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The Energy Information Administration shows oil production from the Niobrara, Eagle Ford and Bakken fields dropping for the first time, by 24,023 bbl/d — much sooner than some predicted. Production from the Permian Basin is still rising. Operators may be delaying completion of wells already drilled, in effect storing their reserves in the ground. (Click image below to enlarge.)

 

EIA production graph

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Last November, the Texas General Land Office lost its appeal in Commissioner v. SandRidge Energy, Inc., in the El Paso Court of Appeals. For the first time, a court has ruled that a lessee can deduct post-production costs under the Texas General Land Office’s Relinquishment Act lease form, citing Heritage Resources v. NationsBank, 939 S.W.2d 118 (Tex. 1996).

The case actually involves several oil and gas leases owned by SandRidge in Pecos County, some covering lands owned by private parties, some covering Relinquishment Act lands. (The State owns the minerals under Relinquishment Act land; the surface owner is agent for the state in granting oil and gas leases, for which the surface owner receives ½ of bonuses and royalties. The lease must be approved by the GLO and be on the approved GLO lease form.) The most interesting part of the case is the court’s interpretation of the GLO’s Relinquishment Act lease form. There are somewhere between 6.4 million and 7.4 million acres of Relinquishment Act lands in Texas, principally in West Texas, in and around the Permian Basin.

SandRidge’s wells on the leases in dispute produce mostly carbon dioxide, mixed with some natural gas. Originally, SandRidge paid the GLO royalties on its sales of natural gas and carbon dioxide. More recently, SandRidge made an agreement with Oxy USA; SandRidge built a plant, the Century Plant, to extract the CO2 from SandRidge’s gas. Oxy owns and operates the plant and gets the CO2 extracted; SandRidge gets the natural gas. Oxy doesn’t charge SandRidge for separating the gas from the CO2. Oxy uses the CO2 in secondary recovery projects. The plant reportedly cost a billion dollars.

When the Century Plant was up and running, SandRidge stopped paying royalties on CO2 under its Relinquishment Act leases. The State sued, and the parties filed motions for partial summary judgment. The trial court ruled in favor of SandRidge.

The GLO relied on the following provisions of the Relinquishment Act leases:

4(B).  NON PROCESSED GAS. Royalty on any gas (including flared gas), which is defined as all hydrocarbons and gaseous substances not defined as oil in subparagraph (A) above, produced from any well on said land (except as provided herein with respect to gas processed in a plant for the extraction of gasoline, liquid hydrocarbons or other products) shall be 25% part of the gross production or the market value thereof, at the option of the owner of the soil or the Commissioner of the General Land Office, such value to be based on the highest market price paid or offered for gas of comparable quality in the general area where produced and when run, or the gross price paid or offered to the producer, whichever is the greater ….

 7.  NO DEDUCTIONS. Lessee agrees that all royalties accruing under this lease (including those paid in kind) shall be without deduction for the cost of producing, gathering, storing, separating, treating, dehydrating, compressing, processing, transporting, and otherwise making the oil, gas and other products hereunder ready for sale or use. Lessee agrees to compute and pay royalties on the gross value received, including any reimbursements for severance taxes and production related costs.

 The State argued that SandRidge was paying for the cost of treating the natural gas by giving the CO2 to Oxy, and that this cost is not deductible under the Relinquishment Act lease form. SandRidge argued that the cost of treating the gas is deductible, based on Heritage v. NationsBank.  In Heritage, the Texas Supreme Court held that, where a lease provides for royalties based on “market value at the well,” a lessee may deduct post-production costs even if the lease prohibits such deductions. According to the Court, “from SandRidge’s perspective, Heritage stands for the principle that a market value at the well clause trumps any other provision that conflicts with it.” SandRidge argued that the paragraph 4(B) of the Relinquishment Act lease is in effect a market-value-at-the-well royalty provision. The El Paso Court of Appeals agreed. It said that the clause provides for royalties based on the wellhead measurement of gas volume. “The royalty is therefore owed on the substance so measured: raw gas, including all of its components. ‘When there is a wellhead measurement, payment is due for gas in its natural state, not on the liquid hydrocarbons which are later extracted.’ ConocoPhillips Co. v. Incline Energy, Inc., 198 S.W.3d 377, 381 (Tex.App.–Eastland 2006, pet denied)(citing Carter v. Exxon Corp., 842 S.W.2d 393 (Tex.App.–Eastland 1992, writ denied)).”

To my knowledge, this is the first appellate decision applying the Heritage rationale to a royalty clause that does not contain “market-value-at-the-well” language.

The GLO intends to appeal to the Texas Supreme Court. The Supreme Court has already agreed to hear Chesapeake’s appeal in the Hyder case, which also implicates Heritage.

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Betty Lou Bradshaw’s parents owned 1773 acres in Hood County. In 1960, they sold the land and reserved 1/2 of the royalty on oil, gas and other minerals. Betty Lou inherited her parents’ royalty interest.

In 2005, Steadfast Financial (subsequently renamed KCM Financial) acquired the right to purchase the land. In 2006, KCM made a deal with Range Resources by which it simultaneously (1) exercised its right to purchase the land, (2) sold the land to Range, reserving all minerals, and (3) leased the mineral estate to Range. The lease provided for 1/8th royalty, and the bonus was $7,505 per acre.

Betty Lou sued KCM and Range. She alleged that they conspired to limit her royalty on production from the lease to 1/16 (1/2 of 1/8), whereas it should have been 1/8 (1/2 of 1/4), since the going rate for lease royalties in Hood County at the time was 1/4. She alleged that Steadfast had agreed to a lower royalty in order to receive an above-market bonus.

The trial court dismissed Betty Lou’s claims, holding that KCM and Range had not breached any obligation to Betty Lou.

The Supreme Court remanded Betty Lou’s case against KCM for trial, but it dismissed her case against Range.

It has long been known in Texas that the owner of minerals whose mineral estate is subject to a royalty interest owned by another has a duty of “utmost good faith” to the royalty owner. The Supreme Court held that Betty Lou had presented sufficient evidence that KCM had breached its duty to her to entitle her to a jury trial on the issue.

The Court said that the holder of the “executive right” – the right to grant oil and gas leases – has a duty “to acquire for the non-executive [the royalty owner] every benefit that he exacts for himself,” but that “the executive is not required to grant priority to the non-executive’s interest.” Evidence that the holder of the executive right is guilty of self-dealing “can be pivotal.” “Self-dealing has most commonly been observed in situations where the executive employs a legal contrivance to benefit himself, a close familial relation, or both.” “The controlling inquiry is whether the executive engaged in acts of self-dealing that unfairly diminished the value of the non-executive interest.”

In Betty Lou’s case, “the allegation is that the executive [KCM] has misappropriated what would have been a shared benefit ( market-rate royalty interest) and converted it into a benefit reserved only unto itself (an enhanced bonus), with the intent to diminish the value of Bradshaw’s royalty interest. If proved, such conduct is the essence of self-dealing.”

As part of KCM’s agreements with Range, KCM promised “to honor and uphold any interest Betty Lou Bradshaw is determined to be entitled to in” the leased property. It is evident that Range knew that Steadfast was bargaining for a below-market royalty in order to get a higher bonus, and it was concerned that it might have some liability to Betty Lou. But the Supreme Court held that Range had no duty to protect Betty Lou’s interest. “Evidence that Range knew the [mineral] estate was burdened with Bradshaw’s non-participating royalty interest, may have known about tensions between Bradshaw’s and Steadfast’s interests, and agreed to a one-eighth royalty and an eight-figure bonus payment to Steadfast are simply insufficient to impute Steadfast’s liability, if any, to Range.” “[I]n negotiating with the executive, a lessee should not fear liability for doing nothing more than getting a good deal closed.”

After KCM granted its lease to Range, it transferred its reserved lease royalty to third parties. Betty Lou included those third parties in the suit and asked for a “constructive trust” on those royalty interests, on the theory that she should have received a 1/8 royalty, and since the lease provides for only 1/8 royalty, all of the royalty should go to her. A constructive trust is a remedy courts will grant where (1) there has been a breach of a special trust or fiduciary relationship or fraud, (2) the wrongdoer has been unjustly enriched, and (3) as a result the injured party has lost identifiable property that can be returned. The remedy is that the wrongdoer is found to be holding the property in “constructive trust” for the injured party.

The Court refused to accept Betty Lou’s constructive trust remedy. It said she had failed to show that she had lost “identifiable property” that could be returned to her. The Court’s logic was: Betty Lou owned an interest equal to 1/2 of the royalty. Her parents had sold the other 1/2 of the royalty when they sold the land. The royalty interest Steadfast had transferred to the other defendants was the royalty Betty Lou’s parents had sold, not part of the royalty she owned. “The royalty payments on which Bradshaw seeks a constructive trust emanate from [the mineral interest her parents had sold], which Steadfast retained when it conveyed [leased] the mineral rights to Range, and not from the one-half of royalty interest reserved by [Betty Lou’s parents] in the 1960 deeds.”

What if KCM had not transferred it reserved royalty interest to third parties, but still owns it? Would the Supreme Court say that Betty Lou could not claim that royalty interest? I think another way to analyze the case is that KCM traded its royalty interest to Range for an increased bonus, so, to make Betty Lou whole, she should receive the royalty reserved in the lease.

If Betty Lou wins her case before the jury, she can get a judgment against KCM but not against Range or the persons to whom KCM transferred its royalty interest. It is not clear to me what the measure of damages for Steadfast’s breach of duty should be. One way to approach the problem: suppose that a market bonus rate for the lease would be $3,000/acre. Steadfast got $7,505/acre. For 1773 acres, the part of the bonus above the market rate would be $7,996,375. That is the additional bonus Steadfast received for lowering its royalty from 1/4 to 1/8. Another way to look at it is that the additional 1/8 royalty was worth $8 million to Range. Betty Lou should have received 1/2 of that additional 1/8 royalty, so she should get 1/2 of that $8 million.

To my knowledge, the question of the lessee’s potential liability to a royalty owner like Betty Lou has not previously been addressed by the Supreme Court. This case seems to shut the door on that issue. But suppose a slightly different set of facts. Suppose that, instead of paying KCM a higher bonus, Range had agreed to assign to KCM’s sole shareholder a 1/8 overriding royalty on lease production, as part of the lease deal. If the additional 1/8 royalty is worth $8 million, the result is the same economically to Range. But under these facts, it seems to me that Range might have some liability. It looks more like Range  is conspiring with KCM to deprive Betty Lou of her rights.  Not Betty Lou’s facts, but a case can be made that, under some circumstances the lessee could be held liable for conspiring with its lessor.

The Court’s opinion can be found here.

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Here are bills filed in the current Texas Legislative session that may be of interest to mineral owners:

House Bill 539: This is the bill to prohibit municipalities from banning drilling within their jurisdictions.

Senate Bill 540: The Senate’s version of House Bill 539.

House Bill 1552: Filed by Representative Craddick, this bill declares that “allocation wells” – horizontal wells drilled across multiple tracts without pooling – are allowed by oil and gas leases unless expressly prohibited, and requires the Texas Railroad Commission to rule on how production should be allocated among the tracts crossed by the wellbore if the mineral owner disputes the lessee’s allocation method.

Senate Bill 118: Filed by Senator Van Taylor, this is the new and improved version of his bill from last session, authorizing forced pooling of tracts for secondary and tertiary recovery units. Titled (ironically) “Oil & Gas Majority Rights Protection Act for Secondary & Tertiary Recovery Operations.”

Senate Bill 402: This bill requires a company paying royalties, if requested, to provide the formula used to calculate the royalty owner’s decimal interest on a division order.

The text and status of these bills can be found at Texas Legislature Online.

 

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A team of lawyers in Pennsylvania has filed an anti-trust suit against Chesapeake and Williams Partners (Formerly Access Midstream Partners) alleging that they conspired to restrain trade in the market for gas gathering services in and around Bradford County, Pennsylvania. The plaintiffs also sued Anadarko, Statoil, and Mitsui, all of whom own interests in Chesapeake’s leases. The suit alleges violation of the oil and gas leases granted by the plaintiffs, violations of ant-trust law, and violation of the Racketeer Influenced and Corrupt Organizations Act (RICO). A copy of the complaint, filed in federal court in Pennsylvania, can be found here.

The team of lawyers who filed this suit have their own website, “Marcellus Royalty Action.” They say that their approach differs from other suits against Chesapeake in that they will not seek class action status, they intend to pursue discovery before negotiating settlements, and they will sue all working interest owners responsible for royalty payments.

Royalty owner suits against Chesapeake have become a growth industry for attorneys. Recently, Chesapeake requested that multiple royalty owner suits against it in the Barnett Shale region of Texas be assigned to a pretrial court for consolidated and coordinated pretrial proceedings.  (Defendants Joint Motion for Transfer and Request for Stay) The request says that more than 3,200 landowners have filed 97 separate suits in Johnson, Tarrant and Dallas Counties alleging that Chesapeake and Total E&P, USA, Inc. (Chesapeake’s working interest partner in the Barnett Shale) have charged excessive post-production costs. This request results primarily from multiple suits filed by the McDonald Law Firm. See http://royaltyripoff.com/.  McDonald has said he does not oppose Chesapeake’s request.

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On February 6, 2015, The Supreme Court of Texas released its second opinion in FPL Farming Ltd. (“FPL”) v. Environmental Processing Systems, L.C. (“EPS”).  The Beaumont court of appeals had held that injected fluids that migrate beyond the boundary of the land owned by the surface owner constitute a trespass on a neighbor’s property.  The Supreme Court declined to address whether or not subsurface wastewater migration is actionable as a common law trespass in Texas, and instead focused on consent as a general element of a trespass cause of action.

Until recently, subsurface wastewater migration had never been addressed by a Texas appellate court, and the assumption in the disposal industry was that such incursion was not actionable. But the Beaumont Court of Appeals, in FPL v. EPS, concluded that the neighbor does have a trespass claim.  The Beaumont Court issued two opinions in the case; the first was appealed to the Supreme Court which reversed and remanded to the Court of Appeals, and the second resulted in the opinion released February 6.

The facts in FPL are these: EPS operates an injection well for non-hazardous waste on land adjacent to the land owned by FPL. FPL had previously objected to an amendment of EPS’s permit that increased the rate and volumes allowed to be injected. The Austin Court of Appeals affirmed the permit amendment over FPL’s objections, ruling that “the amended permits do not impair FPL’s existing or intended use of the deep subsurface.” FPL Farming Ltd. v. Tex. Natural Res. Conservation Comm’n, 2003 WL 247183 (Austin 2003, pet. denied). FPL then sued EPS for trespass and negligence, alleging that injected substances had migrated under FPL’s tract causing damage. FPL lost a jury trial and appealed. The Beaumont Court affirmed, holding that because EPS held a valid permit for its well, “no trespass occurs when fluids that were injected at deep levels are then alleged to have later migrated at those deep levels into the deep subsurface of nearby tracts.” FPL Farming Ltd. v. Environmental Processing Systems, L.C., 305 S.W.3d 739, 744-745 (Tex.App.-Beaumont). The Supreme Court reversed, holding that Texas laws governing injection well permits “do not shield permit holders from civil tort liability that may result from actions governed by the permit.” FPL Farming Ltd. v. Environmental Processing Systems, L.C., 351 S.W.3d 306, 314 (Tex. 2011). But the court was careful to say it was not deciding that owners of injection wells could be guilty of trespass if their injected fluids migrated onto other lands. “We do not decide today whether subsurface wastewater migration can constitute a trespass, or whether it did so in this case.” The court remanded to the court of appeals for it to consider the other issues raised by the appeal. Continue reading →

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On January 30, the Supreme Court issued its opinion in Hooks v. Samson Lone Star, Limited Partnership, No. 12-0920. In doing so, it kept alive a $21 million verdict against Samson and limited its prior holdings barring suits by mineral owners based on the statute of limitations.

The principal claim the Hooks made against Samson alleged breach of a lease provision intended to protect the Hooks’ lease against drainage from wells on adjacent lands. The lease provided that, if a gas well is drilled within 1,320 feet of the lease, Samson must either drill an offset well, release sufficient acreage for an offset well to be drilled, or pay “compensatory royalty” – the amount of royalty the Hooks would be entitled to if the well on adjacent lands had been drilled on their lease.

In 2000, Samson permitted a well on lands adjacent to the Hooks lease, and it approached the Hooks asking permission to pool portions of the Hooks land with that well. Mr. Hooks asked Samson how close the well would be to the Hooks lease boundary. Samson sent him a plat showing that the location of the well would be 1,400 feet from the lease. Based on this, the Hooks agreed to the pooling.

In 2007, in connection with related litigation, the Hooks discovered that the adjacent well in fact was located within 1,320 feet of the Hooks lease, and the Hooks sued Samson for misrepresenting the well’s location and inducing them to agree to the pooling. They sought damages under the lease compensatory royalty clause – the royalty they would have received had the offending well been located on the Hooks’ lease. They argued that the four-year statute of limitations applicable to their claim should not apply because Samson had fraudulently induced them to believe that the well was 1,400 feet from their lease. The jury found that the Hooks should not have discovered the true facts until less than four years before bringing suit. It awarded more than $20 million damages to the Hooks. Continue reading →

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Earthquakes linked to oil and gas activity are in the news.  A recent study in Ohio linked a rash of small earthquakes to fracing of wells in the area. Earthquakes in Oklahoma have increased tenfold since 2009. A swarm of small earthquakes hit the Dallas-Fort Worth area recently. The US Geological Survey is raising its evaluation of earthquake hazard risk in Texas as a result. 

In Texas, the spate of small earthquakes is tentatively tied to injection wells rather than fracing of new wells. The theory is that the injected water lubricates lithologic layers, allowing them to slip and causing quakes.

The Environmental Protection Agency estimates that there are 144,000 Class II injection wells in the US. The RRC has permitted more than 50,000 Class II injection wells in Texas since the 1930’s. These injection wells are used to dispose of water and waste produced from wells, both that from the fracing process and water produced with oil and gas in the production phase. Many oil wells produce hundreds of barrels of water for each barrel of oil produced. Without injection wells, the Texas oil and gas industry would screech to a halt.

In response to the increased seismic activity in Texas, the Texas Railroad Commission hired its own seismologist
and proposed new rules for those applying for permits to drill disposal
wells. The RRC’s proposed rules originally were drafted to require applications for injection well permits to provide a calculation of the estimated “five pounds per square inch, 10-year pressure front boundary,” as a way to determine whether or not the well would likely cause seismic activity in the area. When water is injected into a formation underground, it increases the pressure in the formation, and that pressure spreads through the formation over time. The five-psi, 10-year pressure front is the distance from the injection well to which pressures will increase by five psi if the well is operated at the permitted rate and pressure over a 10-year period.

The RRC published the proposed rule for comments and received 36 comments, including comments from the Environmental Defense Fund, the Sierra Club, the Texas Alliance of Energy Producers, some groundwater conservation districts, the EPA, the US Geological Survey, and Chevron USA. In response to comments, the RRC changed its proposed rule. Instead of requiring the five-psi, 10-year pressure front study, the RRC will require each applicant to provide copy of a USGS map showing all recorded seismic events within 9 kilometers of the proposed well location (about 6.1 miles).  The pressure-front study will be required “only in certain limited circumstances where additional information is necessary to demonstrate that fluids will be confined if the well is to be located in an area where conditions exist that may increase the risk that fluids will not be confined to the injection interval.”

The original proposed rule also said that the RRC could modify, suspend or terminate a permit “if injection is suspected of or shown to be causing seismic activity.” The final rule modifies this language to read “if injection is likely to be or determined to be causing seismic activity.”

The RRC’s discussion of comments, and the final rule, can be found here. rrc earthquake rule.pdf

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