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OIL & GAS

I. BackgroundI. Background"

|Recoverable Reserves 1989 | |

|Country |BB Barrels |

|US |27 |

|Mexico |54 |

|USSR |59 |

|Saudi |255 |

|Other OPEC (Abu Dhabi, Ecuador, Indonesia, |504 |

|Iran, Iraq, Kuwait, Nigeria, United Arab |(about 2 world |

|Emirates, Venezuela) |reserves) |

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A. ReservesA. Reserves"

1. production figures not significant in the long runΧreserves areΧwho can keep producing

2. defined as recoverable reserves2. defined as recoverable reserves"

a. oil in the ground

b. technology (ability to produce oil in the ground)

c. cost of production compared to selling priceΧrecoverability increases with decrease in cost of production or increase in selling price

(1) increase in price increases recoverable reserves

(a) exploration

i) Alaska National Wildlife Refuge

ii) offshore

(b) drilling

(c) more expensive recovery technology

i) research

ii) use

(2) continuing production important

(a) once shut-in, danger of build-up of migrating hydrocarbons (natural gas)Χdon't want explosion at the surface or invasion of water supply

(b) regulations require plugging to avoid safety hazards and environmental damage

B. Policy IssuesB. Policy Issues"

1. do our legal arrangements support efficient use of reserves (the most oil for the longest time)?

a. private law

b. regulations

2. other goals?

3. do you adapt legal system to underground structure and technology or force operations to conform to legal system?

a. ex: pocket formations with different surface owners most efficiently recovered by horizontal drilling

C. ReservoirsC. Reservoirs"

1. origin of oil1. origin of oil"

a. theories

(1) organic theory: over millions of years, accumulation of microscopic plants and animals in shallow seas were overlain with silt; sank; heat, pressure, and chemical reactions led to complex hydrocarbons that separated into natural gas and petroleum; continued pressure on petroleum caused it to migrate into secondary source rock; oil migrated a second time into reservoirs

(2) inorganic theory: lightest and simplest hydrocarbon is methane (component of natural gas); methane on Jupiter's moon and in meteorites where there is no bacteria, so methane must be a building block of the universe and part of the earth's original components; methane probably at the earth's core; also subject to heat and pressure and migrated

b. which theory you believe makes a difference where you look

(1) under (1), only look near old, shallow sedimentary beds

(2) under (2), if you go deep enough, you'll find it anywhere

2. productive petroleum reservoir requires zone of permeable and porous rock2. productive petroleum reservoir requires zone of permeable and porous rock"

a. zone because oil and gas saturates rock (need a trap)

b. permeable: spaces between rocksΧallows flow

(1) tight sands: highly impermeable; very little space

c. porous: absorbent

3. substances in reservoir3. substances in reservoir"

a. gas

(1) free gas (absorbed in limestone or sandstone)

(2) gas cap

(3) solution gas (absorbed in oil, similar to carbonated drinkΧreleased by uncapping/drilling)

b. oil

c. water

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4. drives4. drives"

a. gas drive

(1) if gas released:

(a) oil more viscous and more difficult to produce

(b) pressure gone

(2) ergo, drill into oil so gas expands (downward), pushing oil out

(a) drill into oil: 35-50% produced

(b) drill into gas: 10% produced

b. water drive

(1) water pressure pushes oil to surface

D. Drilling OperationsD. Drilling Operations"

1. Drilling Mud1. Drilling Mud": clay, water, and chemicals pumped into well while drilling:

a. lubricate drill bit

b. circulate through the wellΧbrings up rock particles being drilled out

c. helps prevent blow outsΧlikely to run into little pockets of oil or gas under enormous pressure; if drilling through the pocket, don't want gas bubbling up through it, so use fairly heavy mud

2. Enhanced Recovery Operations2. Enhanced Recovery Operations"

a. secondary recovery:

(1) reinjecting natural gas

(2) waterfloodingΧpushing salt water into well, moving oil toward other wells

(3) firefloodingΧstart a fire in the hole to decrease viscosity

b. tertiary (enhanced) recovery:

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(1) thermal recovery: steam injection through lateral extensions of previous well to thin the oil; very expensive

(2) miscible recovery: inject chemical decrease viscosity and separate chemical back out after recovery

(3) surfactant recovery: detergent effect to separate oil from grain of rock

II. RULE OF CAPTUREII. RULE OF CAPTURE"

A. RuleA. Rule": Get Everything from Well Bottomed in Your Land, Even if Draining Neighbor

1. includes using technology to recover as much as possible Tyner (dropping nitroglycerin into well)

2. can't damage neighbor's surface

a. Tyner enjoined nitroglycerin use on surface

b. Rylands v. Fletcher explosion that causes fractures on neighbor's land is inherently dangerous activityΧstrict liability

c. maj: fractures and shock waves aren't physical intrusion, so no trespass

d. Geo Viking v. Texlee Operating when fracking fails, damages only for predicted increased oil production from under client's land, not neighbors because fluid being pushed under neighbor's land

(1) damages holding, not trespass suit

(2) maybe just damages too speculative beyond boundary [maybe preventing double recoveryΧneighbor can still try to produce]

3. if not bottomed on your land, liable for damages for trespass and may be enjoined

4. correlative rights: neighbors' rights in a common reservoir

a. can't be negligent

(1) rule of capture concerned with nonliability for correct method of productionΧdoesn't protect against negligence injuring plaintiff Eliff (( would have been able to produce but-for 10-year blowout caused by >; > wasted ('s gas by burning it)

b. can't waste (injunction available)

(1) developed from spite-fence theory

(2) if neighbor can't get pipeline connection, can't vent just to reduce neighbor's production (no valid economic purpose)

5. limits developed due to changes in technology, knowledge

B. HistoryB. History"

1. developed because traditional mineral law didn't workΧdon't own everything above and below because it moves

2. water and wild animals analogyΧfugaciousΧget it while you can

a. have exclusive right to hunt on your own land Pierson v. Post

b. could lure animals onto your land from your neighbors Keeble v. Hickeringill

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C. Remedy: self-help onlyΧdrill offset wells as close to first well and boundary as possibleC. Remedy\: self-help onlyΧdrill offset wells as close to first well and boundary as possible"

1. result: dense drilling

D. Policy RationalesD. Policy Rationales"

1. judicial convenienceΧdidn't know where it was coming from in early 19th century

2. promote the industryΧincentive to exploit (albeit maybe too much incentive)

a. if you enjoin production from draining a neighbor and require accounting, may shut down exploration and development where reservoirs might cross a boundary

b. order of accounting assumes we can determine how much is thereΧcan't tell at beginning because don't know size or shape of reservoir or whether it's draining [and don't know what technology will be by the end of production]

c. person getting accounting has to pay share of expenses and should pay additional charge for risk explorer took to find reservoir

3. even if rule doesn't make sense, too late in TX, OK, & LA where layers of law built on rule of capture

a. could have another rule where not well-developed (MA, HI, or international)

b. fairness goes to discoverer

E. Regulations try to ameliorate effects of rule of capture

1. setoff from boundary

2. spacing and density rules

III. OWNERSHIPIII. OWNERSHIP"

A. Ownership/Non-ownership StatesA. Ownership/Non-ownership States"

1. distinction1. distinction"

a. ownership states: own oil in place, but lose title if drained

b. non-ownership states (OK & LA): not owned until produced; exclusive right to explore and produce on your own property

(1) stretched wild animal analogy too far

2. tax ramifications2. tax ramifications"Χnot part of property if you don't own it

a. OK fixed by statute and taxes “unowned” hydrocarbons anyway

b. TX responded by adopting ownership in place

3. storage ramifications3. storage ramifications"

a. Hammonds (KY) not a trespass

b. Lone Star Gas v. Murchison (TX) Lone Star pumping gas into existing reservoir for storage; Murchison leased over reservoir and began producing; H: Texas is an ownership stateΧalready produced once, so title not lost without abandonment

c. acquisition of rights to depleted reservoir:

(1) ownership stateΧbelongs with surface because no minerals

(2) non-ownership state: went with minerals and stayed there (easement/profit)

(3) safer bet: pay both

B. fee interestB. fee interest": ownership of both surface and mineral rights in fee simple absolute

1. surface interest1. surface interest"

a. all rights not included in mineral interest

b. subject to easement of mineral interest owner or its lessee to use as much of the surface when, where, and as is reasonably necessary to search for, develop, and produce the minerals

2. mineral interest (common law)2. mineral interest (common law)"

a. TX: mineral fee

b. implied easement appurtenant by necessity for surface use to search for, develop, and produce minerals

c. power to sell minerals

(1) create cotenancy if dividedΧeach owns undivided interest

d. right to benefits under an O&G lease (as lessor)

(1) signing bonus

(2) delay rentals: payments for maintaining the lease without development

(3) shut-in royalty: payments for maintaining the lease without production

(4) royalty: payments for lessor's share of production

e. executive righte. executive right": power to deal affirmatively with minerals in manner that it affects someone else's rights (potential to receive income)

(1) severance of executive right1) severance of executive right"

(a) not mere agency

(b) permanent right to execute leases that affect rights indefinitely

(c) can transfer among cotenants, but can't sever from mineral estate

(2) duty of executive to nonexecutive2) duty of executive to nonexecutive"

(a) duty to lease before terminable interest reverts?

(b) duty to obtain highest royalty?

(c) standards:

i) just don't defraudΧe.g., don't classify as surface damages when it bears no relationship to injury to surface and is really royalty with a different label

a) too lowΧnonexecutive can't protect himself

ii) maj: utmost fair dealing: good faithΧarms'-length transaction

a) prudent landowner test: act as any other reasonably prudent landowner would act if she owned all mineral rights, i.e., would do the same thing if no other mineral interest

b) if Garcia owns a 5-year terminable interest and Smith turns down offered lease, must decide if Smith would have refused if Garcia not around Hope v. Pickens

c) if trying to wait 3 years, can't do it

d) if think offer too low and can get better, okay

e) look at whether lease consistent with others in the area

iii) fiduciary standardΧwhat trustee owes beneficiaryΧmust ignore your own self-interest and only do what's in the best interest of the beneficiary

a) would have to accept highest royalty even if not best deal

b) only applies if transaction suggests fiduciary relationship (e.g., elderly grandmother gives fee with executive right)

iv) Texas appeared to take intermediate standard until Manges v. Guerra (~1986)

a) Manges v. Guerra lease covering 25,000 acres of Manges ranch; Guerra family owned nonparticipating mineral fee; Manges leased to himself for 1/8 royalty and $5 bonus (total, not per acre); Guerras get $2.50 + 1/2 of 1/8 royalty; Manges reassigned to someone else for 1/2 of production once well had paid out (1/2 of 7/8)

b) court implied fiduciary duty applied; Guerra would have won under any standard

c) now courts trying to get around Manges language and use middle standard

d) ex: Mims v. Bill similar to Guerra but not as egregious: Bills convey to Mimses and retain 1/4 of royalty; when area becomes a hot prospect, Mims lease to their son for 1/8 royaltyΧbare minimum; 2-3 months later son reassigns lease to Henderson Clay ProductsΧretaining 1/16 overriding royaltyΧif son and parents treated as unit, 3/16 overriding royalty but lease only says 1/8ΧBills say 1/4 of 3/16, not 1/4 of 1/8; Mimses effectively engaged in self-dealingΧtransferring interest in property to member of immediately familyΧcould have leased land directly to oil companyΧonly purpose was limiting Mimses royalty

e) self-dealing inherently suspect; if significantly higher benefit to executive or family member, violates the duty

f) 5th Cir. approach: unjust enrichmentΧis the benefit the executive is claiming as his alone one that would be normally shared with someone owning the type of interest the nonexecutive has Sheldon v. Exxon

3. mineral servitude (civil law)3. mineral servitude (civil law)"

a. right to search for, develop, and produce minerals

4. adverse possession4. adverse possession"

a. ownership state: no adverse possession because mineral owner has separate fee simple Bodcaw Lumber Co. v. Goode (AR 1923) (mineral owner hadn't been around for 30 years and hadn't authorized anyone else to explore)

(1) statute of limitations never starts running because surface owner not using mineral estateΧcause of action never accrues in nonmineral owner

(2) theoretically possible for either fee simple owner to adversely possess the other estate, but must possess it for the statutory period

(3) once severed, tends to stay that way

b. nonownership state: can be abandoned like easement or equitable servitude if evidence of intent not to use it Gerhart v. Stevens (CA) (mineral owners abandoned because hadn't used in decades and some evidence of intent not to use again)

(1) subject to prescription for nonuse after 10 years

(2) interrupted by good faith discovery and production operations on the land or land pooled with it

c. trend: dormant mineral interest acts

(1) if mineral owners don't assert rights in 20 years (explore, drill, or authorize someone else to), the estate terminates

(2) except for MN where terminated interest split between state and surface owner, all give mineral estate to surface owner

(3) legislative reaction to Bodcow

5. “other minerals”5. “other minerals”"

a. reasons for controversy

(1) mineral estate valued as interest in oil and gas

(a) possible because oil and gas traded so often

(b) other minerals not paid for

(2) strip mining will destroy surface

(a) for uranium, coal, or lignite, federal law requires surface reclamation, but not for other kinds

(b) strip mines usually 6-stories deep; may cover 2,000-10,000 acres in SW and MW

(c) not just losing surface for 10-20 years until reclamationΧserious disruption

b. OK: narrowest constructionΧjust oil, gas, and what comes with it

(1) if they wanted to convey more, they would have said so

(2) problem: makes surplusageΧreads phrase out

c. ejusdem generisΧtraditional rule of construction used in many states; when construing, list of specific followed by general term; general only includes things like specific terms

(1) if other minerals means minerals like oil and gas, what characteristic?

(a) other hydrocarbons (coal and lignite)

(b) fugaciousΧnot coal, but includes helium and gaseous sulfur; liquids and gases only, not solids

d. ambiguousΧdon't know what parties thought; admit extrinsic evidence of what parties intended to convey

(1) in Texas, would litigate every deedΧoutside of urban areas, every tract has a deed with that kind of language; deeds are from 1920s-40sΧparties dead

e. general intentΧnot practical to find specific intent of the parties, so construe by what parties in that situation generally understand it to mean

(1) any substance that has value if extracted (Professor Kuntz)

(a) in west TexasΧwater is a mineral; in east Texas, sand is a mineral

(b) federal government has adopted the rule for its reservationsΧreserved other minerals in western homesteads

(2) surface destruction test (CJ Greenhill): Smith doesn't intend for Garcia to be able to injure or destroy retained estate; if extraction by destroying the surface, not a mineral; shaft mining okay

(a) surface destruction, not just surface damage

(b) strip mining problem

i) date of deed: grant in 1950; no one dreamed of strip mining uranium or lignite 200' below the surface in 1950 because the technology didn't exist, so no intent to strip mine then

ii) current technology: if litigation in 1982, uranium is no longer strip minedΧextracted by drilling holes; inject highly acidic or alkaline solution to dissolve uranium ore and pump it back up

iii) TX: if at any time between severance of estates and now, strip mining may have been a reasonable way to extract, substance didn't go with mineral estate (case where no one proposing strip mining held for surface owner)

(c) problem: can't tell from deed who owns it; must know how deep and history of technology

(3) ordinary and natural meaning testΧif usually thought of as a mineral, it is one

(a) what people generally thinkΧGallup poll test

(4) Moser (Tex.)

(a) 1983 opinion changed from surface destruction to ordinary and natural meaning test, but if Smith conveyed to Garcia in 1978, Smith assumed uranium belonged to him; decision seems to say it now belongs to GarciaΧproblem if Smith gave uranium lease within the last 5 years

(b) 1984 opinion:

i) any conveyance using “other minerals” after 6/8/83 uses ordinary and natural meaning test

ii) any conveyance before 6/8/83 uses surface destruction test

a) can use old opinions

b) minerals: oil, gas, sulfur, uranium, gold, silver (minerals as a matter of law)

c) not minerals: sand, gravel, limestone, water, lignite (at least close to surface)Χpart of ordinary composition of soil

(c) can't grant something you don't have, so ordinary and natural meaning test can't be applied to take interest someone has as a result of pre-1983 conveyance

i) 1978 conveyance from Smith to Garcia of oil, gas, and other mineralsΧsurface destruction test applies; because uranium would have been strip mined sometime after 1978, Smith owns surface and uranium; 1992 Garcia conveys all he owns to Morales; ordinary and natural meaning test applies to 1992 grant, but Garcia can't convey what he doesn't have, so Morales doesn't get uraniumΧSmith still gets it

ii) if Smith conveys oil, gas, and other minerals to Garcia in 1978, then surface only to Jones in 1992, Smith still has the uranium

(d) redefines rights of dominant and surface estate owners to protect surface owner

i) if substance named, owner of substance has implied right to use surface as reasonably necessary without compensation (except for excessive use or negligence)

ii) if substance not named, miner must compensate for injury

6. fractions6. fractions"

a. own land subject to fractional right and try to convey, but retain another fractional interest

(1) ex: Owen owns 1/4 of oil and gas in Blackacre in fee simple; Smith owns 3/4 of oil and gas and the surface; Smith conveys to Jones with language reserving undivided 1/2 interest in minerals; 1/2 of all minerals or 1/2 of what Smith ownedΧdoes Jones get 1/4 or 3/8?

(2) TX: depends on whether 1/2 of land described or interest conveyed Averyt v. Grande, Inc. (although not the intent in the case)

(a) granting clause description of land almost invariably includes everything (without exception for outstanding interest), then conveyance, then reservation

(b) if it says 1/2 of minerals in land described, keep 1/2 of total; Jones gets 1/4

(c) if it says 1/2 of interest conveyed, keep 3/8 of totalΧJones gets 3/8

b. someone purports to deal with larger interest in the minerals than the person owns

(1) arises:

(a) grantor doesn't understand what he has

(b) missed outstanding deed

(2) ex: Owens owns undivided 1/2 interest in oil and gas; Adams grants land to Brown; deed describes everythingΧnothing indicating Owens owns outstanding interest, so both deed description and granting clause purport to deal with all of Blackacre and Adams purports to reserve 1/2 interest in minerals; deed appears to convey surface and 1/2 minerals, then Adams purports to reserve 1/2 mineralsΧcan't have 3/2

(3) maj: estoppel doctrineΧAdams estopped to assert reservation Duhig v. Peavey-Moore Lumber Co. (only UT repudiated Duhig)

(a) if you can't give Brown what deed appears to, reservation gives way

7. subdivision7. subdivision"

a. nonapportionment rulea. nonapportionment rule"

(1) lease, then sale of part of land

(2) rule causes royalty to go to parcel drilled

(3) remedies

(a) entirety clause: share on acreage basis

(b) force pooling

b. community leaseb. community lease"

(1) land subdivided, then leased

(2) landowners agree to lease together

C. Leasehold InterestC. Leasehold Interest"

1. a/k/a working interest or operating interest

2. exclusive right to explore, drill, transport for stipulated period

3. TX: even though instrument titled “lease,” it's a deedΧtransfers a fee simple determinableΧfor so long as something happens (delay rentals, oil or gas produced, etc.)

a. retain royalty interests (incorporeal interest); right to a fraction of production free of preproduction expenses but bearing postproduction expenses (transportation, processing); possibility of reverter

4. contracts by lessee4. contracts by lessee"

a. lease assignmentsa. lease assignments"

(1) one oil company assigns to another

(2) assignee must act as reasonably prudent toward lessor

(3) no implied duty from assignee to assignor

(a) Brandon v. Ohio Oil Co.: assignee sat on lease; obtained top lease (becomes effective when existing lease terminates); drilled after top lease effective; assignor has no rights even though assignee washed out assignor's interest

(b) assignor must negotiate for right to royalty from future leases

i) watch rule against perpetuities

(c) maybe implied duty if assignor received no benefits (no cash, etc.)

(d) contrary to duty owed to nonexecutive, but difference in sophistication of parties

(4) can have express duty if representation to drill before end of term

(5) implied covenant

(a) Cook v. El Paso: U.S. leased western 320 acres to Cook and eastern 320 acres to El Paso; Cook was a lease broker; sold lease to Phillips with 5% royalty; Phillips sold lesae to El Paso; El Paso got production on eastern tract

i) U.S. has lessor has no problemΧgets royalty from either tract

ii) assignee has no problemΧleased both tracts

iii) only assignor shafted

iv) assignor allowed to assert implied covenant to prevent drainage

a) Smith: wrongΧnot in vertical privity

v) courts split

b. support and farmout agreementsb. support and farmout agreements"

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(1) ex: A to B: if you'll test drill at 7000', we'll pay you $100,000

(2) neighbor pays because waiting game otherwise to see who drills first on unproven acreage; company that drills first confers benefit on others; if drill gets production, neighbors know depth from agency report and how productive the well is; if dry hole, also valuable information

(3) unilateral contractΧB not contracting to do anything, but A offering to pay if B drills

(a) if A really wants well drilled and can't do it itself, can contractually obligate B to drill

(b) if B obligates itself to drill, will demand immediate assignment of acreage with agreement to assign back if it doesn't drill

(c) A's damages difficult to prove if B doesn't drillΧopportunity cost, not cost of drilling, but don't know what opportunity cost is; A usually gets nominal damages because it can't prove actual damages

(4) types:

(a) bottom hole agreement: if B drills, A must pay regardless of result

(b) dry hole agreement: A pays B if B drills and it's a dry holeΧshare risk of nonproduction

(5) support agreements often involve lease assignments

(a) ex: A has lease on 640 acres; A agrees that if B will drill in x area to 10,000' to test the Wilcox formation and do it within the next 6 months, A will assign to B the 40-acre drill site

(b) ex: A retains overriding royalty (e.g., 1/16) and right to share in total net profits if well pays out; if underlying oil and gas lease gives landowner 3/16 royalty, A has 1/16 overriding royalty as farmor, B drills and gets assignment, has cost of $1MM to drill; paying 1/4 in royalties; recouping drilling costs out of remaining 3/4 of production; once 3/4 of production equals $1MM, A has right to convert 1/16 overriding royalty into right to share in all productionΧassumes 1/2 of net profits > 1/16 of production

i) A pays 1/2 of costs and gets 1/2 of production

ii) B may insist on conversion option coming later

iii) must determine what expenses count toward payout

iv) B may try to get share in remaining acreage

a) common interest: gets assignment of drilling site and undivided interest in remaining acreage; maybe 25-50%

b) alternative: drill and earn optionΧdrilled first option and earned interest in it; has 6 months to drill another and earn interest in 2d well

c. joint operating agreementc. joint operating agreement"

(1) needed when:

(a) interest assigned to the well owned by 2+ oil companies

(b) pooling

(c) lease promoted

i) small operator leases and gets investors

ii) venture so expensive and so risky that no single company willing to commit to full risk, esp. off-shore and international; join to explore prospect, e.g., North Slope in Alaska

(2) purposes:

(a) practical

i) who's the operator (in charge)

a) operator has almost all managerial and decisionmaking rights

b) operator is to other lessees as lessee is to lessor

c) does all contracting

d) decides how fast to drill

ii) how production and costs are splitΧusually percentage ownership

(b) legal

i) negates existence of joint venture (negate possible presumption of general partnership)

ii) nonoperators don't want to be liable for more than proportionate share

a) if operator contracts for $3MM drilling and nonoperator pay its $1MM, doesn't want to be liable for entire $3MM if operator doesn't pay

b) if operator not careful and rig blows, don't want to be liable for $100MM personal injury judgments

c) TX: works under Uniform Partnership ActΧoperating agreement doesn't create partnership or join ventureΧonly operator liable

d) elsewhereΧworks for contract creditors (no cases where contract creditors recover full claim from nonoperators; only get proportionate share from them)

e) tort claimants may be able to recover from nonoperatorΧworking for everyone (may be true in Texas)

iii) operator's standpoint

a) operator doesn't want fiduciary dutiesΧdoesn't want to subordinate its own interests to nonoperators'; if it gets cut rate with refinery, doesn't want to have to share the benefit

b) will be treated as fiduciary sometimes, regardless of what agreement says

c) if it receives funds from operations and commingles the funds, will be treated as a trusteeΧbasic agency law

d) if Texaco, lawyer Smith, Dr. Gonzales, and Dentist Jones, Texaco won't be protected by language in joint operating agreementΧowes some duty to nonknowledgeable participants

e) post-contract course of conduct can create confidential relationship

f) in other states, no matter what you say you created, it's a joint venture

g) some joint operating agreements say operator will perform in a good and workmanlike manner, but liable only for gross negligence or willful misconduct

h) Stein v. Marathon (5th Cir.) all knowledgeable participants, you agreed to it, so must be gross negligence or willful misconduct (nonoperator claimed breach of conduct but didn't show gross negligence or willful misconduct)

D. PaymentsD. Payments"

1. Royalties1. Royalties"

a. common elementsa. common elements"

(1) classified by transaction in which they were created

(2) not production-cost bearing (may bear post-production costs)

(3) no incidents of ownership

(a) no right to search, develop, or produce

(b) no surface rights except to collect royalty

(c) no right to lease (except landowner with possibility of reverter)

(4) can reserve terminable interest, either in fee or in royalty

(a) 1/16 NPRI for 5 years and so long thereafter as oil or gas is produced

b. landowner's royaltyb. landowner's royalty": interest in production retained by lessor (usually 1/6)

c. nonparticipating royaltyc. nonparticipating royalty": carved out of the mineral interest

(1) share of production without regard to any lease

(2) if there is ever production on Blackacre, get royaltyΧnonparticipating in the sense that royalty owner doesn't get to participate in leasing and has no possessory rights (can't explore, etc.), just postproduction if someone else does it

(3) often retained by mineral interest owners who sell their rights

(4) purchased for speculation

(5) often done as part of estate planning

(6) avoids cotenancy

(7) two different ways to express size of royaltyΧflat percentage of production or fraction of royalty reserved in oil or gas lease (e.g., half of landowner's royalty)

(a) problem because 1/8 was so standard that many royalty contracts state both as 1/2 of royalty reserved and 1/16 of production

(b) construction when 1/2 1/16

(8) construction of “royalty”

(a) shut-in royalty

i) landowner's argument: contracted for share of production, not shut-in royalty that just maintains lease past primary term (equal to delay rental)

ii) royalty owner's argument: contracted for anything deemed to be production, including shut-in royalty

iii) H: must share shut-in royalty (Tex. Civ. App.)

iv) shut-in royalties not big enough to justify litigation

v) lessee may be willing to pay extra 1/16 of shut-in royalty to be sure all bases covered

(b) minimum royalty

i) purpose was to ensure marginal well didn't maintain lease on large tract; often 4-5 figures

ii) H: minimum royalty must be shared

iii) rat: royalties paid on something other than sale priceΧe.g., market value, would give right to royalty, so should have right here

(c) production payment

i) gives specified percentage until specified sum paid

a) usually outside of lessor/lessee contextΧpaid by lessee to someone other than lessor, e.g., method of securing financing

b) if security, amount set for repayment of principal and interest

c) may be used for bonus, e.g., pay $50/acre now and extra 1/16th of production until $50K received

ii) H: not royaltyΧequitably part of bonus or expense payment

a) royalty based on production means based on production that continues throughout the lease, so if there is a cap, it's not a royalty

b) only one case where cap so large it couldn't be recouped during the life of the lease; wasn't a bona fide production payment without a reasonable possibility of termination during the life of the lease (IRS wonΧdon't know what happens with private party)

d. overriding royaltyd. overriding royalty": carved out of lessee's interest

(1) often used to compensate land agents, lawyers, geologists, etc.

(2) may be retained by lessee when assigning lease, e.g., assigns lease to real oil company but wants to share in prospect of development, so retains overriding royalty of 1/12

(3) ends when lease from which it is carved terminates

e. term royaltye. term royalty": carved out of the mineral interest for a stated or defeasible term

f. perpetual royaltyf. perpetual royalty"

g. mineral royaltyg. mineral royalty" (civil law): similar to defeasible term royaltyΧsubject to prescription for nonuse; terminates after 10 years if no production

h. drafting problemsh. drafting problems"

(1) distinguishing between conveyance of mineral fee interest and royalty

(a) can have nonparticipating mineral fee a/k/a nonexecutive mineral fee

(b) if 1/16 NPRI, royalty owner gets 1/16 of gross production, but not bonus or delay rentals and doesn't get to participate in leeeeeeasing process; if 3/16 lease royalty, 1/16 NPRI leaves 1/8 for remainder

(c) if 1/16 fee, gets bonus and delay rentals and participates in leasing process, but gets 1/16 of all benefits including 1/16 of 3/16 royalty = 3/256 (proportionate benefits clause)

(d) in Texas “1/16 royalty” gives 1/16 royalty

i) Barker v. Levy H: royalty because “produced and saved” refers to oil and gas after it gets to the surface

ii) in some states, old common law doctrine that if you give someone a right to income from the property, it's equivalent to an interest in fee (WV, OK; CO until last year) (either right to 1/16 royalty or produced and saved gives 1/16 fee)

(e) to convey an interest in fee: “1/6 of the oil and gas in and under the described tract of land”

(f) combination: O 6 A 1/16 interest in oil and gas in and under and produced and saved, but no interest in delay rentals or leasing. A has the right to enter for purposes of exploring, drilling, etc.

i) in and under 6 mineral fee

ii) produced and saved 6 royalty

iii) maj: fee because if you have a fee interest, get both

iv) Texas courts' approach:

a) focus on granting language; “in and under” and “produced and saved” 6 fee

b) examine how many of the fee rights have been subtracted:

c) surface rights (explore, drill, store): granted

d) executive right: withheld

e) lease benefits:

f) bonus: unknown

g) delay rentals: withheld

h) royalty: unknown

v) only case where combination held to be royalty: only case crossing the line: O to A 1/16 interest in oil and gas in and under and produced and saved but no interest in delay rentals or leasing or bonus and no right to enter and A has only a royalty (take away everything and say only a royalty)

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(2) pooling NPRI

(a) ex: Smith inherited 2 tracts from his mother; Garcia's interest is a 1/16 NPRI in one of the tracts; Smith thinks of as one tract of land, so leases all of it to Oryx; has pooling clause like all leases; Oryx has also leased neighbor's land; Oryx exercises pooling rightΧ20 acres from western tract with 20 acres of neighbors tract; drills on western tract; under pooling, treats as 50% from neighbor and 50% from Smith's western tract

(b) if 3/16 royalty in Smith's lease, Oryx pays 3/16 on 50% of production

(c) LA: can pool NPRI's interest

(d) TX: Garcia bought 1/16 of gross production on entire western tractΧnot involved in pooling agreement; not limited to 50% of 1/16

i) instrument between Garcia and Mrs. Smith controlsΧcan't decrease right by authorizing pooling

ii) Oryx paying 3/32 (1/2 of 3/16)ΧGarcia gets 1/16, Smith stuck with 1/32

(e) if drilled on neighbor's side of the line (#2), Garcia's deed doesn't give him any right to production from the neighbor's land

i) Garcia can ratify the leaseΧauthorize Smith to pool his NPRIΧwhen ratified, gets benefit of poolingΧ1/16 of 50% of production attributable to Blackacre

ii) ratification:

a) execute instrument labelled “ratification”

b) implied ratification upon acceptance of benefits to which royalty owner would not be entitled but for the lease

c) letter to oil company saying “I ratify your lease”

d) sue to share in benefits London v. Merriman

e) lease covered two tracts; NPRI in one tract; oil found on other tract

f) pooling clause

g) anti-communitization clause: prevents parties who sign same lease for 2 tracts from sharing benefits in proportion to ownership regardless of well location

h) separate tracts by definition if differing ownership interests

i) Merriman sought and got forced pooling

j) suit for royalty constituted ratification and Merrimans got royalty from date of suit

k) never any poolingΧjoined interests in one tract, not two tracts

l) anti-communitization clause just prevented pooling “merely” by being included in same leaseΧthis occurred under pooling clause

(f) courts bend over backwards to give NPRI production; trying to protect interest that can't protect itself

(g) partial cure: lease tracts separately

2. Production Payments2. Production Payments"

a. share of production

b. free of costs

c. terminates after stated sum paid

d. often used for mortgages of producing property

3. Net Profits Interest3. Net Profits Interest"

a. fraction or percentage of production

b. non-operating

c. free of costs

d. payable only if there is a net profit

IV. REGULATORY DOCTRINESIV. REGULATORY DOCTRINES"

A. JustificationsA. Justifications"

1. conserve resources1. conserve resources"

a. e.g., too many wells delete reservoir energy too quickly

b. liquids don't readjust quickly, if ever, if wells shut-in

2. prevent surface pollution2. prevent surface pollution"

3. prevent economic waste3. prevent economic waste"

a. 5 wells won't drain any more from 40 acres than one well willΧjust costs more

b. if production divided too thinly, become unprofitable with small price fluctuations and are shut-in too early; reservoir may not readjust to so hydrocarbons never producible after shut-in

4. protect environment generally4. protect environment generally"

a. contamination of water supplies

b. wildlife habitats

5. protect correlative rights5. protect correlative rights"

B. History of Natural Gas RegulationB. History of Natural Gas Regulation"

1. Natural Gas Act mid-1930sΒmid-1970s1. Natural Gas Act mid-1930sΒmid-1970s"

a. starting regulating because pipelines were monopolies with respect to consumersΧinevitable complaints of monopolistic pricing, so protect consumers by federal pricing regulation

b. perceived problem in 1930s was pricing by long interstate pipelines; not subject to state regulation because in interstate commerce; very few intrastate pipelines then; assumed intrastate price gorging could be handled by states

c. language of NGA referred to "gas sold for resale in interstate commerce"

(1) Phillips v. Wisconsin S.Ct. H: price regulation at selling end (monopoly) and buying end (monopsony)

d. FPC regulated price for which gas producer could sell gas to interstate pipeline

(1) regulated price rarely >504/mcf

(2) intrastate unregulated price >$2/mcf

2. Natural Gas Pricing Act 1970sΒ19882. Natural Gas Pricing Act 1970sΒ1988"

a. attempted to deal with bifurcated market by regulating everythingΧall gas subject to pricing mechanism in NGPA (southwest producers concerned about regulatory agency controlled by northeast consumers, so mechanism in statute itself)

b. at least 8 natural gas prices, depending on interstate commerce, already in intrastate commerce, within certain distance of another well, within certain depth of another well, offshore, newly discovered, etc.; 274Β$9/mcf

c. stairstep based on assumed rate of inflation

d. exacerbated market value problemΧargued about which market value

3. Deregulation 1988Βpresent3. Deregulation 1988Βpresent"

a. now possible to hire pipeline for transportation rather than having to sell to pipeline

b. much shorter delivery contractsΧnow typically 1-year; maybe 5; not 20

c. some actual spot sales

C. Fair ShareC. Fair Share"

1. developed from correlative rights

2. if agency going to regulate drilling and production methods, agency must provide everyone over reservoir the opportunity to enjoy their fair share of the reservoir

3. density rulesΧrequires certain acreage assigned to well so draining only that landowner's land and not much from neighbors'

4. production allowablesΧif producer exceeds allowables, liable to neighbors because creating low pressure area and sucking their oil Wronski v. Sun Oil

a. tort: violation of statuteΧcategory of persons intended to be protected

b. correlative rights: improper method injures other interests in reservoir

c. rule of capture can't apply because neighbors aren't allowed to protect themselves

5. doesn't obliterate rule of captureΧif you don't drill, you can't recover

D. Drilling PermitsD. Drilling Permits"

1. can't drill without

2. original regulation to protect correlative rights

3. if you comply with spacing and density rules, entitled to permit as a matter of law

E. Location Regulations (Texas)E. Location Regulations (Texas)"

1. spacing - Rule 371. spacing - Rule 37"

a. 467' from property line

b. 1200' from well bottomed in same formation

2. density - Rule 382. density - Rule 38"

a. 40 acres per oil well

b. 160 acres per gas well

c. 10% tolerance allowed

d. minimum acreage that will lead to effective drainage

e. Texas unusual because operator can specify which acres are to be assigned to a well (no jagged boundaries)

(1) most states lay out inflexible grid

3. special field-wide rules3. special field-wide rules"

a. may be necessary due to:

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(1) odd reservoir shape or structure

(a) seek exception to prevent wasteΧpermit doesn't do any good if you can't drill over reservoir

(2) technology required

(3) variations in porosity and permeability

b. procedure

(1) hearing

(2) notice to area landowners

4. exceptions4. exceptions"

a. to prevent wastea. to prevent waste"

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(1) Exxon v. RRC economic waste valid consideration (won't drill if forced to move 1000' feet instead of completing well up one formation); also showed internal reservoir waste if not granted

(2) Schlacter v. RRC economic waste w/o production waste isn't sufficient

(3) may be used if oil cannot be produced without drilling in exceptional location due to geological conditions

b. to prevent confiscationb. to prevent confiscation" (Texas)

(1) every landowner gets at least one well to prevent others from draining the oil

(2) always deal with tracts smaller than standard drilling unit

(a) up to others to disprove presumption

(3) voluntary subdivision problem: don't get an exception if land divided into tracts ................
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