Dow Construction, LLC v. BPX Operating Company resolved a bundle of issues arising out of a drilling unit established by the Louisiana Commissioner of Conservation: who has the right to a drilling cost report, the operator’s right to deduct post-production costs, forfeiture of the operator’s right to reimbursement of drilling costs, and prescription.

The facts

BPX is operator of a drilling unit. Dow is a lessee of property within the unit. BPX was deducting PPCs from Dow’s share of production proceeds. Dow sued on several claims, arguing that BPX forfeited the right to demand contribution for drilling costs from Dow as an owner of unleased interests and BPX improperly deducted PPC’s from Dow’s proceeds. BPX responded that Dow’s interest was not an “unleased interest”, and Dow’s claims were time-barred.

The statutory scheme

Each non-operator of a drilling unit is responsible for its share of development and operating costs of unit wells. Upon request, the operator must issue a report containing sworn statements about drilling and operating costs, production volumes, and sales prices. The operator who fails to timely respond forfeits its right to recover costs. BPX was burdened by previous operator Petrohawk’s failure to respond to Dow’s requests for well cost information.

FOUR QUESTIONS

Standing and the “unleased interest”

LA. R.S. 30:10(A)(3) refers to “unleased interests” in establishing who has the right to demand a drilling cost report from the operator. The Court found the statute to be ambiguous; having different meanings depending on the context. Based on Civil Code art. 12 and the context in which the words occur and the text of the law as a whole, the Court read “unleased interests” to be unleased to the as to the operator rather than having no lease whatsoever. Dow had the right under the statute to demand a report and the operator risked forfeiture of the right to recover drilling costs if it failed to comply with the statute.

Negotiorum gestio and deduction of PPCs

Without significant comment the Court vacated and remanded the trial court’s application of the doctrine of negotiorum gestio, which would authorize the operator to deduct PPC’s from non-operators’ proceeds on the basis of Civil Code art. 2292. This was consistent with the Louisiana Supreme Court’s recent opinion in Self v. BPX Operating Company.

PPCs and recovery of costs

Per La. R.S. 30:103.2 the operator’s right to demand contribution for drilling costs from owners of unleased interests is forfeited when it fails deliver the proper reports. The question: What costs are included in drilling operations? The Court followed a Louisiana Third Circuit opinion that under La. R.S. 30:103.1 “drilling operations” refers to the total cost of drilling and completing the unit well and “all other unit costs” allocable to an owner. “All other unit costs” encompasses PPCs. PPCs should be categorized as operational costs and expenses as they form an integral part of the overall business operation.

Prescription

Whether Dow’s claims were governed by one-year or 10-year prescription depended on whether the damages were contractual or delictual. The courts treat causes of action as delictual unless the plaintiff alleges a violation of a specific contractual provision. In an action arising out of the breach of duty imposed by law damages are delictual and are extinguished by the prescription of one year. Dow’s allegation of a breach of the notice provision of 30:103.1 did not arise from a contractual obligation. Thus, the prescriptive period was one year.

Your musical interlude

Co-author Stephen Cooney

In Cactus Water v. COG Operating, the Supreme Court affirmed that mineral lessee COG, not water rights owner Cactus (who derived it rights from the surface owner), has the right to possession, custody, control, and disposition of constituent water in liquid waste – so-called produced water – from its hydrocarbon production.

Homework is recommended.  See these previous posts on the subject.  We will pick up from there.

Texas Supreme Court Will Review Produced Water Case | Energy & the Law

Who Owns Produced Water in Texas? | Energy & the Law

Ownership of produced water depended on the scope of the language employed in the granting clauses of COG’s leases, which specifically named only “oil and gas” or “oil, gas, and other hydrocarbons.”

According to the Court, resolution of the ownership question depended not on uncertainty about the lease language but on what set of established principles governs conveyance of an unnamed substance: produced water. Water is not part of the mineral estate. Unless expressly severed, subsurface water remains part of the surface estate subject to the mineral estate’s implied right to use the surface—including water—as reasonably necessary to produce the minerals. A conveyance of water is not effected by implication. But if an unnamed substance is part and parcel of an oil-and-gas conveyance, there is no need to list it separately because the substance would already be included in what was expressly conveyed regardless of whether their presence or value was known at the time of conveyance.

The Court said that there is no dispute that produced water is, and was at the time of the leases, oil-and-gas waste. That the leases did not mention or define “waste” or “produced water,” was not unexpected. The production of liquid waste is an inevitable and unavoidable byproduct of oil-and-gas operations. Granting the right to produce hydrocarbons necessarily encompasses the right to produce and manage the resulting waste.

The Court rejected Cactus’ reliance on groundwater cases, which do not address waste by-products of oil-and-gas production. The Court observed that while produced water contains molecules of water, both from injected fluid and subsurface formations, the solution itself is waste – which is “a horse of an entirely different color.”

Statutes and regulations treat water and produced water differently and distinctly because they are distinct and different. The Court relied on the same statutes and regulations cited by the lower court to conclude that Texas laws define “oil-and-gas waste” in terms that include produced water.

The Court also rejected Cactus’ argument that COG’s possession of the produced water was usufructuary in nature.  The right to destroy, dispose of, or consume property is generally inconsistent with a usufructuary right. Instead, the right to the capital value of property, including by means of consumption, waste, or destruction, is inherent in property ownership.

Several of the leases explicitly restrict COG’s water usage. From this Cactus posited that the leases are clear that no water produced from the land could have been included in the conveyance. But those express limitations further emphasized to the Court the distinction between water molecules entrained in hydrocarbon production and the common understanding of water.

Remember freedom of contract

Surface-estate owners can take comfort in the Court’s observation that parties are free to make their own contract with respect to incidentally produced liquid-waste if surface owners intend to retain ownership. Here they did not, and courts cannot employ a backward-looking construction of conveyances that is informed by new technologies that were not within the parties’ contemplation at the time of the conveyances.

In a concurring opinion three justices agreed with the result but identified questions the opinion did not resolve. In particular, the ruling does not address unleased minerals and, having held that the leases at issue include groundwater produced with hydrocarbons, the Court does not go on to address the mineral lessee’s obligations to the landowners with respect to this leased groundwater. What does that mean? Litigation over water in Texas is far from over.

Your musical interlude, change Boston to Austin and there you have it.  That one was to easy. How about a dose of optimism.

In Franklin v. Regions Bank the Fifth Circuit concluded that a royalty clause in a mineral lease resulted in a gross proceeds royalty; the royalty owners did not bear their proportionate share of post-production costs. Read on if you want to know how the Court reached this conclusion.

The form lease said,

  • Royalty on gas would be “the market value at the well of one eighth of the gas so sold or used, provided that on gas sold at the wells the royalty shall be one eighth of the amount realized from such sale”.

An addendum (Exhibit “A”) said,

  • “In the event of a conflict between the language as stated in Exhibit A and the language stated hereinabove, the language in Exhibit “A” shall prevail.
  • [W]henever the term one-eighth (1/8) appears in the printed lease form … said term is hereby deleted and the term 25% is inserted and substituted therefore.
  • There shall be no cost charged to the royalty interest created under this lease.  

The ambiguity

The Fifth Circuit deemed the royalty provision to be ambiguous and allowed extrinsic evidence to determine the parties’ intent. The form provided the royalties would be paid on the “market value at the well” but the addendum included inconsistent limiting language: PPC’s would not be charged to the royalty interest.

The parties’ failed by express language in the addendum to alter the royalty calculation from market-value-at-the-well to gross proceeds. That would have fixed it. And the addendum did not make it apparent at what point in the post-extraction process the royalty would be calculated. The meaning of the agreement was fairly susceptible to more than one interpretation and therefore was ambiguous.

The trial court considered conflicting testimony from witnesses, expert and otherwise, and previous lessee Petrohawk’s history of paying royalties without deducting PPC’s. Per La. CC art. 2053, Petrohawk’s course of dealing gave particular meaning to and supplemented or qualified the terms of the agreement.

The Louisiana Rule

The Court discussed Warren v. Chesapeake Exploration, and Heritage v. NationsBank, but those were Texas cases. The Louisiana default rule is that the royalty owner shares responsibility for PPC’s, but the allocation is discretionary between the parties.

According to the Court, Louisiana has identified two methods for determining market value at the well: The method that has meaning here is to reconstruct market value by starting with gross proceeds from the sale of the minerals and deducting costs of taking the minerals to the point of sale. The increase in the sales value attributable to the expenses incurred in transporting and processing the commodity ordinarily must be deducted from the royalty. But here the addendum’s controlling language demanded a different result.

The result

The District Court awarded Franklin $3.4 million in past damages and $954,000 in estimated “future royalty damages”. The Fifth Circuit affirmed the District Court’s ruling that the royalty clauses created gross-proceeds leases and reversed and remanded the rejection of evidence of actual future losses. The evidence was available at trial but ignored, which was reversible error.

There was more

No room here to discuss other issues:

  • A previous suit by Franklin against Matador to rescind a 2007 extension of a 2004 lease and a previous trip to the Fifth Circuit in this case,
  • This suit was against Regions for mishandling the lease extension which caused them to receive 20% royalties on the extended lease instead of 25% under two 2008 Petrohawk leases,
  • Region’s prescription, law-of-the=case, and exculpatory clause defenses (all failed),
  • Calculation of pre-judgment interest,.
  • The Court’s several references to Louisiana Mineral Leases: A Treatise, by Lafayette lawyer Patrick Ottinger.

Your surprising musical interlude … and the (incomparable, sorry Mick) original.

Your Legislature has adjourned after enacting significant bills affecting the energy industry. To sum it up, the industry has friends in high places whenever the Lege is in session (Alternative energy was in jeopardy for a while with regulatory burdens in SB 715 and 819 that would make California proud. My guess: Back in the day the bills’ several cosponsors preferred to picket abortion clinics rather than remain in civics class to absorb the virtues of limited government.)

HB 49 Produced Water

Operators who sell produced water for beneficial use, companies who treat the water, and landowners who pay to treat the water and then sell it will not be liable for personal injury, death, or property damage. The protections do not extend to gross negligence, intentional, wrongful acts of omission, breaking state and federal laws, or failing to meet TCEQ standards. The bill directs the commission to write rules outlining how produced water should be treated and used.

SB 1172 Landman Licensing  

Amends the Occupations Code to eliminate licensing requirements by the Texas Real Estate Commission for land work. The bill is in response to a Texas Attorney General opinion that “a person negotiating a lease for property of a wind power project on behalf of another, for compensation, is required to hold a license issued by the Commission.” The new definition in the Occupations Code includes a nonexhaustive list of energy sectors that would have required licensing.

SB 1150 Plugging Inactive Wells

Requires that a well older than 25 years and that has been inactive for more than 15 years be plugged by the operator.  The Bill allows extensions based on a number of factors, allows for a two-year implementation period and allows the RRC to promulgate a rulemaking by 12/26. There is also a financial hardship exception.

SB 1146 Plugging Orphan Wells

Allows operators in good standing, mineral owners, or surface owners to voluntarily plug or replug orphaned wells without assuming legal liability or operational responsibility for the well. The Bill ensures that such voluntary actions do not imply an obligation to plug the well and protects participants from liability for damages related to the plugging activity. The Bill aims to encourage cleanup of orphaned wells by reducing legal and financial risks for those willing to participate in remediation efforts.

HB 48 Oil Field Theft   

Requires the director of DPS to create an organized oilfield theft prevention unit to enforce laws pertaining to the theft of oil, gas, and related equipment, develop and deploy specialized training, resources, and policing strategies tailored to investigating and preventing organized oilfield theft, among other activities. See also SB 494 and HB 1806

HB 3619 Surface Restoration

Requires the Railroad Commission to restore the surface of land on which it has plugged a well and forbids anyone working under this statute from interfering with the surface owner’s access to the land.

HB 3159 Severance Tax Exemption

Provides a severance tax incentive for hydraulic re-fracturing of inactive oil and gas wells that have been inactive for at least two years prior to re-stimulation. The incentive exempts production from severance tax for up to 36 months or until the exemption equals the lesser of actual re-fracturing costs or $750,000.

SB 1759 Limitation of Liability in Emergencies

Authorizes the Railroad Commission to declare an oil or gas emergency in response to incidents such as uncontrolled releases from wells. Anyone providing assistance, advice, or resources during an emergency at the request of a government agency will be immune from civil liability, except in cases of gross negligence, recklessness, or intentional misconduct.

HB 14 Nuclear Energy

Establishes within the governor’s office the Texas Advanced Nuclear Energy Office. The Bill will provide strategic leadership, coordination and support for the development of advanced nuclear reactor technologies. The Bill also creates the Texas Advanced Nuclear Development Fund and Grant Program and establishes a Nuclear Permitting Coordinator and an Advanced Nuclear Energy Workforce Development Program.

Your musical interlude

The takeaway from DDR Weinert, Limited et al v. Ovintiv USA Inc. is that equitable recoupment rescued a royalty payor from its mistaken payment of royalties. But first,

The events.

The Richters were mineral lessors in land in Karnes County. In 2016 lessee Ovintiv mistakenly adjusted gas flow on the property resulting in overpayment to some royalty owners and underpayment to others. Ovintiv did not catch the error until 2018. Meanwhile, in 2017 in their estate planning the Richters conveyed their minerals to plaintiffs Weinert and Williams. Ovintiv prepared division orders and plaintiffs became the successor lessors under the oil and gas lease on the property. Before catching the error Ovintive mistakenly overpaid the Richters $608,000 in royalties. Upon discovering the overpayment Ovintiv notified Weinert and Williams that it would make a prior period adjustment and then deducted Richters’ overpayments from Weinert’s and Williams’ royalty payments.

Plaintiffs sued for breach of contract, violations of the Texas Natural Resources Code and conversion. Ovintiv claimed that it was entitled to recover its overpayment to the Richters from Weinert and Williams. The federal court granted summary judgment for Ovintiv. The Fifth Circuit affirmed.

Equitable recoupment saves the day

The court identified two general requirements for equitable recoupment: (1) some type of overpayment must have been made, and (2) both the creditor’s claim and the amount owed to the debtor must arise from a single transaction. The plaintiffs conceded that recoupment is a valid, commonly accepted remedy in the oil and gas industry. The question was whether each month’s royalty obligation was part of the same transaction. The court deternined that each payment obligation under the same oil and gas lease was part of a single transaction for the purpose of recoupment.

The court discussed Gavenda v. Strata Energy, which concerned the applicability of the default rule that division and transfer orders bind underpaid royalty owners until revoked. Under that rule, division and transfer orders would have been binding during the entire period of underpayment, estopping the underpaid royalty owner’s claim against the operator. In Gavenda the operator kept some of the underpaid royalties and thus profited at the underpaid royalty owner’s expense. Gavenda did not help the plaintiffs in this case.

Equitable recoupment barred the plaintiff’s claim here. But for the doctrine, Ovintiv would have to pay the amount of overpayment twice, once to the overpaid Richters and again to the underpaid plaintiffs. Here Ovintiv did not profit by underpaying the plaintiffs.

A wrinkle that informed the result?

The court noted that it “cannot ignore” that the overpaid Richters control the underpaid plaintiffs. Both the plaintiffs and the Richters would be unjustly enriched if plaintiffs prevailed. What would be “equitable” about such an outcome? Plaintiffs still have a remedy. They have the right to pursue reimbursement from the Richters, the only parties that were unjustly enriched.

RIP Sylvester Stone

RIP Brian Wilson

Two brilliant and troubled individuals.

Co-author Gunner West

In American Midstream (Alabama Intrastate), LLC v. Rainbow Energy Marketing Corporation, the Texas Supreme Court held that the trial court improperly inserted the words “scheduled” and “physical” into a contract. By blue‐penciling these terms, the trial court improperly altered the plain text of the contract. This opinion was issued on the same day as Cromwell v. Anadarko, leaving no doubt about the Court’s approach to contract interpretation.

The contract

AMID owns the Magnolia pipeline, linked to the Transco pipeline. Producer Rainbow contracted under “MAG‑0001”, a “firm” transportation agreement requiring AMID to accept Rainbow’s gas nominations (unlike “interruptible”, where the pipeline may refuse nominations). When Rainbow nominated equal volumes in and out of Magnolia, AMID scheduled the same amount into Transco, which Rainbow then withdrew to sell to a downstream customer.

A “single‐point imbalance” occurs if scheduled volumes into Transco don’t match physical flow at the interconnect. Under an Operational Balancing Agreement, AMID could carry daily imbalances (treated as received) that do not exceed 5 percent of nominations or cause operational concerns, at which point Transco could issue an Operational Flow Order (OFO) forcing AMID to limit the imbalance.

Balancing Arbitrage in MAG‑0005

Seeking to leverage AMID’s balancing flexibility, Rainbow negotiated MAG‑0005, a 20,000 MMBtu/day “Firm Gas Transportation Agreement” whose practical purpose was for AMID to provide Rainbow with balancing services.

Section 9.1 states: “[Rainbow] shall not be obligated to balance receipts and deliveries of gas on a daily basis unless, on or for any Day, either [AMID] or [Rainbow] is requested or required by an upstream or downstream party [e.g., Transco] to balance receipts and deliveries of gas attributable to [Rainbow].

Thus, Rainbow could create “point‐to‐point imbalances” with monthly settlement. Rainbow viewed this agreement as an insurance policy for forward‐sales contracts: By paying a daily demand rate it could withdraw gas during price spikes and replace gas later when prices fell.

Trial Court

AMID limited Rainbow’s imbalanced nominations on specific days, citing Transco OFOs and operational concerns. Rainbow sued for breach, repudiation, and tort claims, seeking lost profits for disrupted trading.

The trial court read “scheduled” into Section 9.1, excusing AMID from providing balancing services only if Transco instructed to balance “scheduled” quantities with “physical” deliveries. This excluded physical‐only imbalances. The court found that AMID breached MAG-0005 on seven identified days (and on several unspecified occasions) and repudiated the “firm” nature of the contract by describing it as “interruptible” on a conference call between the parties. The trial court awarded Rainbow $6.1 million; the court of appeals affirmed.

Supreme Court

The Court focused on one textual question: Did Section 9.1 excuse AMID’s balancing obligation on any day Transco issued an OFO, regardless of naming or imbalance type?

Under MAG-0005 there could be point-to-point imbalances of two types: either “scheduled” or “physical”. But 9.1 makes no such distinction. Nowhere in the text of 9.1 do those words appear. By improperly inserting two words the trial court narrowed AMID’s excuse for nonperformance to only scheduled point-to-point imbalances.

Properly read, 9.1 allows AMID to refuse balancing whenever Transco requires either party to limit any Rainbow imbalance—scheduled or physical. As all but one contested day coincided with an OFO, the $6.1 million judgment could not stand. The Court remanded to decide liability and damages for the single non‐OFO day.

Reversing contract interpretation also wiped out Rainbow’s ancillary claims. Because 9.1 permitted refusals during an OFO, AMID’s remark that MAG‑0005 was “interruptible” simply asserted a contractual right, not repudiation. The repudiation claim failed. For the same reason Rainbow’s fraud‑based tort claims collapsed.

Lastly, the Court offered guidance on the proper measure of lost-profits damages: Speculative futures‐trading profits are not recoverable without a concrete usage history and reliable market data.

Your traveling interludes:

Going

Leaving.

On the highway.

In Cromwell v. Anadarko E & P Onshore LLC the Supreme Court of Texas did what it so often does: In order to provide “legal certainty and predictability”, the Court considered the plain language of a contract in order to arrive at the parties’ intent.

At issue were habendum clauses in two oil and gas leases written in the passive voice; that is, the clauses did not specify who has to do the producing in order to perpetuate the lease beyond its primary term.  The Court reversed a court of appeals ruling that it had to be lessee, Cromwell himself, to cause production in order to keep the leases alive.

The facts

After Anadarko drilled three wells on a tract, Cromwell obtained two leases on the same tract. Under the habendum clause, the Ferrer lease would be in effect for three years “and as long thereafter as oil, gas or other minerals are produced from said land, or land with which said land is pooled hereunder, … .”

The Tantalo lease was for a primary term of five years “and as long thereafter as oil, gas liquid hydrocarbons or their constituent products or any of them is produced in commercial paying quantities from the land … .”

The Court identified Cromwell’s repeated efforts to participate in operations, all of which were rebuffed by Anadarko. But, among other actions, Anadarko sent him an AFE and monthly JIBs and after the first well paid out referred to him as a working interest owner. Anadarko asserted that all of this was a mistake (Given the size and complexity of large organizations, that is not difficult to imagine).

Anadarko produced oil and gas at all relevant times. After the primary terms of the two leases ended Anadarko asserted that the leases terminated because Cromwell himself failed to obtain production. Anadarko did not tell Cromwell his leases had expired and continued sending JIBs. Anadarko then acquired top leases.

The result

The plain language of the habendum clauses does not specify who must produce to maintain the leases beyond the primary term. The clauses could have said the leases continue as long as oil or gas is produced by the lessee, but the leases were not written that way. The Court refused to write in a term specifying which party must do the producing.

The Court did not accept the court of appeals’ reasoning that the leases’ stated purpose was drilling and declined to ensure that every provision in a contract comports with some grander theme or purpose, particularly when the parties have not said which purpose matters most, and that everything in the contract should be subject to that purpose.

Paragraph 16 of the Tantalo lease would be extended beyond the primary term “if Lessee has completed a well as a producer  … .” That clause was expressly subject to other paragraphs having passive voice language. The Court found Paragraph 16 to be ambiguous and therefore governed by the default rule against forfeiture of mineral interests. Texas courts decline to impose a special limitation on a grant unless the language is so clear, precise and unequivocal that it can be given no other meaning. Neither habendum clause met that standard, so the Court declined to imply such a requirement to cause forfeiture of Cromwell’s interest.

In reversing the court of appeals, the Court disapproved of a line of cases to the extent that they hold otherwise: Mattison v. Trotti, Hughes v. Cantwell, and Cimarex Energy Co. v. Anadarko Petroleum Corp.

A query – not an opinion

We’re into extra innings here, but there are some who will question whether this is the correct result or the best result for the industry. The Ferrer lease was “for the purpose of exploring by geological, geophysical and all other methods, and of drilling, producing and operating wells for the recovery of oil, gas and other hydrocarbons … .” The Tantalo lease was “for the sole and only purpose of exploring, drilling, operating power stations, and construction of roads and structures thereon to produce, save, care for, treat and transport oil, gas and liquid hydrocarbons … .”

The Supreme Court faulted the court of appeals for “unduly focusing” on the purpose of the leases set forth in the granting clauses, and cited the 1923 case of Texas Co. v. Davis for the proposition that the “vital consideration” in an oil-and-gas lease is royalties on mineral production. That wasn’t what the parties here agreed to.  

The doubters might also be concerned that the opinion will embolden free-riders who will seek to benefit from operations without sharing in the drilling risk.

Musical interludes; everybody loves to sing about Memphis

JJ Cale

Chuck Berry

Lyle Lovett

John Hiatt

Co-author Gunner West

In Williams O & G Resources, LLC v. Diamondback Energy, Inc., a federal magistrate judge concluded that the Texas Relinquishment Act does not apply to public-school lands patented after 1931. The report and recommendation was adopted by the district court.

The facts

Williams’ predecessor-in-interest acquired a tract of public land from the State of Texas in 1948 reserving a 1/16th royalty to the State. Diamondback ultimately acquired rights to the Bone Springs annd wolf camp formations under a 1957 lease. In 2017 the parties entered into a Surface Use Agreement covering various operational matters, including water purchases for hydraulic fracturing.

Williams sued Diamondback alleging duties to drill offset wells or pay compensatory damages under the Texas Relinquishment Act, breach of the implied covenant to manage and administer the lease, and breach of the SUA’s water provisions.

Relinquishment Act or Land Sales Act?

The Relinquishment Act of 1919 applies to permanent school fund lands sold by the State and reserves to the State 1/16th of the minerals (other than sulfur) designating the landowner as the State’s leasing agent for minerals. The Act and compelled operators to drill offset wells (or pay compensatory royalties) when a well on a neighboring tract is drilled within 1,000 feet.

Sales under the Land Sales Act of 1931 conveyed 15/16ths of the minerals to patentees and left the State 1/16th of the minerals.

Tracing legislative history (see pp 3-6), the court concluded that post‑1931 land conveyances are governed by the Land Sales Act, not the Relinquishment Act. Because the tract was patented in 1948, Diamondback was not subject to any duty under the Relinquishment Act. The court dismissed both the offset-well and compensatory-royalty counts.

Pooling allegations run dry

Williams claimed Diamondback breached an implied covenant to pool. Texas law’s implied covenants to develop, protect against drainage, and manage leases as a reasonably prudent operator arise only where necessary to effectuate the lease and never override express terms. A lessee has no power to pool absent express authority. The Williams Lease permits pooling for gas but is silent on pooling for oil. Moreover, Williams offered no evidence of actual drainage and supplied no information about either the costs of pooling or the profits that such pooling might reasonably yield. The court declined to graft an implied covenant onto a lease that already addresses the subject and found Williams’ pleadings deficient on drainage facts. The pooling claim was dismissed.

Water clause: “and/or” and other ambiguities

Finally, Williams asserted Diamondback violated the SUA by purchasing frac-water from off-lease sources even though surface water was available on the premises.

The SUA obligates Diamondback to buy from Williams all water for wells on the leased premises “and/or other lands” when Lessor can supply it and relieves Lessee only if Lessor lacks sufficient water and expressly excludes water for wells “drilled from the Drillsite Location to other lands.”

The court flagged several ambiguities in the SUA. For example,

  • “other lands” could refer narrowly to tracts horizontally drilled from the leased premises or broadly to any property.
  •  “and/or” introduced two possible interpretations (Courts have long noted that the term “and/or” can be ambiguous. Think it through before using it).
  • There was an apparent contradiction between the first and last sentence of a provision that required extraneous evidence of the parties’ intent.

The magistrate judge recommended denying Diamondback’s motion to dismiss that claim. The district court approved.

A musical interlude for your Memorial Day.

In Myers-Woodward, LLC v. Underground Services Markham, LLC et al, (discussed previously) the parties disagreed on how to calculate Myers’ royalty on salt produced by Underground.  

The facts

The 1947 mineral deed reserved to Myers “a perpetual one eighth (1/8th) royalty on all oil that may be produced and saved from” the property “the same to be delivered at the wells or to the credit of Grantor into pipe line to which the wells may be connected.” The parties later executed a correction deed providing that the royalty would be “1/8th of all of the gas and other minerals … .”

The contentions

Myers’ contention: The language reserved an in-kind royalty under which Myers is entitled either to physical possession of 1/8th of the salt produced from the land or to 1/18h of the net proceeds from the sale of that very salt.

Underground’s contention: The royalty entitles Myers not to 1/8th of the net proceeds from the sale of any particular salt but instead to 1/8th of the market value of the amount of salt produced from the land.

Myers conceded that it is entitled to a share of net proceeds, which means it must bear its proportional share of postproduction costs incurred to make the salt marketable.

Underground calculated that 1/8th of the market value was roughly $260,000. Myers calculated that value to be over $2 million. The court acknowledged the economic reality that a mineral’s market value and the price paid for it in a given transaction can diverge, but there is generally some connection between the two measures such that one can often yield a useful approximation of the other, referring to the “workback method” to estimate wellhead market value for gas cited in Bluestone Natural Resources v. Randle.

The result

The parties gave the court no Texas case confirming this precise question in the context of a similarly worded conveyance. The court said it was not necessary to develop new generally applicable rules to resolve the dispute. The court saw its job as to ascertain the parties’ intentions as expressed in the words of the document.

Myers’ salt royalty was payable in-kind. The language indicated that Myers has an ownership interest in and to a portion of the actual, physical salt removed from the property. There was no “delivery” language in the correction deed to signal an in-kind royalty. But the oil royalty was, “to be delivered at the wells to the credit of Grantor … “. (emphasis added) The parties agreed that the original royalty language reserved an in-kind oil royalty because of the delivery language.

The correction deed contained neither delivery language nor express mention of an in-kind royalty. But the entire correction deed in its context indicated that the parties intended to create identical royalties for all three categories (oil, gas and other minerals) and executed the correction because they had inadvertently neglected to include gas and other minerals in the in-kind oil royalty created by the original deed. The oil royalty was clearly in-kind. The correction deed added gas and other minerals in the pre-existing in-kind oil royalty.

The case was remanded to the trial court to sort out the damages.

Your musical interlude.

In a word, the surface estate owner. If that’s all the learning you are up for today, proceed directly to the musical interludes. If you want to know why the Supreme Court of Texas had to say this again, read on.

In a 1947 mineral deed Myers retained the surface estate in a 160-acre tract. The grantee received “]an] 8/8ths interest in the said oil, gas and other rminerals … ” in the property. Underground Services later acquired “… all of the salt and salt formations … “ from the mineral owner.

In Myers-Woodward, LLC v. Underground Services Markham, LLC et al, the court addressed claims to the right to store oil in large, empty caverns within a salt-rock formation. Citing its holdings in Humble Oil & Refining v. West and Lightning Oil Company v. Anadarko the court concluded that Underground does not own the subsurface caverns remaining after salt production and has no right to use them for purposes not specified in its deed.

Citing Lightning, the court observed that the mineral estate generally includes the right to possess the minerals but does not include the right to possess the specific place or space where the minerals are located.

In Coastal Oil & Gas Corp. v. Garza Energy Trust the court reasoned that the mineral owner’s right does not extend to specific oil and gas beneath the property. The right is not to the molecules actually residing below the surface but to a fair chance to recover the oil and gas in or under the tract. Ownership must be considered in connection with the rule of capture, which is also a property right.

Underground sought to confine these precedents to only migratory minerals like oil and gas, contending that a different rule must apply to solid minerals like salt, which do not migrate and are not subject to the rule of capture. From this, Underground asserted unqualified ownership and control of the molecules actually residing below the surface, which should apply to solid minerals such as salt and, more specifically, ownership of the salt formations themselves.

The court assumed that Underground correctly asserted unqualified title to the molecules of salt underground rather than simply the right to a fair chance to recover them. However, Underground does not own the salt formations; all it owns is the salt. The deed to Underground referred to “salt formations” from which it argued that it owns the other geologic features, including voids contained within the salt formations. But its predecessor did not own the salt formations. A grantor cannot convey a greater or better title than he holds. The predecessor was conveyed the minerals, which includes the salt itself but not the salt formation.

The court declined to make one rule for underground storage space encased in salt or other mineral formations and another rule for underground storage space can say stop encased in nodding mineral rock formations.

Underground argued its right to use that part of the surface estate as an owner of the dominant mineral estate. A mineral owner’s right to use as much of the surface and subsurface as is reasonably necessary to recover applies only to his minerals. Storage of hydrocarbons produced off the property is not related in this case to Underground Services’ production of salt on the property.

The court explicitly overruled Mapco Inc. v. Carter, a 1991 court of appeals opinion holding that the mineral estate owner retains a property interest in the underground storage cavern created by salt mining.  Mapco probably presented the last avenue available to the mineral owner to claim dominion over the pore space.

More than once, the opinion qualified its ruling by “unless the parties agree otherwise” language. This signals that pore space can be severed from the surface along with the mineral estate if an instrument is worded the right way, including, one woujld assume, instruments executed in the past and those in the future.

Myers also reserved a 1/8th royalty, the calculation of which we will address next time.

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