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.
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
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
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,
12. See Young Refining Corp. v. Penzoil Co., 46 S.W.3d 380, 389 (Tex.
App.--Houston [1st Dist.] 2001, pet. denied).
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.).
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.
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
(last visited Jan. 31, 2013).
31. See Harper Estes & Doug Prieto, Contracts as Fences, Texas Bar Journal,
May 2010, 378-87.
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
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