January 27, 2015

The Economist - "Let There Be Light"

In a special section of the January 17 edition of The Economist, Edward Lucas gives a broad overview of the world energy outlook and the future for renewable energy. His is an optimistic forecast for cleaner, cheaper and more plentiful energy. His article can be found online here.

First, the article provides this view of current world energy production and consumption:

economist.pngThis picture doesn't present a very optimistic view. Almost 60% of energy production is "wasted energy." Oil still provides 33% of all energy consumed, while wind supplies only 1.1%, and solar only 0.2%. And the EIA projects that global demand for energy will increase by 37% in the next 25 years.

But Lucas says things are changing. Solar electricity, and ways of storing it, are becoming cheaper and better. China invested $56 billion in renewable energy in 2013, and it installed 13 gigawatts of solar, more than its new fossil-fuel and nuclear capacity combined. Wind now provides a third of Denmark's energy supply and a fifth of Spain's. Solar is becoming competitive with traditional fossil fuels, and costs are continuing to decline.

Lucas says solar is pulling ahead of wind. In 2013, additions of solar electricity generation exceeded that in wind for the first time. The cost of solar panels has reduced by a factor of five in the past six years. EIA predicts that solar will provide 16% of world electric power by 2050.

Lucas also describes "distributed generation" - domestic fuel cells, rooftop solar generation, "net metering rules", and breakthroughs in electricity storage -- up to now the stumbling block for wind and solar generation, which is intermittent and unreliable. And he recounts breakthroughs in reducing energy consumption, including better building insulation and more efficient vehicles. Lucas mentions Austin, Texas, where "7,000 households have signed up for a scheme in which they get an $85 rebate on an internet-enabled thermostat." With those thermostats, "Austin Energy can shave 10 MW from its summer peak demand."

Lucas's five keys for the future of energy: (1) abundant energy, largely from the growth of cheap solar; (2) development of storage technologies; (3) growth of distributive energy - making consumers small producers and storers of energy; (4) intelligent use of energy - smart meters, better management of electricity distribution, smart meters, "smart grids"; and (5) new business models to finance these new energy systems.

A good read.

January 20, 2015

The Oil and Gas Lease - Part V: Implied Covenants

Over the last 100 years courts have developed a body of case law in disputes between lessors and lessees of oil and gas leases. Courts have held that certain provisions are "implied" in the contracts, even though there is no language in the lease to support those provisions. The rationale behind these implied provisions goes back to cases interpreting hard mineral leases, and back to the cradle of the oil industry, Pennsylvania. The idea behind these implied provisions is that they are necessary for both parties to get the benefit of their bargain and to make the lease work as intended. Because the lessee has control over what operations are conducted under the lease, most of these implied provisions are intended to benefit the lessor, who generally has less bargaining power in negotiation of the lease and no say in whether and how the lease is developed.

An example: oil and gas leases generally provide that the lease will remain in effect for the primary term and for as long thereafter as oil or gas is produced from the leased premises. Courts have implied a requirement that, for the lease to remain in effect, the production must be in "paying quantities." The production must be sufficient for the lessee to realize a profit over operating costs.

Another example: what if the well on the lease temporarily ceases production at some point after the end of the primary term. Does the lease terminate, even if the well can be repaired and restored to production? Courts developed the implied provision that a "temporary" cessation of production will not cause the lease to terminate, as long as the lessee acts with reasonable diligence to restore production.

Cases have also imposed implied obligations on the lessee -- obligations that are not expressed in the lease. In Texas, the Supreme Court has described those implied obligations as a duty "(1) to develop the premises, (2) to protect the leasehold, and (3) to manage and administer the lease." Amoco v. Alexander, 622 S.W.2d 563, 567 (Tex. 1981). Other commentators have described these implied obligations as a duty to (1) develop the lease, (2) protect the lease against drainage, (3) market production, and (4)  act as a reasonably prudent operator. Courts have held that these obligations are implied in every lease unless the lease expressly disclaims the duties.

Whole books have been written about these implied covenants, the most recent of which is an excellent book by John Burritt McArthur, "Oil and Gas Implied Covenants for the 21st Century" (Juris Publishing, Inc. 2014). Courts in different states differ on the scope and meaning of these implied covenants, but they are generally recognized in every oil-producing jurisdiction -- and they are fertile ground for litigation.

A recent example of courts' differing interpretations of implied covenants is evidenced by recent cases involving the covenant to market. It is generally recognized that the lessee has a duty to market oil and gas from the leased premises once it has been discovered, including the duty to obtain the best price obtainable. In some jurisdictions, courts have interpreted this duty to require the lessee to put the production into marketable condition for sale. Because most oil is marketable in the condition it is in when produced, this "marketable condition" requirement applies mostly to gas. Gas usually has to be treated, compressed, processed and/or transported to become "marketable." Courts who have adopted this "marketable condition rule" have held that all costs incurred to make the gas marketable must be borne by the lessee, unless the lease provides otherwise. No such costs can be charged to the royalty owner.

Many producing states have now adopted the marketable condition rule, including Colorado, West Virginia, Oklahoma, Kansas, Arkansas, Alaska, Virginia and perhaps New Mexico. Nevada, Wyoming and Michigan have barred the deduction of downstream field costs by statute. Cases vary on which costs are deductible from royalties.

Texas, on the other hand, along with Louisiana, Kentucky, Mississippi, Montana, Pennsylvania, North Dakota, Utah and California, although agreeing that the lessee has the obligation to put gas in marketable condition, hold that downstream costs must be borne in part by the royalty owner under the typical oil and gas lease. Texas has gone so far as to say that, if a lease provides for royalties based on the market value "at the well," the lease must inevitably allow deduction of post-production costs from royalties, regardless of what else the lease may say. The seminal Texas case is Heritage v. NationsBank, 939 S.W.2d 118 (Tex. 1996), reh'g denied, 960 S.W.2d 619 (Tex 1997). In his book, John Burritt McArthur criticizes Heritage as taking an "absolutist approach [that] treats 'at the well' as magic words that fully determine what deductions are allowed, as the beginning and end of the analysis, and that when present leave no room for other terms no matter how specific they are."

Although implied covenants do provide protections for the lessor, they are necessarily very general in their development and application, and provide no bright lines for measuring the lessee's conduct. The lessee must only act as a "prudent operator." Implied covenant cases are therefore often prohibitively expensive for a lessor to pursue except in the most egregious circumstances.

Modern lease forms drafted by landowners' counsel have crafted express provisions that supplement or replace the implied covenant obligations of the lessee with express obligations regarding development, protection against drainage, marketing, and management and administration of the lease. The express provisions are intended to give more certainty to the parties by expressing their intent and providing objective criteria for compliance and express remedies for breach.
January 14, 2015

Colorado Oil & Gas Conservation Commission Initiates Online Complaint Process

The Colorado Oil and Gas Conservation Commission now allows landowners with complaints against operators to file their complaint online. Go to http://cogcc.state.co.us/ and click on "Complaints" in the left-hand column.If you're a surface owner with no mineral rights and you have objections to a proposed well location, you can also get the COGCC to inspect the site and consider your objections and require the operator to accommodate your concerns.

The online portal is very user-friendly and a real effort to make it easier for the public to participate in the process. The Texas Railroad Commission should take note.  The COGCC has also significantly increased its oversight staff, increased its collaboration with local governmental entities, sponsored studies on air and water impacts, and adopted policies on health and safety issues.
January 13, 2015

Break-Even Prices in Shale Plays

Here is a chart I came across estimating what oil price is necessary to achieve a 20% after-tax rate of return on wells in various shale plays. Not pretty in light of current oil prices.
Break even chart.JPG

January 12, 2015

Earthquakes in Irving

A recent "swarm" of small quakes in Irving has caused a stir and ignited a series of articles about the relation between oil and gas activity and seismic events. The quakes in Irving were strong enough to knock some books off of shelves.

After residents of the town of Azle experienced a series of quakes in 2013, residents protested in Austin before the Texas Railroad Commission, and as a result the RRC hired its own seismologist to study the problem. Most scientists have linked quakes in Texas and Oklahoma to injection of large volumes of produced water. Recently one study in Ohio linked quakes there to recent fracking of wells in the area.

Most if not all of the actual studies of recent quake activity are being done by Southern Methodist University. It has studied the quakes around Azle, and a report of its study is expected soon. After the quakes in Irving, SMU is installing seismic monitors in that area.

Stories about the quakes:

Dallas Morning News

Dallas Morning News

Dallas Morning News

CBS News

Columbus Ohio Dispatch

Fort Worth Star Telegram

New York Times

Washington Post

January 7, 2015

Prices Continue to Plummet

Here are Flint Hills postings for Texas for January 1, 2, 5 and 6:

Eagle Ford West Light Crude has dropped from $42/bbl on January 1 to $36.75/bbl yesterday. Amazing.

View all Flint Hills postings here:  http://www.fhr.com/refining/bulletins.aspx

December 23, 2014

The Oil and Gas Lease - Part IV: The Royalty Clause

The only three essential terms of an oil and gas lease are the granting clause, including a description of the property, the habendum clause, which defines the term of the lease, and the royalty clause. The following would be a valid, enforceable lease:

John Doe hereby leases to Gusher Oil Company the oil and gas in and under Section 5, Block 4, T&N RR Co. Survey, Jones County, Texas, for the purpose of exploring for and producing oil and gas. This grant shall be for a term of three years and as long thereafter as oil or gas is produced from the property. John Doe reserves a royalty of 1/4th of all oil and gas produced and saved.

Dated ___________________, 2014

John Doe

All other provisions of the typical lease, although important, are not essential. The above lease would be legal and enforceable and might be all the parties need, assuming that they get along with each other. The numerous other provisions now used in leases have been added to answer questions that have arisen in the course of time, as the industry developed and parties faced disputes over the lessor-lessee relationship. 

For the landowner, the royalty clause is the most important part of the lease. The royalty is the principal consideration for granting the lease. In its most general terms, a royalty is a share of profits or revenue from sale of a product -- think book royalties paid to the author. In oil and gas, it is a share of the revenue from the sale of the oil and gas produced.

In Texas, leases generally provide that the royalty on oil is a share of the oil itself - an "in-kind" royalty, whereas the royalty on gas is a share of the proceeds or amount realized from the sale of the gas. Oil was traditionally sold by the producer to a purchaser who would pick up the oil from tanks at or near the well. As a service to the producer, the purchaser would agree to be responsible for paying the royalties owed on the oil. The purchaser would send the royalty owner a division order setting out the percentage of oil owed to the royalty owner and providing that the purchaser would purchase the royalty owner's share at the "posted price" in the field. The division order was therefore a purchase agreement between the purchaser and the royalty owner. If the producer sold gas, the producer would pay the royalty owner her share of the gas proceeds.

Today, most royalties on both oil and gas are paid by the producer, who sells the oil and gas and remits the royalty owner's share.

Most disputes about royalties concern how royalties are calculated on gas production. Most oil production is still sold to purchasers at or near the well, and there is an established price in the field for the oil; the producer and royalty owner are both paid based on that price. Gas is more complicated.

Natural gas, as consumers think of it, is what is burned when you turn on your stove. That gas is methane, each molecule containing one carbon atom and two hydrogen atoms -- CH2. But gas coming out of a well may also contain some ethane, butane, propane and other "heavier" gases. Those heavier gases have a higher Btu content. Burning one cubic foot of ethane will create more heat than burning one cubic foot of methane. Also, the heavier gases have uses in various manufacturing processes. Also, the heavier gases can be compressed into liquid form for transporting -- they are sometimes called "natural gas liquids," or NGL's. If gas contains NGL's, it has a higher Btu value than methane. One cubic foot of methane, at a standard temperature and pressure, will create 1,000 Btu of heat when burned. We say that it is 1,000-Btu gas. But if the gas has some NGL's in it, its Btu content may be 1,200 or more.

Gas with significant amounts of NGL's must be processed to remove the NGL's, and the NGL's will be sold as separate products. Often the producer will contract with a gas processor to process the gas before sale. So the calculation of the amount realized from the sale of the gas includes proceeds from the sale of the methane and the NGL's.

Gas may also contain impurities such as hydrogen sulfide and water that must be removed before the gas can be sold.

All of the activities that must take place in order to sell or market the produced gas have a cost, and those costs are referred to as post-production costs. If an oil and gas lease provides for royalties based on the "net proceeds" or "amount realized" or "market value" "at the well," courts have ruled that the producer may deduct those post-production costs from gas sales proceeds before paying the royalty owner her share. So the royalty owner must bear her share of the post-production costs. Litigation over how gas royalties are calculated and whether and how post-production costs can be deducted has engaged lawyers for as long as natural gas has been a valuable resource.

You would think that lawyers drafting oil and gas leases could come up with language that would clearly define how gas royalties are calculated and paid and what post-production costs can be deducted, so as to avoid controversy and litigation. Unfortunately, that has often not been the case. The result is continued litigation, some of which I have written about. Technology advances. Gas markets evolve. Producers become more creative in how they structure their marketing programs to shift costs to royalty owners. Royalty owners become more sophisticated in understanding the industry and crafting language to avoid post-production costs. And lawyers continue to prosper from the disputes that arise.

December 18, 2014

TLMA and NARO Texas File Amicus Brief in Chesapeake v. Hyder

As I have written, Chesapeake has asked the Texas Supreme Court to reverse the San Antonio Court of Appeals' decision in Chesapeake v. Hyder. The court of appeals ruled that Chesapeake could not deduct post-production costs from the Hyders' royalty.

The Texas Land & Mineral Owners' Association and the National Association of Royalty Owners - Texas have filed an amicus brief in Hyder supporting the Hyders' case. The brief can be viewed here. Final Amicus_Brief_Chesapeake_v__Hyder.pdf It was authored by my firm and by Raul Gonzalez, who was a member of the Texas Supreme Court when the court decided Heritage v. NationsBank, the case relied on by Chesapeake as authority for its deduction of post-production costs.

December 16, 2014

The Oil and Gas Lease -- Part III: the Leased Premises

An essential element of any oil and gas lease is a description of the land to be covered by the lease. The test for a legal description is that it must contain, or make reference to recorded documents that contain, a description of the land of sufficient specificity that a surveyor could locate the property on the ground with reasonable certainty.

The lease itself can contain a metes and bounds description from a survey, or (more commonly) it can refer to an earlier recorded document that contains a metes and bounds description of the property. Sometimes descriptions have to be cobbled together from two or more other descriptions. For example: "All of that certain 100 acres of land described in deed from John Doe to Robert Smith recorded at Volume 99, page 99 of the deed records of Karnes County, Texas, save and except 10 acres of land described in deed from Robert Smith to Mary Jones recorded at Volume 100, page 100 of the deed records of Karnes County, Texas."

There are other ways to adequately describe a tract. The test is whether the surveyor can use the description to locate the property.

The requirement that the lease contain an adequate legal description comes from the Statute of Frauds. That statute in Texas is in Texas Business and Commerce Code, Section 26.01. It provides that any agreement regarding land, including an oil and gas lease, must be in writing and must contain a description of the property. The original Statute of Frauds was passed by the British Parliament in 1677 as "An Act for Prevention of Frauds and Perjuries." Every state has a version of this law.

The minerals covered by an oil and gas lease can be limited by depth. An oil and gas lease can cover only certain defined depths - for example, from the surface of the ground to 5,000 feet subsurface -- or certain known formations - for example, the Eagle Ford formation.

Although lease forms generally cover all "oil, gas and other minerals," it is better practice for the lease to cover only "oil, gas and associated hydrocarbons and other substances produced with oil and gas." The land may have other mineral deposits like coal or uranium, and there is no reason for the lease to cover such other minerals.

Most lease forms contain a clause like the following:

This lease also covers and includes all land owned or claimed by Lessor adjacent or contiguous to the land particularly described above, whether the same be in said survey or surveys or in adjacent surveys, although not included within the boundaries of the land particularly described above.

Such a clause is referred to as a "Mother Hubbard" clause. (I'm not sure how it got that name.) Care should be taken if this clause is included. If the Lessor owns other land adjacent to the leased premises that is not intended to be leased, it should either be stricken or limited. The purpose of the clause is to include small strips of land and mineral interests under adjacent roads that are owned by the Lessor but are not included in the description of the leased premises. A more narrow Mother Hubbard clause might read:

This lease also covers and includes any narrow strips of land and adjacent roads owned or claimed by Lessor adjacent or contiguous to the land particularly described above, whether the same be in said survey or surveys or in adjacent surveys, although not included within the boundaries of the land particularly described above.

Even if the Lessor does not own the entire mineral estate in the lands to be lease, an oil and gas lease almost never describes the interest owned by the Lessor. The title work done prior to acquiring an oil and gas lease may not be complete, and the Lessee wants to be sure that the lease covers the entire interest owned by the Lessor even if the title work done to quantify the Lessor's interest is wrong.  So the lease reads as if the Lessor owned the entire mineral estate. If the Lessor owns less than all of the minerals, the "proportionate reduction clause" in the lease takes care of the problem. That provision typically states something like the following:

If this lease covers less than all of the oil and gas in the leased premises, then the royalties and other monies provided herein to be paid to Lessor shall be reduced in the proportion that the interest in the oil and gas owned by Lessor bears to the entire fee simple mineral estate in the leased premises.

Landowners should be confident before they sign a lease that they agree with the Lessee's conclusions as to what interest the landowner has in the minerals to be leased. If the landowner is unsure, she should get the title information from the company upon which it based its conclusions, and satisfy herself that the computation of her undivided interest is correct.

December 8, 2014

New Texas Railroad Commission Rules on Pipeline Permits

The Texas Railroad Commission has adopted amendments to its pipeline permits rule, 16 TAC Sec. 3.70. The amendments require pipeline companies to submit documentation to support their claim that they will operate the line as a common carrier or gas utility.

In Texas, pipelines have the right to condemn pipeline easements for lines that are common-carrier or gas-utility lines. Until the Supreme Court's decision in Texas Rice Land Partners v. Denbury in 2011, pipelines assumed that all they had to do in order to exercise the right of eminent domain was file a form at the RRC - a Form T-4 - stating that the proposed line would act as a common carrier or gas utility. In Denbury, the court said that filing the form is not enough.

The court in Denbury first held that a pipeline does not acquire condemnation authority merely by obtaining a permit from the Railroad Commission and subjecting itself to that agency's jurisdiction as a common carrier. The court then held that in order for a pipeline to have condemnation power it must serve a public purpose, and to serve a public purpose, "a reasonable probability must exist, at or before the time common-carrier status is challenged, that the pipeline will serve the public by transporting gas for customers who will either retain ownership of their gas or sell it to parties other than the carrier." Once a landowner challenges its right to exercise eminent domain, "the burden falls upon the pipeline company to establish its common-carrier bona fides if it wishes to exercise the power of eminent domain."  The court said that the question of whether the pipeline is dedicated to a "public use" is ultimately a judicial question.

The rule amendments adopted by the RRC last week were proposed by the pipeline industry and were apparently an attempt to address the problems created for them by the Denbury decision. If a pipeline company wants to classify a proposed new line as a common-carrier or gas-utility line, it must include in its permit application a sworn statement "providing the operator's factual basis supporting the classification and purpose being sought for the pipeline," and "documentation to provide support for the classification and purpose being sought for the pipeline ...."

The RRC received many comments to the proposed rule, and its discussion of those comments reveals much about the RRC's intent in adopting the rule amendments. The RRC's discussion makes clear that it does not intend to get involved in the Denbury debate:

A T-4 Permit to Operate an intrastate pipeline in Texas is literally and specifically a permit to operate a pipeline. It is not a permit to construct a pipeline, nor is it authorization for a pipeline operator to exercise eminent domain in the acquisition of pipeline right-of-way.

The permitting process does not determine property rights. ... Litigation over the rights of a property owner or a pipeline's easement is not a Commission matter; it is a courthouse matter.

The Commission disagrees with assertions made by [Texas Southern Cattle Raisers Association] and other commenters that the Court in Denbury suggested the Commission should expand its processing of applications for T-4 permits to encompass investigation and adversarial testing of, particularly, the common carrier assertions made by T-4 applicants. In fact, the Court stated, "the parties point to no regulation or enabling legislation directing the Commission to investigate and determine whether a pipeline will in fact serve the public."

The new permitting process requires a pipeline operator to substantiate the basis for the classification sought. ... Property owners will know the basis on which a pipeline operator claims common carrier status much earlier in the permitting process.

The rule amendments, and the RRC's responses to comments, can be found here:


Denbury has given landowners the ability to challenge pipeline companies' assertions of eminent domain authority. That has slowed the process of pipeline right-of-way acquisition and made the process more expensive for pipelines. If pipeline companies intended these rule amendments to address those issues, I'm not sure they succeeded.




December 2, 2014

The Oil and Gas Lease -- Part II: The Primary Term

In Texas, an oil and gas lease grants to the lessee the fee mineral estate in the leased premises for the term of the lease. The lease provides for an initial term during which the lessee need do nothing in order to keep the lease in effect -- called the "primary term." Thereafter, the lease terminates unless the lessee is producing oil or gas or conducting operations in an effort to discover and produce oil or gas. If the lease remains in effect beyond the primary term, the remaining time the lease is in effect is called the "secondary term." A typical lease will provide that

"This lease shall remain in effect for a term of three (3) years (the primary term) and as long thereafter as oil or gas is produced from the leased premises or operations, as provided herein, are being conducted on the leased premises."

The primary term can be one month or ten years or more. Today, most leases provide for a three-year primary term. If no production or operations take place during the primary term, the lease terminates automatically and the mineral estate reverts to the lessor.

It is not necessary to obtain a release of the lease from the lessee in order to terminate the lease. It is, however, a good practice to request a release from the lessee to record in the county records, in order to give notice that the lease is no longer in effect.

It used to be common practice to include in the lease a provision for payment of "delay rentals." A delay rental clause provides that the lease will terminate at the end of each year during the primary term unless the lessee either commences operations or production or pays the lessor a delay rental, which keeps the lease in effect for another year during the primary term. Under an "unless" delay rental clause, the lessee has no obligation to pay the delay rental, and the lease expires if there is no production or operations and the delay rental is not paid. Delay rentals are usually expressed as a number of dollars per acre.

Today most leases are "paid-up" leases, meaning that all payments necessary to keep the lease in effect during the primary term have been paid. Such leases contain no delay rental clause.

Instead, it is now common for lessees to request an option to extend the primary term. Such a clause provides that the lessee has the option to extend the primary term by making an additional payment to the lessor prior to the end of the primary term. A provision for an option payment has similar effect as a delay rental clause, but is expressed differently. A typical offer might be for a three-year paid-up lease with a two-year option. Usually, the option payment is the same amount as the bonus paid for the initial execution of the lease. The option payment must be tendered to the lessor during the primary term in order to avoid lease termination.

November 26, 2014

The Oil and Gas Lease - Part I

I got the idea for starting this blog from a presentation I made at a meeting of the Texas Land & Mineral Owners' Association, titled "Checklist for Negotiating an Oil and Gas Lease." TLMA posted the outline of my presentation on its website. I soon began receiving calls from people who had found the article on the net. I had no idea that the article had found its way to the net, but the popularity of the checklist led me to believe that landowners might profit from other articles of interest to them on matters related to oil and gas exploration and development.

The oil and gas lease is the foundational document on which the oil and gas industry in the US is based. Its form and provisions have been modified and shaped over the years to respond to changing industry practices and developments in the law, but its essential form has remained unchanged since the latter half of the 19th century. It is one of the most commonly used and successful legal documents in US commerce.

So, I thought it would be a good idea to write a few posts focused on the oil and gas lease, of which this is the first.

The basic concept and form of the oil and gas lease was developed in Pennsylvania, shortly after Edwin Drake drilled the first commercial oil well in Cherrytree Township, near Titusville, Pennsylvania, in 1859. The well was drilled to 69.5 feet at a cost of $3,000, and produced 12 to 20 barrels a day, but was never profitable and ceased production in 1861. But it started the first oil boom in the US.

Drake Well.png

Drake is the man on the right, in front of his well.

Drake drilled his well under an agreement with the owners of the land, the Brewer and Watson farm. The agreement provided that the landowners "demised, leased and let" the land "to bore, dig, mine, search for and obtain oil, salt water and other minerals," and "to take, remove and sell such" for a term of 15 years, at a "rental" (royalty) of "one-eighth of all oil as collected from the springs." The lease provided that "if lessees fail to work the property for an unreasonable length of time, or fail to pay the rent (royalty) for more than 60 days, the lease to be null and void."

Drake's form of "lease" was adapted from lease agreements developed for the purpose of allowing the mining of salt brine through the drilling of wells. Salt mining agreements allowed the lessee to drill a well to produce brine that would then be evaporated and processed into salt. The agreements typically provided for payment to the landowner of a portion of the salt obtained from his land, usually every twelfth barrel.

An 1862 case decided by the Supreme Court of Pennsylvania is one of the earliest decisions involving oil rights. The dispute involved a salt mining lease. The lessee had discovered oil in the process of drilling for salt, and the question presented was, to whom did the oil belong?  The court held that the well produced both brine and oil, and it was necessary to separate the oil from the brine in order to produce salt, so the oil belonged to the lessee.

The first printed form of oil and gas lease was by a Mr. J.A. Heydrick of Oil City, Pennsylvania. His first lease form was published in about 1870. His Oil Lease No. 3, published in 1880, is recognizable as the basic form of oil and gas lease still in use today. It granted a lease for a term of 15 years "and so long thereafter as oil or gas can be produced in paying quantities." Heydrick's OIl Lease No. 4 Form became the standard oil and gas lease form in Pennsylvania.

For many years after leases began to appear, courts struggled with the legal nature of the rights granted to the lessee. Today, in most states -- including Texas --- courts agree that the lease grants to the lessee a fee simple determinable in the mineral estate in the land. "Fee simple" is the legal term for ownership. The word "determinable" means that the estate will terminate and revert to the lessor at some time in the future, when production has ceased. So the term "lease" is misleading. An oil and gas lease actually grants title to the mineral estate for the term of the lease. The lessor reserves a royalty interest --- also a real property interest --- in production for the term of the lease. So the lease creates two different real property interests in the minerals -- the ownership of the oil and gas, sometimes called the "working interest" or the "mineral leasehold estate," which belongs to the lessee, and the royalty interest reserved by the lessor. Both are interests in land and treated as such under the law.

Next installment - the essential terms of the oil and gas lease.

November 19, 2014

The Episcopal Church and the Texas Supreme Court

On August 30, 2013, the Texas Supreme Court decided two cases involving the Episcopal Church of the United States. Last week, the U.S. Supreme Court refused to hear the cases, making the results final. (In case you're wondering, this has nothing to do with oil and gas. The cases are of interest to me as an Episcopalian.) The two cases were basically a fight over ownership of church property. The parties engaged some of the most powerful firms and lawyers in the state, and multiple amicus briefs were filed. And the cases grapple with the right to free exercise of religion guaranteed by the First Amendment of the U.S. Constitution.

There are about 4.5 million Episcopalians in the U.S. -- fewer than the number of Baptists, Methodists, Mormons, Lutherans, or Presbyterians. Episcopalians, however, are often some of the elite and most powerful members of society in the U.S. The Episcopal Church in America was founded in 1789 and is a part of the Anglican Communion, which has about 80 million members worldwide. The Church is associated with and has its roots in the Church of England, founded by Henry VIII when Pope Clement VIII refused to approve the annulment of Henry's marriage to Catherine of Aragon.

The two cases decided by the Texas Supreme Court last year, The Episcopal Diocese of Fort Worth v. The Episcopal Church, and Masterson v. The Diocese of Northwest Texas, have their genesis in the consecration of Gene Robinson by the Diocese of New Hampshire in 2004 -- the first openly gay bishop in the Episcopal Church. In response, the Diocese of Fort Worth voted in 2007 and 2008 to withdraw from the Episcopal Church and enter into membership with the Anglican Province of the Southern Cone, a group of Anglican churches in South America. And the Diocese claimed to still own the properties of the churches within the Diocese of Fort Worth. (Three churches in the Diocese did not agree with the Diocese's action and withdrew from the Diocese; the Diocese transferred property used by those churches to them.)

Meanwhile, in San Angelo, the Episcopal Church of the Good Shepherd voted (53 to 30) to withdraw from the Episcopal Church and the Diocese of Northwest Texas and to form a new church, the Anglican Church of the Good Shepherd. And it claimed to own its church property.

In both cases, the trial court, after hearing the parties' arguments, ruled in favor of the Episcopal Church, holding that the Fort Worth Diocese and the Church of the Good Shepherd could not keep church property when they left the Episcopal Church. The Texas Supreme Court reversed in both cases, holding that they could.

The Episcopal Church argued that it was a "hierarchical" church, meaning that it is structured with a central organization -- the General Convention of the Episcopal Church -- at the top, Dioceses -- geographic regions headed by a Bishop -- below that, and individual churches, or parishes, at the bottom. It argued that all church property is held by each individual parish church in trust for The Episcopal Church, and that any congregation which severed its ties with The Episcopal Church lost its right to manage the Church's property. The Canons of The Episcopal Church provide that "All real and personal property held by or for the benefit of any Parish, Mission or Congregation is held in trust for this Church and the Diocese thereof in which such Parish, Mission or Congregation is located. The existence of this trust, however, shall in no way limit the power and authority of the Parish, Mission or Congregation otherwise existing over such property so long as the particular Parish, Mission or Congregation remains a part of, and subject to, this Church and its Constitutions and Canons."  When Good Shepherd Church in San Angelo was formed, it agreed in its petition for formation that its members were "conscientiously attached to the Doctrine, Discipline and Worship of the Protestant Episcopal Church in the United States."

The majority opinion in the Good Shepherd case agreed that the First Amendment to the U.S. Constitution "severely circumscribes the role that civil courts may play in resolving church property disputes," and prohibited civil courts from inquiring into matters concerning "theological controversy, church discipline, ecclesiastical government, or the conformity of the members of a church to the standard of morals required of them."  It quoted the U.S. Supreme Court's prior decision that "whenever the questions of discipline, or of faith, or ecclesiastical rule, custom, or law have been decided by the highest of church judicatories to which the matter has been carried, the legal tribunals must accept such decisions as final, and as binding on them."

The majority of the court nevertheless held that title to church property was a matter of state law, not ecclesiastical law, and that, under Texas law, the church properties belong to the individual churches and are not held in trust for the benefit of The Episcopal Church. Two justices dissented.

Disputes within church organizations arise from time to time, resulting in schisms and fights over church properties. Protestant churches divided during the Civil War. Churches have disagreed over ordination of women. Last week, the Anglican Communion voted to allow women to be appointed as bishops.

The relation between church and state also pops up in other ways -- for example, the recent dispute over application of provisions of the Affordable Care Act to church-affiliated hospitals. Courts will continue to struggle with these issues as long as the Constitution stands and citizens continue to worship their gods.

November 12, 2014

The Fall in Oil Prices

The news is filled with stories predicting the effect of falling oil prices on US production.  Good news for the economy, bad news for the Texas oil and gas industry. Will the rig count fall? Will companies go into bankruptcy? Only time will tell.

The answer may depend on OPEC. OPEC countries produce about one-third of the world's total oil each month. OPEC countries have about 80 percent of the world's oil reserves. Predictions of OPEC's demise are greatly exaggerated. But US production has increased to almost 9 million barrels a day, close to Saudi Arabia's production. Texas is responsible for a big part of that increase:

Texas production chart.PNG

Clearly the increased US production, combined with the predictable decline in demand and the slowdown of China's and Europe's economies, is affecting the world oil price. OPEC convenes on November 27, and pundits are guessing what it will do. On October 29, OPEC's Secretary-General Abdalla El-Badri, cautioned calm, after a conference in London: "We don't see really fundamental changes in the supply side or the demand side.  Unfortunately everyone is panicking. The press is panicking, consumers are panicking. We really should think and see how this will develop."

El-Badri has a point. Looked at over the long term, as shown below, this may be but another adjustment in world prices.

EIA gas and oil price chart.PNG

Not all OPEC countries are the same. Some countries will be squeezed by oil prices below $80:

OPEC price squeeze.PNG

So far, the falling oil price appears to have had little effect on drilling activities in Texas. The Texas Petro Index published by the Texas Alliance of Energy Producers reached 312.3 in September, up 6% over last September. The Baker Hughes rig count in Texas was 902 in September, up from 837 rigs in September 2013. But the US rig count dropped by 4 rigs to 1,925 for the week ended November 7, although horizontal rigs gained 9 to 1,362.

One analyst, Gavekal Dragonomics, says that, if oil prices continue to fall, "drilling activity is likely to decline." But the negative effects on the energy sector will be outweighed by the positive effect on US consumers. Lower prices will lift net exports. And each one-cent drop in gasoline prices puts $1 billion in the pockets of consumers over a one-year period.

Dr. Harold Hunt, professor at the Texas A&M Real Estate Center, recently presented an analysis of how falling oil prices affect the Houston economy. Here is a link to the Powerpoint of his presentation: Hunt_S_TX_College_Oct__2014___.pdf  Dr. Hunt notes the declining cost of drilling in the Eagle Ford, lowering the break-even price of oil:

Well Costs - Hunt.PNG


Down-sizing of well spacing has also maximized the value of Eagle Ford acreage:

Well spacing.PNG

Dr. Hunt also notes the increased rates of initial production in the Eagle Ford, but also the increase in decline rates of those later wells:

EIA increased production rates over time.PNG


His conclusion: 80% of shale oil resources in the US can make money with oil at $50 to $80 per barrel:

Hunt break-even.PNG

Much depends on where the acreage is in the play. There are good sections and bad sections in the Eagle Ford, as in all fields. Those producers on the margins will suffer at $80 prices. And investors may be more wary of putting their money in areas with higher risk.

November 3, 2014

Trespassing on the Mineral Estate

Last week the San Antonio Court of Appeals decided Lightning Oil Company v. Anadarko, No. 04-14-001152-CV, a case involving "mineral trespass."  What is interesting about the case is what the court did not decide.

Lightning Oil Company owns two oil and gas leases covering 3,250 acres within the Briscoe Ranch in Dimmit County. The Briscoe Ranch owns the surface but not the minerals in this 3,250 acres. To the south of Lightning's leases is the Chaparral Wildlife Management Area, a wildlife sanctuary managed by Texas Parks and Wildlife Department. TPWD owns the surface and 1/6 mineral interest in the Chaparral WMA. The Light family (some of whom own Lightning Oil) own the other 5/6 mineral interest. Anadarko holds oil and gas leases on the Chaparral WMA.

The TPWD lease to Anadarko prevents use of the surface of the Chaparral WMA for oil and gas wells except with TPWD consent, and says that Anadarko must use off-site drilling locations "when prudent and feasible." Anadarko made an agreement with Briscoe Ranch to use the surface of the Ranch to drill horizontal wells under the Chaparral WMA. The first location Anadarko chose is located on the land covered by the Lightning Oil Company leases. So Anadarko proposed to drill a horizontal well from a surface location on Lightning's lease; the well would penetrate the Eagle Ford formation on Lightning's lease, but no perforations, or "take points," in the well would be located on Lightning's lease.

Lightning sued Anadarko to prevent it from drilling its well, and it sought a temporary injunction to stop the well while the case was pending. After a hearing on Lightning's application for temporary injunction, the trial court refused to grant the injunction, and Lightning appealed.

The opinion of the San Antonio Court of Appeals (Lightning Oil Co v. Anadarko.pdf ) affirmed the trial court, holding that Lightning had failed to prove a probable, imminent and irreparable injury if Anadarko is allowed to drill its well.

To obtain a temporary injunction, the plaintiff must prove that it can probably prevail when a trial on the merits of its case is held, and that it probably will suffer irreparable injury if the temporary injunction is not granted to maintain the status quo until trial on the merits.

Lightning alleged that Anadarko's well would trespass on Lightning's mineral estate. Anadarko argued that its well would not result in a trespass.  The Court of Appeals decided not to address that question. Instead, it focused on whether Lightning's evidence showed that it would probably suffer irreparable harm if the well were drilled. After reviewing the parties' testimony, the Court held that Lightning's evidence failed to show probable irreparable harm. The testimony, said the Court, only showed a "potential" for injury, and Lightning failed to show that the potential injury would not be "susceptible to quantification and compensation."

The more interesting question in this case is the one the Court of Appeals elected not to address -- whether the drilling of Anadarko's well would constitute a trespass.  In my experience, operators routinely obtain permission from the surface owner to locate well pads off-lease, but do not consider it necessary to obtain consent of the mineral owner. The general theory is that the owner of the surface estate owns the land from the surface to the center of the earth; the owner of the mineral estate owns only the oil, gas and other minerals under the land. Under this theory, a mineral trespass can occur only if a well actually produces (or perhaps harms) the oil, gas or other mineral under the land. Following this line of reasoning, drilling a well through a formation capable of producing oil or gas would not constitute a mineral trespass. And the right to grant permission to use the surface estate for an off-lease location, under this theory, belongs to the surface owner.