 The Oil & Gas Lease

15Purpose of OGL

15OGL

15Conversion Date

15Primary Term

16Royalty

16Bonus

164/76 OGL example

16Granting Clause

16Subrogation Clause

16Granting Clause-Surface Uses

16Hunt Oil v. Kerbaugh (Dominant Mineral estate has right to use servient surface estate as reasonably necessary)

16Getty Oil v. Jones (Accommodation Doctrine)

16Accommodation Doctrine

17Limits on the use of the servient estate by the dominant estate n. 2, p136-141

17Robinson v. Robbins Petroleum

17Maintaining the leaseDelay rentals

17Habendum Clause

17Anniversary Date

17Bonus

17Primary Term

17Delay Rental

17Schwartzenberger v. Hunt Trust Estate (technical compliance with HC is requiredright amount, right time, right persons, right manner)

18Breaux v. Apache Oil (p178) (meaning of operations substantial preparations for drilling in good faith and with due diligence)

18Secondary Term

18What kind of production

18Assignment Clause

18Cheyenne Resources v. Criswel (repudiation by lessor)

18Clifton v. Koontz (paying quantities revenue > operating expenses)

19Operating Expenses

19Stanolind Oil & Gas v. Barnhill (TX-production in paying quantities requires actual severance/sale)

19Pshigoda v. Texaco (p27 left-hand column reworking is not operations)

19Garcia v. King

19Clifton

19Skelly

19Working Interest & Assignment

19Overriding Royalty Interest ORRI

20NRI

20Division Order Title Opinion DOTO

20Pooling Provision

20MMBTU

20Produced Overview

20Bundle of sticks in the mineral estate (on the exam)

21Savings Clauses and Doctrines (shut in, TCOP, cessation of production, dry-hole, continuous ops, & force majeure)

21Shut-in royalty clause

21Freeman p204 (shut in gas royalty = constructive production)

2230-60 day clause (doctrine of temporary cessation of production)

22Watson v. Rochmill (p. 29s)

22Cessation of production, dry-hole clause, continuous operations clause

2230-60 Day Clause

22Continuous operations clause

22Rogers v. Osborn (restarting operations after TCOP violated does not extend lease)

22Samano (30-60 days clauses strictly construed)

22Force Majeure clause

22Haby v. Stanolind Oil & Gas Co (no force majeure clause in the lease)

23Perlman v. Pioneer Ltd Pship (unilateral decision that production is impossible is insufficient to trigger a force majeure clause)

23Force Majeure Rules

23Hydrocarbon Tracker

23Royalty payments

23Types of royalty interests

23Overriding Royalty ORRI

24Nonparticipating Royalty NPRI

24Landowners Royalty RI

24Market value royalty issue

24Piney Woods Country Life School v. Shell Oil Co. (defn: market value at the well)

24Proceeds

24Market Value at the Well

24Comps

24Cost Netting

24Vela Rule

24Implied Covenant to Market

24Pyote (likely no longer good law b/c of changes in natural gas market)

25Take or pay

25Killam Oil v. Bruni (s41) (royalty is not due royalty owners on take or pay payments)

25Alameda v. Transamerica Natural Gas (RI owner not due royalty on damages for breach of take or pay clause-absent a specific clause in the lease)

25Costs after production

25Garman v. Conoco (CO)costs of production v costs subsequent to production

26Heritage Resources v. Nationsbank, Co (1996) (MVW is a term of art)

26Division orders

26Gavenda v. Strata Energy (beware reservation of X royalty v. X of royalty)

26Division Order Statute Tx Natural Resources Code 91.401

27Cannon v. Cassidy (non-payment of royalty is not a terminating condition)

27Remedies for failure to pay royalties Caanan (CoA for damage, not cancel)

28Royalty paid on production after subtracting gas used by LE in production (Free Gas Clause)

28Implied Covenants

28Nature and Classification

28Brewster v. Lanyon Zinc Co (KS) (implied covenant to further develop; not in TX)

28Drainage

28Amoco v. Alexander (TX 1981) Implied Covenant to protect against Drainage (local & field-wide)

29Oil in Place (OIP)

29Kerr-Mcgee v. Helton (2004 Tx)-- Drainage

29Net feet of pay

29Exam Implied Covenants in Texas

29Develop

30Protect

30Manage & Administer

30Implied Covenants to Drill or Explore

30Superior Oil v. Devon Implied Covenant to Develop (step-outnot explore)

30Sun Exploration & Production v. Jackson (p59S) Implied Covenant to Further Explore (not in Texas!!)

30Explore

31Develop defn

31Diligent operation (one of the duties to manage & administer)

31Baldwin v. Kubetz (CA)

31HECI v. Neel (no IC of notice of suit by LR to LE before sue LE)

31Res Judicata

31Collateral Estoppel

31For the exam, need to know the general contents of the two oil & gas leases

32Ch 3 Titles & Conveyances: Interests of Oil & Gas

32Mineral Interests and Royalty Interests (Deeds, Assignments & the use of Words with Magical Qualities)

32Nature of the Interests

32Bodcaw Lumber v. Goode (Ark. 1923) (ME & SE may be severed and held by different owners in perpetuity)

32Type of estate in the TX bundle of sticks in the ME

33McSweyn v Musselshell County, MT(2% mineral interest (working interest) v. 2% royalty interest)

33Creation of Mineral & Royalty Interests

33Barker v. Levy (grant of NPRI or NPMI)

33Nonparticipating

33NPMI

33NPRI

33Schlittler v. Smith (p340) (NPRI participates in LO royalty, minimum royalty and compensatory royalty)

33Minimum Royalty Clause

33Compensatory Royalty

33Net Profits Interest

33Carried Interest

33Magic words of granting (creating Mineral Interest v Royalty Interest)

33Altman v. Blake (if use in and under it is a MI no matter what else might be reserved)

34French v. Chevron (in and under that may be produced = MI)

34Watkins v. Slaughter (p359), Temple-Inland v. Henderson

34Anderson v. Mayberry (Okl) (a MI and other sticks may be reserved separately)

34Review

34NPRI Defn

34Shared ownership

34Law v. Heck Oil (Minority Rule) (NOT IN TX)

34Prairie Oil & Gas v. Allen (non-operating co-tenant in the ME participates in net proceeds; pays his share of development costs in proportion to ME%)

35Earp v. Mid-Continent Petroleum (p. 371 n. 7) (co-tenants may execute separate OGLs; proportionate reduction clause ensures they only get royalty on the % of ME that each owns)

35Proportionate Reduction Clause

35Marital Property Issues w.r.t. Mineral estate

35Mosley v. Hearrell (co ME owners can seek to partition; operating agreements must be in writing because they affect an interest in the land (SoF applies))

35Welborn v. Tidewater Associated Oil (life tenant & remainderman may not execute an OGL individually)

36Hynson v. Jeffries (p380) (treatment of lease benefits between LE and remainderman)

36Open mine doctrine

36Uniform Principal & Income Act

36Moore v. Vines (p. S-71) (open mine doctrine)

36Terminable Interest

36Royalty Deed

36Archer County v. Webb

36Executive Right

36Mims v. Beall (owner of executive rights has a pseudo-fiduciary duty to NPRI holderno self dealing to reduce NPRIs proceeds)

37Luecke v Wallace (executive right owner cannot maneuver to reduce NPRI owners benefits)

37In re Bass (no implied covenant to develop or fiduciary duty to develop if no OGL; NPRI Holder cannot force an OGL to be executed)

37Bean v. Bean (power of attorney to sell the property does not include severance and sale of the mineral estate via OGL only)

37Day & Co v. Texland

37Other Minerals

37Moser v. US Steel Corp. (para 1 of the OGL) (meaning of other minerals pre- and post-June 8, 1983)

37Substances deemed minerals as a matter of law

38Amoco Production v Southern Ute (coal does not include coal-bed methane gas as an other mineral)

38Amarillo Oil v. EnergyAgri (phase severance separation of oil rights from gas rights; OGL to one lessee for oil/casinghead gas; OGL to another lessee for gas)

38Conveyances of Fractional Interests

38Averyt v. Grande (be careful to apply the fractional interest to the land described or the land conveyed as noted in the conveyance)

38Duhig v. Peavy-Moore (reservations in successive warranty deeds must account for all prior reservations plus the amount to be reserved)

39Warranty Deed

39Benge v. Scharbauer (separate clauses dealing with B, DR, RI are not subject to Duhig rule regarding fractional interests in the ME)

39Fixing Duhig

39Duhig Example Problem

39Duhig Example Problem

39Acoma v. Wilson (even if grantee knows about the prior reservation Duhig still applies)

40Mineral Acre

40Greatest Possible Estate

40Subrogation Clause

40Proportionate Reduction Clause

40Texas Co v. Parks (royalty is for land described, not whole tract if GR only owns a portion but does not describe the whole tract)

40Jones v. Colle (Mother Hubbard Clause)

40J Hiram Moore v. Greer (Catchall clause/Universal Clause will not include large tracts of land not properly described in the conveyance)

41Conveyances of Interests in Leased Land

41Hoffman v. Magnolia Petroleum

41Double Grant Theory (clarify this)

41Concord v Pennzoil (ON THE EXAM) (mineral deed with conflicting granting clause and subject to clause conveyed a 1/12 MI considering document as a whole and not as two separate estates of differing sizes)

41Future Lease Clause

41Luckel v. White (GE had RI only, no executive power) (granting clause is a floor; future lease clause applies is future lease provides greater benefits)

42Ratification v. Reviver

42Nonapportionment doctrine

42Japhet v McRae (non-apportionment doctrine applies to royalties under an OGL that was executed before the tract was physically divided)

42Gilcrease v. Stanolind Oil (entireties clause: when a LE has OGL over different tracts and there are subsequently multiple tract owners, LE pays royalty to each in proportion that eachs interest bears to the total leased premises)

43Top Leasing

43Hamman v. Bright (a top lease violates RAP if it says it is effective upon termination of the bottom lease b/c the bottom lease may not expire for > 21 years)

43Top Lease

43Phillips Petroleum v. Peterson (p92-S) (RAP not violated by a unitization clause because that clause does not convey an interest)

43Ch 4 Interference with Interests in O&G

43Trespass

43Enron O&G v. Worth (seismic permit - right to explore can be severed from right to bore & produce; subject to SoF

43Seismic Permit

44Earp v. MidContinent/Alan v. Prairie

44Grynberg v. City of Northglenn (right to explore is a protectable property interest)

44HORCO v. Kishi (if OGL expires, LE commits trespass if he continues to enter the property)

44Kennedy v. General Geophysical (seismic vibrations are not trespass)

44Phillips Petroleum v. Cowden (it is a geophysical trespass to conduct seismic operations on the land without the agreement of the ME owner; agreement of SE owner is not sufficient)

44Tail

45Halo

45Byrom v. Pendley (bad faith trespassor v. good faith trespassor)

45Bad Faith Trespassor

45Edwards v. Lachman (p519 n. 1) (subsurface trespass is bad faith trespassing; P gets 100% of proceeds from the well; D cannot recover any drilling costs)

45Measures of Damages for Trespass

45Phillips Petroleum v. Cowden

45Hunt v. HNG Oil Co (costs for recompletion of a well are recoverable when good faith trespass occurs after OGL under which well originally completed expires but not costs for originally completing the well)

45p520 n. 5 Continuing Tort of Trespass & Conversion

46Hamman v Bright (Slander of Title- failure of LE to release the lease when the OGL terminates)

46p528, n4 Adverse possession & protection lease

46Loss of Title (Adverse Possession)

46Jones v. McFadden

46Diederich v. Ware (after severance, AP of ME requires actual production and severance of the minerals for the limitations period)

46Natural Gas Pipeline Co of America v. Pool (when OGL terminates, OGL (working interest) on ME may be extended through AP by producer that simply continues production for the limitations period)

47Terms (Eli v. Briley)

47Riparian

47Accretion

47Reliction

47Avulsive

47Abandonment (p537)

47Ch 5 Contracts & Transfers by the Lessee

47Lease Assignments-Rights/obligations of the Assignor

47Reynolds-Rexwinkle Oil v. Petex (wash out)

47Cook v. El Paso Natural Gas (since the ORRI is carved out of the working interest, the ORRI owner has standing to sue for enforcement of the implied covenant to prevent drainage)

48Compensatory Royalty

48Lessor Rights against an assignee (some OGLs require approval before assignment)

48Trafalgar House O&G v. De Hinojosa

48OAG v. Desert Gas Exploration (express covenants in OGL are indivisible)

48Ridge Oil v. Guinn Investments (wash out non producing assigned lessee by terminating the lease on the producing half of a metes & bounds (physically) divided assigned lease)

48Kothe v. Jefferson (implied covenants in OGL are indivisible; in TX divisible)

48Support Agreements

48Contribution Letter

48Dry Hole Letter

49Farmout Agreements

49Payout

49Martin v. Darcy

49Westland Oil Dev. Corp. v. Gulf Oil Corp. (EXAM very important) (a purchaser is bound to follow up on every recital in a deed that may affect his chain of title)

49Areas of Mutual Interest (AIM) agreement

49Operating Agreements (JoA)

49Model Form Operating Agreement

49Accounting Agreement

50Gas Balancing Agreement

50Abraxas v. Hornburg (operator authority & responsibility)

50Unit Area

50Authority for Expenditure (AFE)

50Joint Interest Billing (JIB)

50Exculpatory Clause

50M&T Inc v. Fuel Resources Dev. Co (non-op liability for costs goes beyond the AFE to actual reasonable costs incurred)

50Dry Hole Election Point

50MBank v. Westwood Energy (expenditures & liabilities of parties--liens and payments)

50Blocker Exploration v. Frontier (liability of NonOps if Op defaults; creditor cannot reach non-ops personal assets)

50Mining Partnership

51Mineral Property Lien

51Texstar North America v. Ladd Petroleum (properly given nonconsent is not a breach of JoA)

51Valence V Dorsett (meaning of V.B.1 notice provisions for consent/nonconsent)

51Non-consent penalty

51Johnston v. American Cometra (Ops duty to NonOps w.r.t. selling prdn)

52Seagull Energy v. Eland Energy (effect of assignment; EXAM; OGL assignor is still liable under its OGL contract unless the assignment expressly releases it from its obligations under the contract)

52Long Trusts v. Griffin

52Amoco Production v. Action Well Service (LE liability for negligence of drilling contractor)

52Day Rate

52Footage Rate

52Turnkey Rate

52Ch 6 Pooling and Unitization

52Problem of Small Tracts

52(No questions on Rule 37 on the exam)

53Ryan

53Halbouty

53Accomplishing Pooling

53French (community lease multiple landowners voluntarily sign the same OGL; community lease in Texas creates a presumption that the LRs have pooled their interests)

53Community Lease

53Jones v. Killingsworth (improper pooling can result in loss of lease b/c production in the invalid pool is not production on all the leases in the pool)

54When pooling is done properly:

54Tittizer v. Union Gas (if OGL says pooling not effective until the unit designation is recorded, then drill site tract gets all royalties until recordation)

54Amoco Production v. Underwood (gerrymandering a unit to perpetuate leases is okay)

54Elliott v. Davis

54SE Pipeline v. Tichacek (pooling can be used to discharge the implied duty to protect against drainage)

55Bennion (a mineral co-tenant is not subject to a non-consent penalty for not pooling his interest; he pays his fair share of the costs of production the same as any other co-tenant)

55Youngblood v. Seewald (the current working interest owner has the responsibility of paying ORRI not the prior working interest owner)

55Carson v. RRC (MIPA of 1961) ON THE EXAM (a fair & reasonable offer to pool must be made before MIPA can be used to force pooling)

55Hladik v. Lee (OK)

56Effect of Pooling

56Effect on Lessees Operations

56Bibler Brothers Timber v. Tojac Minerals (Pugh Clausean OGL is only preserved as to the leased acreage included in the pooled acreage.)

56Wells v. Continental (implied covenant to rzbly develop applies to pooled acreage and non-pooled acreage in a single OGL)

56Effect on Property Interests

56Veal v. Thomason (not an important case)

56London v. Merriman (effect on non-operating interests; non-pooled NPRI owner on a tract in a multi-tract OGL can ratify the OGL to enable him to receive royalties from production on other tracts)

56Brown v. Getty Reserve Oil

56MCZ v. Triolo

56Montgomery v Rittersbacher

57NPRI (EXAM)

57Edmonston v. Home Stake O&G Corp (effect on terminable interests)

57RRC v. Pend Oreille O&G Co (the fair & reasonable offer to pool is subject to the substantial evidence rule)

57Enhanced Recovery (secondary & tertiary recovery) Unitization

57Baumgartner v. Gulf 0il Corp. (encroachment across lease lines of RRC approved secondary recovery method is not a compensable trespass)

57Square Mile defn and size in acres

57Unitization

57Secondary Recovery

58Tertiary Recovery

58Negative Rule of Capture

58Tide Water Assc. Oil Co v. Stott (dry gas (a less valuable substance) pumped back into a reservoir that produces wet gas (a valuable substance) is a valid exercise of the negative rule of capture; LE did not trespass)

58Wet gas

58Gas Recycling

58Waseco Chemical & Supply v. Bayou State Oil Corp (no implied covenant to use enhanced recovery techniques; RPO standard applies)

58Browning Oil v. Luecke (anti-pooling provisions; horizontal drilling creates a drill site tract in every tract the well bore crosses; measure of damages is the amount of oil drained from each tract horizontallyrule of capture does not apply)

59Federal and State Lands

59Davis & Sons v. Gulf Oil Corp (Jones Act applies for PI actions if the K has a genuine salty flavor)

59Lewis (owners of RLA lands are Agents of the State and cannot self-deal in executing OGLs; of any benefits negotiated are due the State)

60Exam

Ch 1 Accumulation Ownership & ConservationAccumulation1. Oil reservoir area of reservoir rock literally soaked with liquid oil & gas with ceiling cap rock to keep oil in the reservoir. This is a trap, which prevents the oil from migrating out of the reservoir rock; the trap forms first. Exploration is about finding the traps.

a. Faults (a break in the formation) and anticlines (an archlike up fold) control the movement of O&G through the rock.

2. Exploration is the search for economic accumulations of oil & gas.

3. Must establish the ownership interest in the oil & gas before drilling can begin.

a. Oil & Gas Lease is used to do this.

b. Landowners have the right to extract & produce O&G on their property but because of costs usually lease these production rights to a production company.

4. Mud is drilling fluid water, clay and chemicals; used to maintain pressure in the formation.5. Pressure sink is created by the well bore; it is an area of low pressure which induces well fluids into the well bore. Fracturing treatments can be used to create more flow.6. After O&G is severed from the ground, it becomes personal property. It becomes a good and thus is subject to the UCC and the law of contracts.

Law (Rule) of Capture and Private Ownership

Rule of Capture1. A rule of non-liability As long as it is legitimate production (no subsurface trespass by slant drilling), you are not liable for the value of oil drained from a neighboring property. Neighbor can go and do likewise. A landowner can drill for oil on his own property and legitimately drain oil from a neighbors land without liability.

a. Exceptions to rule of capture TC Exceptions to Rule of Capture \l 4 i. Champlin Exploration v. Western Bridge TC "Champlain Exploration v. Western Bridge" \l 4 - For oil, severed (brought to surface past the well head) and not abandoned, is personal property and is not subject to the rule of capture.

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

ii. Texas American TC "Texas American" \l 4 A. For gas, severed and not abandoned, is personal property and is not subject to the rule of capture. If it is reinjected into the ground, it remains personal property. (Lone Star Gas v. Murchison, White v. NY State Natural Gas Co)

iii. Police powerregulate morals, health, safety of the publice.g., ordinance no large quantities of dynamite exploded in the city limits to shoot a reservoir (Peoples Gas--nuisance); RR commission rulesiv. Tx S Ct (1991-1992) trespass by drilling under anothers land to drain o/g; appeals court (Geo Viking) TC "Geo Viking" \l 4 v. Administrative regulation duly delegated by the legislature (Wronski, Elliff) e.g., RR commission implements the correlative rights rule by limiting the spacing of wells and number of producing wells per lease. Protecting against waste. RR commission has administrative authority over o/g production in TX

A. Trail Enterprise (after People v. Tyner) TC "Trail Enterprise" \l 4 Houston implemented an extra-territorial ordinance to prevent drilling near Lake Houston watershedTrail Enterprise failed to sue timely to protect their mineral rights; Houston then annexed the area and adopted a city ordinance for the same purpose. Trail Enterprise then sued. After 10 years, Ct App Waco found a taking and awarded Trail Enterprise $25M in damages for inverse condemnation.

vi. Negligence negligence in production activities which causes the destruction of the neighbors ownership of the o/g in place under his land.

2. In Texas, the fee owner owns the O/G in place (OIP) under his property.

a. Rule of capture modifies this property right by allowing you to drill on your own land and suck O/G out from your neighbors land without liability.

b. Statewide Spacing rule in Texas TC "Statewide Spacing Rule in Texas" \l 3 i. Wells must be drilled no closer than 467 feet from any lease line no wells drilled within 467 feet from any lease line and no two wells on the same lease producing from the same formation can be within 1200 feet of each other. Thus, you must have a minimum lease of 40 acres to drill a well.

ii. Permit to drill a well from the Railroad Commission a form W1; RRC can also grant exceptions.

Del Monte Mining & Milling v. Last Chance Mining & Milling (old law)3. He who owns the surface owns the sky above and everything beneath. Owner of FS of soil owns all below the surface limited by the surface boundaries.4. Owner owns subsurface minerals that are contained within his property boundary lines (up to the imaginary line that represents his property line).

5. Extralateral rights allows the vein to extend beyond your boundary and still be considered yours (the vein starts on your land and ends on anothers land)

Kelly v. Ohio Oil Rule of Capture allows boundary line drilling (old law)6. Rule of capture allows construction of wells on property line even though the radial theory of drainage means oil will come from neighbors land. It does not matter that the landowner has the express purpose of draining the oil from under adjoining landowners land. A legal activity conducted on your own land regardless of intent is not actionable. When a person has the legal right to do a certain act, the motive with which it is done is immaterial.7. A landowner may permissibly extract o/g beneath anothers land where all operations for the extraction are lawfully conducted on his property.

Radial Theory of Drainage 8. O/G from the formation will proceed to the well bore equally from all directions because the well bore is a pressure sink (area of low pressure). Higher pressure from the surrounding reservoir moves towards the low pressure seeking to equalize the pressure. This causes the O/G to flow towards the well bore. A pressure wave of reservoir fluids moves towards the pressure sink equally from all directions. 9. Permeability TC Permeability \l 5 is the connectivity between the pore spaces. Permeability affects the ability of the pressure sink to cause the oil to flow.

10. Porosity TC Porosity \l 5 is the pore space in the reservoir rock in which the well fluids may inhere.

i. Rocks generally have porosity (except for ignatius rock)

11. A production unit TC Production Unit \l 5 is a group of oil & gas wells put together for the purpose of efficient exploration and production. Pooling unit pooling done to get enough acreage to drill (limit of 640 acres +10%); drilling unit is a well; unitization unitizing large tracts of land across multiple pooled units/non-pooled acreage for efficient management of a formation.Humble Oil & Refining Co (HORCO now known as Exxon) v. West (extraneous gas)1. Royalty is not due a landowner who owns the royalty rights to native gas produced from the land for extraneous gas that is reinjected into the formation for storage and to preserve the value of the formation for storage and then removed. Why?a. The extraneous gas is personal property.

b. The surface estate includes the interstitial spaces TC interstitial spaces \l 5 in the rock (the matrix of the underlying earthe.g., the reservoir storage space). . The mineral estate is just the o/g that adheres in the spaces.

Peoples Gas v. Tyner (fracing within boundary of own land is okay)1. An owner may shoot his well (increase the number of fractures ) to increase its permeability as long as he is upon his own property and does so within any limitations/restrictions imposed by law (e.g., nuisance law, due regard for rights of others) or by the State (under its police powers)2. Hydraulic fracture stimulation injection of fracing fluid to create fractures; propagation of the fluid creates pressure which causes fractures and increases the flow of o/g.Geo Viking v. Tex-Lee (fracing that crosses lease line is a trespass)

1. O/G produced from the fracture is not subject to the rule of capture because of the trespass.a. Fracing TC Fracing \l 5 injection of propped fluid mixture (Propit) into the casing which has been perforated by blasting to increase the permeability of the reservoir by creating a fracture in the formation. The facture proceeds bilaterally from the well bore along the path of least resistance. It creates a superhighway to the well bore along the fracture.

b. The propping fluid keeps the rock from closing in after stopping the pumping (pressurized injection of the prop fluid) of the frac fluid from the surface.

Wronski v. Sun Oil (correlative rights - great black letter law) (1979 MI) 1. Correlative rights TC Correlative Rights \l 5 the right of every property owner overlying a common reservoir to produce his fair share equivalent to the amount of o/g under his land and to prevent other property owners from violating that right). Taking of more than your allotment (set by the police power of MI) is conversion of personal property (not trespass because the oil had been severed).a. Correlative rights rule TC Correlative Rights Rule \l 5 those individuals over a common source of supply have the right to produce their fair share; proportion of each owners acreage over the field acreage.

i. If you have the right to produce your fair share, you have an obligation not to operate in a fashion that impairs the rights of the other owners to produce their fair share. If you do, other owner has a CoA against you.

b. Any violation of a proration order is a conversion of o/g subjecting the violator to liability to all owners of interests in the pool.

c. Tx RoC you own the O/G in place under your land; produce to your hearts content as long as on your own landi. RoC leads to over development and waste

A. Waste results from too many holes being drilled into the reservoir wastes the energy of the reservoir; less pressure to cause flow; have to do secondary & tertiary drilling to fix (very expensive)ii. Texas regulates the placement of wells to protect correlative rights and prevent waste; the RR commission regulates the o/g industry.

Elliff v. Texon Drilling (RoC exception; liability for negligent production)Blowout consumes o&g on lease and neighboring land) if producer is negligent in production of o/g he is liable to a neighboring landowner and the lessor for negligent waste/destruction of o&g.The Surface and Mineral Estates (The Bundle of Sticks in the ME)1. Two estates in land: surface estate & mineral estate.

a. Mineral Estate in Texas TC Mineral Estate Bundle of Sticks in TX \l 4 has 5 (6) sticks in its bundle of rights

i. Right to explore, bore & produce most valuable right

ii. Executive right right to execute written agreements w.r.t. the mineral estate (o/g leases, seismic leases)

A. Leasehold interest is the right gained when execute an o/g lease.

iii. Right to bonus the amount paid when to execute an o/g lease; a dollar figure per acre; it is the consideration for executing the lease

iv. Right to delay rentals payments for delay in developing the minerals.

v. Right to royalty real property interest that is noncorporeal; cost free percentage or fractional share of the proceeds from production.

vi. Right of reverter when discharge the executive right (e.g., execute an o/g lease which is a fee simple determinable) the reverter goes back to the lessor. When OGL terminates, mineral estate reverts to lessor automatically.b. Each right is a fee interest that can be separately owned, devised and descended

2. Township TC Township \l 4 surveying method for laying out property lines, each section is 640 sq acres (1 sq mi); Surveys describe the land in SE TX by metes & bounds (geographical and artificial markers are used to describe property boundaries) (described in varas unit of measurement equal to the distance traveled by a particular wagon wheel in Spain 32.33 close to a yard but not quite)Conservation

Larsen (RRC is tasked with protecting correlative rights)1. The commission failed to respect correlative rights by failing to establish proration units for the acreage. The Commission must determine the size of the field and of these leases in proportion to the size of the field to protect correlative rightsa. Determine where the reservoir is and then do the proration units (stand up or lay down) to ensure each owners correlative rights are protected.

b. Field-wide spacing rule considers

i. Amount of recoverable oil

ii. Amount of recoverable oil under each tract

iii. The proportion that (i) bears to (ii)

iv. Amount of oil recoverable without waste

2. Pattie TC Pattie \l 4 p 81 - Well location exception may be warranted to protect correlative rights

3. Exxon v. RR Commn TC Exxon v. RRC \l 4 RRC can grant exceptions to the spacing requirements if a producer meets the criteria (economic sense, prevents waste, acting in good faith)a. Bottom hole pressure (bhp) TC Bottom Hole Pressure \l 4 measures the pressure of the well after perforation of the casing and after the well is capped. Measure pressure for 24 hours; allows reservoir engineer to calculate how much o/g is in place.

b. Allowables TC Allowables \l 4 restrict production to prevent physical and economic waste of the o/g resources; restrict production to meet projected demands; allowables allocate a certain amount of production from each drilling (proration) unit.c. Proration units TC Proration Units \l 4 aka drilling unit ~ one well allowables are allocated to each proration unit based on acreagePickens (100 rule)

4. The 100 rule in calculating allowables protects the correlative rights of the owners over the small part until they get watered out; then the owners over the fat part of the reservoir get all the production towards the end of the supply from the reservoira. P challenges the allowables calculation the formula for prorating productionb. P asks for a 50 percent acreage/50 percent acre-feet formula instead of a 100 percent acreage based formula. The reservoir is not square; some leases cover thicker parts of the parabolic shaped reservoir than others.

Denver Producing & Refining (RRC allocation of allowables must be reasonable)

5. The RRC imposition of allowables is subject to reasonableness analysis a just and reasonable exercise of administrative power is valid. a. An allowable imposed for conservation purposes and to maintain pressure in the field is reasonable. If reasonable and supported by sufficient evidence, the allowable is valid.Ch 2 The Oil & Gas Lease

Purpose of OGL1. Producers 88 lease samples; 4/76 & 7/69

a. OGL TC OGL \l 4 is a deed granting a fee simple determinable in the mineral estate. OGL is a deed to the oil & gas in place. The lessor does not own the minerals anymore. It is called a lease because of primary terms and secondary terms and delay rentals. It is a warranty deed to a fee simple determinable in the mineral estate, which is separate and distinct from the surface estate. SoF applies to OGL because it is a conveyance of real property.b. Fee simple determinable with right of reverter means that as long as/ so long as the conditions of the deed are met, the lessee maintains his rights in the minerals. If the lessee fails to meet the conditions, the estate automatically ends and reverts to the grantor.

c. The date on the lease is the conversion date TC Conversion Date \l 4 . AKA Anniversary Date.d. OGL is construed against the lessee because the lessee (the O/G company) is normally the drafter. This is unlike a residential lease where normally the lease is construed against the lessor.

e. OGL locks up the exclusive right to explore, bore and produce in the lessee. OGL conveys the right to the o/g and the right to produce it. The lessee keeps this right for a number of years the primary term TC Primary Term \l 4 before he has to do anything to produce.f. OGL severs the mineral estate from the surface estate.

2. Royalty TC Royalty \l 4 is a right to the proceeds of production; right to a fraction of the gross receipts for the sale of production from the property. Royalty is not ownership of the o/g itself. 3. Lessor is paid a bonus TC Bonus \l 4 per acre for executing the lease. Bonus is like a down payment and the royalty is like installment payments when the lease becomes productive.4/76 OGL example4. Granting Clause TC Granting Clause \l 4 Lease must describe the land being conveyed using its legal description because the deed is subject to the SoF (must be in writing and signed by the party to be bound). Must be notarized and be recorded by the county clerk. The OGL must be recorded because Texas is a race notice jurisdiction first one to record has the valid conveyance.

5. Per the next to the last clause of paragraph 1, the lease covers all the lands the lessor claims, including any part he has acquired by adverse possession, even though not included in the legal description of the land provided. (Mother Hubbard Clause)6. Subrogation Clause TC Subrogation Clause \l 4 p146 allows OG lessee to stand in the shoes of the lessor to pay the lessors bill (e.g., tax lien) and then stand with the rights of a creditor over the lessor; withhold money out of royalty until paid back; The tax lien is a superior right to the OGLGranting Clause-Surface Uses

1. The mineral estate ME is the dominant estate. The surface estate SE is the servient estate. ME can use so much of the SE as is reasonably necessary to effectuate the grant.

a. Litigation happens most often around reasonably necessary language.

i. Reasonably is a question of fact so no summary judgment the jury or judge (bench trial) determines what is reasonable

b. General practice in the industry is that the producers pay surface damages to avoid expensive litigation of reasonably. ($50-$100k to litigate)c. A ME lessee cannot mine sand/gravel for sale but he can take the sand and gravel as reasonably necessary for use effectuating the ME on the leased property.

A. He can also take surface water reasonably necessary to operate the drilling unit.

Hunt Oil v. Kerbaugh (Dominant Mineral estate has right to use servient surface estate as reasonably necessary)2. Rule: The mineral estate (dominant) has the right to use so much of the surface as is reasonably necessary to effectuate exploration and production. Lessor does not have the right to prevent the lessee from reasonable use of the SE.Getty Oil v. Jones (Accommodation Doctrine)3. Jones was a farmer with existing pivot irrigation systems. The pumping jack was too tall and would not allow the irrigation arm to operate. Another producer sunk his pumping jack into a basement so that the irrigation arm could pass over.4. Accomodation Doctrine TC Accommodation Doctrine \l 4 adjust the relative rights between the SE and ME; This is not a balancing test the surface owner has the burden to prove all the elements belowa. Existing Use already in existencei. Crops or grazing is not sufficient but a pivot irrigation system would beb. O/G operations will interfere with the usec. There is a reasonable alternative available (economically feasible) (hard to prove)i. This means cheap as compared to normal o/g operationsd. The alternative is available on the leased premises.i. E.g., the producer does not have to pump water in from elsewhere rather than use water on the leased premisesLimits on the use of the servient estate by the dominant estate n. 2, p136-1411. Reasonably necessary: so much of the servient (surface) estate as is reasonably necessary.2. The Accommodation Doctrine

3. Lessee-producer cant burden a neighboring estate with mineral operations when there are no mineral operations by that same lessee on the neighboring estate.

a. The OGL is limited to the boundaries of the land described in the lease. Robinson v Robbins Petroleum TC Robinson v. Robbins Petroleum \l 5 (note casep139) Operations must be limited to that premises.b. E.g., pay neighboring land owner $x / rod to lay a pipeline across his land to move minerals from the leased premises to the main transit pipeline.

4. Surface use must be related to extraction of minerals.

5. Police power, state statutes, city ordinances and govt regulations may limit the easement rights of the mineral owner or lessee.

6. Lease clauses may curtail the rights of use of the mineral owner or mineral lessee.

Maintaining the leaseDelay rentals

Habendum Clause

1. AD TC Anniversary Date \l 4 Anniversary Date date of signing

2. Bonus TC Bonus \l 4 (a stick in the bundle) consideration paid to lessor by the lessee to execute the OGL. It buys the lessee one year of time in which to commence operations.3. Primary Term TC Primary Term \l 4 the term starting from the AD during which the lessee has to begin operations (e.g., Jan 31, 2005 to Jan 31, 2008)

a. The typical term is 3 years;

b. The OGL will end at the end of the primary term unless the lessee begins operations or pays delay rentals. This unless clause is what creates the fee simple determination.i. Delay rentals TC Delay Rental \l 4 (a stick in the bundle) $ paid per acre of the lease each year by the AD, after the first year, during the primary term. If no operations are ongoing on the AD, the delay rentals are due (if you drilled a dry hole, you are not in operation on the AD unless you have started up some other drilling operation)ii. The number of acres in para 1 is the number of acres on which the delay rental is paid.iii. If the producer is engaged in operations on the AD, no delay rental payments are due even if producer stops operations on the day after the AD.iv. Operations must be operational on the AD each year or the delay rental is due for that next year.Schwartzenberger v. Hunt Trust Estate (technical compliance with HC is requiredright amount, right time, right persons, right manner)

4. A delay rental agreement requires lessee to pay the right people the right amount at the right time or the lease automatically terminates.a. Lease language can be used to create safe harbors to prevent automatic termination e.g., good faith/bona fide attempt to make the delay rental payment

b. Tx Rule p 22 -- It is well settled that with the usual unless lease, a failure of the lessee either to begin a well or to pay the delay rentals, ipso facto terminates the lease on the date set out for the action and the estate reverts to the lessor without the necessity of reentry, declaration of forfeiture, or legal action.

i. Must have an express clause to create an exception for GF effort.

Breaux v. Apache Oil (p178) (meaning of operations substantial preparations for drilling in good faith and with due diligence)

5. Operations is not limited to actual drilling but includes preparations to drill; Staking the location for a well is probably sufficient to be considered to have commenced operations as long as further action occurs within 90 days and continues and does not cease for any period longer than 90 days.

a. Courts are very liberal with respect to commencement but very strict w.r.t. delay rentals.

b. Irresponsible, flippant, less-than-serious intent to commence operations probably is insufficient to avoid payment of the delay rental but courts are less strict on interpreting commencement.

6. Secondary Term TC Secondary Term \l 5 a. The secondary term does not start until the primary term ends even if production starts and is continuous until the end of the primary term. This means you can produce/conduct operations intermittently during the primary term. As long as you pay the delay rentals, then can keep the lease. Once secondary term begins, actual or constructive production must continue for the lease to remain in effect.What kind of production

Assignment Clause1. Paragraph 8 details assignment rights. Allows lessor to assign part of his rights to another.

a. No change in the division of the ownership of the land, royalties, delay rental or other money shall increase the obligations of the lessee. Lessor must give notice to the lessee of any change in ownership; the change in ownership becomes effective after 30 days notice.

Cheyenne Resources v. Criswel (repudiation by lessor)2. repudiation of a lease by the lessor suspends all obligations of the lessee under the lease while the repudiation is pending, even if the operator continues operations.a. Repudiation is a form of estoppel; Lessor is estopped to deny the lease is terminated because he repudiated. All of the obligations (e.g., pay delay rentals, start operations, continue operations, payment of royalties, etc.) of the lease are suspended during the period of repudiation (during pendency of the litigation).

Clifton v. Koontz (paying quantities revenue > operating expenses)3. One well on a large OGL can meet the requirements of the lease; As long as it is a producing well, the habendum clause of the secondary term is met.

a. Producing means producing in paying quantities.

i. Well must pay a profit, even small, over operating expenses to produce in paying quantities, though it may never repay its costs. Test for paying quantities.A. Is revenue < cost of operations?

(1) Time period for revenue to be less than the cost of operations must be at least one year.

B. RPO test Would the reasonable prudent operator continue to operate the well at that level of operating costs and level of production not for speculation purposes but for the expectation of continuing production in paying quantities?C. If answer is yes and no, respectively, the lease terminates.

b. Operating expenses TC Operating Expenses \l 4 includes routine, recurring expenses but not drilling, completing, equipping or depreciation of the original investment. These are CapEx and not included in the equation of operating costs.i. Included: Royalties, electricity, pumper (independent contractor who checks the well for operability), ad valorem taxes, insurance, supplies, administrative overhead for district office, salt water disposal, trucking charges for taking oil to market; labor, transportation, general replacement & repair, production taxes, licenses and permit fees, maintenance and repair of roads, environmental expenses, administrative costs.ii. What gets excluded?

A. overriding royalty because it is carved from the working interest

B. drilling, completing and equipping costs; other capital costs

C. production payments

D. Depreciation of casing, completing equipment (Christmas tree, blowout preventer) but not of surface equipment (e.g., compressor)

Stanolind Oil & Gas v. Barnhill (TX-production in paying quantities requires actual severance/sale)1. TX Rule Paying quantities means actual severance and sales (to the downstream side of the wellhead and marketed, not just stored in a tank); there are no paying quantities unless there is some revenue; discovery of o/g is not enough to continue the lease.a. This is a condition not a covenant; lease terminates if not complied with.b. OK rule says that capability to produce is sufficient to keep the lease active.

i. TX rule if the habendum clause says so long as o/g can be produced instead of so long as o/g is produced then that means capability. (Anadarko v. Thompson)Pshigoda v. Texaco (p27 left-hand column reworking is not operations)1. Sue to terminate because well not producing in paying quantities

2. Is reworking a well a CapEx or a cost of operations? No, reworking is a capital expense and excluded from the operating expense formula

3. Garcia v. King TC Garcia v. King \l 4 production means producing in paying quantities

4. Clifton TC Clifton \l 4 lays out the two step profitability test (revenue > operating expenses, RPO)5. Skelly TC Skelly \l 4 depreciation on salvable equipment is includable in the operating expense calculation; depreciation on production equipment and reworking are excluded.

Working Interest & Assignment

1. An OGL is the conveyance of the explore, bore, produce stick w.r.t. the mineral estate. This is the working interest. Working interest owner owns the ME.a. With a conveyance (assignment) of the working interest to another, the conveyor (original lessee) may reserve an overriding royalty TC Overriding Royalty Interest ORRI \l 4 out of that working interest. The assignee can then assign his interest to another, reserving another overriding royalty. i. Net Revenue Interest (NRI) TC NRI \l 4 is the remaining working interest after subtraction of an ORRI

b. An assignment is another deed, must be recorded and comport with SoF. 2. Division Order Title Opinion (DOTO) TC Division Order Title Opinion DOTO \l 4 a. Determines how the royalty interests and the overriding royalty interests are to be paid out. These are all real property interests entitling the holders to a percentage of the proceeds of production.

b. Pooling provision TC Pooling Provision \l 4 (para 4) allows leases to be pooled into one drilling unit. Royalty owners share in proportion to their surface acreage over the total acreage of the pooled leases x the royalty percent

i. Eg.

A. 160 acre drilling unit in 4 tracts with five land owners; each tract provides a 1/5 royalty

(1) A owns 40 acres = 40/160 x 1/5

(2) B & E together own 80 acres =

(a) B = 80/160 x x 1/5

(b) E = 80/160 x x 1/5

(3) C owns 20 acres = 20/160 x 1/5

(4) D owns 20 acres = 20/160 x 1/5

c. Overriding royalty owners share in whatever percent they reserved to themselves. The remainder goes to the producer.

3. What do you need to know w.r.t. the obligations under the OGL? Classify interests, quantify interests and follow the money.4. MMBTU TC MMBTU \l 4 (million BTU) is equivalent to 1 mcf of natural gas.

Produced Overview1. Produced means produced in paying quantities which means severance and sale of the o/g; Two step test for terminating lease if production ceasesa. Revenue > operating costs over at least a years time (does not include initial drilling costs or depreciation of those costs); if revenue < operating costs, first prong for termination is met.

i. Stanolind v. Barnhill (TX) production without sales is not sufficient.

A. TX capable of production in paying quantities is not sufficient to continue the lease during the secondary term

(1) Recent TX S Ct -- If lease clause says as long as o/g can be produced capability/potential is sufficient to maintain the lease.

B. Pack v. Santa Fe Minerals OK - capable of production in paying quantities is sufficient to continue the lease during the secondary term

b. RPO test would the RPO continue to invest in making production.

c. Lessor will want to terminate the lease; lessor bears the burden of proving the two elements

Bundle of sticks in the mineral estate (on the exam)1. Explore, bore, produce - This is a correlative right of the executive right, the working interest2. Executive right - can convey the e/b/p right and get royalties in return

3. Bonus for executing the lease and for the first year of the primary term.

4. Delay rental Paid yearly on the AD to maintain the lease during the primary term if no operations

a. If a paid up lease no delay rentals; they are prepaid when the lease is signed.

5. Royalty cost free % off the top; free of the costs drilling, completing, and equipping the well.

6. Right of reverter - If the lease is cancelled or terminates, the estate reverts in the holder of the executive right (generally the lessor)Savings Clauses and Doctrines (shut in, TCOP, cessation of production, dry-hole, continuous ops, & force majeure)Shut-in royalty clause

1. Saves the lease when severance and sale is not possible; usually when the drilling unit is capable of producing in paying quantities but there is an inability to get the o/g to the market or there is no market for the product. Usually happens with gas wells b/c no easy way to store gas above ground.

Freeman p204 (shut in gas royalty = constructive production)1. Shut-in gas royalty clause provides that the payment of the shut-in royalty equals production -- constructive production

a. The well must be capable of production (it cant be a dry hole).b. The producer cannot just stop production and pay the shut-in royalty waiting for a better market price. Courts may allow a producer to do this for 1-2 years but the producer cannot do so indefinitely.

2. In TX, constructive production is equivalent to production in paying quantities with severance and sale. It is make-believe production and continues the lease during the secondary term.

a. The shut-in gas royalty clause is a condition, not a covenant; failure to pay it terminates the lease. Without a shut-in royalty clause or other savings clause, the cessation of production after termination of the primary term automatically terminates the lease.b. See the example problemi. If production begins again during the time in which the producer has been paying the shut-in royalty, the producer should still pay the next full shut-in royalty payment out of an abundance of caution to ensure the lease is maintained. (Mike Jones rule)

ii. Shut in royalty payment is payment for time o/g not produced in arrears (the previous months not produced).c. Ex A royalty of $x per year on each gas well from which gas only is produced while gas therefrom is not sold or used off the premises, and while the royalty is paid, the well shall be held to be a producing well.d. Covenants and conditions in contracts

i. Conditions in contract law provide for void/termination of the contract if the condition is breached

ii. Breach of a covenant in contract law only gives a cause of action for damages; does not terminate the contract

30-60 day clause (doctrine of temporary cessation of production)Watson v. Rochmill (p. 29s)1. Doctrine of Temporary Cessation of Production (TCOP)a. If have a TCOP due to a sudden stoppage of the well or some mechanical breakdown, lessee has a reasonable time in which to remedy the defect and resume production. The lease does not terminate automatically.

Cessation of production, dry-hole clause, continuous operations clause

1. Savings clausesa. Dry hole clause

b. Pooling clauses

c. Force Majeure Clause

d. Operations Clause any substantive activity on the surface that is directly related to securing production, begun in good faith and diligently pursued will be sufficient to extend the lease past the primary term prior to completion of production.

e. Temporary cessation of production doctrine sudden cessation; have reasonable amount of time to restart operations before termination

f. Shut-in gas royalty constructive production; provision that allows payment in lieu of actual production to maintain the FSD; cannot be a dry hole.g. 30-60 day clause TC 30-60 Day Clause \l 4 for cessation of production in secondary term if conducting drilling operations at end of the primary term and have clause so long as operations continue the lease into the secondary term is continuedi. Continuous operations clause TC Continuous operations clause \l 4 allow for specified temporary cessation of 30, 60 or 90 days typically. These specific clauses define reasonably if the TCOP default was in play.

Rogers v. Osborn (restarting operations after TCOP violated does not extend lease)Well 1 was not a dry hole but neither was it a producer so clause 1 of paragraph 5 does not apply. Work on Well 2 after end of primary term and after Well 1 shut-in not able to allow lease to continue. Reworking of W1 extended lease past primary term but when shut in during secondary term, lease terminated. W2 could not revive.Samano (30-60 days clauses strictly construed)Had production in secondary term and a 73 day cessation of production. Lease provided for only a 60 day cessation before the lease terminates. An express provision that addresses cessation of production trumps the TCOP doctrine.Force Majeure clause

Haby v. Stanolind Oil & Gas Co (no force majeure clause in the lease)1. A unilateral decision that production is no longer possible after RRC issues orders w.r.t. a well is ineffective to extend the lease where there is no shut-in royalty clause and no force majeure clause in the lease. Production was economically infeasible not impossible.2. Courts will not imply a force majeure clause into a lease.

Perlman v. Pioneer Ltd Pship (unilateral decision that production is impossible is insufficient to trigger a force majeure clause)1. D pleads force majeure because the Wyoming regulations prevented him from cheaply recovering oil in the water drive field.

2. Government regulation was in the FM clause but D did not litigate/administrative procedure the issue with the board to get a final denial of his process for the field. He unilaterally decided to stop trying after he was initially told other permits would be necessary. He was not prevented by the board because he did not get a final decision that he could not use his process.3. An actual material hindrance must occur before performance will be excused, not just the possibility of hindrance.

Force Majeure Rules

1. Is the obligation or performance covered by the clause?

2. Is the event of force majeure described in the clause?

3. Did event prevent performance? Performance must be impossible.a. Causal connection between event and failure of production

b. Not an event of your own making.

i. In Hydrocarbon Tracker TC "Hydrocarbon Tracker" \l 5 , the commission said HT could not produce anymore because HT had overproduced. HT plead FM but the fact that they were shut-in was an event of their own making because they had intentionally overproduced.Royalty payments

1. Three part royalty clauses

a. Oil royalty

i. In kind delivery or money

ii. E.g., lessor gets 1/8 of that oil produced and saved from the land or lessee may buy the oil at market price prevailing on the date of purchase.

b. Gas royalty

i. Only money

A. Sale at the well on the lease

B. Sale off the lease

ii. Lessors want to pay the same royalty whether the gas is sold on or off the lease

A. Gas sold off the lease, ex. 1/5 of the market value at the well or proceeds less certain costs

iii. Market value at the well term of art -

iv. E.g., When sold by lessee 1/8 of the amount realized by lessee computed at the well; if off the lease 1/8 of amount realized from the sale of gasoline or other byproducts extracted and 1/8 of the amount realized from the sale of the residual gasv. Shut-in gas royalty clause

c. Other minerals royalty

Types of royalty interests

1. Overriding royalty (ORRI) TC "Overriding Royalty ORRI" \l 4 carved out of the working interest (the interest the lessee gets to explore, bore and produce the minerals on the land; typically created when the lessee assigns his interest to another)2. Nonparticipating royalty interest (NPRI) TC "Nonparticipating Royalty NPRI" \l 4 is carved out of the landowners royalty (standard royalty) interest (reserved when the landowner sells the surface to another; reserves a right to a certain % of the royalties but loses the executory right)

3. Landowners royalty interest TC "Landowners Royalty RI" \l 4 standard royalty

Market value royalty issuePiney Woods Country Life School v. Shell Oil Co. (defn: market value at the well)1. Gas sold on the lease gave lessors proceeds at the well; gas sold off the lease gave lessors market value at the well.

a. Proceeds TC "Proceeds" \l 4 is actual amount realized by the lessee (in this case, proceeds were governed by the price in the long term k)i. Proceeds = amount received for sales of the gas on the lease (basically the gas with impurities)

b. Market value at the well TC "Market Value at the Well" \l 4 (market value at production, not the K price) Determine by

i. Comparable sales TC Comps \l 5 similar time, quantity, quality, and availability of marketing outlets (hard to determine because data not readily available)ii. Cost netting TC Cost Netting \l 5 Market value less certain costs subtracted back to the well

A. Hubs create a market clearinghouse for gas trades (e.g., Houston Ship Channel, Katy Hub, Henry, LA Hub); basically creates a spot market for gas

B. Subtract the costs of developing/administration of PL, gathering, transporting, compressing, dehydrating, and processing from the spot price to arrive at the market value at the well this determines what a willing buyer would pay you at the lease well head.

(1) The value of pipeline quality gas less the costs to get it to pipeline quality.

(2) What would a reasonable buyer, reasonable seller in an arms length transaction agree to pay for the gas at the well?

(a) Consider location, quality, quantity & time

(3) Cost netting pipeline quality gas less costs to make gas pipeline quality (remove impurities) back to well head (FMV costs to get to market from the well)

C. There can be disagreement between the LR & LE on what the actual costs and amounts are that should be subtracted from the market price.c. To pay: (1) 1/5 of the market value at the well for gas sold off lease (2) 1/5 of the proceeds for gas sold on the lease. Theoretically these are the same

2. Vela Rule (TX) TC "Vela Rule" \l 4 market value at the well means monthly determined fair market value of the gas, not the long term K price

a. Isagary v. KCS TX applies the Vela rule even if the market value is lower than the contract price. Lessor gets royalty on the lesser market value not on the amount received at the higher contract price. Implied Covenant to Market

Pyote (likely no longer good law b/c of changes in natural gas market)

1. Implied Covenant to Market Lessee is not a fiduciary but must seek to market production fairly and in good faith to get highest possible price reasonably obtainable for the gas.i. Good faith duty implied highest price obtainable by exercise of reasonable effortb. There is no implied covenant to market in a market value at the well sold off the lease lease in TX (Isagary v. KCS). There is only one value for the market value at the well (willing buyer, willing seller, no compulsion, price they would agree to pay; the value is expressed in the lease as market value at the well)i. In OK, KS, AR, CO, the implied covenant .does apply

Take or pay

Killam Oil v. Bruni (s41) (royalty is not due royalty owners on take or pay payments)1. Take or Pay clauses assure an income stream to the producer regardless of actual severance and sale. Producer must dedicate its total production from those wells to the buyer and the buyer must buy a quantity that represents a certain percentage of the total production or pay for the amount not taken. If the buyer has to pay because he fails to take the minimum, he can reduce the bill owed in the future when he takes more than the minimum to make up for the amount he already paid.

2. Texas: payments made under a take or pay clause are not constructive production and so no royalty is due the royalty interest owners. Absent an actual severance and sale of the minerals, there is no production. A take or pay payment is a payment for not producing so a royalty is not due. A shut-in royalty clause may apply but the take or pay payment is not a basis for the amount of the shut in royaltythe shut-in royalty payment is usually a fixed payment based on the delay rentals. Alameda v. Transamerica Natural Gas (RI owner not due royalty on damages for breach of take or pay clause-absent a specific clause in the lease)3. Court cites to Killamtake or pay agreements are payment for non-production so RI is not entitled to any part of the settlement of the breach of that agreement. RI get paid only on actual severance and sale. Take or pay agreements are consideration for dedication of supply, not for productionan agreement between the producer and the pipeline company, not the producer and the lessor/RI owner.

a. In LA under the Tara rule, royalties are due on take or pay payments

b. Lessors now include a royalty clause that says Lessors are entitled to their percentage of royalty on take or pay payments or settlements.

Costs after production

1. Market value at the well speaks to the location of value. Must get it from the well to the market. Costs to get it to market are subtracted from value at the market to get to market value at the well.Garman v. Conoco (CO)costs of production v costs subsequent to production2. Issue: whether or not post-production costs can be deducted from the overriding royalty when the assignment that creates the ORRI (carved out of the working interest) is silent as to post-production costs?

3. Holding: Court says lessee has an implied covenant to market. This implied covenant requires the lessee to absorb all the costs to get the product in marketable condition. If further processing is required at market, those costs might be deducted. If the lessee needs to process the product before the product can be put into the market, the lessee must absorb those costs. Same for OK and KS.a. ORRI is an interest in O&G produced at the surface, free of expense of production, generally assessed in addition to the usual mineral owners royalty.

b. In Texas

i. Pyote -- There is no implied covenant to market in a market value at the well lease in TX (Isagary v. KCS). There is only one value for the market value at the well (willing buyer, willing seller, no compulsion, price they would agree to pay; the value is expressed in the lease as market value at the well); best price is not a factorii. Production is complete at severance. Royalty is due on the market value at severance. Thus, post production costs for gas sales are born by everyone. For oil sales, no post production costs are required so royalty is paid without consideration for post-production costs.

Heritage Resources v. Nationsbank, Co (1996) (MVW is a term of art)1. Tx S Ct says market value at the well is a term of art that means market value as the gas comes out of the ground so the clause that attempts to remove the costs of processing, transporting, etc. to get the gas into marketable condition is not valid (surplusage as a matter of law).

2. To get around this term of art, specify percentage of market value at the market (e.g., 1/5 of the price at the Houston Ship Channel, first of the month, large packages, inside FERC); may allow costs for transportation, compression and fixed costs to be deducted from the market price before royalty is paid (e.g., 1/5 x (93.5% x HSC) - .15)

a. Stay away from the term market value at the wellDivision orders

1. A Division Order is binding until revoked. A division order is an executory accord, not a contract. It is a statement to the lessor by the payor (producer) of what lessor will be paid.

a. It is an agreement while you are in execution of a contract that is binding on both sides. If you sign the DO, you get paid what is listed in the DO until revoke it. Otherwise, you are bound by the payments made until revocation.

b. S Ct says DO are an executory accord and binding until revoked unless unjust enrichment results to the lessee. Lessee here was unjustly enriched by 7/16.

Gavenda v. Strata Energy (beware reservation of X royalty v. X of royalty)1. Gavendas had a NPRI not of the 1/8 royalty negotiated by the lessor to the lessee.

a. Lease said undivided non-participating royalty of all the oil & gas in, to and under NOT undivided of the royalty negotiated by the lessor; Gavenda has a CoA against the royalty owners that got part of their royalty (that were overpaid royalties based on miscalculation)b. What was really reserved was a royalty interest, non-participating

Division Order Statute Tx Natural Resources Code 91.401

1. Payor party who undertakes to distribute O&G proceeds to the payee; Payor is usually known as the First purchaser or the First seller2. Division order is an agreement signed by the payee directing the distribution of proceeds from the sale of oil, gas, casinghead gas, or other related hydrocarbons.

a. Transfer order is an agreement signed by a payee and his transferee (new payee) directing the payor under the division order to pay another person a share of the O/G produced (really a type of DO)3. Time for payment proceeds from the sale of o/g production from an o/g well must be paid to each payee by payor on or before 120 days after the end of the month of the first sale of production. ( 91.402)

a. E.g., 120 days after 2/29/08 of the first sale of o/g is on 2/18/08. (turn the well to sales on 2/18/08)

i. On oil, after the first payment, 60 days from the date of sale

ii. On gas, after the first payment, 90 days from the date of sale

b. Failure to pay by the deadline causes the payor to incur interest on the late payment ( 91.403); 2% over the rate charged to banks by the NY branch of federal reserve bankc. Payments may be withheld without interest beyond the time limits when there is some kind of question as to titlei. A dispute concerning title

ii. Reasonable doubt that payee has sold its share of the o/g to the purchaser of the o/g

iii. A requirement in a title opinion that places in issue the title, identity, or whereabouts of the payeeA. Division order title opinion DOTO.

iv. Payment can be suspended, interest free, until resolution but payor must tell the payee about the suspension.

4. Payor can condition payment of proceeds on the execution of a division order as long as the DO contains only the specified provisions 91.402(c)(1)

a. As a condition for the payment of proceeds from the sale of o/g to payee, a payor shall be entitled to receive a signed division order from the payee containing the listed information.

i. One provision is that the division order does not amend any lease (the DO must be in harmony with the lease)

b. This part of the statute is a default provision and can be contracted around such that the lessor does not have to sign a division order.

5. The sample DO in (d) cannot be used for natural gas production. It says of all the oil and related hydrocarbons and for all the oil

a. If the DO is not completely in line with the statute, payor cannot make signing the DO a condition of payment.

Cannon v. Cassidy (non-payment of royalty is not a terminating condition)1. Under the division order statute, non-payment causes the payor to incur interest but it does not allow the payee to terminate the lease. Non-payment creates a CoA in the payee for damages (breach of the covenant to pay royalties).

2. On rare occasions, lessors will make payment of royalty on time a condition of the lease continuing. Remedies for failure to pay royalties Caanan (CoA for damage, not cancel)Failure to pay royalties is not grounds to cancel an oil & gas lease unless payment is expressly made a condition of continuing the lease. Failure to pay royalties creates a cause of action for damages in the lessor.

Royalty paid on production after subtracting gas used by LE in production (Free Gas Clause)1. Problem

a. 90,000 mcf ng/month x $9 = $810,000b. Gas is at 500 lb/sq in; must be boosted to 1000 lb/sq in to enter the pipeline. Thus he must compress the gas; he compresses at 750 lb/sq in

i. The compressor uses 300 mcf/day; 9000 mcf/month

c. 90,000 9000 = 81,000 net mcf/month

d. Royalties paid on the 81,000 because para 3 of the OGL is a standard provision royalty on oil, gas and coal shall be computed after deducting any [oil, gas, coal] used by the lesseei. The royalty is paid after the amount of o/g used by the producer on the lease is deducted from the gross production so on the 85,000.

2. Free gas clauses let the lessor have free use of gas

Implied Covenants

1. Implied covenants

a. Are not in writing (address terms and conditions the parties did not agree on)b. Are implied by necessity; court will imply a covenant if it finds that the parties would have addressed the issue with such a covenant if they had thought in detail about it or could have foreseen the issue.

c. Are not implied into leases that have expressly addressed the issue in the OGL.

2. Implied covenants are implied in fact in Texas (so issues of implied covenants are a jury/factfinder question). They are implied in law in other states.

3. Implied covenants

a. To develop the premises initially drill and further develop as an RPOb. To protect the leasehold act to protect as an RPOc. To manage and administer the lease

Nature and Classification

Brewster v. Lanyon Zinc Co (KS) (implied covenant to further develop; not in TX)

1. Implied covenant to continue to explore, develop and produce after oil has been found2. An implied covenant does exist to continue to explore, develop and produce after o/g has been produced in paying quantities; otherwise the lease terminates.

3. Texas Standard: What would the Reasonable prudent operator do under the circumstances considering his own interests and those of the lessor?Drainage

Amoco v. Alexander (TX 1981) Implied Covenant to protect against Drainage (local & field-wide)

1. Lessee has a duty to its lessor to protect against field-wide drainage as a RPO.

a. There is no duty unless such an amount of oil can be recovered to equal the cost of administrative expenses, drilling or reworking and equipping a protection well, producing and marketing the oil and yield to the lessee a reasonable expectation of profit.

b. Pyote case in 1980 implied a covenant to market in good faith and fair dealing

i. After Alexander, the standard is not GF/FD, it is RPO no duty to act unless operator can make a reasonable profit.

2. Original oil in place (OIP) TC "Oil in Place (OIP)" \l 4 the amount of oil in place under a leased premises before a well is drilled; important to know for a unitized field because that allows a determination of percentage of production due each royalty owner.

Kerr-Mcgee v. Helton (2004 Tx)-- Drainage1. Elements of CoA for drainage; Lessor has burden to show

a. Notice not required because KM was the common lessee; otherwise notice requiredb. Substantial drainage

c. Common reservoir

d. That an RPO would have acted to prevent/correct the drainage (whether RPO could make a profit considering administration, drilling, reworking, equipping, producing and marketing expenses)i. This requires expert testimony

e. Damages royalty on the production from the hypothetical lease or royalty on amount drainedi. Net feet of pay TC "Net feet of pay" \l 5 (productive feet within a formation that will produce o/g; kind of like OIP) determines the production from the well.

ii. Traditional measure of damages is to hypothesize production from an offset well that is developed and completed without complication

A. Determine how much o/g has been drained and calculate royalty on the amount of o/g that has been drained.Exam Implied Covenants in Texas1. In Texas, there are three broad categories of implied-in-fact covenants in every OGL except where LR/LE expressly addresses the issue in writing. The standard is RPO. (example: 4/76 lease: last sentence of para 6)2. Develop TC "Develop" \l 3 (Superior Oil v. Devon, p310)

a. Lessor must prove

i. Production on the leased premises

ii. An RPO could drill, complete and operate wells profitably.

iii. Common reservoir (formation)iv. Notice & demand (60d for chance to cure)v. Remedies

A. Damages

(1) Lost royalty the amount of royalty that would have been paid

(2) If the lessee then drills and produces o/g, does the lessee owe the royalty if it has already been paid? No, $ for $ credit given (future credit against royalties to be paid once production has begun after cure).(a) OGL lessee gets a credit against future royalty owed for royalties paid as damages

(3) Interest paid on what the royalties would have been (compensation for delay in drilling which delayed payment of the royalty); gets around the problem of future credit against royalty owed.

B. Conditional cancellation requires drilling of wells by the breaching operator; 60d to cure or cancel part of lease3. Protect TC "Protect" \l 3 (most important IC) protect from local (Kerr-McGee v. Helton) and field-wide drainage (Amoco may implicate the IC to Manage & Administer to join all other operators on the field into the efforts or to get exceptions from RRC)

a. Payment of delay rentals will not excuse a lessee from protecting the leasehold from drainage after a well is producing on a neighboring parcel.

i. The implied covenant trumps the use of delay rentals as a substitute for production.

b. Lessor has burden of proof to show i. substantial drainage of lessors land and ii. that a RPO would have acted to prevent substantial drainage from lessors land. LR does not have to give notice to a common lessee that drainage is occurring (Stansbury case). The common lessee (who has more than one lease in the same field) is presumed to have notice that it is draining a field. RPO must act ifA. Same geological formation and it will support productionB. Drilling, completing and operations will be profitable.iii. Damages4. Manage & administer TC "Manage & Administer" \l 3 a. To produce & market

b. To operate with reasonable care diligent operation (Baldwin)c. To use successful modern methods of production and development

d. To seek favorable administration action (from RRC) comply with all government rulesImplied Covenants to Drill or Explore

Superior Oil v. Devon Implied Covenant to Develop (step-outnot explore)1. IC to Develop arises after production is obtained. Operator required to act with reasonable diligence in developing the lease as an RPO would (subject to the profitability constraints noted above). (the IC springs full blown like Athena from the head of Zeus)

2. IC to develop says that continuous production into the secondary term is not enough to maintain the lease if an RPO would have been reasonably diligent about continuing development.

3. Lessor must give the lessee notice and demand for a remedy before the lease can be terminated. a. Unconditional cancellation is not a remedy in TX. After lessor proves at trial that the operator breached the IC to develop, the operator must be given a period of time to correct the breach.

b. Waiver of notice is possible if the operator does some affirmative act to show no intent to develop.Sun Exploration & Production v. Jackson (p59S) Implied Covenant to Further Explore (not in Texas!!)1. Explore TC "Explore" \l 3 = wild cat (exploratory drillinglike a box of chocolatesnever know what youre going to get)

2. Develop TC "Develop defn" \l 3 = step out (a well drilled near a well that produces profitably); use closeology to drill another well nearby

3. There is no implied covenant to further explore in TX. RPO Standard for development applies.a. Clifton v. Kuntz production in TX is severance & sales in paying quantities; implied covenant to develop and drilling additional wells. b. There is no IC to roll the dice. If an RPO would do seismic studies elsewhere on the lease to determine if o/g in paying quantities might exist there, then operator has that duty.

Diligent operation (one of the duties to manage & administer)Baldwin v. Kubetz (CA)

1. Operator is in violation of city ordinances. The city cancels his lease.

2. Operators have to comply with all rules & regulations that govern their operations.

HECI v. Neel (no IC of notice of suit by LR to LE before sue LE)1. In TX, there is no IC requiring a lessee to give notice to the lessor of its intent to sue or actual commencement of a suit against an adjoining lessee.a. Lessors must exercise reasonable diligence in protecting their interests.

b. Issue preclusion

i. Res judicata TC "Res Judicata" \l 3 litigation that has already decided an issue precludes bringing that same issue up again in another litigation.

ii. Collateral estoppel TC "Collateral Estoppel" \l 3 is party preclusion on the same issue; if a matter was or could have been decided in litigation and you are in privity with one of the parties, then you are collaterally estopped from bringing a claim against either of the parties.

2. In TX, there is no fiduciary relationship between a lessee and royalty owners.3. Common reservoir under HECI & AOP. AOP over-produced from their wells. HECI properly approached RRC for resolution. AOP again over-produced causing a permanent loss of o/g in the reservoir. HECI sues AOP and gets $3.7M judgment in 12/88

4. Neels learn of the settlement in 5/93 and sue for a portion of the settlement in 12/93.

a. Neels argue that the discovery rule should govern the SoL. Discovery rule:i. Inherently undiscoverable condition/situation

A. Ct says the judgment is not inherently undiscoverable; royalty owners have an obligation to keep informed about such issues. ii. Condition/situation is objectively verifiable

A. Over-production was objectively verifiable

For the exam, need to know the general contents of the two oil & gas leases

1. What does the royalty clause provide? Market value at the wellwhat does that mean?

2. What are delay rentals? What are shut in gas royalties (constructive production)?

3. What are operations?

4. What is force majeure?

5. Implied covenants; implied in fact, not lightly impliedmust be obvious the parties intended to include themimplied out of necessity to effectuate the intent of the agreement.

6. Covenant to develop

7. Covenant to protect; exceptionsexpress provision overrides an implied covenantexcept for an express offset provision not in compliance with law and delay rental will not trump duty to develop.8. Diligent operation required.

Ch 3 Titles & Conveyances: Interests of Oil & Gas

Mineral Interests and Royalty Interests (Deeds, Assignments & the use of Words with Magical Qualities)

Nature of the Interests

Bodcaw Lumber v. Goode (Ark. 1923) (ME & SE may be severed and held by different owners in perpetuity)1. Severance of the two estates: The mineral estate and the surface estate can be severed and held by different owners. Exist independently from one another in different owners perpetually. Severance effectuated by a. Deed reservation

b. Deed grant

c. Partition

d. OGL with right of reverter to grantor creates a FSD in the mineral estate.

e. Divorce decree property settlement

f. Surface lease grazing lease

g. Eminent domain

h. Devise or bequest in a will

i. Adverse possession of the minerals.

j. Civil judgment/settlement

2. AR S Ct follows the TX rule: a reservation vests the grantor immediately in the mineral estate and it is not void as against the RAP. Grantees args are null because the interest vested immediately.a. In TX you cannot abandon a real property interest because it vests immediately.

Type of estate in the TX bundle of sticks in the ME1. Fee interest in the Mineral estate in TX includes these 6 rights (sticks in the bundle)a. Explore, produce, ingress, egress use of surface as reasonably necessary to effectuate the grant.

i. This is a correlative right of the executive right. When the executive right is exercised, the e/p/i/e right is correlative to that exercise.

b. Executive right separate fee, non-possessory interest

c. Bonus separate fee, non-possessory interest

d. Delay rentals separate fee, non-possessory interest

e. Royalty separate fee, non-possessory interest

f. Right of reverternon-possessory until the OGL determinate condition occurs

2. All of the sticks in the mineral estate can also be separately severed (conveyed)

McSweyn v Musselshell County, MT(2% mineral interest (working interest) v. 2% royalty interest)1. 2% mineral interest bears 2% of operating costs before he can get any return from the minerals; 2% royalty interest gets 2% of the proceeds free of the costs of production (drilling, completing, equipping & operating).

2. Thus, a mineral interest can be worth less than a royalty interest because a ME does not get real profit until the costs of operating are recouped.

Creation of Mineral & Royalty Interests

Barker v. Levy (grant of NPRI or NPMI)1. As payment for services, attorney has client grant him 1/160th : issue: NPRI or NPMI?a. Nonparticipating TC Nonparticipating \l 5 means no executory right; your interest is subject to the executory right holders action.

b. NPMI TC NPMI \l 5 has all the sticks but the executive right; royalty is %MI * RI (here, 1/160 * 1/8 = 1/1280th)c. NPRI TC NPRI \l 5 p340-341 the royalty is the fraction expressed (here 1/160th)Schlittler v. Smith (p340) (NPRI participates in LO royalty, minimum royalty and compensatory royalty)1. Problem (p342)

a. An NPRI participates in landowner royalty, minimum royalty, compensatory royalty but not ORRI, shut-in gas royalty

b. E.g., H ( 1000 acres ( C&JS reserving of all the royalty (NPRI)

i. Minimum royalty clause TC Minimum Royalty Clause \l 5 ?...yes (this clause only applies if the operator is producing and selling; it is not constructive production)

ii. Compensatory royalty TC Compensatory Royalty \l 5 (a royalty paid in exchange for a waiver of a breach of the implied covenant to protecte.g., Amoco v. Alexander)

iii. Net profits interest TC Net Profits Interest \l 5 an interest after profit (recover the costs of drilling, completing, equipping and incremental amounts of operating costs, then you get your interest) (ORRI, MI/Working Interest, NPMI)iv. Carried interest TC Carried Interest \l 5 (5% carried interest to the tanks your 5% of the drilling, completing, and equipping costs are paid until operations begun then you start paying your portion of the incremental costs before you get your royalty)

Magic words of granting (creating Mineral Interest v Royalty Interest)1. Produced and saved ( royalty interest

2. In and under ( mineral interest (MI)3. In and under that may be produced and saved ( mineral interest

Altman v. Blake (if use in and under it is a MI no matter what else might be reserved)1. 1/16th in and under (MI)2. This was determined to be a mineral interest because of the in and under language; once a mineral interest, always a mineral interest, even though other incidents of the ME were also conveyed.French v. Chevron (in and under that may be produced = MI)1. 1/656th interest of 32,000 acresRI or MI?

2. in and to all the o/g/om in and under and that may be produced and its a royalty interest only and no participating in delay rentals or bonus and no executory right; royalty language was superfluous.3. Chevron says MI because of the granting language so 1/656th * 1/8 * 8/8 (8/8th is the gross proceeds)

4. French says RI only because the granting language says royalty so 1/656th * 8/8th

Watkins v. Slaughter (p359), Temple-Inland v. HendersonA royalty interest was found when the granting clause said grant an undivided 15/16th in the oil/gas in and under the land and provided that the 1/16th retained by the grantor is and shall always be a royalty interest, and shall not be charged with any of the costs which the grantee may incur in exploring, drilli