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319 Texas Bar Journal April 2013 texasbar.com


IN TEXAS, OIL AND GAS DEVELOPMENT IS

REACHING UNPRECEDENTED HEIGHTS DUE

TO THE UTILIZATION OF INNOVATIVE TECHNOLOGY

LIKE HORIZONTAL DRILLING AND

HYDRAULIC FRACTURING.1 This technology allows

operations to move into spaces previously filled with dry

holes and the lost hope of meaningful mineral production.

2 As the industry expands into new areas and

enhances production in others, the chance of oil- and

gas-related conflict also increases, which creates a greater

need for attorney involvement. A 30-year general practitioner

in Abilene may be asked to negotiate an oil and

gas lease for the first time in his career, while a first-year

associate in Midland may be asked to revise a complex

joint operating agreement. Whatever the case may be,

Texas attorneys must have a basic understanding of oil

and gas principles so they can diagnose a client's problem

and recognize available remedies.


Oil and

Gas Basics

BY DEREK COOK AND JENNIE K. MARTIN

Understanding the sticks to

avoid stones and broken bones.

SEPARATING THE WORKING INTEREST FROM THE BUNDLE


To understand the impact of an oil and gas lease, imagine

an individual receiving a fee simple absolute grant of

land under a land patent. Under the common law ad coleum

doctrine, that person would own the surface of the land,

all of the space above it, and everything below it, including

the mineral estate.3 Before the execution of an oil and

gas lease, the owner would possess the entire "bundle of

sticks" in the mineral estate, i.e., the rights to: (1) execute

an oil and gas lease; (2) receive bonus for executing a lease;

(3) receive delay rental payments; (4) receive royalty

payments; and (5) produce oil and gas from the property

(including necessary rights of ingress and egress).4

Given the amount of expense and expertise necessary

to profitably produce oil and gas, mineral owners typically

convey the right to produce, known as the working interest,

to an experienced operator via an oil and gas lease.

While "lease" carries the connotation of granting a limited

right of possession for a defined period of time, an oil and

gas lease effectuates a fee simple determinable conveyance

of the working interest to the lessee.5 Given the

conveyance's determinable nature, in theory this transfer

could last into perpetuity or, typically, terminate upon

the occurrence of some future condition, thus causing the

working interest to revert to the mineral owner.6

By acquiring the working interest, the lessee gains the

right to a net revenue interest from hydrocarbon production.

7 This is typically 100 percent less the value of the

royalty interest retained by the lessor.8 Since the lessee

bears all production and operating costs, it may assign a

portion of the working interest to other operators or

investors in order to gain capital.9 In such a case, a joint

operating agreement may be necessary to outline cost

participation guidelines and other rights and obligations

between the leasehold owners.10

Generally, a lessee has a two- to three-year period, known

as the primary term, during which to drill and attain profitable

mineral production to avoid termination of the

lease.11 Given the great cost associated with drilling wells,

lessees with an excess of leased acreage may participate in

farmout agreements, term assignments, or area of mutual

interest agreements with other operators.12 These tools

allow lessees to retain some interest in production while

bearing less cost.13

If profitable production is accomplished at the end of the

primary term, the lease is then "held by production" into

the secondary term and, generally, will terminate if and

when oil and gas production ceases, either totally or profitably.

14 If production is not attained by the end of the primary

term or ceases during the secondary term, certain

savings provisions, such as a shut-in royalty clause, a dryhole

clause, or an operations clause, may perpetuate the lease untill

production begins or resumes.15 Given that an oil

and gas lease contains many terms of varying effect, it is

important to advise all parties as to whether an obligation is

a covenant giving rise solely to money damages in the event

of a breach or whether it is a condition, which, if not complied

with by the lessee, could result in lease termination.16


THE ROYALTY INTEREST

Once a lease is executed, the lessor retains the royalty

interest.17 This allows the lessor to receive a fraction of

mineral production revenue free from drilling and operating

expenses.18 Lessees typically send royalty owners division

orders seeking agreement as to the fraction owed.19

While terminable by either party at any time, signed division

orders generally shield the lessee from claims of misallocation

of royalty payments.20

Royalty owners may have claims that their payments

are misallocated,21 not timely,22 incorrectly include deductions

for production costs,23 or not properly based on fair

market value at the time and place of sale.24 Despite the

typically unsophisticated nature of royalty owners, Texas

courts have maintained that royalty owners have a duty

to discover most payment issues within the applicable

four-year limitations period.25 When advising royalty owners,

one must stress the need for constant diligence so

they are not left begging for the rare application of the

discovery rule.26


SURFACE ISSUES

Oftentimes the mineral owner is also the surface

owner.27 Under Texas law, the mineral estate is dominant,

and, thus, a mineral lessee has the right to use so much of

the surface as is reasonably necessary to access the mineral

estate.28 This can include building new roads, utilizing

sand or caliche, accessing the property at unknown times,

or even injecting disposed salt water back into the land.29

Surface use agreements may be necessary to define land

usage parameters and lay out applicable surface damages.30

It is important to remember, however, that no surface use

agreement is better than a bad surface use agreement.

Ultimately, as with many oil and gas disputes, the exercise

of common courtesy between each stick owner is usually

the best means of avoiding any slinging of stones or

breaking of bones.31

NOTES

1. See Martin S. Raymon & William L. Leffler, Oil and Gas Production in

Nontechnical Language, 10-16, 216-18 (3d ed. 2006).

2. See id.

3. See 2 William Blackstone, Commentaries on the Law of England 18

(William Draper Lewis ed., 1902).

4. French v. Chevron U.S.A. Inc., 896 S.W.2d 795, 797 (Tex. 1995).

5. Jupiter Oil Co. v. Snow, 819 S.W.2d 466, 468 (Tex. 1991).

6. See id.

texasbar.com/tbj Vol. 76, No. 4 • Texas Bar Journal 320

7. See Paradigm Oil Inc. v. Retamco Operating Inc., 372 S.W.3d 177, 181 &

n.2 (Tex. 2012).

8. Concord Oil Co. v. Penzoil Exploration and Prod. Co., 966 S.W.2d 451,

460 (Tex. 1998).

9. See, e.g., Berchelmann v. Western Co., 363 S.W.2d 875 (Tex. Civ. App.--

El Paso 1962, writ ref'd n.r.e.); Smith v. L.D. Burns Drilling Co., 852

S.W.2d 40 (Tex. App.--Waco 1993, writ denied); Lavy v. Pitts, 29

S.W.3d 353 (Tex. App.--Eastland 2000, pet denied); Mulvey v. Mobil

Producing Tex. & N.M. Inc., 147 S.W.3d 594 (Tex. App.--Corpus

Christi 2004, pet. denied).

10. Yates Energy Corp. v. Enerquest Oil and Gas, L.L.C., 2005 WL 1530510,

*1 (Tex. App.--Corpus Christi 2005, no pet.).

11. King v. Swanson, 291 S.W.2d 773, 776 (Tex. Civ. App.--Eastland 1956,

no writ).

12. See Young Refining Corp. v. Penzoil Co., 46 S.W.3d 380, 389 (Tex.

App.--Houston [1st Dist.] 2001, pet. denied).

13. Id.

14. Anadarko Petroleum Corp. v. Thompson, 94 S.W.3d 550, 554 (Tex. 2002).

15. Krabbe v. Anadarko Petroleum Corp., 46 S.W.3d 308, 316 (Tex. App.--

Amarillo 2001, pet. denied).

16. See Rogers v. Ricane Enters. Inc., 772 S.W.2d 76, 79 (Tex. 1989).

17. See Alamo Nat'l Bank v. Hurd, 485 S.W.2d 335, 338 (Tex. Civ. App.--

San Antonio 1972, writ ref'd n.r.e.).

18. Id.

19. Gavenda v. Strata Energy Inc., 705 S.W.2d 690, 691 (Tex. 1986).

20. See id.; see also Tex. Nat. Res. Code Ann. § 91.402(g) (Vernon 2012).

21. Coghill v. Griffith, 358 S.W.3d 834, 838 (Tex. App.--Tyler 2012, pet.

denied).

22. Tex. Nat. Res. Code Ann. § 91.402(a).

23. Hurd, 485 S.W.2d at 338.

24. Yzaguirre v. KCS Resources Inc., 53 S.W.3d 368, 372-73 (Tex. 2001).

25. Wagner & Brown Ltd. v. Horwood, 58 S.W.3d 732, 734-737 (Tex. 2001).

26. See id.

27. In our example, if the mineral owner were to convey the property yet

reserve the entire mineral interest, this would effectuate a severance of

the surface and mineral estate such that the surface owner and mineral

owner would be different persons. Flag-Redfern Oil Co. v. Humble Exploration

Co. Inc., 744 S.W.2d 6, 8 (Tex. 1987).

28. This principle is limited by the accommodation doctrine in relation to

certain preexisting surface uses. Getty Oil v. Jones, 470 S.W.2d 618, 621-

22 (Tex. 1971).

29. See, e.g., Brown v. Lundell, 344 S.W.2d 863 (Tex. 1961); Humble Oil &

Refining Co. v. Williams, 420 S.W.2d 133 (Tex. 1967); Sun Oil Co. v.

Whitaker, 483 S.W.2d 808 (Tex. 1972); TDC Eng'g Inc. v. Dunlap, 686

S.W.2d 346 (Tex. App.--Eastland 1985, writ ref'd n.r.e.).

30. See University of Texas Field Manual of Required Operating Procedures

for Oil & Gas Leases, utlands.utsystem.edu/forms/pdfs/FieldManual.pdf

(last visited Jan. 31, 2013); see also University of Texas Rate and Damage

Schedule, utlands.utsystem.edu/forms/pdfs/Rate_Damage_Schedule.pdf

(last visited Jan. 31, 2013).

31. See Harper Estes & Doug Prieto, Contracts as Fences, Texas Bar Journal,

May 2010, 378-87.



DEREK COOK

is an associate in the trial section of Lynch, Chappell & Alsup, P.C.,

in Midland. His practice is concentrated in the areas of oil and gas

and commercial litigation.



JENNIE K. MARTIN

is an associate in the oil and gas section of Lynch, Chappell &

Alsup, P.C., in Midland. Her practice is concentrated in the preparation of title opinions and the acquisitions and divestitures of oil and

gas properties.


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