April 2009 Archives

April 27, 2009

The Meaning of "Other Minerals."

Conveyances of minerals in Texas usually describe the interest conveyed or reserved as an interest in "oil, gas or other minerals." Texas courts have struggled mightily to try to discern what the parties meant by the term "other minerals." If the parties did not specifically name a particular mineral, such as coal or uranium, did they intend that substance to be included in their reference to "other minerals"?

Making the matter more complicated, the Texas Supreme Court has changed its mind on how to approach the problem. At one point, the Court adopted a "surface destruction test" to determine whether a substance was intended to be a "mineral." Under this rule, the Court reasoned that the parties would not intend to sever ownership of a substance from the surface estate if the commercial way to mine the mineral was by strip mining, so a near-surface substance would not be considered a "mineral." Then the Court decided that such a test was not workable, and it adopted (but only for reservations or conveyances of "other minerals" after the date of its opinion) a different test, the "ordinary and natural meaning" test. Under this test, a substance is a mineral if it is within the "ordinary and natural meaning" of the word "mineral." In effect, each substance must be tested by litigation to determine if it is a "mineral" within the ordinary and natural meaning of that term. Once a court has decided that a particular substance is a mineral under this test, it is a mineral for all reservations and conveyances of "oil, gas and other minerals" to which the test applies..

Because of all of the confusion about the term, I have created a short-hand decision tree to use when looking at a conveyance or reservation, to help me remember how to apply these tests.  My decision tree is below.


Continue reading "The Meaning of "Other Minerals."" »

April 24, 2009

Sources and Users of Energy in the U.S.

Below is an interesting chart published by the U.S. Energy and Informaton Administration, showing how the U.S. used energy in the U.S. in 2007:

U.S. Primary Energy consumption by source and sector 2007.jpg

The sources of energy are on the left, the sectors of the economy that consume energy are on the right. The lines connecting supply sources and demand sectors show which sectors use which sources of energy. For example, petroleum represents 39.8% of the total supply of energy in the U.S. Seventy percent of that petroleum is used for transportation. Petroleum is the source of 96% of all sources of energy for the transportation sector. The transportation sector consumes 29% of all energy consumed in the U.S.

The chart reveals how natural gas is used in the U.S.: 34% in the industrial sector, 34% in the residential and commercial sector (as fuel to heat and cool homes and buildings), 30% to generate electricity. Most electricity is used by residential and commercial buildings, so in reality electricity is an intermediate demand sector. If it is eliminated as a demand sector, 61% of total demand would show as consumed by residential and commercial buildings. Natural gas would supply 14.8% of total energy used in residential and commercial buildings, either directly for heating and cooling or indirectly through its use to generate electricity. 

Unlike coal and petroleum, demand for natural gas is spread among three demand sectors -- industrial, residential and commercial, and electric power. Today demand for natural gas is depressed, principally because of increased supply and low demand in the industrial and electric power sectors. If natural gas' share of the transportation sector could be increased by conversion of vehicles to burn it, domestic supplies of natural gas could supplant imported petroleum as a source of supply for the transportation sector. For an excellent article on the use of natural gas as an alternative fuel for transportation, see Seeking Alpha's article.

April 21, 2009

Texas Railroad Commission orders Chesapeake Energy to plug back illegally-drilled Barnett Shale well

The Texas Railroad Commission has denied Chesapeake Energy's request for permission to produce its Ramey 1H well in Tarrant County, because the well was drilled in violation of RRC spacing rules. Chesapeake drilled the horizontal well with a 3,553-foot lateral, even though its permit was for a lateral of only 1,839 feet. The RRC ordered Chesapeake to plug back the well so as to comply with the permit. The problem was that the wellbore passed wihin 330 feet of an unleased tract, violating the Barnett Shale field rules that require all wells to be located at least 330 feet from the boundary of the lease or unit. Kevin Cunningham, regional counsel for Chesapeake's southern division, said that the ruling "would have the negative effect of rendering a significant amount of gas" unrecoverable under Chesapeake's leases. For the story in the Fort Worth Star-Telegram, click here. Situations like those faced by Chesapeake will drive the debate for forced-pooling legislation in Texas.
April 20, 2009

Congress preserves oil and gas industry tax provisions

Congress passed the 2010 federal budget without adopting the Obama Administration's proposal to eliminate several tax provisions favorable to the oil and gas industry, including percentage depletion and expensing of intangible drilling costs. See my earlier post discussing these tax provisions.  Adam Haynes, EVP of Texas Independent Producers and Royalty Owners Association (TIPRO), was quoted in TIPRO's April 17 newsletter as saying that that the industry had "dodged a bullet," and that repeal of these tax provisions, which purportedly cost taxpayers $80 billion a year, "would very negatively impact the exploration for needed energy here and throughout the nation."
April 17, 2009

Natural Gas Market News

The Energy Information Administration has revised its forecast for 2009 U.S. industrial natural gas demand, to decline by 7.4% this year. It predicts total natural gas consumption to fall 1.8% in 2009. U.S. natural gas production is expected to decline 0.3% in 2009, and to slip 1% in 2010. EIA predicts natural gas Henry Hub prices to average $4.24/mcf in 2009 and $5.83/mcf in 2010, compared with $9.13/mcf in 2008.

Chesapeake Energy has elected to further curtail its gas production, by a total of 400 mmcf in 2009, representing approximately 13% of Chesapeake's production capacity.

One petroleum geologist and industry consultant, Arthur Berman, believes that the Haynesville Shale in Lousiana, touted as the hottest onshore gas play in North America, is overrated. His analysis of early discoveries shows that the wells decline rapidly, cost about $7.5 million per well to drill and complete, and would require a price of $8/mcf to break even.  http://petroleumtruthreport.blogspot.com 

April 17, 2009

Range Resources Announces Giant Barnett Shale Well

Range Resources announced on April 16 that it had completed a horizontal well in the Barnett Shale in southern Tarrant County that produced an average of 9.6 mmcf per day for the first 30 days of its production. This would be the largest Barnett Shale well completed to date. Range currently has three rigs drilling in the Barnett Shale.
April 15, 2009

How do seismic surveys work?

Seismic surveys have become the primary tool of exploration companies in the continental United States, both onshore and offshore.  3-D seismic surveys have lowered finding costs and allloowed exploration for reserves not locatable by other means, revolutionizing the industry.  Below is a non-scientific explanation of how seismic surveys work.

A seismic survey is conducted by creating a shock wave - a seismic wave - on the surface of the ground along a predetermined line, using an energy source. The seismic wave travels into the earth, is reflected by subsurface formations, and returns to the surface where it is recorded by receivers called geophones - similar to microphones. The seismic waves are created either by smalle xplosive charges set off in shallow holes ("shot holes") or by large vehicles equipped with heave plates ("Veibroseis" trucks) that vibrate on the ground. By analyzing the time it takes for the seismic waves to reflect off of subsurface formations and return to the surface, a geophysicist can map subsurface formations and anomalies and predict where oil or gas may be trapped in sufficient quantities for exploration activities.

seismic truck.JPG

Until relatively recently, seismic surveys were conducted along a single line on the ground, and their analysis created a two-dimensional picture akin to a slice through the earth beneath that line, showing the subsurface geology along that line. This is referred to as two-dimensional or 2D seismic data. 

A 2D Seismic Line Image:

2D seismic.JPG


In the last 20-30 years, with the development of computers, geophysicists have been able to take seismic testing to a new level by conducting three-dimensional, or 3D, seismic tests. In 1980, about 100 3D surveys had been performed. By the mid 1990's, 200 to 300 3-D surveys were being performed each year. In the 1980's it took the most sophisticated Cray computers to analyze the data. Today, the analysis is performed on super-desk-top computers. Currently, almost all oil and gas exploratory wells are preceded by 3-D seismic surveys. The basic method of testing is the same as for 2D, but instead of a single line of energy source points and receiver points, the source points and receiver points are laid out in a grid across the property. The resulting recorded reflections received at each receiver point come from all directions, and sophisticated computer programs can analyze this data to create a three-dimensional image of the subsurface.

A 3D Seismic Image:

3D seismic.JPG

3D surveys can be conducted in almost any environment - in the ocean, in swamps, and in urban areas. A 3D seismic survey may cover many square miles of land and may cost $40,000 to $100,000 per square mile or more. The data obtained from such a survey is therefore very valuable, and if protected from disclosure constitutes a trade secret.  Seismic datea is licensed, bought and sold by seismic survey companies, brokers and exploration companies.

Continue reading "How do seismic surveys work?" »

April 14, 2009

Obama's Proposal to Repeal Energy Industry Tax Breaks

President Obama, in an attempt to recoup some of the money being spent to revive the economy, proposes to repeal several tax provisions near and dear to the oil and gas industry:

  • Enhanced oil recovery credit
  • Marginal well tax credit
  • Expensing of intangible drilling costs
  • Deduction for tertiary injectants
  • Passive loss exception for working interest owners in oil and gas properties
  • Manufacturing tax deduction for oil and gas companies
  • Percentage depletion deduction for oil and gas
  • Not surprisingly, the oil and gas industry is mounting a huge lobbying campaign to prevent loss of these tax benefits. 

The only one of these tax benefits that directly affects royalty owners is the percentage depletion deduction.  Currently, 15% of royalty income is deductible as "percentage depletion."  The deduction is intended to recognize that the sale of oil and gas is in part the sale of a depleting asset, so that a portion of the royalty should be treated like a return of capital rather than as income.

The principal argument being made against repeal of these tax benefits that are peculiar to the oil and gas industry is that their repeal would reduce the amount of oil and gas produced in the U.S., because those who invest in exploration and production would be less willing to do so, or would invest less.  The argument would be difficult to defend if oil were above $100 per barrel and gas were above $12 per mcf, as they were last summer.

The oil and gas industry has always been subject to price volatility.  When prices are low, the industry obtains tax breaks by using the argument that the breaks are necessary to avoid declines in domestic production.  When prices are high, the same tax breaks provide a windfall to the industry.

It will be interesting to see if the Administration's plan can withstand the onslaught of opposition from the industry and royalty owners.

April 13, 2009

NAT GAS Act Introduced in House

H.R. 1835, the New Alternative Transportation to Give Americans Solutions Act of 2009 (NAT GAS Act) was introduced in the U.S. House of Representatives by Dan Boren (D-OK), John Larson (D-CT) and John Sullivan (R-OK).  Its purpose is to promote the use of natural gas in vehicles, with an emphasis on large trucks and fleet vehicles.  It wiould provide incentives for installation of natural gas fueling stations.  It is the first legislation to promote Boon Pickens' plan to use domestic natural gas to reduce dependence on foreign oil.
April 9, 2009

Chesapeake Energy Master Drilling Plan Approved by Fort Worth City Council

Chesapeake Energy has obtained City approval for a "master drilling plan" that lays out plans to drill 69 horizontal wells from seven drilling locations within the City of Fort Worth.  The plan identifies the drilling locations and the gathering lines, and how produced water will be disposed of.  The plan shows how horizontal drilling technology has revolutionized the drilling of wells in shale formations.  untitled.JPG    
April 6, 2009

Texas Supreme Court Record on Royalty Owner Cases

In a previous post I discussed a recent Texas Supreme Court case, Exxon v. Emerald, reversing a multimillion-dollar judgment against Exxon for intentionally sabatoging wells so that they could not be re-entered. This nudged me to look at other royalty-owner related cases handed down by the Texas Supreme Court over the last ten years. The court's record is not a good one for royalty owners. Highlights of the Court's work:

HECI v. Neel (1998). HECI sued an adjacent operator for illegal production on an adjoining lease that damaged the common reservoir underlying both leases, and recovered a judgment for more than $3.7 million. HECI did not inform its royalty owners of the suit and did not share any of the judgment proceeds with the royalty owners. When HECI's royalty owners found out about the suit, they sued HECI to recover their share of the judgment. The Supreme Court held that the royalty owners had waited too long to bring their suit, even though they did not find out about the suit until five years after the trial. The Court held that the royalty owners should have known that the adjacent operator was damaging the common reservoir by its operations.

Yzaguirre v. KCS Resources (2001). Plaintiffs were royalty owners who received royalties under a lease operated by KCS. KCS sold its gas under a 20-year contract with Tennessee Gas Pipeline, and the price under the Tennessee contract greatly exceeded the spot market price of the gas. But KCS paid royalties based on the "market value" of the gas, using comparable spot sale prices, well below the price it received from Tennessee. The Court held that KCS did not owe royalties based on the Tennessee price -- and, it held that the Tennessee contract was not even competent evidence of the market value of the gas.

Wagner & Brown v. Horwood (2001). Plaintiffs sued Wagner & Brown for deducting excess compression fees from their royalties that were charged by a Wagner & Brown affiliate. The Supreme Court ruled that all claims for royalties paid more than four years prior to the suit were barred by the four-year statute of limitations. Plaintiffs argued that Wagner & Brown had falsely told them, when they inquired about the fees, that the fees were only 12 cents per mcf, rather than 25 to 30 cents, so Wagner & Brown should not be allowed to rely on the statute of limitations. The Court rejected this argument, holding that the Plaintiffs' claims were not "inherently undiscoverable," even if Wagner & Brown lied to them about the charges.

Natural Gas Pipeline Company of America v. Pool (2002). Plaintiffs sued NGPL claiming that two leases had terminated due to a lack of production. The trial court entered a judgment for lessors on a jury verdict, which the Court of Appeals affirmed. The Supreme Court reversed.  It held that, if the leases had terminated for lack of production, the lessee had subsequently re-acquired title to the leases by adverse possession. This is the first case in the country to hold that adverse possession statutes apply to recover title to an expired oil and gas lease.

In re Bass (2003). Plaintiffs owned a royalty interest under a ranch owned by the Bass family. The Basses refused to lease their land for oil and gas exploration, and the royalty owners sued them for breach of an implied duty to develop the land. The Supreme Court held that the Basses had no implied duty to lease or develop the minerals under their property.

Union Pacific Resources Group v. Hankins (2003). Royalty owners in Crockett County brought suit against Union Pacific, alleging that UPRG was selling gas to an affiliated company at a low price and then reselling it at a higher price, but paying royalties on the lower price.  The plaintiffs sought to make the case a class action brought on behalf of all royalty owners in UPRG wells in Crockett County.The Supreme Court held that the case could not be brought as a class action because the royalty language in the leases could be different.

Kerr-McGee Corp. v. Helton (2004). Kerr-McGee drilled a well, the Holmes 17-1, in Wheeler County which produced more than 8.7 billion cubic feet of gas. The well was located 660 feet from the Heltons' lease. Kerr-McGee did not drill an offsetting well on the Helton lease, and the Heltons sued Kerr-McGee for failing to protect their lease against drainage from the Holmes 17-1. The trial court awarded $860,000 in damages, and the Court of Appeals affirmed.  But the Supreme Court reversed, ruling that the plaintiffs should have no recovery.  The Court held that the plaintiffs' expert witness had not adequately explained how he had measured the amount of gas that would have been produced from a well on the Helton lease if Kerr-McGee had drilled it;  the Court said that there was "simply too great an analytical gap between the data [relied on by the expert] and the opinion proffered."  The Court refused the plaintiffs' request to remand the case for a new trial.

Forest Oil Corp. v. McAllen (2008). In 1999, Forest Oil settled a lawsuit with McAllen and others who own the McAllen Ranch in Hidalgo County, over claims for royalties and leasehold development. In 2004, McAllen filed a separate suit against Forest to recover for damages caused by burying mercury-contaminated and radioactive material on the ranch.  Forest claimed that McAllen was obligated by the 1999 settlement to arbitrate any disputes over its operation of the lease. McAllen claimed that he was fraudulently induced to sign the settlement and was not bound to arbitrate his claims. The Supreme Court held that McAllen was contractually bound to arbitrate. It held that language in the settlement agreement, providing that McAllen was not relying on any statement or representation of Forest in executing the agreement, prevented McAllen from arguing that he was fraudulently induced by Forest to sign the settlement agreement. In so holding, the Court overruled a prior case it had decided in 1997, in which it held that a settlement agreement must "clearly express .. the parties' intent to waive fraudulent inducement claims" in order to preclue a fraudulent inducement claim.

I was unable to find any Supreme Court case in the last ten years that ruled in favor of royalty owners.

April 2, 2009

Wind Energy in Texas

Renewable energy is a hot topic in the new Obama Administration.  Wind Energy is being touted, especially in Texas, as a solution to global warming and U.S. dependence on foreign oil.  Wind farms have sprouted all across Texas.  Texas is now the leading wind energy producing state.  Texas utilities are about to spend billions of dollars extending high-voltage transmission lines into West Texas and the Panhandle, opening up those areas to additional wind energy projects.  The Texas Panhandle will see the next boom in wind energy development.  Having grown up in the Panhandle, I can verify that the wind blows there.

Three points are good to keep in mind when reading stories about renewable energy in general, and wind energy in particular.  First, it is important to distinguish between two different goals being pursued by the Obama Administration:  freedom from dependence on foreign oil, and reduction of carbon emissions.  Wind energy is "clean," because it does not produce CO2.  To the extent that wind energy can replace conventional coal- and natural gas-burning power plants, it therefore reduces CO2 emissions, thus fighting global warming.  But wind energy has little or no effect on imports of oil, which is mostly used for fueling cars and trucks.  If and when the auto industry solves the battery problem and is able to produce electric cars, wind energy could contribute to reduction in oil imports. 

Second, it is important to understand that, although wind farms are increasing exponentially, they contribute only a tiny portion of the nation's total energy consumption.  According to the Energy Information Administration, as illustrated below, in 2007 wind energy contributed only 5% of 7% of the nation's energy -- .35%!




Renewable energy contributes a larger share of the nation's total electricity production, as shown below:


US Electricity Production 3.JPG


But wind energy again makes up only a small percentage of total renewable energy sources used for electricty production.  By far the largest contributor is hydroelectric power, a source that is already largely developed.

Third, wind is not an efficient or reliable source of electric power.  Electricity is generated only when the wind blows, and that may not be when consumers need the electricity.  Utilities must therefore still have available coal and natural gas power plants to provide electricity when the demand arises, even if the wind is not blowing.  Again, until we can solve the battery storage problem so that wind energy can be stored as electricity until it is needed, wind will be only a small contributor to the nation's energy problems.