OIL AND GAS

Here is a basic overview of some of the key terms associated with oil and gas leasing in Texas. Since, property rights governing leases varies from state to state, this information may not apply in all states. Mineral and Surface Estates: It is best to think of property rights as a bundle of sticks, where each stick is a right that can be bought and sold separately or together.

Often, the surface owner owns every thing above (until you get to the point of right of ways for airplanes, etc) and everything below his property (which includes the mineral estate). However, a landowner may sell the rights to the mineral estate or everything below the surface and retain the surface estate and everything above. Similarly, he could sell the surface estate and retain his rights to the mineral estate. The point at which this happens is called severance, where the surface and mineral estates are severed from each other and become two separate pieces of property that can be conveyed in their own right. If the property has never been severed, the mineral and surface estate are owned by the same owner and upon sale, it is assumed that both surface and mineral rights are being sold unless otherwise stated in the deed.

Once the mineral and surface estate have been severed we think of the surface estate as being the subservient estate and the mineral estate being the dominant estate. This implies that the mineral owner in most circumstances has a right to access his estate and get the benefits of his estate even if that means the surface owner may incur damages. Complex court cases determine the boundaries of what the surface estate owner must endure, and when and how much the mineral estate owner must compensate the surface owner for damages to his property.

 

Mineral Estate:

When we think of the mineral estate we can think of several important rights in our bundle of sticks that go under this estate. Remember these rights may be owned by different people and can be bought and sold independently of each other.

  • Right to ingress/egress
  • Right to lease- executive right
  • Right to receive bonus
  • Right to receive delay rentals
  • Right to receive royalties

Leases:

In the past, leases followed the standard “Producers 88” lease form. However, today inserting provisions and adding addendums to the standard form is the norm and more commonly people are shifting away from the Producers 88. This is in large part because of the increased sophistication of landowners and executive right owners that are demanding more protections for their interests and negotiating harder on the specifics of each lease. Issues and disputes between landowners and operators can often lead to temporary injunctions or restraining orders, and in some cases more complex litigation.

 

A Few Examples of Lease Issues:

  • Know the market rates for bonus and royalty. This often depends on the level of interest in the area as well as current prices. It is important to keep in mind that the operator/lessee will generally want to maintain at least 75% to maintain enough room for future assignment. Without, this the operator may lose enough negotiating power to make the lease profitable
  • Retained Acreage Provision (Pugh Clause). This clause spells out what happens to the portion of the acreage under the lease that does not either contain a well or is not included within a producing petroleum pool or unit. Typically only acreage around active wells and to a certain depth around active wells is maintained under the lease. This is used as a strategy to prevent one well from keeping the whole property from being developed.
  • Shut in Royalties. Shut ins limit the amount of time that a shut in well can hold the lease. Shut in wells that are capable of producing but are “shut in” or not active for any number of reasons such as the current market price. Shut in royalties paid to the lessor under the lease allow the lessee to hold the lease until favorable conditions to operate the well.
  • Pooling. This is important as it allows the operator to form a drilling unit. However, the pooling clause should be in all of the leases covered by the unit. This can be a positive or a negative for the royalty owner. If you are a royalty owner and you have a tract with no well you may be entitled to royalty from an adjoining tract. However, if you are a royalty owner and you have a tract with a well your royalty may be diluted by surrounding pooled properties in the same unit. Texas law requires a certain minimum acreage for pooling.

Implied Covenants:

There are a set of implied covenants that are typically implied under a lease that can lead to litigation:

  • Duty to further develop
  • Duty to protect from damage
  • Duty to reasonably market
  • Other Duties- Duties can be implied to effectuate the purposes of the lease.

 

These issues surrounding implied covenants are often resolved out of court often due to the presence of an election of remedies clause in the original form leases. Leases without this clause can open the door for liability in breach of implied duty cases.