Co-author Chance Decker
In Murphy Exploration & Production Co. — USA v. Adams the Texas Supreme Court held that an offset well clause in an oil and gas lease did not require the lessee to drill wells calculated to protect against drainage. Four dissenting justices believed the majority disregarded the well-established meaning of “offset well” used in the oilfield for decades.
Murphy’s two oil and gas leases with the Herbsts had identical offset well clauses:
… in the event a well is completed as a producer … on land adjacent to and contiguous to the leased premises, and within 467 feet of the premises covered by this lease, that Lessee … is obligated to . . . commence drilling operations on the leased acreage and thereafter continue the drilling of such off-set well or wells with due diligence to a depth adequate to test the same formation … . (emphasis ours)
When a well on a neighboring tract triggered the clause, Murphy drilled a well on the Herbsts’ tract 2,100 feet from the triggering well. Everyone agreed this well would not prevent drainage. The Herbsts argued the well did not satisfy the clause because it was not designed to protect against drainage.
Murphy responded that the well satisfied the clause because all the clause required was that the well be drilled on the leased premises to the same depth as the triggering well. That an offset well must actually protect against drainage or even be calculated to do so has no place in horizontal drilling in tight shale formations where drainage is minimal.
The clause did not require Murphy to drill a well to protect against drainage. Murphy’s well satisfied the clause.
The opinion was based on two premises. First, the leases provided their own definition of “offset well”: Murphy had to drill a well:
- on the Herbsts’ tract,
- with due diligence,
- to the same depth as the triggering well, and
- drilling “such offset well” would satisfy the Clause.
“Such offset well” did not require proximity or actual protection from drainage, and the Court would not impose those terms.
Second, as it was entitled to do, to inform its interpretation the Court considered the “surrounding circumstances” under which the leases were negotiated and executed. The Court concluded that the leases were drafted with horizontal drilling in mind. Expert testimony was that drainage is almost non-existent from horizontal wells in tight-shale formations like the Eagle Ford. Thus, it would be “illogical” for an offset well clause to require a well – even an “offset well” – to even attempt to protect against non-existent drainage.
According to the dissenters the commonly understood definition of “offset well” required Murphy to drill its offset at a location where a reasonably prudent operator would drill to protect the leasehold from actual or potential drainage, regardless of whether drainage was actually occurring. The majority opinion effectively read “offset” out of the leases.
The dissent also challenged the majority’s conclusion that the Herbsts negotiated the leases with horizontal drilling in mind. They just wanted production, and the majority ignored other, non-shale formations.
Where will the Court go from here?
The Court purported to limit its holding to these facts, but the opinion could have far-reaching consequences. Wells drilled in the most active plays in Texas today are by and large horizontal, tight-shale wells. The opinion indicates the historical understanding of an “offset well” is antiquated in this context. How can operators protect against drainage that doesn’t exist? Does the Supreme Court believe they can’t and don’t have to even try?
We will soon have more on this topic in a lengthier client advisory.
Lessors who can’t get a break from the court, listen to a therapeutic car song for today’s musical interlude.