offset well obligation

Co-author Chance Decker

The Texas Supreme Court recently heard oral argument in three intriguing oil and gas cases.  Here’s what you need to know about two of them (We’ll address the third case soon).

Adams v. Murphy Exploration & Production Co. USA

Did lessee Murphy comply with an offset-well clause that doesn’t state where the offset-well must be drilled?  When a well was drilled on an adjacent tract, Murphy drilled its offset-well more than 2,000 feet from the triggering well. Continue Reading Opinions to Expect From the Texas Supreme Court

pleadingCo-author Sandra L. Mazan

It s been said that if you don’t ask for what you want you’ll get what you deserve.  Mr. Hooks took that truism to heart.

Hooks v. Samson is about more than the discovery rule (See last week). Here are the other claims at issue:

Most Favored Nations Clause

In royalty suits the court must rely on the language of the agreement at issue. Nevertheless, general principles of oil and gas law inform the court’s decision.

The “most-favored nations” clauses required Samson, if it paid higher royalties on nearby leases, to pay matching royalties to Hooks. Hooks alleged that Samson paid a higher effective royalty rate to the state of Texas. Samson responded that the higher effective rate was not the result of a higher royalty, but rather was the result of increasing the State’s “unit royalty interest” in order to induce the State to agree to a pooling agreement.

The court applied the “primary legal consequence” of pooling to resolve the issue: Production anywhere on a pooled unit is treated as production on every tract in the unit. The court reached way back to Montgomery v. Rittersbacher:

Pooling “effects a cross conveyance among the owners of minerals under the various tracts of royalty or minerals in a pool so that they all own undivided interests under the unitized tract in the proportion by contribution bears to the unitized tract”.

Royalty owed on production from the whole unit is necessarily tied to the royalty owed on production from the lessor’s tract. To increase one is increase the other.

Samson’s increase of the State’s royalty on unit production meant that the State’s 25% lease royalty was really 28.28896%.

Score a run for Hooks. (Humor me. Spring training is on.)

Formation-Production Clause

Each lease said:

“For the purposes of calculating all royalties payable under Article III herein, it is expressly provided that all such calculations shall be based on formation production as reported on Texas Railroad Commission Forms P-1 and P-2.”

The issue was gas that left the reservoir as gas and produced at the surface as condensate. When reporting the total volume removed from the reservoir, Samson would convert the volume of condensate at the surface to its equivalent volume as a gas. Samson paid royalties on proceeds from sales rather than on total amount of formation production. Hooks claimed this clause required that a royalty be paid on liquid condensate, which must then be converted to its equivalent in gas volume so that another royalty must be paid on it. Samson responded that such an interpretation imposed a double royalty by requiring that Samson pay royalties on condensate twice. The court agreed.

Score a run for Samson.

Wrongful Pooling

 Samson pooled the Hooks leases into a unit, effective as of first production. Samson amended the unit designation and notified Hooks that the name was changed. The amendment also significantly altered the unit boundaries.

Hooks claimed that Samson did not have the unilateral right to “unpool” Hooks’ leases. The Court invoked ratification and waiver. Because Hooks did not deny the validity of the new unit, which existed only after Hooks was notified that the old unit was being amended, he could not later assert that he should also receive royalties from the old unit.

Score a run for Samson.

Offset Well Obligation

Two of Hooks’ leases required that if a well were completed within 1,320 feet of Hooks’ lease line but not unitized with Hooks’ acreage, then within 90 days Samson must either drill an offset well, pay royalties, or release the offset acreage. Because the statute of limitations did not apply to the compensatory royalties that might have been owed within the preceding four years, the court remanded for the court of appeals to consider the merits.

Score a runner on third for Hooks. This contest will go to extra innings.