Texas Bar Exam Essays - Oil and Gas
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What is the Rule of Capture?
A person owns all of the oil, gas, and groundwater produced by a well bottomed in his land even though some of it may be draining from a neighbor’s land/minerals on an adjacent tract.
What is the Doctrine of Correlative Rights?
Every O&G owner has a right to fair opportunity to produce oil and gas from a common reservoir underlying his or her property.
What are some exceptions to the Rule of Capture and the Doctrine of Correlative Rights?
- These theories do not apply to:
- • Negligently drilled wells
- • Illegally drilled wells
- • Escaped stored gas (but BOP on storer)
What are the different types of oil and gas interests?
- • Before Severance
- o FSA
- • After Severance
- o Servient Estate – Surface Estate
- o Dominant Estate - Mineral Interest
- o If the Mineral Interest is leased →
- working interest (right to explore, develop, produce), and
- royalty interests (share of production, free of production costs)
What are the rights of a mineral interest owner?
• EXCLUSIVE DEVELOPMENT RIGHT – right to explore, develop, and produce minerals AND right to use surface as reasonably necessary for these purposes.
• EXECUTIVE RIGHT – Right to lease the mineral estate
• ECONOMIC BENEFITS – Bonus payments, royalty payments, delay rentals
What is a bonus payment, what is a royalty payment, and what are delay rentals?
- • Bonus Payments – upfront payment for signing the lease
- • Royalty Payments – fractional share of any oil and gas produced (no costs for production included)
- • Delay Rentals – compensation for deferring drilling during the Primary Term of a mineral lease
What is the Accommodation Doctrine?
- The lessee of a mineral lease must not interrupt a surface owner’s use of the surface (even though they are generally allowed to do so), if the surface owner can prove:
- (1) there was a pre-existing use on the surface
- (2) the mineral estate owner has a reasonable method of developing the oil and gas which is less destructive to the existing surface uses
- (3) the reasonable alternative is available on the leased tract
- (4) the reasonable alternative is not unreasonably costly
What is a NPRI and is it a type of mineral interest?
NPRI – Non-Participating Royalty Interest: the NPRI-owner has a right to receive a royalty share from any production of oil and gas.
NPRI is not a mineral interest.
- NPRIs do NOT have:
- (1) the right to lease minerals
- (2) the right to bonus payments
- (3) the right to delay rentals
What is a NPMI?
NPMI – Non-Participating Mineral Interest Owner: this person has the right to a share of all of the benefits under the lease to the amount of the interest held.
Can a Co-Tenant lease the mineral estate without the permission of the other Co-Tenants? What is the result of this situation?
Ever Co-Tenant can produce or lease his undivided share without the consent of other Co-Tenants, BUT must account to them for their rightful share of the profits from production (profits = revenues – costs).
Co-Tenant may later ratify the lease (in which case they would just get their share of the royalties).
Dry holes cannot be assessed against the Co-Tenant who did not lease the mineral estate.
Can a life tenant lease the mineral estate? If so, what benefits would they be entitled to under a mineral lease (and are there any exceptions)?
The life tenant cannot lease the mineral estate without the joinder of the remaindermen (and vice versa).
Life tenant receives all delay rentals + interest on bonus and royalty payments.
- (1) agreement between life tenant and reminderman
- (2) Open Mines Doctrine – Life tenants receives 100% of all payments under a lease that was IN PLACE when the life tenant received his interest.
What benefits would a life tenant receive under an oil and gas lease if their estate was created by a trust?
Accounting when life estate created by trust:
- Pre Jan. 1,. 2004:
- (1) LT gets delay rentals + 72.5% of bonus/royalty + interest on other 27.5%
- (2) Remainderman gets 27.5% bonus/royalty
- Post Jan. 1, 2004:
- (1) LT gets delay rentals +85% bonus/royalty/shut-in/non-nominal delay rentals + any interest on production payments if agreement to pay production payments provides for interest
- (2) The reaminder goes to the remainderman
Is a lessee’s working interest subject to a mortgage lien? What is the Doctrine of Marshalling the Assets?
If a mortgagee executes and records their mortgage before a lease is executed, the Lessee’s interest will be subject to the mortgage lien.
Doctrine of Marshalling the assets – mortgagee must sell surface assets first, then can sell mineral estate if the sale of the surface assets don’t pay-off the mortgage plus costs, etc.
What are the different types of trespass to a mineral estate?
- (1) Ordinary Trespass – lease expires but lessee stays on the tract
- (2) Slant Well Drilling – bottoming a well underneath someone else’s trach
- (3) Drilling Dry Well – Wrongful lessee enters and drilss a dry hole on tract and lessor loses lease value (bonus money) that he could have received before the world found out that his land was dry.
- (4) Geophysical or Seismic Trespass – Must be more than mere vibrations or fracing; remedy is to waive the tort of trespass and sue in assumpsit when there is only mere vibrartions (i.e. sue for the FMV of the right to do seismic exploration).
What is the difference in damages when a trespasser acts in good faith versus acting in bad faith?
- (1) Good Faith Trespasser – gets a creditor for the costs incurred in production so long as the costs benefitted the rightful owner
- (2) Bad Faith Trespasser – does NOT get a credit for costs; liable for the gross value of production from the well
What are the elements for proving Slander of Title and what damages could a plaintiff receive?
- Plaintiff must prove
- (1) publication of a false claim of title to the property
- (2) done with malice
- (3) resulting in the rightful owner losing a specific sale or leasing opportunity because no buyer wanted to buy a lawsuit
Damages – difference between fair market value of the lease at time of slander and value at trial with cloud removed.
How is adverse possession affected before and after severance of a mineral estate?
Prior to severance – adverse possessor will get title to both the surface and the mineral estate
After severance – adverse possessor will only get title to the surface estate (unless he has also possessed the mineral estate by some physical act, such as drilling a will, etc.)
What is a Granting Clause? What is a Mother Hubbard Clause?
Sets forth the rights given by the Lessor to the Lessee as well as a description of the property and normally includes a Mother Hubbard clause to pick up small strips of land not specifically included because of mistake in surveys or land descriptions. Mother Hubbard Clause is invalid for large tracts of adjacent land (rule of thumb = 1,000 acres or more)
What is a Habendum Clause?
Sets for the duration of the Lessee’s interest in the premises, including defining the limits of the primary term and the secondary term.
Primary Term – fixed period during which the lessee has no obligation to conduct drilling operations.
Secondary Term – indefinite, but normally linked to production in paying quantities.
What does Production in Paying Quantities mean?
Revenues – Lessor’s royalty interest in the lease – operating costs (not drilling costs) > 0
What are some exceptions to producing in paying quantities?
- (1) Temporary Cessation Doctrine – Once PPQ established a (1) short term shutdown, (2) which lessee acts diligently to fix, and (3) which is due to a mechanical breadown or the like, will not terminate the lease.
- (2) Marginal Well Doctrine – Test: whether a reasonably prudent operator would continue to operate the well to make a profit, not merely for speculation. As long as the well is still producing oil or has (and is not completely shut-in), the courts will give lessee a reasonable amount of time to show that the well is capacble of profitable production.
- (3) Doctrine of Repudiation – if Lessor obstructs Lessee from developing the lease, courts will add the period of delay and obstruction to the Lessee’s lease
What is a Delay Rentals Clause? Will a lease terminate automatically if a delay rental clause is not met?
Authorizes a Lessee to delay drilling or commencing production during the primary term by periodically paying a stipulated amount to the lessor by a specific date (time is of the essence with these payments unless the lessor ratifies by accepting a late delay rental payment).
- Whether or not the lease will terminate automatically id the lessee (who has delayed drilling) fails to timely pay the delay rental, depends on whether the word “unless” or “or” was used in the clause.
- (1) Unless – creates a condition, so lease terminates automatically
- (2) Or – creates a covenant, so lease does not terminate automatically; Lessor must sue for breach of contract to recover unpaid rentals.
Does failure to pay royalties terminate a mineral interest lease?
No – promise to pay royalties is a covenant, not a condition; therefore, failure to pay royalties does not terminate a lease.
What is a Commencement of Drilling Clause?
States that operations must be commenced on ore before a certain anniversary date during the primary term (unless there is a delay rentals clause).
Commenced: Must show (1) objective physical acts on the leased premises (building road to bring in rig, etc.), and (2) with subjective good-faith intent to continue to pursue the drilling operation to find oil and gas.
What is a Shut-in Royalty Clause?
When a well is capable of PPQ and gas is shut-in for lack of a market, the Lessee can hold the lease by paying shut-in royalties.
What is a Dry Hole Clause?
If a Lessee drills a dry hold, he can keep the lease alive by starting to drill another well on lease within stated period of time.
What is a Continuous Operations Clause?
Covers situations where at the end of the primary term, operations have commenced and were continuing but there was not actual PPQ, allows lease to continue as long as operations are sought and cessation does not last more than XX days (60 is typical)
What is a Cessation of Production Clause?
If a well ceases producing, Lessee can nevertheless keep the lease alive provided the Lessee commences repairs within a stated period of time.
What is a Force Majeure Clause?
Excuses performance, or extends time for performance, because of unforeseeable factors beyond the Lessee’s control – act has to be identified in lease and event must prevent performance.
What is a Pooling Clause?
Allows Lessee to hold several tracts under lease with production from just one well located on one of the tracts. Courts require pooling be exercised in good faith.
What is a Pugh Clause?
In a situation where only a portion of a Lessor’s land is used for the pool, the lease is maintained only as to the landed included in the pooled unit. With this language, the Lessee would have to do something else, like pay delay rentals, etc. in order to avoid the lease being released.
How does a Pooling Clause affect NPRIs?
The executive right owner has no power to pool the non-participating interests. Thus, if a well is srilled on the part of the lease the NPRI has an interest in, he gets his royalty, but if it is stilled on the part of the pooled unit outside the land his NPRI is on, then he gets nothing unless he ratifies the pooling act (which would be illegal as to the NPRI until he did so) and then receive a share of the royalty from the well on the adjacent tract.
What is a Royalty Clause? Are royalties free from costs of production and post-production costs?
Royalty clause provides that the Lessee make a payment of a certain amount to the royalty interest owner.
Royalty interests are typically free of costs of production, but not post-production costs (like compression costs and transportation). Thus, Lessor of a 1/8 royalty must pay 1/8 post production cost – but only for oil and gas actually produced (i.e. not cost-share in take-or-pay contracts).
What some market value issues with Royalty Clauses and how are they resolved?
- (1) “on the premises” – If the product is sold on the premises AT THE WELLHEAD, then the Lessor get his SHARE OF THE PROCEEDS (royalty * price agreed to in lease)
- (2) “off the premises” – AAATTC, Lessor gets the FMV of product computed at mouth of the well.
- a. Comparable Sales Method (preferred) – appraised market value of product based on (i) comparable quantity, (ii) comparable quality, (iii) sales at the same time period, and (iv) sales in the same geographic area.
- b. Net-Back Method – when there are no comparable sales, take the price at a distant spot (i.e. a refinery) and start deducting back expenses until you get to the mouth of the well. The end value will be market value.
What is a Division Order?
Tell the Lessee or well operator or purchaser how to divide the proceeds from a well among all the various Lessors and NPRIs and working interest owners.
Common Law Approach – Division orders were binding until revoked even if the provisions of the division order differed from the language of the lease.
- Division Order Act of 1991 (applies after August 26, 1991):
- (1) D/O are binding until revoked
- (2) A provision in a D/O can never contradict the lease (if it does, it is invalid)
- (3) D/O can clarify the royalty settlement terms in a lease
- (4) Lessee/Payor owing royalties can withhold payments without owing interest ONLY IF
- a. There is a title dispute that affects the distribution, OR
- b. Payee refuses to sign a standard D/O and Payor may withhold until signed
- (5) Lessee/Payor has NO right to withhold payments to royalty owner who refuses to sign D/O if it contains items not authorized in the statute.
What are the implied covenants in oil and gas leases?
(1) Standard of performance – Lessee must act as a reasonably prudent operator (RPO)
(2) Implied covenant to Protect against drainage – must prove (i) substantial damages, (ii) lessee could drill a profitable well to offset drainage, and (iii) damages
(3) Implied covenant to Market – must market (i) within a reasonable time, and (ii) at the best price realizable (judged by the RPO standard)
(4) Implied covenant to Develop – note, there is not an implied covenant to explore. The standard for breach is whether Lessor can prove a reasonable expectation of profit from additional drilling, regardless of whether the proposed well is on an already proven tract or on new strata.
What duties do executive-rights owners owe to other mineral interest owners?
The duty of upmost good faith (which is sometimes a fiduciary duty).
Duty owed to non-executive interest owners is one of utmost good faith and fair dealing, which requires the executive to act with due regard for the interest of the non-executive and to be willing to execute a lease on the same terms and conditions as a reasonably prudent landowner would do if there was no non-executive interest.
If the executive engaged in egregious self-dealing, then courts impose a fiduciary standard (must subordinate his interest to the non-executive).
What are “minerals”?
- (1) Step 1: Is the mineral one of the following list of 9? If so, they belong to the surface owner.
- a. Water
- b. Limestone or other building stone
- c. Caliche
- d. Sand
- e. Gravel
- f. Surface shale
- g. Near-surface iron ore
- h. Near surface coal
- i. Near surface lignite
- j. Near-surface: The 200-foot rule: if the substance is found within 200 feet from the surface, then the substance belongs to the surface owner >>> as long as the bein or deposit begins at, or above, a depth of 200 feet, then the entire vein/deposit will still belong to the surface owner.
- (2) If not one of the above, then ask whether the lease was executed before or after June 8, 1983.
- a. If before, then apply the Surface Destruction test.
- i. If (1) the reasonable method of extraction (2) on or after the date of conveyance/reservation (3) would consume, deplete, or destroy the surface, then (4) the substance belongs to the surface estate (remediation is irrelevant)
- b. If after, then apply the Ordinary Natural Meaning test
- i. If the substance in question (under the ONM of the locality in question) is ordinarily considered a mineral, then it is owned by the mineral owner. It doesn’t matter if the method of extraction would destroy the surface.
How is a conveyance affected with regards to the Non-apportionment Rule versus the Community Lease?
Under the non-apportionment rule, when property is subdivided after an oil and gas lease covering the land has been entered into, the purchasing-owners of the subdivided interest are not entitled to an apportioned lease royalty payment if the well is not on their subdivided portion of the land; they are entitled to an apportioned delay rental though.
The purchasing-owners of the subdivided land has one other option which would be to invoke the Mineral Interest Pooling act (MIPA) to force her way into the well on the other tract of the subdivided land. MIPA applies only to fields discovered AFTER March 8, 2961 and purchasing-owner must first make a fair and reasonable offer to pool voluntarily.
What is the Duhig Doctrine and who does it apply to?
Duhig only applies to 3-party (or more) chains of conveyances of mineral interests or royalty interests where the grantor seemingly conveys more than 100% of the mineral or royalty interest.
Duhig – where the full effect CANNOT be given to both the interest granted and the interest reserved, priority will be given to the interest granted.
Additionally, Duhig requires that grants of mineral interests or royalty interests be strictly construed. (i.e. a ½ mineral interest in the “above conveyed land” will be interpreted to convey only a ½ interest in the land conveyed; whereas a ½ mineral interest in the “land described” will be interpreted to convey a ½ mineral interest in the land actually described in that section even if it conflicts with the land conveyed).
How do you determine whether a mineral interest or a royalty interest has been conveyed?
Royalty language – “oil, gas, and other minerals PRODUCED AND SAVED…”
Mineral language – “oil, gas, and other minerals IN AND UNDER…”
Who regulates mineral production and what are their major objectives?
- The Texas Railroad Commission (RRC) regulates oil and gas production to serve three public objectives:
- (1) prevent waste and maximize the recovery of oil and gas
- (2) to protect correlative rights by giving all owners of interests in a common reservoir the opportunity to recover their fair share of the oil or gas
- (3) to protect the environment from oil and gas activities
How does the RRC attempt to prevent waste and protect correlative rights?
- (1) drilling permits and spacing rules
- a. permit needed before well can be drilled; min. 40 acres to drill a well
- b. Exception to the 40-acre requirement: (i) small tract owner can prove confiscation (drainage) and (ii) the small tract was subdivided by deed BEFORE oil and gas was discovered in the area or leased.
- (2) prorationing rules
- (3) Mineral Interest Pooling Act (MIPA) and compulsory pooling
What is the Relinquishment Act?
Applies to public (state-owned) land which was sold to private parties between 1895 and 1931. The grantees DO NOT own the oil and gas; Texas does. Grantees have right to lease and to share in lease benefits (royalties, bonuses) equally with the State.
Surface owners cannot convey a mineral interest because they do not own the minerals; cannot convey NPRIs either.
Who is responsible for plugging wells?
- Duty to plug wells is:
- (1) on the operator – the person responsible for the physical control of the well at the time the well is about to be abandoned or ceases production;
- (2) on the non-operator who owns a working interest in the well at the time, but isn’t an operator and are thus secondarily liable for plugging costs.
Landowners and royalty interest owners are NOT responsible for well plugging.
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