Oil & Gas

Question 1

A landowner who owns the land in fee simple absolute owns two separate estates. What are they?

Answer 1

1) Surface Estate

2) Mineral Estate

Question 2

How much did a landowner own at common law?

Answer 2

The AD COELUM DOCTRINE states that the owner owns the airspace above the surface, and all the subsurface to the center of the Earth.

Question 3

Can the surface estate and the mineral estate be split?

Answer 3

Yes. They can be severed.

Question 4

What is the Texas rule as to what a landowner owns?

Answer 4

OWNERSHIP-IN-PLACE THEORY - Texas follows this. Provides that mineral interest owners actually own the minerals under their tract; but, ownership is subject to the RULE OF CAPTURE.

Question 5

What is the Rule of Capture?

Answer 5

States that anyone who LEGALLY OR LAWFULLY drills on their own property owns ALL MINERALS THAT ARE PRODUCED from their well (INCLUDING MINERALS THAT MAY HAVE COME FROM ANOTHER’S TRACT).

Question 6

Although the Rule of Capture is the basic rule in Texas, what are its limitations?

Answer 6

1) It does not apply to personal property (oil and gas that has already been extracted);
2) Limited by the doctrine of Correlative Rights - Correlative rights means that everyone is entitled to their FAIR SHARE of production from a reservoir and NO ONE CAN NEGLIGENTLY DAMAGE THE RESERVOIR;
3) Police Power - Governmental, state, and city regulations may also limit the Rule of Capture; AND
4) The Rule of Capture is limited by NEGLIGENCE.

Question 7

T/F - Mineral interests are highly fractionalized and several people can own a mineral interest in the same tract.

Answer 7

True

Question 8

T/F - A conveyance will generally convey the greatest amount possible, unless it is severed or reserved from the conveyance.

Answer 8

True

Thus, a deed conveying real property will pass the entire estate (surface and mineral, including all characteristics) unless it is severed.

Question 9

What are the four characteristics (bundles of sticks) of owning a mineral interest?

Answer 9

1) Executive leasing rights - a mineral owner has the exclusive right to enter into an oil and gas lease to develop the minerals. This does not violate RAP;
2) Exclusive right to develop the minerals under your tract;
3) Ingress and egress - The right of ingress and egress is known as the Dominant Estate Theory, which states that the mineral owner may enter the surface estate and use as much of the surface estate as is REASONABLY NECESSARY to develop the minerals underneath that tract.
4) The right to RECEIVE MONETARY LEASE BENEFITS.

Question 10

What are the limitations on the right of ingress and egress?

Answer 10

1) Reasonableness;
2) Use of the surface tract must benefit the materials DIRECTLY UNDER that surface tract;
3) The terms of the lease; AND
4) THE ACCOMMODATION DOCTRINE

Question 11

What is the Accommodation Doctrine?

Answer 11

States that a mineral interest owner must accommodate the surface owner’s use IF:

1) There is a SUBSTANTIAL interference;
2) With a PRE-EXISTING USE; AND
3) There are ALTERNATIVE METHODS to develop the mineral acreage in question.

Question 12

What is a Royalty interest? What are the different types?

Answer 12

A share in the production FREE OF PRODUCTION COSTS.

The three types are:

1) Landowner Royalty - proportionate share of the gross production of minerals, free of production costs;
2) Non-Participating Royalty (NPRI) - a royalty interest CARVED OUT of the land owner royalty interest (ONLY rights are to royalties / NOTHING ELSE);
3) Overriding Royalty (ORRI) - Carved out of the LESSEE’S REVENUE INTEREST (the oil company’s revenue interest).

Question 13

What is the name of the interest granted to the lessee under the terms of an oil and gas lease? Is it like a royalty interest?

Answer 13

This is the LEASE HOLD INTEREST, also known as the WORKING INTEREST.

It DIFFERS from a royalty interest in that the leasehold interest BEARS ALL COSTS AND RISKS associated with drilling the wells.

Question 14

How does “trespass” operate on a mineral estate.

Answer 14

There are three common instances of trespass in oil and gas law:

1) Ordinary Trespass - unlawful drilling into another’s mineral estate. If minerals are actually produced, then a claim for trespass AND CONVERSION will arise;
2) Slant Well Trespass - drilling from one tract into and under an adjacent tract without permission;
3) Geophysical Trespass - gathering geophysical data DIRECTLY from under the tract without permission.

Question 15

What are the damages that are available for a trespass claim on the mineral estate? What if an oil & gas lease is in place?

Answer 15

The amount of damages for a trespass will depend on whether the trespasser acted in GOOD FAITH OR BAD FAITH:

1) Good Faith - If trespasser has acted in good faith, but has unlawfully produced minerals, then the mineral interest owner would be entitled to receive the FAIR MARKET VALUE of the minerals produced, VALUED AT THE TIME OF THE PRODUCTION. HOWEVER, the good faith TRESPASSER will be entitled to recover the COST TO DRILL THE WELL.
2) Bad Faith - If the trespasser acts in bad faith, then the trespasser shall be liable in the amount equal to the FAIR MARKET VALUE of the minerals produced, VALUED AT THE TIME OF PRODUCTION. The TRESPASSER will NOT BE ENTITLED TO RECOVER THE COSTS TO DRILL THE WELL.

If an Oil & Gas Lease is in place - BOTH the lessor and the lessee have a right to seek monetary damages. A lessor’s remedy is LOST ROYALTIES, while the lessee can sue for the FMV of the oil and gas. BOTH CAN SUE TO EJECT THE TRESPASSER.

Question 16

Define Slander of Title in a mineral rights scenario.

Answer 16

Mineral interest owner must prove FIVE ELEMENTS:

1) Publication;
2) False Statement;
3) Made with MALICE;
4) Causing ECONOMIC LOSS (specific sale); AND
5) The owner has standing

Question 17

How is standing proved in a Slander of Title case?

Answer 17

Owns the mineral interest that was affected.

Question 18

What are the damages recoverable for Slander of Title?

Answer 18

The measure of damages is the DIFFERENCE of the FMV BEFORE SLANDER and the FMV AFTER SLANDER.

Question 19

Explain adverse possession of a mineral estate.

Answer 19

There are two separate rules used in applying adverse possession to the mineral estate:

1) Unsevered Estate - When the minerals and the surface estate are owned by the same person: If the adverse possessor adversely possesses the surface estate, they will obtain the mineral estate at the same time.
2) Severed Estate - When Owner A owns the surface estate and B owns the mineral estate: In order to adversely possess the mineral estate, the adverse possessor must ACTUALLY DRILL AND PRODUCE FOR THE STATUTORY PERIOD OF TIME.

THE DOCTRINE OF RELATION BACK APPLIES!

Question 20

What is the doctrine of Relation Back?

Answer 20

Provides that the title relates back to when the adverse possession began.

Therefore, in order to determine which adverse possession rule to apply, you must look back to when the adverse possession began to determine if the mineral and surface estates were severed at that particular time.

Question 21

Owners of undivided mineral interests in the same tract are called ___________.

Answer 21

Co-tenants

Question 22

What are the rules with regard to co-tenants?

Answer 22

Either party can lease the ENTIRE MINERAL ESTATE WITHOUT THE CONSENT OF THE OTHER PARTY but NOT TO THE EXCLUSION OF THE OTHER PARTY.

Question 23

What if one co-tenant doesn’t consent to the lease by the other co-tenant?

Answer 23

Leasing co-tenant must account to non-consenting co-tenant who is still entitled to a FAIR SHARE of production of the minerals.

Question 24

What does it mean to “account” to the non-consenting co-tenant? What are the non-consenting co-tenant’s options?

Answer 24

Consenting co-tenant is considered a royalty interest owner. The non-consenting co-tenant is not.

Royalty interest owner’s share is free of production costs. The non-consenting co-tenant does NOT retain a royalty, but is a mineral interest owner treated as a WORKING INTEREST OWNER. As such, they must pay their pair share of the cost to drill.

Non-consenting co-tenant has three options:

1) Enter into an oil and gas lease himself and obtain a royalty interest;
2) Ratify the oil and gas lease other co-tenant created and become a royalty interest owner that way; OR
3) Do nothing and be treated as a CARRIED WORKING INTEREST OWNER (meaning he starts paying and receiving after the well pays itself / doesn’t pay anything out of pocket up front until his part of the production costs are paid off).

Question 25

How does successive ownership (life tenant and remainderman) affect an oil & gas lease?

Answer 25

In order to have a valid lease from a life tenant and a remainderman, the oil and gas company must obtain a lease from ALL OF THEM.

Trespass - Because remainderman does not own a possessory interest, the remainderman could not develop because of trespass.

Question 26

What doctrine applies to life tenants of mineral interests with regard to keeping up the property?

Answer 26

DOCTRINE OF WASTE - Because a life estate is temporary, a life tenant CANNOT DAMAGE OR DEVALUE THE LAND.

Question 27

How are proceeds distributed when the lease hold interest is a life estate owner? Is there an exception to the rule?

Answer 27

General rule - If the life tenant and remainderman execute an oil and gas lease, RENTAL PROCEEDS ARE PAID TO THE LIFE TENANT and BONUSES AND ROYALTIES DUE UNDER THE LEASE ARE PAID TO AN INTEREST BEARING ACCOUNT.

The INTEREST off of that account is PAID TO THE LIFE TENANT.

The PRINCIPLE remaining upon the death of the life tenant is PAID TO THE REMAINDERMEN.

EXCEPTION IS THE OPEN MINES DOCTRINE - States that if an oil and gas lease is effective AT THE TIME THE SUCCESSIVE OWNERSHIP IS CREATED, then ALL proceeds under the oil and gas lease are to be PAID TO THE LIFE TENANT for so long as the lease remains effective.

ONCE THE LEASE TERMINATES OR THERE IS AN EXTENSION OF THE EXISTING LEASE (considered a new lease under Texas law), THE GENERAL RULE APPLIES.

Question 28

Co-tenants have a legal right to partition. What is required to partition?

Answer 28

1) Joint ownership;
2) Possessory interests;
3) Equal dignity (same type of interest / not quantity); AND
4) The ownership must exists throughout the entire tract.

Question 29

What are a court’s options when co-tenants want to partition?

Answer 29

1) Partition in kind - equal tracts (generally applies to undeveloped tracts) OR checkerboard (generally applies to larger tracts;
2) Partition in sale - if the land is PRODUCTIVE or there is evidence that a FAIR DIVISION CANNOT BE MADE.

Question 30

How do liens affect a mineral estate?

Answer 30

If a lien attaches prior to the mineral estate being severed from the surface estate (an oil and gas lease is a severance), then the lien will be considered SUPERIOR to the lease.

Example: If bank forecloses on Blackacre, and the oil and gas lease was taken after the date of the lien, the lease does not affect Blackacre.

Question 31

How does a lessee protect its lease against a superior lien?

Answer 31

The lessee must obtain a SUBORDINATION AGREEMENT from the lien holder.

Question 32

When an oil & gas company pays the owner of the land a royalty in order to use the land, what does the oil & gas company have?

Answer 32

They retain the mineral interest.

Question 33

T/F - An oil & gas lease, unlike a landlord-tenant lease, is a conveyance.

Answer 33

True.

It conveys a mineral interest to the lessee oil and gas company. It is a FEE SIMPLE DETERMINABLE conveyance. This means that the lessee becomes the owner of the mineral estate, while the lessor retains a POSSIBILITY OF REVERTER in the mineral estate.

Question 34

What is the granting clause?

Answer 34

Identifies the interest being granted and provides a physical legal description of the property.

Question 35

If a lease conveys “oil, gas, and other minerals,” what might be an issue?

Answer 35

The definition of “other minerals” needs to be determined.

Question 36

How are “other minerals” defined?

Answer 36

KNOW THIS DATE

LEASES PRIOR TO JUNE 8, 1983 - Texas uses the SURFACE DESTRUCTION TEST to determine which minerals were owned by the mineral owner and surface owner. Here, if the minerals are NEAR THE SURFACE (200 feet has been held to be near), and if extracting the minerals would cause the surface estate to be DESTROYED, then those minerals are considered part of the surface estate.

LEASES ON AND AFTER JUNE 8, 1983 - Texas uses the PLAIN AND ORDINARY MEANING TEST stating that if the substance is a mineral by the plain meaning of the word, then it belongs to the mineral estate.

EXCEPTIONS TO THE PLAIN AND ORDINARY MEANING TEST - IF:

1) The minerals are either: water, sand, gravel, building stone, limestone, clay, or surface shale; OR
2) The minerals are near the surface (no bright line rule, 200 feet has been held “near the surface”) lignite, iron, or coal;

THEN, THOSE MINERALS STILL BELONG TO THE SURFACE.

Question 37

What is a Mother Hubbard Clause? What is its effect?

Answer 37

Grants an interest in a piece of land (e.g., adjacent tract) that was not physically described in the conveyance.

Example - “I hereby lease to you the oil, gas, and other minerals under Blackacre, as weell as all of my tracts adjacent to blackacre.

No matter HOW BROAD the Mother Hubbard Clause is written, courts will ONLY construe the provision as pertaining to SMALL STRIPS OF LAND CONTIGUOUS AND ADJACENT to the described tract which were mistakenly omitted from the legal description.

Ex: A 50 acre tract won’t stick, but a 10 acre tract might.

Question 38

What is a Habendum Clause?

Answer 38

This provision establishes the DURATION of the lease (when it will terminate) and creates two terms - the primary and secondary terms.

The term “for so long as” creates the determinable fee. That is the secondary term.

The stated number of years in the habendum clause is known as the primary term.

Absent other provisions in the lease, the only way a lessee can maintain the lease in its secondary term is to actually produce minerals IN PAYING QUANTITIES.

Question 39

What does “produced” mean? What is “paying quantities?”

Answer 39

Actually PRODUCED AND MARKETED. The determination of “paying quantities” is subject to a TWO-PART TEST:

1) Litmus Test: Do the oil and gas company’s proceeds EXCEED their operating costs (breaking even) over a REASONABLE PERIOD OF TIME (no bright line rule / 12 months has been reasonable)? If yes, then PPQ. If no, then go to the SECOND part of the test;
2) Objective Test: Would a REASONABLY PRUDENT OPERATOR continue to operate the well AT A LOSS for reasons OTHER THAN MERE SPECULATION? If yes, then PPQ. If no, then the lease TERMINATES per the Habendum Clause.

Question 40

What is a Delay Rental Clause? When does it apply?

Answer 40

The Delay Rental provision says that the owner is leasing the property to the oil and gas company which requires them to drill a well quickly.

The Delay Rental Clause applies ONLY TO THE PRIMARY TERM.

The Delay Rental Clause is a condition. Breach of a condition is AUTOMATIC TERMINATION of an oil and gas lease (must pay the right amount within the right time or lose the oil and gas lease).

Question 41

What is an “Engaged in Operations” clause?

Answer 41

If the oil and gas company is engaged in operations, even though they are not actually producing, they are able to maintain the lease AS LONG AS the operations are in GOOD FAITH AND DILIGENT PURSUIT (usually limited in time) to obtain production.

This acts as a SAVINGS CLAUSE because it saves the lease from terminating based upon the Habendum clause.

Question 42

What is a Dry Hole Provision?

Answer 42

If you are engaged in operations, and that particular well does not produce oil and gas, you have X AMOUNT OF DAYS TO COMMENCE OPERATIONS on another well.

Question 43

What is a Temporary Cessation of Production?

Answer 43

ALWAYS IMPLIED IN AN OIL AND GAS LEASE. Every well will have a time where it ceases production (whether by mechanical failure or other reason.

If there is an EXPRESS PROVISION, you have X AMOUNT OF DAYS TO BEGIN REPRODUCTION.

If there is NOT AN EXPRESS PROVISION, the oil and gas company has a REASONABLE AMOUNT OF TIME TO PURSUE PRODUCTION (must do so DILIGENTLY).

Question 44

What is Force Majeure?

Answer 44

A provision that maintains the lease when the lessee is prevented from operating under the lease DUE TO AN ACT OF GOD OR SOME OTHER EVENT out of the control of the oil and gas company

NOT IMPLIED. YOU MUST HAVE AN EXPRESS PROVISION FOR THIS TO APPLY.

ONLY APPLIES TO PRODUCTION - DOESN’T APPLY TO THINGS LIKE DELAY RENTAL PAYMENTS.

Question 45

What is a Shut-in Clause?

Answer 45

Allows the lessee to maintain the lease if it pays a “shut-in royalty” to stop producing a well WHICH IS CAPABLE OF PRODUCING. This acts as a savings clause.

CAN BE DRAFTED AS A CONDITION OR COVENANT.

“Unless” = Condition

Breach of a condition = automatic termination of the lease.

Breach of a covenant = MONETARY DAMAGES.

Question 46

What is “pooling?”

Answer 46

Mineral interests of one owner are pooled together with those of another. MUST HAVE TWO OR MORE TRACTS. This serves as a savings clause.

Question 47

What is a “pugh clause?”

Answer 47

In Texas, a production on any portion of the leased premises will maintain the entire lease as to all the acreage under the lease, UNLESS a Pugh clause is included.

Under a Pugh clause, production on the pooled unit may maintain ONLY the portion of the leased premises that are included in the pooled unit.

Question 48

What is an “entireties clause?”

Answer 48

If the original owner of a particular tract enters into an oil and gas lease and then that tract is later subdivided, if the oil and gas company drills on a particular subdivided tract, the owner of that particular tract would be entitled to ALL of the royalties IF THERE WERE NO ENTIRETIES CLAUSE.

Question 49

What is a “royalties clause?” Can they vary in how royalties are calculated?

Answer 49

Provides a share in the proceeds FREE OF PRODUCTION COSTS. Most of the time, it is drafted as a covenant instead of a condition.

AMOUNT REALIZED vs MARKET VALUE

1) Some value the amount of the royalties based on the amount realized by the oil and gas company.
2) Others use a “market value at the well” royalty provision. The question here is “what would a reasonably prudent purchaser pay for it at the well?”

IF the minerals are not being sold directly at the wellhead or within the vicinity of the well, a court will look at THREE FACTORS TO DETERMINE THE MARKET VALUE:

1) Other direct sales;
2) Comparable sales of the same QUALITY of gas in the VICINITY of that well;
3) Netback Method: Take the market value at the actual point of the sale and DEDUCT the amount of money it costs to get the minerals from the wellhead to the actual point of sale (these are post-production costs).

Question 50

What are “division orders?”

Answer 50

Piece of paper given to the landowner that states what the oil and gas company believes that the landowner is due.

THIS IS AN ACTUAL AGREEMENT to determine the amount the landowner will get paid.

IT IS BINDING BUT REVOCABLE IF THE RI HOLDER LATER DECIDES HE IS OWED MORE.

Question 51

What are warranty provisions in an oil & gas lease?

Answer 51

THREE TYPES:

1) General Warranty - warrants title against ANY problem throughout the chain of title;
2) Special warranty - warrants title by, through, and under the grantor only; and
3) No warranties provision.

Question 52

What is a “change of ownership provision?”

Answer 52

Benefits oil and gas company. Oil and gas company will pay the royalties until they receive NOTICE of a change of ownership.

Question 53

What is a “notice to cure provision?”

Answer 53

Owner must provide notice to cure a breach to the oil and gas company, and they are given a reasonable amount of time to cure. Note that this provision does NOT apply to conditions.

Question 54

What is a “proportionate reduction provision?”

Answer 54

Important to the oil and gas company. Most oil and gas leases purport to cover 100% of the mineral estate in the lease. A proportionate reduction provision says the the monetary benefits under the lease will be REDUCED PROPORTIONALLY to the amount that is actually owned.

Example: If A owns a 1/2 interest and leases to the OG company and there is a provision like this in the lease, then all monetary benefits due to A would be proportionately reduced by 1/2. If there is no provision, then A would be entitled to the ENTIRE royalty.

Question 55

What is a “subrogation provision?”

Answer 55

If there is an outstanding lien against the property, the oil and gas company has the right to pay off the lien or not and subrogate its interest and step into the shoes of the lienholder.

Question 56

What is a “separate ownership provision?”

Answer 56

Oil and gas company wants to assign a percentage of ownership of property to another oil and gas company.

If this exists, when the lease is divided, that oil and gas company is only responsible for the acreage that they own. The other oil and gas company would be responsible for the other acres.

Question 57

What is an “equipment removal provision?”

Answer 57

If the lease expires, the oil and gas company would have X months to get the equipment off the premises.

Question 58

What is a “surrender clause?”

Answer 58

Allows the oil and gas company to release any portion or the entire lease at ANY time.

Question 59

Are there implied covenants in an oil and gas lease? THIS IS HEAVILY TESTED ON THE BAR EXAM.

Answer 59

THERE IS ALWAYS A BASIC COVENANT TO ACT IN GOOD FAITH.

The standard is a REASONABLY PRUDENT OPERATOR.

THERE ARE SIX IMPLIED COVENANTS IN AN OIL AND GAS LEASE:

1) Covenant to Protect Against Drainage - If the landowner can prove the following, then the oil and gas company must protect against drainage: (a) substantial drainage; (b) reasonably prudent operator would drill to protect aginst drainage (off-setting well); AND (c) damages for failure to do so.
2) Covenant to Market - Once oil and gas is discovered, every oil and gas company MUST market for the prevailing market price.
3) Covenant to Fully Develop - Once you discover oil or gas, you MUST act as a REASONABLY PRUDENT OPERATOR and fully develop the tract.
4) Covenant to Test - ONLY APPLIES IF there is no delay rental provision and no substitute for a delay rental provision (paid-up provision, which provides that all rentals have been paid up front). Within a reasonable time of executing the lease, the company will at least test the property for minerals.
5) Covenant to Further Explore - If oil or gas is discovered under a particular tract, the oil and gas company has an implied duty to explore for other sources of oil or gas. TEXAS DOES NOT RECOGNIZE THIS IMPLIED COVENANT. It is instead treated as part of the covenant to Fully Develop.
6) Covenant to Operate Diligently and Properly - Catch-all category.

Question 60

What are the remedies for breach of an implied covenant?

Answer 60

Courts PREFER MONETARY DAMAGES as a remedy.

HOWEVER, the landowner MUST give the oil and gas company NOTICE TO CURE.

If notice is given and still no cure, the court MAY award termination of the lease.

Question 61

Distinguish a mineral interest from a royalty interest.

Answer 61

Language that identifies a mineral interest reserves or conveys an interest in the rock itself. “Into and under” is language that conveys a a mineral interest.

Language that conveys an interest in production conveys a royalty interest.

IF the document COMBINES the conveyances, it is considered a MINERAL INTEREST. A mineral interest owns the bundle of sticks (leasing, develop, ingress and egress, receive monetary benefits).

A royalty interest is only an interest in the royalty itself, a right to receive a percentage of the production, free of production costs.

Question 62

Within the rights of a mineral interest owner, what does the right to receive monetary benefits include?

Answer 62

Includes delay rentals, shut-in payments, royalties, and bonus payments (the amount of money paid up front to the landowner for signing the lease).

Question 63

What is the difference between “of” language and “out of” language in determining fractional royalty interests?

Answer 63

“OF” - MULTIPLY. Ex: 1/2 of 1/4 is 1/8.

“OUT OF” - SUBTRACT. Ex: 1/4 out of 1/2 = 1/4

Question 64

What happens in the case of an overconveyance? How does this even happen? What is the fix?

Answer 64

When the document purports to reserve or convey more interests than actually exists. CONSTRUCTIVE NOTICE DOES NOT APPLY. Look only to the four corners of the document to determine what is purported to be conveyed.

THE DUHIG DOCTRINE SAVES THE DAY

Duhig Doctrine (“Doctrine of Estoppel”) - The grantor who overconveys an interest because of a reservation is ESTOPPED from claiming the reservation insofar as it is necessary to SATISFY THE GRANT TO THE GRANTEE.

Exam Tip: Take each conveyance chronologically.

Example 1: A owns Blackacre. A conveys Blackacre to B and reserves 1/4 mineral interests. B then conveys to C and reserves a 1/4 mineral interest and does NOT mention A’s previous 1/4 interest (appears to be conveying 3/4 but means to convey 2/4). Because of DUHIG, B is estopped from his reservation. A keeps his 1/4, and C gets his entire 3/4 interest.

Example 2: Same facts except B reserves 1/8 (appearing to convey 7/8. We take the 1/8 away from B and give it to C, who only has 6/8 afterwords because of A’s 2/8. C gets less than he thought because B didn’t have enough to satisfy the entire amount.

Question 65

How is a landowner’s royalty interest calculated if there is a non-participating royalty interest?

Answer 65

Mineral interest owned X royalty retained by the lease MINUS any non-participating royalty interest.

Example: A owns 100% of Blackacre and the royalty is 1/8. 100% X 1/8 = 1/8. Thus, A’s landowner royalty would be 1/8. If there is also a NPRI that is 1/16, then A’s royalty will be 1/16.

Question 66

How is the working interest calculated?

Answer 66

Take the net revenue interest of the oil and gas company, THEN subtract the overriding royalty interest, if any (carved out of the working interest).

Question 67

What is “voluntary pooling?”

Answer 67

Pooling is when a lessee combines two or more tracts to create one particular unity (a pooled unit). This gives the oil and gas company flexibility in developing the oil and minerals below the tracts of land.

Pooling serves as a savings provision in that production on ANY TRACT in a pooled unit MAINTAINS THE LEASE on ANY of the pooled tracts.

In the event that the oil and gas company exercises its right to pool, it must do so in GOOD FAITH and get the mineral interest owner’s CONSENT before entering into a pooling agreement.

Courts will STRICTLY CONSTRUE POOLING PROVISIONS and the pooling authority of oil and gas companies.

Question 68

How are royalty interests calculated in a pooled unit?

Answer 68

The royalty interest is proportionally reduced by the number of acres they own on the pooled unit.

Ex: 5 tracts of 20 acres each for a total of 100 acres. All 5 leases call for a 1/8 royalty. Here, all 5 owners own 1/5 of the unit. Multiply 1/5 by 1/8 to get 1/40, which is each owner’s share in the production. The oil and gas company owns the remaining 7/8.

Question 69

What happens in a “community lease?”

Answer 69

If owners of separate tracts sign a single lease covering BOTH their tracts, a pooled unit is AUTOMATICALLY CREATED. Production on EITHER tract is shared among the owners based proportionally on the amount of acreage they own.

Question 70

What is “forced pooling?” What is the purpose?

Answer 70

The Mineral Interest Pooling Act states:

When there are two or more tracts over a single reservoir that cannot agree on a voluntary pooled unity, BOTH tracts are PRODUCTIVE, and one of those owners has either DRILLED OR PROPOSES TO DRILL A WELL, the regulatory authority MAY CREATE A FORCED POOLED UNIT.

Purpose:

1) To prevent waste;
2) To avoid unnecessary drilling of wells; AND
3) To protect correlative rights (everyone’s opportunity to produce their share of gas.

This requires the owners to exhaust all efforts to voluntarily pool before applying for a forced pooled unity.

Question 71

What is “unitization?”

Answer 71

This is a field-wide pooling (i.e., tracts in many different pooled units are combined on a field-wide basis (a producing reservoir)).

Few fields are unitized in Texas.

Pooling and unitization ARE NOT INTERCHANGEABLE TERMS.

Question 72

Who is the regulatory authority for oil and gas operations? What are its main purposes?

Answer 72

The Texas Railroad Commission has authority to create the rules that regulate oil and gas operations in Texas.

Its Purposes:

1) To prevent waste;
2) To avoid drilling of unnecessary wells; and
3) To protect correlative rights.

Question 73

What is the Rule 37 “Spacing Rule?”

Answer 73

There are statewide and field-wide spacing rules. FIELD RULES ALWAYS TRUMP STATEWIDE RULES.

Rule 37 is a statewide spacing rule providing that:

1) A producing well must be 467 feet from a lease line or from un-leased lines.
2) A producing well must be 1200 feet from another producing well.

EXCEPTION:

1) An oil and gas company can file an exception with the RRC;
2) Notice to affected parties; and
3) Have a hearing.

AGAIN REMEMBER THAT FIELD-WIDE RULES TRUMP STATE RULES!!!!

Question 74

What is the Rule 38 “Density Rule?”

Answer 74

Rule 38 is a statewide density rule stating that at least 40 ACRES must be attributable to each well drilled.

EXCEPTION - Everyone, even those owning less than 40 acres, are entitled to drill a well as long as the tract does not violate the VOLUNTARY SUBDIVISION RULE.

Question 75

How is the Voluntary Subdivision Rule violated?

Answer 75

THREE WAYS:

1) If a less-than-40-acre tract is trying to get the exception was a larger tract at the time that oil and gas was DISCOVERED AND PRODUCED, and later became SUBDIVIDED, that is a voluntary subdivision and violates the voluntary subdivision rule;
2) The particular tract was subdivided by an oil and gas lease, OR
3) The larger tract was subdivided for the sole purpose of circumventing Rule 38. This is true EVEN IF IT IS BEFORE oil and gas is found.

Question 76

What does “allowable” mean with regard to oil production?What happens if you are granted an exception under Rule 38?

Answer 76

Allowable: Formula that says how much each well can produce in a particular field. It is based on “acreage attributable to a particular well.

Example 1: The allowable for a 320-acre tract is one million MCF per month. If someone owns 160 acres, they are allowed to produce 1/2 of that allowable formula (500,000 MCF)

If granted an exception under rule 38, you are still subject to the allowable formula.

Example 2: 10-acre tract with Rule 38 exception. 320-acre tract is allowed one million MCF per month. 10/320 = 1/32. Thus, the production allowed is 1/32 of 1,000,000 MCF per month for the 10-acre tract.

Question 77

How is a well classified (oil or gas)?

Answer 77

Depends on the ratio of oil and gas that is produced.

Question 78

What specific Environmental Regulations are in play with oil and gas production?

Answer 78

1991 Clean-Up Fund - All operators that drill a well must provide bonds that are paid to the fund in the event that the well is not plugged or abandoned, or there was a spill that needed to be cleaned up. If an operator committed a violation that required the RRC to use the funds within the LAST 5 YEARS, that operator IS BARRED FROM DRILLING ADDITIONAL WELLS.

Relinquishment Act - Applies to ALL PUBLIC LANDS CONVEYED BETWEEN 1895 AND 1931. The Act granted the land but ONLY THE SURFACE RIGHTS. The mineral rights belong to the State of Texas. Meaning 1/16 of the mineral rights go to the State. A surface owner held the minerals as a fiduciary to the State of Texas, but could not convey them in fee. Surface owners could lease the minerals but had to pay a 1/16 royalty to the State. Also, surface owners had to protect against drainage.