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Last Friday the Texas Supreme Court issued opinions in XOG Operating, LLC v. Chesapeake Exploration Limited Partnership et al., No. 15-0935, and Endeavor Energy Resources, L.P. et al. v. Discovery Operating, Inc. et al., No. 16-0155.  In both cases, the Court affirmed the decisions of the trial courts and courts of appeals.  Both cases garnered substantial attention from the industry, as evidenced by amicus briefs from the Permian Basin Petroleum Association, the Texas Independent Producers and Royalty Owners’ Association, the Railroad Commission and the Texas Oil and Gas Association, among others.

Both cases construe retained acreage clauses. The opinion in Endeavor includes a good explanation of the purpose and effect of retained acreage clauses, the purpose and operation of field rules and proration units, and the interplay between the two. I summarized the facts and results in both of these cases when the Supreme Court granted the petitions for review. My prior post can be viewed here.   I have also previously written about the relationship between field rules and retained acreage clauses. I’ve said that it is a mistake to rely on field rules and proration units to determine how much acreage can be retained under a retained acreage clause; these cases illustrate why that is so.

One comment on Endeavor:  the field rules applicable in that case were for the Spraberry (Trend Area) Field. Those rules provide for “standard” proration units of 80 acres but allow the operator to assign up to 160 acres to a well, with a corresponding increase in its allowable rate of production. The allowable rate for a well on an 80-acre proration unit is 515 barrels per day.  The retained acreage clause provided that the lease would expire except for the “proration unit assigned to a well,” and that each proration unit would “contain the number of acres required to comply with” Railroad Commission rules “for obtaining the maximum allowable.” Endeavor assigned 80 acres to each of four wells, and Discovery said the lease expired except as to those four proration units “assigned” to the wells. Endeavor argued that it was entitled to 160 acres per well because that amount of acreage was necessary “for obtaining the maximum allowable.”  The Supreme Court agreed with Discovery.  In discussing Endeavor’s argument on the “maximum allowable” language, the Court quotes from two CLE papers: Continue reading →

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On April 2, the Superior Court of Pennsylvania issued its opinion in Briggs v. Southwestern Energy Production Co., 2018 PA Super 79, No. 1351 MDA 2017.  It held that “hydraulic fracturing may constitute an actionable trespass where subsurface fractures, fracturing fluid and proppant cross boundary lines and extend into the subsurface estate of an adjoining property for which the operator does not have a mineral lease, resulting in the extraction of natural gas from beneath the adjoining landowner’s property.” In doing so, the court rejected the reasoning of the Texas Supreme Court in Coastal Oil & Gas Corp. v. Garza Energy Trust, 268 S.W.3d 1 (Tex. 2008), which held that the rule of capture prevented any such cause of action.  The court agreed with the conclusion of a federal district court in West Virginia in Stone v. Chesapeake Appalachia, LLC, No. 5:12-CV-102, 2013 WL 2097397 (N.D.W.Va. Apr. 10, 2013), which held that hydraulic fracturing can give rise to a trespass claim. The court also agreed with Justice Johnson’s dissent in Coastal v. Garza, in which he said that he “would not apply the rule [of capture] to a situation  … in which a party effectively enters another’s lease without consent, drains minerals by means of an artificially created channel or device, and then ‘captures’ the minerals on the trespasser’s lease.”

The court concluded:

… we are persuaded by the analysis in the Coastal Oil dissent and Stone, and conclude that hydraulic fracturing is distinguishable from conventional methods of oil and gas extraction. Traditionally, the rule of capture assumes that oil and gas originate in subsurface reservoirs or pools, and can migrate freely within the reservoir and across property lines, according to changes in pressure. … Unlike oil and gas originating in a common reservoir, natural gs, when trapped in a shale formation, is non-migratory in nature. … Shale gas does not merely “escape” to adjoining land absent the application of an external force.  …

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The Texas Supreme Court recently decided JPMorgan Chase Bank v. Orca Assets GP, LLC, No. 15-0712, an interesting exposition on the value and risks of including no-warranty language in an oil and gas lease.

JPMorgan was trustee of the Red Crest Trust, which owns about 40,000 acres of minerals in the Eagle Ford Shale. In 2010, JPMorgan leased about 1,800 of those acres to GeoSouthern Energy. Later that year, JPMorgan was approached by another company, Orca Assets GP, to lease some of the same land.  JPMorgan’s trust offer erroneously concluded that the acreage Orca wanted had not been previously leased to GeoSouthern, and he negotiated a deal to lease to Orca.  But he put the following provision in the proposed leases to Orca:

Negation of Warranty.  This lease is made without warranties of any kind, either express or implied, and without recourse against Lessor in the event of a failure of title, not even for the return of the bonus consideration paid for the granting of the lease or for any rental, royalty, shut-in payment, or any other payment now or hereafter made by Lessee to Lessor under the terms of this lease.

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Last week the Texas Supreme Court issued its opinion in ConocoPhillips Co. v. Koopmann, No. 16-0662. Its opinion rejected Burlington’s argument based on the Rule Against Perpetuities.

Strieber sold 120 acres in Dewitt County to Koopmann, reserving one-half of the royalty for a term of 15 years and as long thereafter as there is production in paying quantities.  The 15-year term ended on December 27, 2011.  At that time the 120 acres was under lease to Burlington. Burlington included the 120 acres in a pooled unit and drilled a well in 2011, but the well was not producing on December 27. Prior to that time, Strieber conveyed to Burlington 60% of her reserved term royalty, “presumably as an incentive to motivate Burlington to begin drilling.”  The parties – Koopmann on one side, contending the term royalty had expired, and Strieber and Burlington, on the other, contending it had not — then joined suit.

Burlington and Strieber contended that the interest the Koopmanns claimed – the one-half-of-the-royalty that would be owned by her on expiration of the 15-year term – was void because it violates the Rule Against Perpetuities.  In effect, they argued that the royalty reserved by Strieber should remain in effect indefinitely because of the Rule.  The court disagreed, holding that the future interest conveyed to Koopmann was “vested” and therefore did not violate the Rule.  After a detailed discussion of the Rule and its application, the court followed more modern scholarship that construes the Rule based on its purpose and intent rather than by archaic application of terms and concluded that application of the Rule in this instance would not serve the Rule’s purposes.

Oil and gas attorneys will be greatly relieved at this result, since it is and for many years has been common for grantors to reserve term royalties in conveyances of their land. The rule advocated by Burlington would have made all such royalty reservations perpetual. Continue reading →

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Although this has nothing to do with oil and gas, I’d like to share a great story about one of my partners, Doug Kilday. Doug is one of Graves Dougherty’s senior litigators. He and his family are also active members of Covenant Presbyterian Church in Austin. In 2017, the Kildays decided to combine their professional skills and their call to service and ministry by spending a year in Cambodia. Kilday-family-1

Doug and his wife Thais worked for International Justice Mission (IJM) (https://www.ijm.org/), the largest international anti-slavery organization in the world, working to end all forms of human trafficking, which currently victimizes more than 40 million people across the globe. IJM works to rescue victims, restrain and prosecute criminals, and restore survivors.  The Kildays worked in IJM’s Phnom Penh office with local IJM employees. Doug’s job was to assist in prosecuting cases against traffickers in slave labor. Thais created systems to help the office manage their many cases. During their year in Phnom Phen Doug and the team conducted IJM’s first labor trafficking trial in Cambodia. Over the course of the year Doug helped conduct eight trials resulting in eighteen convictions. Doug: “There are more people in slavery today than at any other time in history. It is a 150 billion-dollar per year industry.”

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Doug and Thais’ three children, Naeda (15), Lincoln (12) and David (9), attended Hope International School, which welcomed kids from thirty countries.

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Our firm filed suit last week to challenge Devon Energy Production Company’s permit for an “allocation well” in Ward County. Monroe Properties, Inc., et al. v. Railroad Commission of Texas, Cause No. D-1-GN-18-001111, 53rd District Court, Travis County. A copy of the petition may be viewed here. Monroe v. RRC

Devon’s proposed well is called the NI Helped 120 6H Well.  (The odd name comes from an old TV commercial in which the line “‘n I helped!” appears.) The permit and plats for the well can be viewed here.  N I Helped 120 6H Permit and Plat

Our firm filed a similar suit a few years ago on behalf of the Klotzman family challenging an allocation well permitted by EOG. EOG and the Klotzmans settled their dispute shortly after they appealed the RRC’s grant of EOG’s permit.  For my discussions of the Klotzman case, search for “Klotzman” in this site’s search engine.

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An article in the Harvard Business Review, Oil’s Boom-and-Bust Cycle May Be Over. Here’s Why, provides an excellent overview of how the global oil market has been changed fundamentally by development of shale oil resources.  Excerpts:

  • U.S. shale producers “now represent half of U.S. oil production, up from a mere 10% just seven years ago in 2011. In fact, 2018 may mark the first year shale producers will be able to fund future expansions of drilling programs through their own cash flow.”
  • ” Oil companies will need to develop both new conventional and unconventional crude oil resources to keep up with current demand for roughly one million more barrels of oil every year in addition to replacing the approximately four million barrels lost annually as reservoirs are naturally depleted. In total, we estimate that the oil and gas industry will have to replace about 40% of today’s oil production over the next seven to nine years.”
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Lawyers for royalty owners have filed multiple suits against Chesapeake Energy in Dimmit County seeking damages for breach of Chesapeake’s leases. These cases were consolidated for discovery and case-management purposes into a single matter, In re: Chesapeake Eagle Ford Royalty Litigation, Cause No. 2016CI22098, in the 224th District Court in San Antonio.

TexasBarToday_TopTen_Badge_SmallIn addition to claims for underpayment of royalties, the plaintiffs in the Dimmit County cases allege that Chesapeake has breached clauses in the leases requiring the lessee to protect the lease against drainage from adjacent wells – sometimes called an express offset clause. Chesapeake has filed a motion for summary judgment arguing that these clauses are unenforceable because they impose a “penalty.”

One of the implied covenants in all oil and gas leases is the covenant to protect the lease against drainage from wells on adjacent tracts. The implied covenant requires the lessee to drill an “offset well” to the draining well if a reasonable and prudent operator would do so. Damages for breach of the implied covenant are the value of the royalty lost to the lessor, based on the amount of drainage that would have been prevented by the drilling of the offset well. Liability and damages for breach of the implied covenant are difficult to prove, so lessors have come up with an alternative – the express offset clause.

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A client recently asked me whether he should sign a production sharing agreement. I replied that this is not an easy question to answer.TexasBarToday_TopTen_Badge_Small

First, the nomenclature.  These terms are not defined anywhere and their usage is not always consistent, but here’s what I mean when I use these terms:

Allocation Well. A horizontal well drilled across two or more lease lines without creating a pooled unit including the leases. Because no provision of the leases dictates how production will be shared among the leases, production must be “allocated” among the leases.

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Contact Information
John McFarland
 Graves, Dougherty, Hearon & Moody, P.C.
401 Congress Avenue, Suite 2200
Austin, Texas 78701
Phone: 512-480-5618
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