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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.

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.

October 20, 2014

Steadfast v. Bradshaw - Supreme Court and NPRI's

Last week the Texas Supreme Court heard oral arguments in Steadfast Financial v. Bradshaw, No. 13-0199. The case presents the court with another opportunity to grapple with an issue that Texas courts have struggled with since the court first addressed it in 1937 - what duty does the owner of the mineral estate owe to a non-participating royalty owner?

The term "non-participating royalty owner" is the name commonly given to a royalty interest in minerals created by a grant or reservation in a deed.  "Non-participating" is really redundant; it means that the holder of the royalty estate has no right to lease the mineral estate or to receive any bonus for a lease.  In fact, that is true of all royalty interests. A better name for this type of royalty interest might be "fee royalty interest," to distinguish it from a royalty interest reserved by the mineral owner in an oil and gas lease.

The owner of a fee royalty interest, having no right to lease or to drill wells, is dependent on the owner of the mineral estate out of which his/her royalty interest must be paid; the royalty interest has no value unless the mineral interest is leased and wells are drilled. In recognition of this fact, court decisions have imposed a duty on the mineral owner to protect the royalty owner's interest. How this duty is defined, and in what situations the duty is imposed, have been issues Texas courts have struggled with for many years. The cases that have addressed this issue over the years show how the common law develops -- very slowly, and with varied results for the litigants involved.

In Steadfast, Steadfast Financial owned the surface and mineral estates in 1,800 acres of land in Hood County. In 2006, Steadfast entered into a transaction with Range Resources: it sold the surface estate to Range for $8,976,600, and it granted an oil and gas lease to Range providing for a 1/8th royalty. At the time, Betty Lou Bradshaw owned a royalty interest in the 1,800 acres that she had inherited from her parents. When her parents sold the land in 1960, they reserved a royalty interest of 1/2 of the royalty; in other words they were entitled to 1/2 of any royalty reserved by the mineral owner in any oil and gas lease covering the 1,800 acres. 

When Ms. Bradshaw learned about the Steadfast-Range transaction, she sued Steadfast and Range. She claimed that the going royalty rate for oil and gas leases in Hood County in 2006 was 1/4th, and that Steadfast had a duty to her to get the best royalty it could obtain. She alleged that Steadfast and Range had conspired to breach Steadfast's duty to her, and that Range should be liable for its participation in Steadfast's scheme. She argued that Steadfast got a much better deal on its sale of the land to Range by agreeing to reduce the royalty rate in its lease to Range from 1/8 to 1/4.

The trial court threw out all of Ms. Bradshaw's claims, but the Fort Worth Court of Appeals held that she was entitled to a trial and remanded the case to the trial court.  Bradshaw v. Steadfast Financial, 395 S.W.3d 348 (Tex.App.-Fort Worth 2013). Steadfast appealed to the Texas Supreme Court, which agreed to hear the case. You can view the oral arguments in the Supreme Court here.

The Texas Supreme Court first considered the mineral owner's duty to a royalty interest owner in Schlittler v. Smith, 101 S.W.2d 543 (Tex. 1937), where it described the mineral owner's duty as one of "utmost fair dealing."  One of the most important Supreme Court cases on the topic is Manges v. Guerra, 673 S.W.2d 180 (Tex. 1984), involving the infamous Clinton Manges. Manges leased the minerals under his ranch in Duval County to himself for 1/8th royalty, and then sold the lease, reserving an additional 1/8th royalty for himself. The Court held that in doing so he breached his duty to the Guerras, who owned a royalty interest in the ranch. The Court held that Manges breached his "duty of utmost good faith" to the Guerras.

More recently, the Supreme Court has grappled with the mineral owner's duty to royalty owners in In re Bass, 113 S.W.3d 735 (Tex. 2003) and Lesley v. Veterans Land Board, 352 S.W.3d 479 (Tex. 2011). In Bass the Court held that a mineral owner has no duty to the royalty owner to grant an oil and gas lease. In Lesley the Court appeared to backtrack on what it had held in Bass, holding that a mineral owner does have a duty to a royalty owner to lease under some circumstances.

The lawyers arguing for Steadfast and Range said that Steadfast had no duty to Ms. Bradshaw to obtain the highest royalty rate it could, and that Steadfast should have the right to enter into a lease with 1/8th royalty and the highest bonus it could negotiate, even though the result would be to lessen Ms. Bradshaw's share of production. Bradshaw's attorney said that such a rule would be contrary to the substantial body of case law that had recognized a duty of "utmost good faith" owed by the mineral owner to its royalty owner. Questions from some members of the Court indicated that they were reluctant to require Steadfast to negotiate the best royalty it could obtain. If the Court decides to rule against Ms. Bradshaw, it could show an increasing reluctance by this Court to impose implied covenants or higher standards of conduct in the relationship between mineral and royalty owners in Texas.

October 9, 2014

Supreme Court Refuses to Hear Appeal of Trail Enterprises v. City of Houston

Trail Enterprises' efforts to collect an inverse condemnation judgment against the City of Houston have finally come to an end. The US Supreme Court has refused to hear its case. Trail Enterprises' story is instructive to parties who may be thinking of challenging cities' decisions to ban drilling within their boundaries.

The dispute has a long history.  Lake Houston is a major source of drinking water for the City of Houston. In 1967, the City passed an ordinance restricting the drilling of new oil and gas wells in a "control area" around the lake. That restriction has remained in place except for an eleven-month gap in 1996-97, when the lake was annexed into the City and the City passed a new ordinance protecting the lake. 

In 1995, Trail Enterprises, an owner of mineral interests in the restricted area around the lake, sued the City, claiming that the 1967 ordinance restriction amounted to a "taking" of the mineral interests in violation of the US Constitution. The trial court dismissed that suit, and the Houston Court of appeals affirmed. Trail Enters., Inc. v. City of Houston, 957 S.W.2d 625 (Tex.App.-Houston [14th Dist.] 1997, writ denied). In 1999, Trail sued again, this time arguing that the City's 1997 ordinance resulted in a taking of its property. The trial court held that the ordinance did not constitute a taking. This time the Houston Court of Appeals reversed and remanded the case for a trial. Trail Enters., Inc. v. City of Houston, 2002 WL 389448 (Tex.App.-Houston [14th Dist.] Mar. 14, 2002, no pet.). But the parties decided to dismiss that case.

Finally, in 2003, Trail, joined by other mineral owners, filed suit a third time. In 2005 a trial was finally held and a jury awarded the plaintiffs $19 million. But the trial judge dismissed the case on the ground that the plaintiffs had never applied to the City for a drilling permit.  That order was again appealed. The appeal was transferred to the Waco Court of Appeals, which affirmed the trial court's dismissal. Trail Enters., Inc. v. City of Houston, 255 S.W.3d 105 (Tex.App.-Waco 2007). Trail appealed to the Texas Supreme Court, which reversed and remanded the case back to the trial court. City of Houston v. Trail Enters., Inc., 300 S.W.3d 736 (Tex. 2009). This time, the trial court, after another evidentiary hearing, entered judgment against the city for $17 million.

The City appealed again, and in an opinion in 2012 the Houston Court of Appeals held that no "compensable taking" had occurred and reversed the trial court's judgment.  City of Houston v. Trail Enters., Inc., 377 S.W. 3rd 873 (Tex.App.-Houston [14th Dist.] 2012). Trail sought review by the Texas Supreme Court, but in October last year that court refused to hear the case.  And this week, the US Supreme Court also refused to hear Trail's appeal. After 19 years, Trail's efforts have finally come to naught.

Why such a tortuous fight through the courts? One reason is the very murky law of inverse condemnation. The Fifth Amendment to the US Constitution provides: "nor shall private property be taken for public use, without just compensation." The US Supreme Court has struggled mightily over the years to define what this means. Its seminal case on the matter is Penn Central Transp. Co. v. New York City, 438 U.S. 104 (1978).  In that case, the court attempted to define when a government's restriction of use of private property was so onerous as to require the government to pay the property owner -- when governmental restrictions amount to a "taking" of private property. The court's decision in Penn Central laid out a three-part test. Under this test, a court must evaluate a regulatory takings claim based on (1) the economic impact of the regulation, (2) the owner's "reasonable investment-backed expectations," and (3) the character of the regulatory action. Those words don't mean much until fleshed out by subsequent cases, and the factors are fuzzy and subjective. So inverse condemnation cases like Trail Enterprises become very fact-specific analyses, and the subjectivity of the test sometimes allows the biases of court judges to emerge.

I'm no expert on takings law. But recent developments in Texas and other states, centered around municipalities' increasing efforts to restrict drilling for oil and gas within their limits, may end up in takings cases like Trail Enterprises. The mineral owners' extreme difficulty in getting a final determination of their claim in Trail, and the multiple appellate opinions grappling with the takings issues, is an indication of the hurdles that other mineral owners may face in seeking compensation for cities' restrictions on drilling that affect the value of their mineral interests. In Texas, the City of Denton has a proposition on the November ballot:  "Shall an ordinance be enacted prohibiting, within the corporate limits of the City of Denton, Texas, hydraulic fracturing ...."  See "In Texas, a Fight Over Fracking," in the New York Times, Oct. 8.  Already a group of mineral owners has sued Denton over its temporary moratorium on drilling within city limits. If Denton's referendum passes, more lawsuits are a certainty. Similar bans are being passed by cities in Colorado and Pennsylvania, and the State of New York has had a moratorium on fracking since 2008. All good news for lawyers specializing in inverse condemnation suits.

September 3, 2014

Potts v. Chesapeake

Last month I wrote about two cases recently decided by the U.S. Court of Appeals for the 5th Circuit in which Chesapeake defeated royalty owners' efforts to prevent it from reducing their royalties by deducting post-production costs. One of those cases is Potts v. Chesapeake. The plaintiffs in that case have asked the Court of Appeals to reconsider its appeal "en banc," meaning that it has asked the other judges on the court to grant its petition for rehearing and reconsider the decision of the three-judge panel who decided the case. Plaintiffs' Petition for Rehearing may be viewed here:  Potts Petition for Rehearing En Banc.pdf

Yesterday, our firm filed a friend-of-the-court brief in the Potts case, on behalf of the Texas Land and Mineral Owners Association and the National Association of Royalty Owners - Texas, asking the Court to grant the plaintiff's motion for rehearing and either consider the case en banc or refer the question to the Texas Supreme Court for its consideration. A copy of our brief may be viewed here:  Potts v. CHK Amicus Brief.pdf

Meanwhile, in Pennsylvania, suit has been filed against Chesapeake claiming that its conduct in selling gas to its affiliate company at prices well below market, and then selling its affiliate company for a substantial profit, constituted fraud on its royalty owners in violation of the Racketeer Influenced and Corrupt Organizations Act, known as RICO.  That petition can be viewed here:  Suessenbach v. Chesapeake.pdf

August 7, 2014

Two Wins for Chesapeake in 5th Circuit

The 5th Circuit Court of Appeals in New Orleans has ruled for Chesapeake in two cases, holding that it can deduct post-production costs from gas royalties. Potts v. Chesapeake Exploration, No. 13-10601, and Warren v. Chesapeake Exploration, No. 13-10619. Both cases were decided by the same three judges, and both opinions were written by Judge Priscilla R. Owen. In both cases, Judge Owen relied on the Texas Supreme Court case of Heritage Resources v. NationsBank, 939 S.W.2d 118 (Tex. 1996). Judge Owen was on the Texas Supreme Court when Heritage v. NationsBank was decided, and she wrote an opinion in that case. Judge Owen cites her own opinion in Heritage as the principal precedent for her opinions in Potts and Warren.

The Potts and Warren cases were tried in federal district court. Because Chesapeake's home office is in Oklahoma, it has the right to remove suits filed against it in Texas to federal court. Federal courts have "diversity" jurisdiction over cases between citizens of different states. In diversity cases, federal courts must follow the law of the states. No federal law is involved. So, in deciding Potts and Warren, the 5th Circuit judges were attempting to predict what a Texas court would do, following prior precedent from Texas courts -- in this case, Heritage v. NationsBank.

Heritage v. NationsBank is a seminal case in oil and gas law, some would say infamous. The question in Heritage was whether Heritage, the lessee, could deduct transportation costs for gas from royalties owed to NationsBank. NationsBank's lease provided that royalties on gas would be "the market value at the well of 1/5 of the gas so sold or used, ... provided, however, that there shall be no deductions from the value of the Lessor's royalty by reason of any required processing, cost of dehydration, compression, transportation or other matter to market such gas." The Texas Supreme Court held that Heritage could deduct transportation costs from NationsBank's royalty. In her concurring opinion, Justice Owen said that the no-deductions proviso on NationsBank's lease was "circular" and "meaningless":

There is little doubt that at least some of the parties to these agreements subjectively intended the phrase at issue to have meaning. However, the use of the words "deductions from the value of Lessor's royalty" is circular in light of this and other courts' interpretation of "market value at the well." The concept of "deductions" of marketing costs from the value of the gas is meaningless when gas is valued at the well.

There were three opinions from the court in Heritage: a majority opinion written by Justice Baker, joined by Chief Justice Phillips, and Justices Cornyn, Enoch and Spector; a concurring opinion by Justice Priscilla Own, joined by Justice Hecht; and a dissenting opinion by Justice Gonzalez, joined by Justice Gregg Abbott.  (Cornyn went on to be Texas' U.S. Senator; Justice Abbott subsequently became Texas Attorney General and is now running for Texas Governor; Justice Owen was nominated by President Bush to fill the vacancy on the 5th Circuit left by Judge Will Garwood's retirement in 2001, but she was not confirmed by the Senate until 2005.)

Several amicus briefs were filed in Heritage asking the court to reconsider its decision, but the court refused. Justice Gonzalez, however, wrote an opinion dissenting on motion for rehearing, in which Justices Cornyn, Spector and Abbott joined. It is published at 960 S.W.2d 619. In that opinion, Justice Gonzalez said that the court was evenly divided, 4 to 4, on whether to grant the motion for rehearing. Justice Enoch had recused himself from the case, for reasons not stated, and Justices Cornyn and Spector had changed their minds, now siding with Justice Gonzalez's dissent. And Justice Phillips had decided to concur in Justice Owen's opinion rather than join Justice Baker's original majority opinion. Because a vote of 5 justices is required to grant rehearing, the motion failed. But, said Justice Gonzalez, there was no longer any majority opinion. "Because we are without majority agreement on the reasons supporting the judgment," he said, "the judgment itself has very limited precedential value and controls only this case." And, he predicted, "the Court's error in this case will have far-reaching effects on the oil and gas industry in Texas, as millions of dollars will now be placed in dispute."  His prediction has proven true.

Of the two cases decided by the 5th Circuit, Potts is the most interesting. The oil and gas lease from Potts to Chesapeake provided that royalties on gas would be "the market value at the point of sale of 1/4 of the gas sold or used." It also provided:

Notwithstanding anything to the contrary herein contained, all royalty paid to Lessor shall be free of all costs and expenses related to the exploration, production and marketing of oil and gas production from the lease including, but not limited to, costs of compression, dehydration, treatment and transportation."

Another lease provision said:

Payments of royalties ... shall be based on sales of leased substances to unrelated third parties at prices arrived at through arms length negotiations. Royalties to Lessor on leased substances not sold in an arms length transaction shall be determined based on prevailing values at the time in the area.

As I have written before, Chesapeake has created a complex relationship among its affiliate companies. One affiliate, Chesapeake Operating, operates the lease for Chesapeake. Another affiliate, Chesapeake Energy Marketing (CEMI), buys the gas from Chesapeake Operating at the wellhead. CEMI gathers the gas from Chesapeake's wells and resells it to purchasers at remote points of sale. The price that CEMI pays Chesapeake for the gas is based on the weighted average price of all gas sold at those remote points of sale, less the post-production costs CEMI incurs between the wellhead and the points of sale. Royalties were paid to Potts based on that net price, so that Potts, as royalty owner, was bearing his share of those post-production costs.

Justice Owen's opinion holds that Chesapeake is entitled to pay Potts royalties net of post-production costs, relying on her own opinion in Heritage v. NationsBank. Potts argued that Heritage was distinguishable, and he pointed to the following sentence from Justice Owen's opinion in Heritage:

There are any number of ways the parties could have provided that the lessee was to bear all costs of marketing the gas. If they had intended that the royalty owners would receive royalty based on the market value at the point of delivery or sale, they could have said so.

Potts' lease provides, as Justice Owen had suggested, that his royalty shall be based on the "market value at the point of sale." But, said Judge Owen, in this case Chesapeake's sale (to its affiliate CEMI) is at the well, so the "point of sale" is on the lease, and the market value at that point is the price received by Chesapeake from its affiliate, net of post-production costs. "Chesapeake has sold the gas at the wellhead. That is the point of sale at which market value must be calculated under the terms of the lessors' lease."

I have seen many lease clauses attempting to prohibit deduction of post-production costs. Some of those clauses include language such as this: "This provision is intended to avoid the result in Heritage v. NationsBank." I've not seen a case construing such a clause. Despite Justice Gonzalez's insistence that Heritage has very limited precedential value, companies have made the most of it, and lessors continue to try to avoid it.

July 29, 2014

Jimmy McAllen's Judgment Against Forest Oil Affirmed

Jimmy McAllen's battle against Forest Oil has moved one step closer to conclusion. Last week the Corpus Christi Court of Appeals affirmed an arbitration award of more than $20 million against Forest Oil for environmental and other damages to the McAllen Ranch and personal injuries to Mr. McAllen.

The fight began in 2004, when McAllen sued Forest. He claimed that Forest had buried mercury-contaminated iron sponge wood chips on the 27,000-acre McAllen Ranch. The wood chips are waste from Forest's gas plant on the Ranch. He also claimed that he had contracted cancer from pipe containing naturally occurring radioactive material (NORM) that Forest had given him to build pens on his Santillana Ranch.  The pens were built to house endangered rhinoceroses.  McAllen contracted cancer that required amputation of his leg.

Forest responded that McAllen was bound by a prior settlement agreement that required him to arbitrate any claims arising out of Forest's operations on his ranch.  McAllen opposed arbitration. The trial court denied Forest's motion to require arbitration, and the Corpus Christi Court of Appeals affirmed. Forest appealed to the Texas Supreme Court, which held that McAllen was bound by the arbitration agreement. Forest Oil v. McAllen, 268 S.W.3d 51 (Tex. 2008).

So the parties arbitrated McAllen's claims before three arbitrators, one chosen by McAllen, one by Forest, and the third chosen by the other two.  Forest chose Daryl Bristow, McAllen chose Donato Ramos, and the third arbitrator was Clayton Hoover. The arbitration hearing lasted for 17 days.  The arbitrators issued a split decision, with Bristow dissenting. The arbitration award gave $15 million to McAllen for the reduced value of the McAllen Ranch resulting from Forest's contamination of the ranch, and $500,000 to Jimmy McAllen for his personal injuries. The panel also awarded $500,000 in exemplary damages and $5 million in attorneys' fees. Bristow dissented, based on his conclusion that the award interfered with the Texas Railroad Commission's jurisdiction to regulate remediation of hazardous waste associated with oil and gas production.

McAllen filed a motion in the trial court to confirm the arbitration award, which the trial court granted. Forest then appealed to the Court of Appeals in Corpus Christi.

Texas courts favor arbitration of disputes, so it is difficult to overturn an arbitration award. A court's review of arbitration awards is very limited.

The Court of Appeals first held that the award did not interfere with the Railroad Commission's jurisdiction over oil field contamination. The court made reference to sections 85.321 and 322 of Texas Natural Resources Code, the first of which expressly grants a private cause of action for damages for violation of Texas conservation laws, and the second of which provides that nothing in the law governing Railroad Commission jurisdiction "shall impair or abridge or delay a cause of action for damages or other relief that an owner of land .... may have or assert against any party violating any rule or order of the commission or any judgment under this chapter."

Forest also argued that the award should be vacated because of the "evident partiality" of Donato Ramos, the arbitrator chosen by McAllen. An arbitration award may be overturned if an arbitrator fails to disclose to the parties known facts that "might, to an objective observer, create a reasonable impression of the arbitrator's partiality." In other words, it is not the partiality per se that is objectionable, but the arbitrator's failure to disclose facts that might show his partiality. Forest said that Ramos failed to disclose that McAllen had proposed Ramos as a mediator in another suit brought by McAllen against Chevron. Evidence in the case indicated that Ramos was never told that he had been proposed as a mediator in that other litigation.  Because there was evidence that Ramos never knew he was being proposed as a mediator, the Court of Appeals held that Forest had not shown grounds for overturning the arbitration -- Ramos could not fail to disclose something that he never knew. The Court of Appeals distinguished a recent Texas Supreme Court case that did overturn an arbitration award on the same grounds, Tenaska Energy v. Ponderosa Pine Energy,  2014 WL 2139215. In that case, the arbitrator failed to disclose the full extent of his business relationship with a party's attorneys in the case.

There is some irony in Forest's complaints about the arbitration award in light of its insistence that McAllen's claims had to be resolved by arbitration. One of Forest's arguments for overturning the award was that McAllen's expert-testimony evidence of damages to the ranch would not have been admissible testimony in a trial court. The Court of Appeals cited the Texas Supreme Court's conclusion that an arbitration award need not be based on admissible evidence. "For efficiency's sake, arbitration proceedings are often informal; procedural rules are relaxed, rules of evidence are not followed, and no record is made." Nafta Traders v. Quinn, 339 S.W.3d 84, 101 (Texas 2011).

Forest is sure to seek review by the Texas Supreme Court. So Jimmy McAllen's ten-year fight with Forest is not quite over yet. 

June 26, 2014

Amarillo Court of Appeals Refuses to Apply Accommodation Doctrine to Groundwater

Last week, the Amarillo Court of Appeals issued its opinion inn City of Lubbock v. Coyote Lake Ranch, LLC, No. 07-14-00006-CV, holding that the accommodation doctrine did not apply to restrict the City's use of Coyote's land to develop the City's groundwater under the land.

In 1953, the City of Lubbock bought the rights to groundwater under the land now owned by Coyote Lake Ranch. In that deed, the City acquired all groundwater rights, and "the full and exclusive rights of ingress and egress in, over and on said lands so that the Grantee of said water rights may at any time and location drill water wells and test wells on said lands for the purpose of investigating, exploring, producing, and getting access to percolating and underground water." The deed granted the right to lay water lines, build reservoirs, booster stations, houses for employees, and roads, "together with the rights to use all that part of said lands necessary or incidental to the taking of percolating and underground water and the production, treating and transmission of water therefrom and delivery of said water to the water system of the City of Lubbock only."

In 2012, the City proposed a well field plan for the property and began testing and development under that plan. Coyote sued, asking for a temporary injunction to halt the City's activity. Coyote claimed that the City failed to accommodate Coyote's existing uses of the property (the opinion does not say what those uses are), and that the City could use alternatives that would lessen damage to Coyote's use of the land. The trial court granted the temporary injunction, holding that Coyote was likely to be able to show at trial that the City's plan could be "accomplished through reasonable alternative means that do not unreasonably interfere with [Coyote's] current uses." The City appealed from that order.

In the Court of Appeals, the City made two arguments: first, it argued that the accommodation doctrine does not apply to the relationship between the owner of the surface and the owner of groundwater. Second, it argued that the express language in the water rights deed would prevail over general accommodation doctrine principles.

The Court of Appeals reversed, agreeing with the City that the accommodation doctrine does not apply to limit the rights of holders of groundwater rights. The Court said that the Texas Supreme Court has not extended the accommodation doctrine to groundwater, and that "changes in the law should be left to the Texas Supreme Court or the Texas Legislature."

The accommodation doctrine was developed to ameliorate the harsh results of the rule that the mineral estate is the dominant estate and mineral owners have the right to use as much of the surface of the land as is reasonably necessary to explore for and extract minerals, without compensation to the surface owner. The doctrine requires the mineral owner to accommodate existing surface uses where that can be done using established industry practices. The Court's opinion does not provide any logical reason why the accommodation doctrine should not apply also to severed groundwater rights. Indeed, the City's use of Coyote's land to develop its groundwater might be more intrusive than would surface use for development of mineral rights under the land.

The opinion does not address the City's second argument, that the express language in its deed granting the City extensive rights to surface use should make the accommodation doctrine inapplicable. Many deeds granting or reserving mineral interests contain express language granting the mineral owner the right to use the surface estate for oil and gas exploration and development. I have not seen a case involving the accommodation doctrine in which the mineral owner contended that the express language in its deed granting access rights prevailed over the accommodation doctrine.

Severance of groundwater from the surface estate is not as common in Texas as severances of minerals. But with increased demands for and value of groundwater, such severances will become more common, and other conflicts between the surface owner and the owner of groundwater will likely arise. I expect that the Texas Supreme Court will have to address the applicability of the accommodation doctrine to severed groundwater rights in the near future.

June 23, 2014

Texas Supreme Court Decides Key Operating v. Hegar

The Texas Supreme Court last week decided Key Operating & Equipment, Inc. v. Hegar, No. 13-0156, reversing the courts below and holding that Key Operating has the right to use a road crossing Hegar's tract to produce from a well on adjacent lands.

The legal principle the Court applied is not surprising and did not substantially change existing precedent. But the unusual facts of the case illustrate how far the Court will go to protect the rights of mineral lessees when those rights conflict with interests of the surface owner.

The legal precedent the Court followed is this:  when two tracts are combined to create a pooled unit, the operator of the unit has the right to use the surface of all of the land covered by the leases included in the unit to operate wells located anywhere on the unit, regardless of the location of the well.

The facts of the case are these:  Hegar bought 85 acres of land in 2002, and built a house there in 2004. The 85 acres was originally part of a 191-acre tract, the Curbo/Rosenbaum tract.  When the Hegars bought the land, 1/8th of the minerals under the Curbo/Rosenbaum tract were owned by the owners of Key Operating, who had leased the mineral interest to Key Operating. Key had a well on an adjacent tract, the Richardson #1, and had created a pooled unit including 10 acres of the Curbo/Rosenbaum tract and 30 acres of the Richardson tract. An existing road crossed the Hegar land and led to the Richardson #1. After the Hegars built their home, Key Operating drilled another well on the pooled unit, the Richardson #4, and traffic on the road increased substantially. The Hegars filed suit, arguing that Key had no right to "access or use the surface of the Hegar Tract in order to produce minerals from the Richardson Tract."  At trial, the Hegars produced expert testimony that the Richardson #4 Well was draining only 3 1/2 acres, and that the well's drainage area did not reach the Hegars' property and was not draining the Hegars' property. The trial court held that Key did not have the right to use the road across the Hegars' property to produce from a well that was not actually draining their property. The court of appeals affirmed. 403 S.W.3d 318 (Tex.App.--Houston [1st Dist] 2013).

The facts recited in the opinion reveal that Key appears to have created the pooled unit primarily if not solely to preserve its right to use the existing road to get to the Richardson #1 well. Key's owners apparently bought 1/8th of the minerals under the Curbo/Rosenbaum tract so that they could lease the interest to their own company and create the pooled unit. The opinion does not say for sure, but Key apparently pooled its lease of the 1/8th mineral interest in 10 acres from the Curbo/Rosenbaum tract even though it had no lease on the other 7/8ths of the minerals in that 10 acres. Because the new well, the Richardson #4, was not draining the Curbo/Rosenbaum tract, there was apparently no geological reason to create the pooled unit.

Even so, the Supreme Court held that, once the pooled unit was formed, Key had the right to use the Curbo/Rosenbaum tract to produce from wells on the pooled unit. The court held that

once pooling occurred, the pooled parts of the Richardson and Hegar Tracts no longer maintained separate identities insofar as where production from the pooled interests was located. So the legal consequence of production from the pooled part of the Richardson Tract is that it is also production from the pooled part of the Hegar Tract, and the Hegars do not contend that Key did not have the right to use the road to produce minerals from their acreage. Because production from the pooled part of the Richardson Tract was legally also production from the pooled part of the Hegar tract, Key had the right to use the road to access the pooled part of the Richardson tract.

So the Hegars will have to put up with the road and the traffic. They are bound by the legal fiction, found to be untrue as a matter of fact, that production from the pooled part of the Richardson tract was "legally" production from the their tract, thus giving Key the right to use its road.

A footnote in the Supreme Court's opinion raises an interesting question: "The Hegars do not argue that the Richardson lease does not grant the right to pool or that the pooling was in bad faith."  Clearly, the mineral owners under the Richardson tract could complain that the pooling of their lease with 10 acres of the Curbo/Rosenbaum tract was in bad faith because the Richardson #4 was not in fact draining the Curbo/Rosenbaum tract. But would the Hegars, who apparently had no mineral interest in their tract and no right to share in production from the unit, have standing to argue that the pooled unit was created in bad faith? The court does not say, but the footnote implies as much.

May 28, 2014

A Second Nuisance Verdict in Barnett Shale

A jury has awarded damages in a second nuisance case against an operator, this time against Chesapeake Energy.  In Crowder et al. v. Chesapeake Operating Inc., case number 2011-008169-3, in Tarrant County Court at Law, the jury awarded the Crowders $20,000 for what the jury found to be a temporary nuisance - drilling operations conducted by Chesapeake in a field behind their house, where Chesapeake has drilled 13 wells. The Crowders complained of offensive odors and extensive noise. The jury failed to find that Chesapeake's operations created a permanent nuisance, which would have entitled the Crowders to additional damages. The Crowders filed their suit in 2011.

While the jury award in Crowder will not excite plaintiffs' attorneys to look for additional such cases -- unlike the $2.9 million verdict recently awarded in another case, Lisa Parr v. Aruba Petroleum, Cause No. 11-01650-E, in the County Court at Law No. 5 of Dallas County -- the case does show the viability of nuisance claims aimed at oil and gas operations near residences, especially in urban areas.

The Dallas city council recently adopted a drilling ordinance prohibiting well locations within 1,500 feet of any residence, effectively prohibiting most drilling within the city limits. The setback in Fort Worth is 600 feet. There are more than 1,700 wells in the City of Fort Worth.

May 5, 2014

Texas Supreme Court Agrees to Hear Hooks v. Samson

The Texas Supreme Court has granted the plaintiffs' petition to review a case important for Texas mineral owners, Hooks v. Samson Lone Star. I wrote about this case when it was decided by the Houston First Court of Appeals in 2011. The court of appeals' opinion reversed a judgment for $21 million against Samson Lone Star in a case involving alleged bad-faith pooling and fraudulent misrepresentations by the Hooks' lessee. The court of appeals threw out the judgment, holding that Texas Supreme Court precedent required it to hold that the Hooks' claims were barred by the applicable statute of limitations.

The statute of limitations bars claims if they are not filed within four years (or two years for some claims) of the event that caused the damages or injury for which the claim is brought. In some cases, courts have excused the delay in filing claims if the damage or injury was not discovered until a later date. Under this "discovery rule," the statute of limitation is "tolled" until the plaintiff discovered or, with reasonable diligence, should have discovered, her injury. Also, courts have held that the statute of limitations is tolled where the defendant fraudulently conceals the facts giving rise to the damage or injury.

Over the last several years, the Supreme Court has severely narrowed the circumstances under which plaintiffs can invoke the discovery rule or claim fraudulent concealment to toll limitations on a claim, particularly in suits by mineral owners against their lessees. In Exxon v. Emerald in 2009, the Supreme Court reversed an $18 million judgment against Exxon on the basis that the mineral owners' claims were barred by limitations -- despite an express finding by the jury that the plaintiffs had filed their claim within four years after they discovered or should have discovered Exxon's fraudulent conduct. In 2011, the Supreme Court in BP v. Marshall overruled a jury verdict in favor of royalty owners, holding that their claim was barred by limitations as a matter of law even though the jury had found that the lessee had fraudulently concealed the facts and that the plaintiffs had no reason to discover the true facts until less than two years prior to filing suit.

One justice on the Houston First Court of Appeals wrote a concurring opinion that may have influenced the Supreme Court to take the case, which bears repeating here:

It is undisputed that Samson drilled a directional well bottomed within the "buffer zone" established in the Hooks' Jefferson County Lease (the "Lease") and failed to elect between the three alternatives outlined in the Lease, thus exposing itself to liability for breach of contract. If the Lease had allowed pooling, Samson could have solved the problem by pooling the lands covered by the Lease with the adjacent lands. The Lease, however, did not allow pooling.

Samson's solution to this problem was to begin misrepresenting various "facts" to escape the consequences of its actions. Its landman, Lanoue, filed papers with the Railroad Commission falsely certifying that Samson had pooling authority from the Hooks. He later filed paperwork in the county's real property records falsely indicating that the Hooks had already agreed to pool. Lanoue then sent a letter to the Hooks asking them to agree to pool the westernmost 50 acres of the Hooks' acreage in the Lease into the BSM 1 Unit. When Charles Hooks called Lanoue and asked for more information about the well's location, Lanoue represented to Hooks that the well was located approximately 1500 feet from the lease line, a location outside the buffer zone. When Charles Hooks asked for a plat, Lanoue faxed him one that represented a bottom-hole location that was +/- 1400 feet from the lease line, the accuracy of which he, Lanoue, had certified with no reference to an actual bottom-hole location, although it was ascertainable from a prior directional survey. Instead, when asked the origin of those measurements, he answered: "I got them from myself." On this basis the Hooks agreed to the formation of the unit.

Thus it is clear that Samson, through its representative, took action to cover up its own error by both oral and written misrepresentations to its lessor, born of "assuming" and "hoping." It is further clear that the Hooks, after asking for and receiving verification of Lanoue's oral representation in the form of a plat, believed its lessee's representations and made no attempt to go beyond them to discover the truth or falsity thereof. On these facts, the majority has found that the discovery rule does not apply to the Hooks' fraud, fraudulent inducement, and statutory fraud claims and that they are barred by limitations as a matter of law.

I reluctantly concur, based on the Texas Supreme Court's holding in BP America Production Co. v. Marshall, 342 S.W.3d 59 (Tex. 2011). In that case, the Texas Supreme Court makes clear that no lies on the part of a lessee, however self-serving and egregious, are sufficient to toll limitations, as long as it is technically possible for the lessor to have discovered the lie by resort to the Railroad Commission records. This burden the Court imposes upon lessors is severe. It is now a lessor's duty to presume that any statement made by its lessee is false and to ransack the esoteric and oft-changing records at the Railroad Commission to discover the truth or falsity of its lessee's statements. If, as is often the case, these records are technical in nature and require expert review to ferret out the truth, it is the lessor's job to hire experts out of its own pocket to perform such a review. If a lessor fails to take these steps, then it will have failed in exercising reasonable diligence to protect its mineral interests and, if the lessee's fraud is successful for longer than the limitations period, the lessor's claims will be barred by limitations.

Such is the case here. Had the Hooks presumed that Samson's oral representations, followed by written representations, about the bottom-hole location of the well were false, and had they hired an expert to resort to Railroad Commission records to trace the various filings (some of which were also false), that expert could have hit upon the directional survey and, by virtue of his expertise, interpreted it to prove the falsity of the representations. Instead they merely relied on the oral and written representations of their lessee, without undergoing what doubtless seemed to them the useless expense of hiring an expert to rake through the Railroad Commission records with an eye towards exposing a potential falsehood.

I believe the Texas Supreme Court has placed an unnecessary and very heavy burden on lessors by its ruling in BP America, one that will result either in much money being spent unnecessarily on prophylactic forensic review of Railroad Commission records or in many viable claims being lost to limitations. As we are, however, bound to follow the Court's rulings, I reluctantly concur in that part of the opinion that finds the Hooks' fraud, fraudulent inducement, and statutory fraud claims barred by limitations as a matter of law.

Amicus briefs supporting Samson Lone Star were filed by the Independent Petroleum Association of America, the Texas Alliance of Energy Producers, and the Texas Oil & Gas Association. Amicus briefs supporting the Hooks' application were filed by the Texas Land & Mineral Owners' Association and by Cardwell, Hart & Bennett, a law firm that regularly represents landowners in oil and gas cases. Links to the briefs of all parties and amici can be found here. The court has not yet set a date for oral argument.

April 28, 2014

$3 Million Verdict for Nuisance in Barnett Shale Case

There's lots of buzz about a recent verdict in a case filed by a landowner in Dallas County alleging injuries from air emissions from drilling and production of Barnett Shale wells in Wise County. The case is Lisa Parr v. Aruba Petroleum, Cause No. 11-01650-E, in the County Court at Law No. 5 of Dallas County. The jury returned a verdict for personal injury and property damages of $2.9 million. According to the petition (Parr - 11th Amended Petition.pdf), Aruba had 22 wells within two miles of the Parrs' 40 acres, including one within 800 feet.

CNN quotes the plaintiff, Lisa Parr, as saying that says she's not opposed to the work oil companies do. She simply wants them to do their business responsibly.

"We are not anti-fracking or anti-drilling. My goodness, we live in Texas. Keep it in the pipes, and if you have a leak or spill, report it and be respectful to your neighbors. If you are going to put this stuff in close proximity to homes, be respectful and careful."

Here is a chart of pending cases related to hydraulic fracturing done last year by Arnold and Porter:  http://www.arnoldporter.com/resources/documents/Hydraulic%20Fracturing%20Case%20Chart.pdf 

April 1, 2014

Allocation Wells

Last Friday I spoke on a panel at the E.E. Smith Advanced Oil and Gas Institute in Houston, discussing allocation wells. The segment was in the form of a debate, actually more like an oral argument. After an introduction of the topic by Bob Goldsmith, Bryan Lauer with Scott Douglas presented the case for the legality of allocation wells, and I presented the case for their illegality. We discussed the precedential value of Browning Oil v. Luecke and Humble Oil v. West and the challenges to allocation wells in the Klotzman proceeding before the Texas Railroad Commission and in Spartan v. EOG, now pending in district court in Harris County.

I can now report that EOG and the Klotzman family have reached a settlement in the Klotzmans' challenge of an allocation well permit on their lands. So the Railroad Commission's authority to issue the Klotzman allocation well permit will not be decided by a District Court in Travis County.

Here is a recent article in the Texas Tech Law Review about allocation wells.

 

March 17, 2014

EOG Sued For Drilling Allocation Wells

I recently have learned of a suit brought by landowners against EOG Resources involving "allocation wells," of which I have written before. The case is Spartan Texas Six Capital Partners, Ltd., Spartan Texas Six-Celina, Ltd., and Dion Menser v. EOG Resources, Inc., Cause No. 2011-27476, in the 11th Judicial District Court of Harris County.  Although the case is in Harris County, it involves wells drilled by EOG in Montague County. The EOG wells are shown on the sketch below; the plaintiffs' tract is in yellow:

 

Spartan v. EOG.JPG

EOG filed pooled unit designations for the Knox, Howard, Howard A, and Wylie A units, even though the plaintiffs' leases did not allow pooling. EOG then calculated the plaintiffs' royalties based on the portion of each well's lateral length located on plaintiffs' tract - allocation based on lateral length. I understand that most companies drilling allocation wells calculate royalties owed on non-pooled tracts on this lateral-length yardstick.

I have reviewed some of the pleadings in the Spartan case, including a motion for partial summary judgment filed by EOG last month. EOG asks the court to rule that "royalties in this case should be based on a reasonable allocation of the total production attributable to the lands covered by the [plaintiffs'] leases," citing Browning Oil Company, Inc. v. Luecke, 38 S.W.3d 625 (Tex.App.-Austin 2000, pet. denied).

Plaintiffs contend that they should be paid royalties based on 100% of production from the wells. Their theory is that, by producing the wells, EOG has commingled production from their land with production from other tracts. Plaintiffs rely on Humble Oil & Ref. Co. v. West, 508 S.W.2d 812, 818 (Tex. 1974), where the Texas Supreme Court said:

[T]he burden is on the one commingling the goods to properly identify the aliquot share of each owner; thus, if goods are so confused as to render the mixture incapable of proper division according to the pre-existing rights of the parties, the loss must fall on the one who occasioned the mixture. ... Stated differently, since Humble is responsible for, and is possessed with peculiar knowledge of the gas injection, it is under the burden of establishing the aliquot shares with reasonable certainty.

Plaintiffs say that it is impossible for EOG to determine "with reasonable certainty" how much of the wells' production is from their tract. EOG argues that Browning v. Luecke supports its use of lateral-length allocation. 

If this case makes it to the appellate courts, it will (as far as I am aware) be the first case since Browning v. Luecke to address what remedies lessors have when their lessee drills a horizontal well across their lease boundary without forming a pooled unit. According to deposition testimony in the Spartan case, these are the first allocation wells actually drilled by EOG, although it has filed allocation well permits before. In fact, the permits for the wells drilled on the Spartan tracts were not filed as allocation well permits.

As in the Klotzman RRC proceeding now on appeal (in which our firm represents the lessors), EOG contends that the drilling of the wells across the Spartan lease did not violate the lease. It does not argue that, by allocating production between the tracts crossed by the wells, it has pooled the tracts. Its view is that the only issue to be resolved is whether its use of the lateral-length allocation method satisfies its obligation to determine what portion of the wells' production comes from the Spartan lease "with reasonable certainty."

March 11, 2014

Chesapeake v. Hyder - Royalty Owner Wins Gas Royalty Dispute

Last week, the Fourth Court of Appeals in San Antonio issued its opinion in Chesapeake v. Hyder.pdf, on gas royalties owed to the Hyder family for production in Johnson and Tarrant Counties, in the Barnett Shale. The court upheld a judgment against Chesapeake for more than a million dollars, including $250,000 in attorneys' fees. The result is not surprising considering the language in the lease, but the case is interesting because it reveals Chesapeake's structure for marketing of gas in the Barnett Shale, obviously designed to reduce its gas royalty obligations.

The principal issue on appeal was whether Chesapeake could reduce the Hyders' royalty by the amount of transportation costs paid by Chesapeake to unrelated pipeline companies. The trial court and court of appeals held that it could not. As I have written before (here, here and here), deductibility of post-production costs is a continuing issue for gas royalty payments in Texas. Prior Supreme Court cases have held that such costs are deductible under most standard gas royalty clauses.

The Hyders' royalty clause was not a standard lessee-form lease. It provided:

Lessee covenants and agrees to pay Lessor the following royalty: ... (b) for natural gas, including casinghead gas and other gaseous substances produced from the Leased Premises and sold or used on or off the Leased Premises, twenty-five percent (25%) of the price actually received by Lessee for such gas. Lessee shall not sell hydrocarbons to entities owned in whole or in part by Lessee or to entities affiliated with Lessee in any way, without the express written consent of Lessors. The royalty reserved herein by Lessors shall be free and clear of all production and post-production costs and expenses, including but not limited to, production, gathering, separating, storing, dehydrating, compressing, transporting, processing, treating, marketing, delivering, or any other costs and expenses incurred between the wellhead and Lessee's point of delivery or sale of such share to a third party. ... In no event shall the volume of gas used to calculate Lessors' royalty be reduced for gas used by Lessee as fuel for lease operations or for compression or dehydration of gas. ... Lessors and Lessee agree that the holding in the case of Heritage Resources, Inc. v. Nationsbank, 939 S.W.2d 118 (Tex. 1996) shall have no application to the terms and provision of this Lease.

Chesapeake has different affiliated companies, each of which has a different role in the process of production, gathering, marketing and sale of its gas. The owner of the lease is Chesapeake Exploration, LLC. Chesapeake Operating, Inc., drills and operates the wells and pays the royalty. Chesapeake Energy Marketing, Inc., buys the gas from Chesapeake Operating (as agent for Chesapeake Exploration). Chesapeake Midstream Partners, LP gathers the gas from the leases and delivers it to pipelines owned and operated by unrelated parties. Those pipelines in turn deliver the gas to purchasers, who pay Chesapeake Energy Marketing, Inc. Confused yet? It gets better.

Chesapeake's royalties are based on a weighted-average sales price for all gas that passes through the gathering system and sold to third parties: total proceeds received divided by total gas sold equals the weighted average sales price, or "WASP". The contract between Chesapeake Operating and Chesapeake Energy Marketing provides that the price paid to Chesapeake Operating is the price received by Marketing for the sale of the gas to third parties, less all costs incurred by Marketing to get the gas to the ultimate purchaser - both the gathering costs charged by Chesapeake Midstream Partners and the pipeline fees charged to transport the gas to the ultimate buyer - plus a "marketing fee" of 3% paid to Marketing. For most royalty owners, Chesapeake pays royalty on this net price, after deducting all post-production costs, including the gathering fees charged by Midstream Partners and the marketing fee charged by Marketing.

But the Hyders' lease prohibited Chesapeake from selling gas to an affiliate without the Hyders' consent, which it never obtained. So Chesapeake agreed that its royalty should be based on its weighted average sales price, without deduction of fees charged by Marketing or Midstream Partners. But Chesapeake claimed that it could deduct the pipeline transportation costs charged by unaffiliated pipelines to transport the gas to the ultimate buyer. This issue became the principal dispute in the case. The trial court and court of appeals agreed that such costs could not be deducted. "Free and clear of all costs" means just what it says, said the courts.

Another interesting issue in the case was whether Chesapeake must pay royalty on gas "lost and unaccounted for." The facts showed that not all gas produced from the Hyder lease was sold:

- some gas was used by Chesapeake as "gas lift" gas, -- that is, reinjected down the wellbore to assist in production from the well.

- some gas was used as fuel for compression and dehydration of gas produced from the lease - "lease-use gas."

- some gas was lost and unaccounted for between the wellhead and the point of delivery to the ultimate purchaser. This gas is lost through leaks in the gathering and transportation system.

Chesapeake agreed that the lease required it to pay royalty on all gas "produced and sold or used ...." It agreed that gas used as fuel for compression and dehydration was gas "used". But Chesapeake argued that it did not have to pay royalty on gas lost and unaccounted for. That gas was neither sold nor used. On this point, the trial court and court of appeals agreed with Chesapeake. "Gas lost or unaccounted for is neither sold nor used." (The parties agreed that no royalty was owed on gas-lift gas.)

The Hyder lease also had a special provision allowing the lessee to locate wells on the leased premises drilled horizontally onto adjacent lands. For such well locations, the lessee agreed to pay to the Hyders a "cost-free" overriding royalty. Chesapeake claimed that it could deduct post-production costs in calculating the Hyders' overriding royalty. The trial court and the court of appeals disagreed; "cost-free" means free of all costs, including post-production costs.

One of the remarkable things about this case is that Chesapeake argued in the trial and on appeal that it should not have to pay royalty on gas lost and unaccounted for because the only "price received" by Chesapeake was the price paid for the sale of the gas to non-affiliated third parties. In fact, Chesapeake obtained a finding from the trial court to that effect. Chesapeake's attorneys showed that the first "buyer" of the gas, Chesapeake Energy Marketing, never received any money from the sale of the gas and never paid any money to Chesapeake Operating, the seller, or Chesapeake Exploration, the owner, even though the gas sales contract for the "first sale" of the gas was between Chesapeake Operating and Chesapeake Energy Marketing. It appears to me that Chesapeake was in effect admitting that its marketing arrangement with its affiliate Chesapeake Marketing was a sham.

Another interesting fact revealed in the Hyders' briefs is that, between 2005 and 2011, Chesapeake changed the way it calculated the Hyders' royalty four times. Initially, it calculated the Hyders' royalty based on the total wellhead volume, using the WASP. Then it began paying only on the volumes sold to unrelated third parties, less third-party transportation costs. Then it stopped deducting transportation costs and paid based on the well-head volume times the WASP. Then it began paying on the volumes sold to third parties, less third-party transportation charges.

It is my experience that Chesapeake does not show any post-production-cost deductions on its check details and refuses to provide that information to royalty owners unless the royalty owner is granted the right to audit its royalties in his/her oil and gas lease--and even then it sometimes refuses. Trying to determine whether a royalty owner is being unlawfully charged post-production costs is very difficult. Trying to collect those charges, even with very good lease language like the Hyders', is expensive and time-consuming, as the Hyders have learned.