Oil and Gas- Spring 2011

I. Oil and Gas Geology

A. Accumulation of Oil and Gas
1. Organic Theory of Origin–generally accepted
2. Accumulation and Occurrence
Things that make up a Petroleum Reservoir (O&G field)
a. carbon and hydrogen from dead life
b. decay and decomposition of C & H to form a mixture of
hydrocarbons (petroleum)
c. porous rock that allows migration of petro and displacement of salt
water
d. trapped oil sealed by salt water that forms a reservoir
3. Oil and Gas Segregation
- gas is at the top, oil, then salt water
4. Reservoir Rock –very poruous and all the gas and oil is held in the
pores
5. Geological types of Reservoirs
a. Dome and Anticlines
b. Fault Traps –due to mvmt under the earth oil is trapped by
c. Unconformities –oil moves into another impermeable rock
d. Dome and plug traps
e. Reef Traps
f. Combination traps
B. Types of Production Processes
1. Conservation: Preventing waste and protecting correlative rights
a. Common Law of Capture

2. Types of Production Processes

- oil can’t move and lift itself so it is dependant on gas or salt water
under high pressure to force oil upward through wells

3. Gas Drive Reservoirs –gas will expand when pressure is reduced

a. solution-gas drive
- least effective
- max 10 to 25% oil
b. gas-cap drive
- more effective
- max 25 to 50%
Gas-condensate reservoir
-deep and under high pressure
-cannot be produced rapidly and underground pressure must
be maintained or gas will liquify
 4. Water Drive Reservoirs
-water under pressure can life oil and gas
-most efficient
-30-50% oil –up to 70%
-Depends on:
i. physical nature of reservoir rock and of oil
ii. care in completing well
iii. rate of oil and gas production from field or reservoir as a
whole
C. Drilling a Well
1. The Drilling Rig and Related Equipment
Components:
a. power
b. housing
c. rotating
d. circulating
2. Making Hole
a. making a connection
b. surface casing concerns
i. groundwater pollution
ii. loss of a hole
iii. loss or damage to equipment
iv. is a must if:
1. drill bit change
2. equip. lost down hole
3. well tests
4. drill pipe and collars are detached and hoisted out of
ground and stored vertically on derrick
c. production casing
3. Testing and Completion
1. to chose a casing point:
a. give up and plug well based on
indicators OR
b. completion attempt
II. Ownership
A. Land Descriptions –fed. “rectangular surveying system
1. Equal Footing Doctrine of U.S. Constitution –lots can be surveyed
under streams and lakes or “navigable waters”
- unsurveyed water drew water lines for property along bank or
shore
- called meander lines describing riparian or littoral lands
B. The Law of Capture: Ownership Prior to and at Extraction
1. Del Monte and Milling Co. v. Last Chance Mining and Milling Co.
 Issue: whether the appellee has the right to follow a vein of silver
and lead-bearing ore beyond the western boundary of its mining
claim on federal public land and beneath the surface of the
appellant’s mining claim on federal public land
Rule: Whoever had the fee of the soil owned all below the surface
Principle: To whomsoever the soil belongs, he owns also to the sky
and to the depths; Private ownership of Oil and Gas –ownership of
land carries w/ it the use of its minerals sovereign state can’t
interfere except for public benefit through severance tax.
2. Kelly v. Ohio Oil Co.-Issue: Did the oil company have legal right to
drill the wells? Principle: The right to acquire, own, and enjoy
property carries w/ it the right to use it as the owner pleases—motive
doesn’t matter; Rule: No cause of action exists if one property
owner drills w/in their own property. Rule: A neighbor does not
have to approve a landowner’s reasonable use of his property
everytime that owner decides to make an improvement. Rule of
Capture: The landowner who extracts oil or gas from beneath his
land acquires absolute ownership of those extracted substances even
though they may be drained from beneath the land of another. Held:
Ct. held Kelly had no cause of action. Whatever gets into the well
belongs to the owner of the well (rule of capture). However, subject
to following O&G regulations
D. Theories of Ownership
Examples:
1. ownership in place: TX – landowner owns all substances including o&g
which underlie his land – qualified by law of capture
2. exclusive right to take: OK- landowner does not own the o&g which
underlie his land – merely has exclusive right to capture by means of
operations on his land
E. Ownership of Oil and Gas after Extraction
1. Champlin Exploration Inc. v. Western Bridge & Steel
Issue: Are refined hydrocarbons subject to the law of capture?
Held: The owner of refined hydrocarbons does not, ipso facto, lose
title to escaped hydrocarbons unless it can be shown that he
abandoned them;Rule: Once O&G are extracted from the earth,
they become personal property; Held: Once O&G is extracted from
the earth, it becomes tangible, personal property and subject to
ownership. He did not abandon.
2. Texas American Energy Corp. v. Citizens Fidelity Bank & Trust
Issue: Whether the gas storage is personal property or whether
stored gas is a real estate interest (which would have a real estate
mortgage as an encumbrance). Held: Not controlled by Hammonds,
stored gas is personal property as “goods” under UCC. Narrowly
 construed Hammonds. It doesn’t lose its personal property quality
when you inject it in a proper storage reservoir. Once out gas back
into ground for storage still personal property but court said must
be put into storage facility and not injected back into the earth-
“reservoirs capable of being defined with certainty and the integrity
of said reservoirs is capable of being maintained” –if not stored
properly, then considered abandoned -if in storage tank and
escapes, if attempt to reclaim, owner will not lose title – if no
attempt to reclaim, then owner is deemed to have abandoned
3. Ellis v. Arkansas Louisiana Gas Co. - Unauthorized use by the gas
company of an underground strata for storage of natural gas (only
persuasive in OK) when have severed estate, and gas company is seeking
permission to store gas in empty reservoir, must get permission from the
surface owner b/c once porous space drained, mineral owner has no
rights- still best to get permission from both mineral and surface owners In
OK, utility company permitted by statute to condemn land for storage
purposes
Rule: One who reinjects gas or water into a reservoir loses ownership of
the reinjection, the D cannot be held liable for trespass or damages;
Reasoning: (1) The power to grant storage rights should be in the mineral
interest owners. The owner of the severed mineral interest is like a license
to hunt or fish. (2) If A owns a tract of land in fee simple and conveys to B
all of the oil, gas, and other minerals in and under and that may be produced
from that
English view v. American view –The cavern is owned by surface owners—
Applies to depleted gas reservoir; Held: This is persuasive, but not a
binding opinion. As a practical matter get both surface and mineral owners.
The surface owner alone should be compensated for use per se of a stratum.
F. Correlative Rights –Conduct Permitted in the Extractive Process
Kinds of Oil and Gas Interests
1. People’s Gas Co. v. Tyner
Facts: Tyner seeks an injunction agst. oil company shooting
nitroglycerin through a gas well
a. public road proximity to residence
b. highly explosive and could destroy life or property
Owner has the right to do as he pleases but he must have due regard
for others – owner of a lot may not erect and maintain nuisance on
lot by which neighbors could be injured – if he does and injury is
sustained, can get injunction if can’t be adequately compensated in
damages
Rule Maxim: Land always extends downward as well as upwards so
that whatever is in a direct line btwn. the surface of any land and the
center of the earth belongs to the owner of the surface
 2. Wronski v. Sun Oil Co. –O&G conservation acts and regs limit right
to capture; Facts: P’s claim that sun oil overproduced oil from 3
wells and that oil was drained from P’s tracts
fair share principle: places limits on the rule of capture to exclude
operations in violation of conservation orders - each owner of the
surface is entitled to his equitable and ratable share of recoverable
o&g in common pool in proportion to recoverable reserves
underlying land – 2 alternate methods for figuring damages: (1)
harsh = willful trespassers liable for enhanced value at time of
conversion (2) mild = innocent trespassers liable for value of oil as
valued when undisturbed
3. Correlative rights –the shared rights and duties of all landowners in
the common source of supply
a. Eliff v. Texon Drilling Co.
i. Law of capture is limited by correlative rights doctrine
–ex. of spoiling
ii. Duties:
1. Don’t waste!
2. Don’t spoil! –must do little fracs so that water
supply is not spoiled
3. Don’t violate conservation regulations
4. Common source of supply –an underground reservoir; All parts of
which are permeably connected so as to permit migration of O&G
when pressure differentials are created by O&G production
G. Kinds of Oil and Gas Interests
1. Mineral interests can be severed from surface interests – can then be
severed and split further
Rights of Severed mineral Owner:
- Right to use the surface in order to exploit mineral interest
- Right to incur costs and retain profits
- Right to alienate
- Right to retain lease benefits
2. Fee simple absolute if A owns Blackacre in fee simple absolute, then
he owns the entire bundle of sticks in the property analogy.
3. Mineral interests – the mineral interest can be severed from the fee
estate by grant or by reservation.
i. By grant, the original owner of the property could convey the
ownership of the mineral estate.
ii. By reservation, the property itself could be conveyed, with the
conveyor reserving the mineral estate to himself.
4. Aspects of severed interest ownership:
 i. The rights of a severed mineral interest owner include the right to
use so much of the surface as is necessary to explore for, develop,
and extract the minerals.
ii. The rights of the severed surface owner are bordered by the rights
just mentioned of the mineral interest owner (its almost like there is
an easement on the property to allow for exercise of mineral interest
owner’s rights). However, the courts often treat the surface owner as
the owner of the vacant pores under the surface, which are often
used for storage of oil and gas or for disposal of salt water.
IV. Conservation
A. Regulatory Measures Modifying and Limiting the Law of Capture
1. Overview of Regulatory Measures Modifying and Limiting the law
of Capture
Spindletop Wells in Pennsylvania everyone was going crazy drilling
all sorts of shit started a "frenzy" all over country.
2. Conservation
Common Abuses
- Too many wells
- Too close together
- Producing wells wide open
Waste
- Fiscal Waste, the waste on top of the land
- Economic Waste: unnecessary development, drilling way too many
wells, incurring unnecessary development costs
3. Because of the madness it was soon decided that oil and gas needs to
be conserved
Problems
- Rule of Capture: Everyone was following the rules
- Migratory Nature of Oil: People didn't really understand the nature
of gas and were afraid it would swim away.
Ultimately, it was decided that it needed to be taken care of in a non
voluntary way
- Conservation legislation started sprouting up
4. Administrative Agencies are in charge
- Environmental Protection Safety; they get power from the
legislature
- APA - Can make decisions as long as they are not arbitrary or
capricious
- Must exhaust remedies through them first
-Regulate 6 Categories
i. Exploration Drilling
ii. well completion, and
iii. plugging
 iv. Production and marketing
v. End Use Unit Operations
vi. Environmental Protection
5. Regulating Drilling, Well Completion, and Plugging
a. Well Permitting
Common Law
- Law of Capture required no permit
Today we need a permit which
- Specifies location
- Depth
- Geological formations
- Usually requires plugging after operation
Permits are to make sure the whole operation is up to snuff
- Surface casing must be used
- Completion report must be filled out
- Usually require vertical drilling
Plugging:
- To guard against pollution
- Wells must be plugged, usually with cement.
b. Well Spacing
Modification of the rule of capture
- Limits the number of wells by distance
- Form shown on Page 62
Exception Well
i. Usually only one well per unit may be drilled
ii. Units are establised with respect to particular common
source of supply
iii. exception well –being able to drill an additional well
Purpose:
- To prevent surface, underground, and economic waste
Pooling
- If too many people own land in one area, then they may pool their
interest through one well. They can also be forced to do this.
B. 52 Okla. Stat. section 87.1
1. Merideth v. Okla. Corp. Com’n
Issue: Did the spacing order violate the Oklahoma statue in the sense
that it said gas, but then produced oil also?
Rule: Court said when the order was made everyone thought it
would be a gas well, just because it also produced oil doesn't mean
that a new spacing order needs to be created
Holding: No violation
2. Phillips Petr. Co. v. Okla. Corp. Com’n.
 Issue: When a company receives an order allowing production can
an application for removal be granted even though there are no
change of conditions?
Rule: No; Reasoning: A commission can not modify its prior order.
It is not appealed and is final. The only way this can be done is by
finding newly discovered scientific or technical knowledge not
available at the time of the order.
C. Creation of Drilling and Spacing Units by the OCC
1. Calvert Drilling Co. v. Okla. Corp. Com’n
Exxon wanted to extend spacing around section 2 which already
existed-in order to avoid economic waste wanted to use existing well
– OCC has power to extend drilling and spacing unit to encompass
land overlying edge of prospective common source – must be
substantial evidence to support the extension
2. El Paso Prod. Co. v. Okla. Corp. Com’n
Corp Comm has option and jurisdiction, when production hx
indicates, to leave unit intact and increase density or to de-space
and re-space – total discretion
D. Granting of Well Location Exceptions by the OCC
1. 52 Okla. Stat. §87.1- Location of the permitted well on each D&S
unit, but allows such exception where it may be reasonably
necessary where it is shown, upon application, notice and hearing
and the OCC finds that any such spacing unit is located on the edge
of a pool and adjacent to a producing unit, or for some other reason
that to acquire the drilling of a well on the prescribed location on
such spacing unit would be inequitable or unreasonable.
E. Environmental Issues to be considered before Acquiring Oil and Gas
Lease
1. Obtaining an Oil and Gas lease
Two areas of concern:
i. Can the activity take place on the land?
ii. What sort of environ cleanup liability might be covered
when giving an o&g lease?
2. Land Use Considerations
a. Clean Water Act –clean up liability for oil spills and
hazardous substance spills
b. Endangered Species Act
-Take provisions
3. Wetlands Protection
a. If land is near a wetland, a permit is needed from the US Army
Corps of Engineers.
If you are going to use
- Fill Materials
 - Dredge Materials
Navigable Waters is a Very Broad Definition
b. U.S v. Riverside Bayview Homes
Issue: Is the defendants development near "navigable waters"
as defined by 404a and thus in need of a permit?
Rule: Yes; Holding: Navigable waters has intentionally been
left as a broad definition by congress to protect against
economic and environmental waste. This was not a taking
Plain language of the act is clear Corps have jurisdiction
c. Leslie Salt Co. v. U.S.
Pits that were in the past holding calcium chloride are
wetlands; even though no hydrological connection –showing
us how expansive navigable waters definition is.
d. Solid Waste Agency of N. Cook Co. v. U.S. Army Corps Engr.
The Migratory Bird Act can not be used as a mechanism for
navigable waters; not enough water nexus here
e. 404(a) of the Clean Water Act –where the US Corps gets all
the authority to grant permits
4. Species Protection
a. Babbitt v. Sweet Home Ch of Commun for Great Or.
Loggers got in trouble b/c they were cutting down trees that birds
were hanging out in. Under the EDA section 9 you have harmed
these animals under the definition b/c you have taken away their
home. The word harm is to be construed broadly to include habitat
modification.
5. Liability Considerations
a. CERCLA – 42 U.S.C. 9601-9675 Super fund law
-EPA can order or define parties who are liable to cleanup hazardous
substances
-look to see who’s considered a PRP (potentially responsible person)
i. current owners of contaminated property
ii. current operators
iii. owners/ operators of the property at the time waste was
dumped
iv. parties that created/arranged for transporting the
hazardous substance
b. Amoco Oil Co. v. Borden, Inc.
Oil company bought old fertilizer land from Borden w/
inactive hazardous substance. Borden was forced to cleanup
under CERCLA b/c although he sold “as is”, caveat emptor
does not work under CERCLA
6. Land Owner Concerns
a. Quaker State Corp. v. U.S. Coast Guard
 Abandoned site had discharged petro residue; then the fed. govt
cleaned up and charged costs to current owner. Gvt didn’t meet
BOP and discharge was not when occupied and therefore, not liable
under CWA. Under CERCLA you are strictly liable, under CWA
you are not. Rule: Owner or operator is to be defined as of the date
the substance is found and not at some date in the past
F. Environmental Issues Respecting Drilling Operations
1. Managing Drilling Waste
SWDA --> RCRA
EPA
- Rule of Thumb: for o&g purposes if the waste is coming as a result
of drilling, it will not be considered hazardous
- only way EPA can require you to clean up is if it presents and
imminent danger to environment or public welfare
2. Managing Water Discharges
a. Clean Water Act –prohibits discharge of pollutant from a point
source; you cannot do so unless you get a NPDES permit
3. Production Activities
- EPA entirely prohibits discharges of drill cuttings, etc. into waters
- you handle those substance by discharging into underground
injection wells
4. Waters of the US Revisited
a. Quivira Min. Co. v. U.S. EPA
The EPA require P to get a permit to discharge shit into the stream.
The P didn’t think it needed a permit to discharge into the stream.
EPA comes back and says they did need a permit b/c anything that
has anything to do w/ a creek, stream, river, or body of water that
affect interstate commerce is going to be regulated.
G. Environmental Issues Respecting Production Activities
1. NPDES permit requirements:
-if you have a nexus w/ waters of the US, then you need a permit
-look at what pollutant is going to be discharged (if it’s too
hazardous you won’t get the permit)
-look at safe drinking water act
2. Underground injection
-safe drinking water act –ensures safe water by limiting
contaminates
3. Special Environmental Status of Oil
-Sec. 311 of CWA –specifies what to do for oil spills
-1990 oil pollution act –prevents new oil spills
a. Cose v. Getty Oil Co.
P discovered pollutants dumped on property. P brought an
action under CERCLA to make D pay for cleanup of crude oil
 tank bottom materials. Ct. denied cleanup by D, b/c crude oil
tank bottom materials were not petroleum under CERCLA.
b. CERCLA’s Petroleum Exclusion
-not petro unless it’s gone through the refining process;
therefore, doesn’t have to be cleaned up
c. Meghrig v. KFC Western, Inc.
-restaurant property contaminated w/ petro. P’s bring action
agst prior owners under the resource conservation and
recovery act. The claim was dismissed in tr ct. but the ct held
that there was imminent and substantial endangerment at the
time it was cleaned-element that must be proved and they
proved it!
V. Oil and Gas Lease
A. Purpose of Lease; Nature of the Leasehold Interest; Significance of
Classification of Lease Interests
1. Lessee
-Wants the exclusive right, but not the obligation to drill (option
contract)
-Wants to keep the drilled lease for as long as it is profitable; if they
do exercise the right they expect to have this right indefinitely
2. Lessor
-Wants immediate royalties
-Not contemplating a long delay in drilling
3. OK v. TX –Classification of Lease Interests
- In Texas, where there is ownership in place theory - a lessee has a
fee simple determinable estate in the mineral estate, and the lessor
now has a possibility of reverter. The interest is corporeal and
possessory in nature, so abandonment does not apply, but trespass
and ejectment do. Lessor parted with interest in minerals and left
with possibility of reversion
- In Oklahoma, where we don’t have the ownership in place theory,
but instead have the exclusive right to take theory. The leasehold
estate is considered to be an irrevocable license or a profit a Prendre.
Not subject to trespass or ejectment. Profit a pendre – exclusive
right to take
-Today, cts regard o&g rights as sui generis –it’s own unique lease
a. Cherokee Water Co. v. Forderhause -TX
R: severance may be accomplished by o&g lease as well as
by mineral conveyance
b. Hinds v. Phillips Petroleum Co. –OK
Mineral rights are devisable, assignable, inheritable Ellis: in
OK, grant of minerals gives to grantee right to explore and
capture
B. Lessee’s Use of the Surface
1. Hunt Oil v. Kerbaugh -Severing the minerals from the surface
impliedly creates in the mineral owner inherent surface right to find and
develop the minerals; The o&g lease holds the dominant estate while the
severed surface state is viewed as the servient estate
2. Accommodation Doctrine (Getty Oil -TX)
(1) where have existing use by surface owner
(2) which will be precluded or impaired
(3) where under established practices in industry there are
alternatives available to lessee whereby minerals can be
recovered, the rules of reasonable usage of surface may
require the adoption of an alternative by the lessee (not
adopted by Kerbaugh court) – not a balancing test – burden of
proof on surface owner to show mineral owner was
unreasonable – surface use must be current or existing and
not just proposed
a. TX v. OK
TX - Accommodation doctrine won’t apply, if land is not
platted for use.
OK – No accommodation doctrine case
b. Principles:
i. Mineral estate is dominant estate
ii. Can only make reasonable use
iii. Can’t violate the accommodation doctrine
C. Oklahoma Surface Damage Act: 52 Okla. Stat. Section 318.3
318.2- Definitions
318.3-Lessor must give written notice before they can enter and drill the
land. Notice shall include where and when the drilling is to occur.
318.3-Lessee must engage in good faith negotiations w/the lessor, w/in five
days of delivery or service of notice to drill, to determine surface damages.
318.5-Prior to drilling, the lessee and lessor must negotiate surface
damages. If no agreement, the operator must petition the District Court in
the county of the drilling site to appoint appraisers to make
recommendations to parties and the court concerning damages. Landowner
and lessee each appoint an appraiser, the two appraisers appoint a third
appraiser. Appraisers must be state certified general real estate appraiser in
good standing with the Oklahoma Real Estate Appraisal Board.
1. Santa Fe Minerals v. Simpson
Landowner had surface rights and lessee had mineral rights and
there was a dispute over surface damages. The ct. wrongly applied
common law doctrine of reasonableness and necessity, but now we
apply section 52 of the Surface Damage Act.
2. Dyco Petr. V. Smith
 The landowners allowed the oil company to drill on the land. The
oil company let the appraisers go onto the land to evaluate what the
surface damage was; inconvenience is not a factor, but appraisers
can look at future damage and current damage.
a. Function of the appraisers - The appraisers are supposed to
determine the diminution of the FMV of the land has occurred and is
going to occur as a result of the oil company’s occupation of the
surface; personal inconvenience may only come in when it affects
the value of the land.
b. It is ok to consider the diminution in value of the parcel beyond
the land actually taken if the oil and gas production efforts have a
direct impact on the entire parcel (Consider a well on a farm where
there was 8 acres in drill site, but that affected the use of an
irrigation system that serviced the entire 160 acres)
c. Appraisers are allowed to consider damages that have occurred or
that will occur
d. OSDA does not contain any provisions for prejudgment interest,
and unless prejudgment interest is allowed by statute, it is not to be
granted.
e. Once a damages award has been determined in favor of the
landowner, it is inappropriate to condition the receipt of that award
on the posting of a bond or other security.
3. Ward Petroleum Corp. v. Stewart
You can combine a tort action w/ you appt of appraiser’s action as
long as the ct keeps it separate
4. Anschutz Corp. v. Sanders
says that the right to exploration (i.e. by seismic work) may be
inherent to the mineral interest, but it is not covered in the OSDA –
OSDA’s plain language only applies to the drilling and production
operations. If the Legislature had wanted to provide for exploration
damages, it easily could have said so.
5. Sanford v. Anadarko Petr. Corp.
says before you move in with heavy equipment, if you haven’t
already arrived at a damage agreement with the surface owner, then
you have to have filed a petition in the district court – the petition
has to be filed before entering
6. Comanche Resources Co. v. Turner
P drilled the well and then reopened the well and drilled more. The
D wanted surface damages for e/ separate drilling. Ct. says under the
surface damage act the P owes for both drillings.
D. Lessee’s Use of Ground Water
1. Groundwater Act =Reasonable allocation for the taking or using of
water based on the # of acres
 - Under the Groundwater Act, OWRB won’t issue groundwater use
permits “to an applicant who does not own the land on which the
well is to be located, or hold a valid lease from the owner of such
land permitting the withdrawal of water from such basin.
- Since the effective date of the amendments to the Water Act, an oil
and gas lessee has to have a water lease from the surface owner in
order to use groundwater.
- Act applies to outside municipalities -->country
- to make sure the ground water is not excessively used by anyone
- Exception –Ranch or farm land –any landowner has the right toe
take water w/out a permit for momestic use
Domestic use – use of water by a natural person or family or
household
Household purposes farm animals, irrigation of land not
exceeding 3 acres for growing garden orchards or lawns
a. Ricks Expl. Co. v. Okla. Water Res. Bd.
Lessee application to use the ground water was denied. Rule:
Not only can surface owners get this permit, people who have
other interests in the land (like lessee) can apply for a permit
for water.
b. Unit Petr. Co. v. Okla. Water Res. Bd.
Lessee denied permit for groundwater. If you are a mineral
owner or owners of severed minerals then you have a vested
right to get a permit for surface water w/ respect to o&g
operations.
E. Measures of Damages for Injury to Land
1. Schneberger v. Apache Corp.
Calculating damages to the land; Schneberger teaches us that the
appropriate measure of damages is based on whether the damages to
the land are temporary or permanent
1) If damages are permanent, then damages are diminution in
value (difference in FMV of the land w/o the contamination
and with the contamination).
2) If damages are temporary, then damages are cost of
remediation.
3) However, if cost of remediation exceeds the diminution in
value, then that diminution becomes the measure of damages.
4) When there is a grossly disproportionate result in remedial
damages then impose only total diminution in value
F. Substances Granted by an Oil and Gas Lease
1. Granting Clause
a. Oil (including but not limited to distillate and condensate)
b. Gas (including casing and helium and all other constituents)
 - Meredith Case: All wells produce some gas
- Associate Gas/Casing Head Gas: comes oil of a primary oil
well producing crude oil expands and separates from crude oil
G. Types of Oil and Gas
1. Natural Gas
Methane-88%
Ethane-4%
CO2- 1+ %
Helium- less than 1%
Propane- less than 1%
Butane- less than 1%
Pentane- less than 1%
Hexane- less than 1%
2. Crude Oil
From one barrel of oil (1 barrel=42 gallons)
19.50 gallons- gasoline
8.61 gallons- fuel oil
4..20 gallons- jet fuel
11.72 gallons misc. produces including Kerosene and asphalt
H. Lands and Interests Granted by an Oil and Gas Lease
1. Fee interest- refers to mineral and surface estates that have not been
severed from each other
2. Mineral interest – severed from fee and can be created by grant or
reservation – owner of this interest has right to explore, drill, develop, and
produce oil and gas on the premises and retain benefits
3. Bonus payments – granted to lessor when he conveys mineral estate –
money paid up front for granting the lease
4. Delay payments – usually annual – paid to keep lease alive while land is
not being produced and primary term running
5. Shut-in Payments – for royalties – used in place of production to keep
lease alive
6. Royalty – payment owner gets when oil produced
7. Interests – lessee owns working interest and lessor owns non-
participating royalty interest
8. Royalty deed – conveys fraction of proceeds derived from sale of o&g
9. Overriding royalty interest – royalty carved out of working interest
10. Production payment – payable out of production
I. Habendum Clause
1. Keeping the lease alive during its primary term by making delay
rental payments
a. Some basic functions of the habendum clause
 i. Habendum clause sets the primary term of the lease;
sets the length of the term that the lease will be in
place.
ii. The secondary term of the habendum clause most
often provides that the lease can go on indefinitely as
long as oil and gas are produced in paying quantities.
b. The function of the delay rental clause
i. The delay-rental clause (called the “drilling clause” in
the Koontz treatise). Basically, this terms says to the lessee
“you either drill or pay.” Imposes a special limitation on the
term of the lease.
ii. Remember, delay rental terms can only keep the lease
alive during the primary term; after that, (i.e., once you are in
the secondary term of the lease) if you want to extend the
lease without re-executing it, you have to have drilled and be
producing the well. In essence, the delay rental clause creates
a special limitation on the duration of the primary term.
iii. Remember, in both OK and TX, failure to pay delay
rentals on time does not result in forfeiture – it results in the
termination of the lease.
c. Dealing with the “unless” term.
i. What the “unless” term is: limitation by which interest of
lessee terminates immediately w/o notice once it has been
extended past the primary term. For example: lease will last
for 3 years unless oil and gas are produced in paying
quantities [and remember that delay rental clauses are often
structured to create a legal fiction of production].
ii. Note the strictness with which the “unless” term is often
interpreted: If you don’t either drill or pay in the correct
amount at the correct time to the correct people, the lease
automatically terminates.
iii. Mailbox rule on delay rentals: Note that in our
“Standard” lease form, there is a mailbox rule provision –
payment is deemed made when it is placed in the US Mail.
iv. Exceptions to the “unless” term: sometimes, the court
will apply equitable principles to save the lease, such as
1. failure of an independent third party (like the
post office)
2. lessor’s acceptance of a later inadequate tender
(essentially estoppel)
3. confusion or ambiguity caused by the lessor
4. [Note also the doctrine of revivor – if both
parties just keep acting as though the lease were still
 valid, then the court may then just accept it as still
being valid]
5. Kuntz’s idea on a basic statement of exception to
the unless clause: “the event which will result in a
termination of the lease is not simply a failure to drill
or to pay delay rentals in strict compliance with the
lease, but is a failure to do so which may be attributed
to the lessee’s fault or dereliction and is not
attributable to circumstances beyond the lessee’s
control.”
v. Alternatives to the “unless” clause in the lease
1. Paid-up leases: not only will lessee pay the up
front bonus money, but they will also pay an additional
sum that basically represents a payment of the delay
rentals in advance
2. The “or” clause: Lessee has a contractual
obligation to make the delay rental payment, and if he
fails to make the payment, then the lessor has a cause
of action for the payment, but the lease does not
automatically terminate if the payment is not made (in
contrast to an “unless” clause lease)
b. Schwartzenberger: failure to make or pay delay rental
correctly results in automatic termination of lease
c. Duer v. Hoover & Bracken: If the Delayed Rental qPayment
is does NOT reach the lessor by the due date, then the lease is
terminated.
3. Habendum Clause Perpetuating the Life of a Lease by commencing
a well: The meaning of commencement
a. Drilling operations are commenced when substantial surface
preparations to drill are sufficient for a commencement. The drill bit
need not pierce the earth.
b. Under the Burkhart Lease Form, the commencement clause is
rather specific. Staking and flagging are not enough for
commencement. “When the first material is placed on the leased
premises or when the first work is done.”
c. A bad faith commencement will not be enough.
d. Doctrine of Obstruction
i. If lessor has obstructed the lessee from completing the
operation or commencement, the lease will not terminate. The
court will give the lessee a reasonable amount of time to
commence.
ii. Applies to both physical and legal obstructions.
(physically blocking the gate or an injunction)
 e. Breaux: OK and majority view: on last day of primary term,
oil co built road – P contended D did not commence drilling
operations within the time specified – court said substantial surface
preparations to drill are sufficient – FACTORS: acts on the
premises, good faith of lessee, diligence in continuing of drilling
operations – no need for drill bit to pierce the earth
4. Habendum Clause: Perpetuating the life of the lease by producing
oil or gas in paying quantities: meaning of “paying quantities”
a. Producing in Paying Quantities: if perpetuate the lease into
the secondary term by commencement, lease is perpetuated
indefinitely if producing in paying quantities
b. Paying Quantities in the Lease Form
i. Production in quantities sufficient to yield a return in
excess of operating and marketing costs, even though drilling
and equipment costs may never be repaid and the undertaking
as a whole may ultimately result in a loss.
c. Paying Quantities – TX rule
i. Look at the current ratio, i.e. revenues and expenses, to see
if the well is profitable. If so the analysis is over. If not, then -
ii. Ask whether a reasonable prudent operator (RPO),
expecting to make a profit, would continue to operate the
well.
d. Paying Quantities – OK Rule
i. Look at the current ratio – so the math – and if the well is
not producing at a profit, look to see if –
ii. There are no compelling equitable considerations to justify
continued production from the unprofitable well operations.
e. Expenses in the Paying Quantities Context
i. Do not include initial drilling costs.
ii. Do not include the initial equipment costs, i.e. the
Christmas Tree.
iii. In TX, do not include depreciation as an expense. This
is included in OK.
iv. Do not include overriding royalties.
v. Only include those costs that are part of the lifting
expenses.
f. Clifton v. Koontz: litmus test – revenues derived from
production must exceed current operating costs however
small – only look to current production costs and not sunk
costs – if fail test, lease may still be alive if a prudent operator
would still be operating the well even at a slight loss – what
time period do we look at? Court did not specify
g. Dreher v. Cassidy Limited Partnership
 The lease has not produced w/ revenues exceeding expenses
for 8 mths. Claims that the well is not producing in paying
quantities. Ct. said that the lessor could not prove it wasn’t
producing in paying quantities so it failed the 2nd prong of the
two part test (TX)
Test for paying quantities:
1. Do the math –litmus test
-quantify the reasonable prudent operator
standard by applying litmus test looking to
operating revenues and operating costs of
reasonable time to determine whether
operations have been profitable. If the lessee
passes then lease it good. If lessee flunks go to
step 2.
2. Legal test
-any reason that a reasonable prudent operator
who expected to make a profit from the lease
would continue to operate
h. Stewart v. Amerada Hess Corp. - only those expenses directly
related to lifting operations can be included in determining if have
paying quantities – depreciation should mandatorily be included –
even if in the red, doesn’t necessarily mean lease is cancelled – look
to other circumstances which might exist
i. Mason v. Ladd Petroleum Corp. - what expenses are properly
deducted?
(1) district expenses – too indirectly and remotely related to
lifting operations so not included in determining whether well
operates at a profit
(2) administrative overhead
(3) depreciation of casing, etc. – although evidence
conflicting, court said not directly related to lifting costs
j. Hininger v. Kaiser -what expenses can be deducted? Overriding
royalties and admn expenses
5. Perpetuating the life of the lease by production: is actual production
(in paying quantities) required, or will capability of production (in
paying quantities) suffice?
a. Actual Production v. Capability to Produce:
i. Stanolind Oil & Gas Co. v. Barnhill: TX – need actual
production in paying quantities within the primary term of the
lease – majority view – best to have a shut-in clause incase
production ceases so lease won’t terminate
ii. McVicker v. Horn: OK – only need capability of
producing in paying quantities – producer can’t wait around
 for best price though – standard of reasonableness: diligent
efforts must be made to market product – minority view – no
need for shut-in clause
J. Cessation of Production Clause – what if the lease contains a 60 day
cessation of production clause and actual production ceases for more than 60
days?
1. Cessation Clause: if well ceases to produce, if within 60 days commence
either drilling of a new well or reworking and production restored, then
lease will not terminate
2. Pack v. Santa Fe Minerals –OK- definition of production at issue –
court defined as capable of producing in paying quantities and does not
include marketing of product – production means same for all terms of
lease – requires due diligence in seeking market – consistent with
McVicker decision
3. Bachler v. Rosenthal-TX- production decreased but hard to tell if had
actually ceased production for 60 days – court held reasonably prudent
operator test not applicable – in such a case, better to take immediate action
or suffer termination of lease
4. Anadarko Petroleum Corp. v. Thompson-TX- (1) gas mining lease did
not terminate when actual production ceased longer than 60 days but well
was still actually capable of producing gas, and (2) so long as o&g is or can
be produced, then the court will read in a capability factor into the
habendum cl.
3. Common Law Doctrine of Temporary Cessation
a. If our lease does not contain a 60 day of cessassion cl, if there’s
hiatus, then the ct allows for a reasonable time for the operator to
restore production. Otherwise, the ct. will see a total cessaion and
the lease will expire
Factors:
i. cause of cessation
ii. time for repairs
iii. diligence in making repairs
b. if cessaion is voluntary, the cts are very unlikely to view the
cessation as temporary
c. if production is interrupted b/ of activities that are mutually
advantageous to lessor and lessee then it will most liely be viewed as
temporary
Factors for temporariness:
i. accidents
ii. price fluctuations
iii. financial problems of lessee
d. State ex rel. Com’rs v. Amoco
 Upon production, lessee became vested with an estate that endures
as long as it conducts diligent operations to produce – 2 factors
important to court’s determination that cessation was temporary: (1)
mechanical difficulties – casing collapsed (2) 2nd well completed in
same formation – court also cited with approval a TX case which
said there was temporary cessation when there where (1) mechanical
difficulties and (2) new well drilled in a different formation
L. Savings Clauses as Substitutes for Production
1. Dry Hole Clause: purpose is to avoid possibility of abandonment – if
drill dry hole, if 2nd well not drilled within a certain time, lease
terminates
2. Continuous drilling clause – deals with only one well; must be
successful in that well v. Continuous Operations Clause – have
reasonable amount of time to start 2nd well if first not successful;
need this to undertake additional operations
3. Rogers v. Osborn: dry hole clause not applicable b/c not dry hole in
literal sense but not producing in paying quantities – court takes
literal, mechanical approach – court also held lessee cannot tack the
reworking of the first well to the drilling of the second
4. Force Majeure Clause – (1) A way for a lessee to protect himself if
operations are interfered with by causes outside the control of the
parties and that could not be avoided by due care. (2) The lessee has
a duty to make a reasonable effort to remove the FM condition
should one occur. (3) The FM must be of the kind that falls with in
the clause in the lease. BURKHART does not have a force majeure
cl.
a. Perlman v. Pioneer Limited Partnership -a force majeure
clause is to relieve lessee from harsh termination due to
circumstances beyond his control that would make
performance untenable or impossible – however, will not
supersede specific terms bargained for and does not mandate
event be unforeseeable before excusable – still need more
than mere possibility of hindrance, actual hindrance must
occur
5. Shut-In Gas Royalty Clause
a. What is a shut-in gas royalty clause? When you have a well
capable of producing gas, but lessees are unable to market the gas,
so they shut the well in. Thus, though capable of production, no
production is being made. (This is because to market gas, you pretty
much have to connect the well to a pipeline, since it is impractical to
store natural gas).
b. In Oklahoma, failure to pay shut-in royalty payments will not
necessarily cause the lease to fail if the well is capable of producing.
 Prof. Hart speculates that this clause isn’t as important in Oklahoma
as it is in Texas (where capability of production means that you
better just be able to turn the valve and have oil or gas produced
c. When is it okay to use the shut-in gas royalty clause, and when
isn’t it? What if a lessee tries to employ the shut in royalty just to
wait for a better market? We can get away with that in Oklahoma
because we can extend a lease just by the capability of production
from a well (as opposed to actual production). Kansas, on the other
hand, says that shut in royalties can’t be used just to wait out the
market.
d. Gard v. Kaiser – OK – shut-in provision not to be construed as
limitation on conditions which would affect termination of lease – if
miss payment, OK court will not allow shut-in provision to terminate
lease
e. Freeman v. Magnolia: TX – no royalty paid at end of primary
term b/c well not producing –have to pay before end of primary term
if clause is unclear as to due date –
3. Pooling Clause
a. Conflicts between units established by exercise of pooling clause
in oil and gas lease and units established by order of conservation
agency
b. Gives lessee right to combine small tracts of land or fractional
mineral interests for purpose of drilling on a spacing unit – keep
lease alive beyond primary term in absence of actual production on
all lands within unit – production anywhere within the unit is
deemed constructive production for all leases within the unit
– drilling of one unti well will satisfy leases of both owners
– pooling after production is acceptable
OK – pooling clause not that important b/c have drilling and spacing
unit
c. Amoco v. Underwood: courts may allow pooling where there is
good faith, Evidence of bad faith is when not done in a reasonable
amount of time, when valueless lands are pooled
4. Conflicts between unites established by exercise of Pooling clause
a. Hladik v. Lee - what happens when Corp Comm creates unit
which is different than voluntary unit? Spacing unit created by Corp
Comm will supersede declared unit created pursuant to pooling
clause
b. Force Pooling by the Oklahoma Corp. Comm.
i. 52 Okla. Stat. § 87.1(e) –two or more people have
combined interest in land – land considered one tract nd not
divided by ownership of acreage – if one party refuses to
lease, then oil co will go to OCC and ask to force pool – OCC
 then tell refusing owner they must either pay their share of
well costs or agree to take a roylaty – if take royalty, then
give up right to participate in mineral interests – if owner
does not take optin to participate, under OK stat, gets mineral
compensation
ii. Pugh clause –“embracing a portion of the leased premises”
Does the habendum clause cover these lands? Yes. Unless
you have a pugh clause
iii.. Statutory Pugh Clause – applies only to d&s units under
87.1 (those created by Corp Comm only)– in a unit of 160
acres or more no oil or gas leasehold interests outside the
spacing unit may be held by production more than 90 days
beyond expiration of primary term
iv. Home-Stake Royalty Corp. v. Okla. Corp. Com’n
non-participating force poolee wanting reversal of pooling
order – asserted was unconstitutional taking of property b/c
not required to present geological data of how much o&g
expected to produce– court affirmed b/c there was substantial
evidence of present market value – no need to show chances
of doing as well as participant
v. Ward v. Okla. Corp. Com’n
non-drilling owners of a divided interest in a spacing unit are
entitled to a share in production from the unit well since they
cannot drill their own well due to the one well per unit rule –
right begins when unit is created
vi. Eason Oil Co. v. Howard Engineering, Inc.
after de-spacing and re-spacing royalties from earlier well
don’t change
c. Drawing the line between oil and gas disputes over which the
OCC has jurisdiction and those over which it does not
i. Tenneco Oil Co. v. El Paso Natural Gas Co.
Joint operating agreement can modify a forced pooling order
by the OCC.
ii. MM Resources, Inc. v. Huston
Was the forced pooling order out of the Comission’s
authority? Yes. This was a private rights law all along and
this was outside agency law. OCC cannot give a $ judgment
D.Ct. can.
iii. Nilsen v. Ports of Call Oil Co. –both parties had a forced
pooling order that needed clarification; the ct. said it could
not clarify, it needed to go to the OCC for clarification
iv. Hadson Petroleum Corp. v. Grynberg & Assoc. –order
designating P as the operator of the well. OCC doesn’t have
 jurisdiction of the claim b/c it was considered a private
agreement of who was going to be the operator.
J. Implied Covenants
- Define: unstated obligations that a lessee must perform that arise from the
nature of the lease.
- 2 views of these covenants:
implied in fact: predicated on intent of parties – courts usually go with this
view when classification has been material
implied in law: quasi-K; obligations a party takes on as part of agreement –
presumed from relationship of parties and object of the agreement
- Brewster v. Lanyon Zinc.: whatever would be reasonably expected of
operators of ordinary prudence having regard to the interests of both lessor
and lessee, is what is required. A plain and substantial disregard of this
requirement constitutes breach of the covenant for the exercise of
reasonable diligence. Implied covenants are as much as part of K as express
covenants!
1. Implied Covenant to Protect Against Drainage
a. Barnes v. Mack Oil Co. - lessor complained that drills off land
were draining oil from beneath his land – lessee did not offset by
drilling more wells on lessor’s land – court cancelled lease to a depth
of 100 feet and not further b/c lessee engaged in exploring there –
since they were spending $$$ on exploration, court did not think it
was equitable to cancel lease to lower depth – damages = however
much oil drained by thief is recoverable (910 barrels)
b. Indian Territory Illuminating Oil Co. v. Rosamond - lessor’s co-
owners had already settled with the oil co for damages when P
brought suit – oil co argued SOL had run – court held that implied
covenants run with the lease and breach is a continuing breach – can
seek damages for 5 years previous to filing – implied covenant is
implied in fact and as much a part of K as express covenants –
damages figured same as in Brewster
c. Sunray Mid-Continent Oil Co. v. McDaniel - to establish breach
of implied covenant to drill protection well, must have: (1)
substantial drainage – evidence must show that protection well
would (2) probably produce sufficient o&g to repay costs and return
a reasonable profit (est at time lessee on the land and not some time
after he is gone)– (3) reasonably prudent operator standard – D is not
liable for future damage when lease relinquished
d. North American Petroleum Co. v. Knight - another way to
measure damages – amount of damages limited to drainage sustained
from time well should have been drilled to date action instituted
2. Implied Covenants to Protect Against Drainage – Common Lessee
-problem
 a. Amoco v. Alexander - covenant to protect from drainage is not
limited to local drainage, but extends to field-wide as well – Duties
of a reasonable prudent operator to protect from field –wide drainage
include: (1) drill replacement wells (2) re-working wells (3) drill
additional wells (4) seek field-wide regulatory action (5) seek
available admin relief – but no duty exists unless such amount of oil
can be recovered equal to cost of expenses – b/c of Amoco’s conflict
of interests which arose out of their common lessee status, court
would not reduce standard to P just b/c had other lessors in same
field, so status as common lessee does not affect Amoco’s liability to
P – lessor has burden to show substantial drainage has occurred and
that offset well would have produce o&g in apying quantities –
covenant is part of lease and contractual in nature, making
exemplary damages not recoverable unless also have action in tort
b. Feely v. Davis - Feely entered into o&g lease with TXO – Davis
received order from OCC for lay-down unit and named Davis as
operator -– JOA between Davis and TXO - analogous to common
lessee situation b/c Feely had working interest in Davis in well –
Feely contends Davis should be held strictly liable and that prudent
operator defense was invalid – court said better position to allow
operator to put on evidence he was acting as a reasonably prudent
operator – burden of proof not shifted from P but allows D to answer
charges of breach of duty – **OK court does not change rules in
cases of common lessee or analogous situations
3. Implied Covenant to Reasonably Develop
a. Implied Covenant to Develop: applies during primary term – not
triggered until lease is propelled into secondary term by production
or some substitute – lessee must continue to develop even after well
in production
b. Elements of Breach of Implied Covenant to Further Develop:
i. proof that additional development will probably be
profitable (probable profitability)
ii. proof that lessee has acted imprudently in failing to
develop (would prudent operator have drilled a well at that
time?)
a. time element must be reconciled with establishing
prudent operator rule – can’t show compliance with
rule if eventually – not losing production but lessee
slow in drilling which causes delay in production –
4. Implied Covenant to Further Explore
a. this implied covenant requires that the lessee act w/ reasonable
diligence in developing the lease as would a reasonably prudent
 operator – lease cannot be canceled for breach of implied covenant
to develop without notice to the lessee beforehand
b. How is this different from the covenant to further develop? The
implied covenant to further explore deals with lessee’s failure to
explore undeveloped parts or formations and their duty to test an
unproven horizon while the implied covenant to further develop is
when lessee fails to develop in known producing formations
c. Only CO, KS, and LA have adopted the theory that the lessee is
subject to a duty to explore – OK and TX have rejected a free-
standing implied covenant to explore further - OK S. Ct in Mitchell
stated that existing legal machinery adequate to handle exploration
controversies – any such controversy handled in covenant to further
develop
d. Proper remedy would be conditional lease cancellation of
unexplored formation – but give lessee another chance before
cancellation
5. Implied Covenant to Market –within a reasonable time
a. Factors to market: (1) market within a reasonable amount of time
(2) market at a reasonable price
b. Bristol v. Colorado Oil & Gas Corp. - reasonable time case –
o&g co waited 7 years before marketing b/c no pipeline in area –
lessor accepted royalties but refused to execute shut-in agreement –
court considered: (1) reasonable time and (2) due diligence and
found oil co had used due diligence and that time was foreseeable
b/c in wildcat country
c. Amoco Production Co. v. First Baptist Church of Pyote -
reasonable price case – duty to market at best price obtainable –
some courts say reasonable price, some say highest price – duty to
use good faith
d.
6. Implied Covenant to Operate Diligently and Properly
a. Use diligence; observe customary oil field practices and modern
methods, appliances and equipment to save all O&G and other
products produced from said premises, which may be saved at a
reasonable profit.
- Forfeitures are discountenanced in law, however, there are
occasions when the only protection a lessor has is through the
exercise of this reserved right. If this right could not be
exercised, the lessor would be at the mercy of his lessee.
Complaints by lessors on the covenant
- Lessee has damaged the property
- Lessee has prematurely abandoned a well
- Lesse has failed to use advanced production techniques
 - Lessee has failed to protect the lessor by seeking favorable
administrative action.
b. Baldwin v. Kubetz - Baldwin v. Kubetzlessee failed to obtain
zoning exception for further drilling – tried a couple of times but
eventually gave up – D cannot excuse nonperformance of his
obligaion by showing he tried but was unable to perform, not unless
the impossibility arises out of the nature of the act to be done
7. Includes a duty to “seek administrative relief”
a. Sinclair Oil and Gas Corp. v. Bishop -breach of implied duty to
protect by not seeking proper administrative relief
– lessors contended well was oil well while lessees contended was
gas well – wells on adjacent lands producing oil and flaring gas b/c
no pipeline available (waste!)
– lessee did relent and produce for 6 weeks which did result in a
waste of gas- S.Ct. did not hold lessee liable for refusing to produce
oil when would have resulted in waste of gas but did hold liable b/c
failed to seek administrative relief – not liable as operator if relied
on experts advice – duty to test and complete in another zone can
only be imposed by showing probable profitability and that lessee
has waited an unreasonable amount of time after notice – duty to
further develop extends to same well bore
b. Spaeth v. Union Oil Corp. - filing a suit does not suspend duty to
protect against drainage – should have applied for permit to drill
offset wells
8. Remedies for failure to pay royalties
a. Cannon v. Cassidy - holding that that the parties' oil and gas lease
could not be cancelled because the lessees failed to pay the accrued
royalties even where that failure was a violation of the express terms
of their lease with lessors because that remedy was not expressly
provided for by the parties lease.
b. Rule: An ogle cannot be canceled for lessee’s failure to pay
royalties, unless it is expressly provided for in the lease.
VI. Royalty Payments
A. The Market Value Royalty problem
1. General Principles
Land owner lessor actually owns 1 out of every 8 barrels that come
out of the ground. It's the rare lessor that actually takes his share of the
royalty-in kind lease-by implication, since the royalty owner doesn't take its
share in kind then the lessor is viewed as the agent. Royalty clause -lessor
should get its share of the proceeds derived. If the lessee mishandles the
lessor in kind's share of the proceeds, then the lessee has a conversion
claim. Gas royalty clause is poorly worded.
- 3 types
 1. market value
2. market gas
3. proceeds
- Issue here, You should be accountable to the owner for his share of the
proceeds--lots of class action lawsuits that show that the law is going in
favor of the lessor in these disputes.
- What are the expenses the lessee can legitimately deduct?
the marketable product rule =100% of the costs to bring the oil to the
ground to make it a marketable product belong to the lessee
- Different things that lessees may want to deduct for:
Processing
Transportation
Gathering
- The royalty is to be paid for the value "at the well"
a. TX VIEW and traditionally - 30-40 yrs ago the lessor's cost free
royalty means free of production costs (money that the oil company
spent to acquire the leases, money it took to equip it and operate it).
View here is that after the fluids hit the top of the ground, then we
are through w/ production and in the post-production part. Costs of
marketing, gathering, etc. --post-production costs that you deduct
from the royalty check that you write them.
b. CO VIEW - Garman –CO-marketable product rule-once the oil
hits the top of the ground, if it's not yet a marketable product, then
the lessee bears all those costs until it is marketable. All costs after
production should be born by the lessee
c. OK VIEW - Middlestat -OK case that adopted the marketable
product rule
d. KS VIEW -Schneburger -KS case that adopted the marketable
product rule
e. Market value gas royalty clause has two facets:
i. Look at where the point of sale occurs
ii. If the point of sale is at the well head then the market value
clause -we will calculate the royalties that whatever cost the
lessee gets at the well head
iii. If the point of sale is off the leased premises (if the gas is
transported elsewhere and maybe processed), then lets have
the royalties be based at the market value, but at the market
value as it existed at the well head.
2. Piney Woods v. Shell Oil I - QUESTION: WHERE DOES THE POINT
OF SALE OCCUR? Two Views For gas sold at the well: 1) Royalties are
based on the proceeds received at the well, 2) For gas sold at a point off the
leased premises. Royalties are based on the market value at the well.
Majority Rule (taken from Vela case in TX): (Used in Piney #1)
 market value means the vale at the time gas is extracted and sol rather than
when the applicable sale contract was made. Followed in TX, MS, KS, MT
Minority rule (taken from Tara case in OK):
market value is equivalent to the price assigned in the sale contract, as long
as that contract was made prudently and in good faith. Followed in OK,
LA, and AR
B. Costs of Production vs. Costs Subsequent to Production
1. Lessor has a cost-free interest but when bring oil and gas to the surface,
any cost incurred after is not production cost but post-production cost and
lessor must bear a proportionate share of the cost which will be deducted
from the royalty
2. Garman v. Conoco, Inc. -P contended post-production costs incurred to
convert raw gas into marketable product – some costs chargeable but not all
3. Piney Woods v. Shell Oil II - traditional view –royalty computed at the
well from proceeds received but no sale at wellhead b/c is sour gas and
must be processed before can market – compute market value: royalty
based upon value before gas processed or transported b/c leases calls for
royalty based on market value at the well Rule: The lessor shouldn't be held
responsible for the processing costs. The ct. says that the lessor's may be
charged w/ all costs that have to do w/ marketing, processing, as long as it's
reasonable. Basically, these costs may be deducted no matter if it's sour gas.
Proportionate costs of production costs may be given to the lessor.
4. Mittelstaedt v. Santa Fe Minerals - OK RULE!!!! – lessor must bear a
proportionate share of costs if lessee can show (1) costs enhanced value of
already marketable product (2) costs are reasonable (3) actual royalty
revenues increased in proportion with the costs assessed against non-
working interest owners
5. Rogers v. Westerman Farm Co. - Costs incurred to make the gas
marketable were to be borne solely by the lessees, while costs incurred
subsequent to the gas being marketable were to be shared proportionately
between the lessees and the lessors.
6. Howell v. Texaco Inc. –Texaco was getting money from selling residue
gas then they gave the royalty owners a share of the gas then this liquid was
divided. Our Ct says that an intracompany type sale cannot be considered
an affiliated sale at all. TX fel as though this was fair b/c they were paying
more. This case is based on marketable product rule. Ct. pays creedence to
the language of the leases. We don’t follow CO rule to pay attention to if
the clause says the mouth of the well.
C. Division Orders
- Document prepared by purchaser to and signed by various owners of
rights of proceeds- sets forth each owners percentage of the proceeds in
order to assure proper parties are paid proper amount
 - 100% Division Order: the operator/producer and purchaser enter into
order then producer makes another division order setting forth who really
owns percentages – saves admin costs and allows purchaser to hold onto $$
$ for awhile – purchaser gets indemnity protection from producer (doesn’t
work if producer bankrupt) – purchaser more careful then in 80’s but these
orders still exist
a. Process
- Lawyer works up the lease title opinion. Lawyer looks at the County
records and finds out who owns the land.
- The drilling opinion is a detailed look at the title.
- Division order analyst looks at the title again.
- Division orders are sent to the interest owners to sign up and signify that
this is the way they should be paid.
- If an assignee steps in the shoes of any royalty owner, they will be sent a
transfer order and the lessee will pay the assignee. The original royalty
owner must give the lessee notice of the assignment.
b. Purpose
- Protect lessee from lessors claiming they are not being paid their requisite
amount.
- To get their money back, the underpaid lessor must get the money from
the overpaid lessor.
- Where the operator prepares erroneous orders and retains the benefits, the
division orders are not binding.
c. Gavenda: when oil co keeps part of profit then party can sue oil co – oil
co liable for whatever portions of royalty it retained
VII. Rights Accorded under Oklahoma Law to a Working Interest Owner Who
Lacks a Contract for Sale of His Share of Gas Produced from a Well
A. Natural Gas Market Sharing Act
1. 52 Okla Stat. sec. 581.1-581.10
B. Timely Payment of Production Proceeds to the Various Parties Entitled
Thereto
1. 52 Okla. Stat. sec. 540
2. Production Revenue Standards Act
a. 52 Okla. Stat. sec. 570.1
3. Maxwell v. Samson Resources Co. - Suit was filed by alleged owners of
gas producing well seeking damages for operator's failure to pay working
interest revenues. It was held that: (1) heirs of property owner were owners
of property entitled to proceeds from gas produced from well before and
after order of heirship; (2) interest was to be compounded annually, rather
than monthly; and (3) treble damages could not be imposed on mere
showing that revenues had not been paid, but rather, some degree of
wrongful intent or motive had to be proven.
C. Distinguishing between Mineral Interests and Royalty Interests
1. The first thing the court looks at is the document itself. If the document
is clear and unambiguous, the document will be the prevailing factor.
2. Ambiguous language is a question for the judge. If the court cannot
construe the intent of the parties, parol evidence will be allowed.
3. Mineral rights may be severed, in that they may be conveyed or retained.
4. When granting an ogle you are in a way granting a term of years lease,
thus it is a conveyance of the mineral rights.
5. A 2.5% royalty interest (RI) and a 2.5% mineral interest (MI) are not the
same.
a. With a 2.5% RI, you get 2.5% of 100% of the production. If
production is $500k, you get 2.5% x $500k = $12,500.
b. With a 2.5% MI, you get 2.5% of the royalty, say 1/8. If
production was $500k, you would get 2.5% of 1/8 x $500k = 2.5% x
$62,500 = $1,562.50.
6. Production payment
a. Money that will be received only as production occurs and only
out of production. Will continue only until the stated sum of money
is received.
7. Non Participating Royalty Interest (NPRI)
a. Owner does not see the fruits of the leasing transaction, Only gets
money from the sale of production. Owner has nothing to do with
the operation.
b. Two ways to create an NPRI:
i. Express it as a certain % of gross production.·2.5% royalty
of oil, gas and other minerals (OG&OM) produced and saved
from the land.
ii. Express it as a certain % of whatever royalty if provided
for in an ogle covering the land.·Undivided ½ interest in and
to all royalty rights expressed in an ogle.
c. When a lessee receives an ogle burdened by an NPRI, it is the
party that the lease was received from that bears the burden.
8. Language of Conveyances
a. “Produced and saved” – connotes grant or reservation of a RI
b. “In and under” – grant of MI
c. If instrument says both – grant of a MI
d. To clarify a MI, use “in and under” with language that allows
ingress and egress.
9. Characteristics of a MI
a. Right to develop
b. Right to lease
c. Right to bonus payments
d. Right to delay rental payments
 e. Right to royalty payments (you can also get this w/ a royalty
interest)
10. When one conveys a portion of their MI’s, and does not reserve the
right to bonus and rental payments, they will purport to convey their leasing
power.
11. Bodcaw - title to minerals beneath the surface is not lost by nonuser nor
by adverse occupancy of the owner of the surface under the same claim of
title. Severance of minerals results in two definite estates: mineral right
owner has dominant estate
12. Mcsweyn v. Musselshell Country, Montana - more valuable to have
mineral interest then royalty interest
–2 ways to create non-participating royalty interest: (1) specify % of royalty
interest (2) let it be fractional part of lease it tags along with2 ways to
provide for an NPRI: (1) stated fraction of gross production (2) a stated
fraction of royalty is provided for in any oil and gas lease covering the land
in question
13. Barker v. Levy - atty gets mineral deed in exchange for representation –
whether deed created royalty interest or mineral interests in atty? Lease
contained two important provisions that combined showed intent to create
mineral interest: “1/160 part of all oil and gas that may be produced and
saved” plus “in and under” – although if either provision had been alone,
1st would have signaled intent to create royalty interest and 2nd would have
showed intent to create mineral interest – if had said “1/160 royalty
interest” would have created royalty interest
14. French v. Chevron - conflict was reconciling language in deed – first ¶
appeared to convey mineral interest and second ¶ explicitly conveyed
royalty only – several attributes of mineral interest stripped (leasing power,
receive delay rentals) court said was conveyance of mineral interest but
okay to strip some attributes away (even though looks like royalty after
stripping court still labels as mineral due to language)
15. Anderson v. Mayberry -no right to rentals or bonus – court said if not
recipient of these then impliedly give up leasing power also – H doesn’t
agree and says still have econ interest so can neg size of royalty
D. Cotenants-e/ owns an undivided one half share of Blackacre
1. Shared Ownership by Mineral Estate
Concurrent Ownership --Development by Co-tenants
- Shared ownership interest by two or more people
- What if one tenant wants to drill a well on the land and the other
co-tenant doesn't want to or objects?
undivided interests in a piece of land – each party owns fractional
share of each square inch of land (1)Concurrent Ownership: – 2
views exists re: whether one cotenant can lease land over
protestations of other
2. Law v. Heck Oil Co.
A co-tenant has a 1/768 mineral interest and wants to drill a well but the
other cotenant objects. He wanted a bonus of 1000$ and they thought it
was excessive so objected to the drilling, but they drilled anyway w/out
consent. minority view – to permit oil co to proceed with development of
land w/o cotenants consent would be to compel them to exchange real
estate for personal property – court will not allow unless drainage will
occur – court enjoined oil co from drilling w/o P’s consent (one cotenant
can enjoin the other from committing waste)- extraction w/o consent =
waste. One tenant can stop the whole show. Reasoning: W. Virginia sees oil
and gas as real estate. Not really true in OK. This man owns an interest in
real estate and he can't be compelled to take them out of the ground and
convert them into cash/realty. This view stems from the statute of
Westminister second 1285 borrowed from England. Cause of action for
waste to protect cotenants enacted by the Parliament. No remedy for cutting
down trees, etc. - the statute would enjoin the tenant from wasting the
property. W. Virginia views the extraction as creating waste.
3. Prarie Oil & Gas Co. v. Allen-OK
Rule: May make use of so much of the surface as might be reasonably
necessary for operating drilling, mining, and marketing the same.
Majority view: A cotenant w/out the permission w/out the other cotenants
and no matter how small the cotenant's interest that wants to drill can do so
w/out being subject to being enjoined – cotenant owes duty of accounting
for proportion of net value of oil produced (market value – cost of
extracting and marketing) – cotenant may extract oil and gas w/o consent of
the other*extraction = enjoyment do no need for consent*cotenant gets
nothing until well paid out (debits outweighed by credits) then will get
share – here was 1/10 of proceeds Issue: What are the rights of the non-
consenting cotenants? Rule: e/ tenant has the right. Held: Lizzie can't stop
the other cotenants from developing.
Net profits view [p. 370] -majority of jurisdictions -will award a royalty
interest rather than a net profits interest if a lease purporting to cover the
entire premises is executed by one cotenant and the other cotenant ratifies
the lease.
When can Lizzie ratify the lease granted to Skelly? Reasonable time?
If the wells are barely producing, she can send a letter to Skelly ratifying
the drilling and make herself a lessee.
4. *Note 3. [p.368] -A cotenant's lessee will never knowingly drill with an
outstanding interest out. The drilling cotenants bear 100% of the risk of
drilling a dry hole. If Lizzie wouldn't consent today, you go to the OCC
and force pool.
Why is this law still so viable and important? b/c you miss people and you
may think you have everything leased up, but you don't. There are a few
 states that don't follow the Lizzie Allen approach -but that's not OK or TX
law. (PA, Kentucky, Louisiana)
5. What if there's a nonconsenting cotenant and you go onto the land in
question and drill a dry hole? When debiting the tenant's side, can we
include the cost of a dry hole that we drilled before to the costs of a
productive well. The magic words are "conferring a benefit". If it
conferred a benefit to the first well you may be able to add it to the second.
Oil company would have to bear the loss of a miscalculation of
overpayment to one tenant and no payment to another.
6. If cotenant executes o&g lease with oil co then oil co becoemes in
effect, cotenant of non-consenting cotenant
7. Law of Non-consenting Cotenants: nonconsenting cotenant does not
bear in risk of dry hole – if no production, then nonconsenting cotenant will
not owe other leasing/ consenting cotenant anything
8. Ratification – if well good enough to produce but won’t reach pay out,
non-consenting cotenant may decide to ratify lease in order to receive
royalty payment – can be accomplished by executing instrument with
express purpose of ratifying lease for entire premises by cotenant or by
accepting lease benefits
9. Blanchard case –gives the competing method of accounting, which is
the weighted average [ex. p. 372].
E. Partition of Mineral Interests
1. In absence of agreement to contrary, holders of undivided interest may
ask court to partition the land – could be in kind (split land and give each
tenant full interest in part of land) – where unfair or difficult to partition in
kind, court will have sale and split $$$ between owners
2. Mosely v. Hearrell –TX - absolute entitlement to partition under TX
statute – equitable principles not material in determining if partition proper
but only in how partitioned – some exceptions exist for fraud and
oppression What about mineral estate? In OK, statute governs: must show
court frustration in development with cotenant could not be solved by force
pooling – show by preponderance of the evidence
Held: There is a statute on this subject. If you are a cotenant you have an
absolute right to partition. The ct. has the right to decide what kind of
partition (in kind or by sale). As far as the grant for partition, the court
must grant it. OK regards fraud and oppression as a viable defense. OK
there is no need to invoke a partition remedy b/c you can force pool --Title
12 sec. 1501.1-- if you are seeking partition and what it is you are seeking
partition of is the mineral estate, then in your estate you must prove by a
preponderance of the evidence that there is a frustration of the objective of
the estate and this section would not effectuate a ….
 If you own both surface and minerals as a cotenant and you come seeking a
partition, in that situation going to the OCC to force pool it will not take
care of partitioning the surface estate.
OK leg. recognizes that we should not bother w/ a partition suit, if we can
do the same thing with forced pooling.
F. Life Tenant/ Remaindermen
1. Welborn v. Tidewater Associated Oil Co. - to make o&g lease for
immediate and present exploration and production, must have consent of
both life tenant and remaindermen – life tenant does not have authority to
produce oil and gas (commits waste) – remaindermen who produces oil and
gas w/o consent of life tenant commits trespass. Facts: Martha Smith (life
tenant) goes to court and she is guardian of Garrett (remainder) as a minor
and she has the authority to grant an o&g lease--primary term of 10 yrs.
Later, Smith and Garrett grant a lease to Tidewater. There is still a term left
of 6 years by the time she grants the second lease. Welborn claims that his
lease is being slandered. Ct. says that Welborn didn't have any title that
was being slandered b/c he only had a contingent right if Smith (life tenant
were to die). Rule: The life tenant, acting alone, cannot grant a presently
effective o&g lease. --they would be committing waste. Rule: The
remainderman acting alone cannot grant a presently effective o&g lease.
--the remainderman would be a trespasser, b/c they have no present right to
do anything, their right only is excersizable when they have a present
interest
Rule: Only when both the life tenant and remainderman come together can
they grant an o&g lease that is presently effective. Both life tenant and
remainderman need to decide who's going to get that up front bonus money.
They need to agree on who's going to get the delay rental payment and the
royalties. If Bonus is never agreed upon--Advanced payment of the corpus
of the estate. The remainderman is entitled to this, but not now…must wait
under life tenant dies. This money must be put in a CD or invested.
2. Trusts: in absence of contrary provision, OK statute lists powers trustee
may have including granting o&g lease that extends beyond term of trust
3. Hynson v. Jeffries - beneficiary of trust argued was entitled to entire
royalty and not just interest on royalty during her lifetime
4. Open Mine Doctrine: (exception to CL rule) if mine opened before
creation of life estate and future interest in land, life tenant may be entitled
to continue and operate open mined mine and retain proceeds of such
operation – court found the rule not applicable in Hynson b/c no wells
opened before creation of life estate (no lease for drilling before trust)
5. CO Rule: unless agreement to the contrary, royalties from corpus
invested for remainderman to get upon death of life estate – life estate
owner to get interest from such royalties during lifetime
 6. Policy: life tenant entitled to enjoyment of land in same manner as it was
enjoyed before creation of life estate
7. Uniform principle and Income Act: income from trust to be paid to life
tenant – statute controls over CL – OK has version that applies only to life
tenant / remainder situations created w/in creation of trust – not
conventional situations, then CL applied- OK statute split is 85% royalties
is allocated to income and 15% allocated to principle
G. Surface Tenants: Holders of Defeasible Fees: Mortgages
1. Situation-Surface and minerals are severed. A owns the surface, and B
owns the minerals. Mineral estate is dominant and the surface estate is
servient. A grants an Ag lease to C. C plants wheat. B then grants and ogle
to D. D tries to bring a rig on the land but C says “NO!”
2. Solution
a. The mineral owners are to exercise their right and not injure the
surface. In this case, C has an action for damages if D unreasonably
damages the land.
b. In OK, the SDA says that surface damages are to be paid to the
owner of the fee. The Ag tenant is not mentioned and would
probably not have a remedy.
3. Holders of defeasible fees, whether subject to a condition subsequent,
possibility of reverter or an executory limitation may usually develop or
lease the property for O&G without the consent of the reversion owner.
4. Creditors: (mortgagee) deemed to have legal title to the land but right to
create rights in oil and gas is held by lessor
a. Subordination agreement – oil and gas lessee gets agreement
from mortgagee to honor the lease. Usually will do this because
money was given based on the value of the surface.
H. Terminable Interests
1. Archer County v. Webb - issue was what kind of production would
maintain royalty interest past primary term – court said lease terminated at
end of term b/c no express provision in royalty deed that payment of shut-in
royalty would extend anything but the lease – however, dissent said royalty
deed and lease must be construed together
2. Fransen v. Eckhardt - production means actual enjoyment of tangible
economic benefits which result from marketing – dealing with term mineral
interest so OK not as lenient as w/ lessors/lessees – definition of production
not the same for deeds as for leases
2. RLM Petr. Corp. v. Emmerich - The language of the conveyance
indicated that the term mineral interest and the complementary future
interest held by the landowners were separate and distinct estates. In order
to acquire a lease covering the complementary future interest held by the
landowners, the leaseholders would have needed to obtain a lease from the
landowners. Absent language granting the term mineral interest owner the
 right to encumber the complementary future interest with a lease, the
successor to the mineral rights reservation did not have the authority to
make the landowners' interest subject to the lease after the term mineral
interest expired.
I. Executive Right in Mineral Interest –leasing power
1. Free standing mineral owner interest (nonparticipating) does not have
right lease minerals but does have an interest in the land
2. Mims v. Beall –surface owner coveys land to Mims but reserves a ¼
npri. Mims lease the land to the son John. The Mims get no bonus for
leasing the land. John Mims leases out the land for 1/8 ri to the
Hendersons. This deal would give the Bealls ¼ x 1/8 =1/32=2/64 instead
of ¼ x 3/16 =3/64. Held: Mims show enough evidence that they are guilty
of self dealing and did not use good faith in dealing.
TX Rule: Upmost good faith dealing is required and this amounts to a
fiduciary duty.
OK Rule: That good faith duty is quasi-fiduciary.
Rule of self dealing: The son had no duty, however, he participated as a
person whose interest are closely identified with those of the fiduciary.
*problem [p.402]
J. Meaning of “oil, gas and other minerals” and Named Substances
1. Executing a mineral deed using the “oil, gas and other minerals” clause
a. TX Rule
i. A severance of minerals in an oil, gas and all other minerals
clause includes all substances within the ordinary and natural
meaning of the word, whether their presence or value is
known at the time of severance.
ii. A substance near the surface is part of the surface estate if
it is shown that any reasonable method of production, at the
time of the conveyance or there after, would consume, deplete
or destroy the surface.
iii. If there is a specific conveyance of other minerals, then
the MI owner is only liable to the surface owner for negligent
surface damages.
iv. If there is no specific conveyance, the MI owner is liable
to the surface owner for surface destruction.
b. OK Rule
i. Is the substance a constituent or component of oil or gas?
c. Moser v. United States Steel Corp -TX
Issue: Is Uranium included as a mineral? Rule: If the mineral
within the ordinary and natural meaning of the substance it is
included as a mineral. Minerals that belong to the surface owners:
stone, limestone, calcihe, surface shale, water, sand and gravel,
lignite, iron and coal.
 d. Oklahoma Ex. Rel. Commissioners of Land Office v. Butler
Issue: Is Coal included as a mineral? Rule: Ejusdem generis
–“other minerals” to be construed generally; Coal is not a
component or constituent of oil or gas. Rule: Extrinsic evidence is
not allowed to show the intent of the parties -Oklahoma has a narrow
view of what “other minerals” means
i. Patents –reservations of “minerals” or specific substances
and “other minerals”
K. Ownership of Coalbed Gas-
Does a grant of coal carry ownership of coal bed methane gas (CBM gas)?
1. Amoco Production Co. v. Southern UTE Indian Tribe
Facts: In response to homesteaders interest and fraud Roosevelt passed the
1909 act. This act authorized issuance of patents to individuals who had
already made good-faith agricultural entries onto tracts later identified as
coal land, but the issuance was to be subject to “a reservation to the US of
all coal in said lands, and the right to prospect for, mine, and remove the
same” held that the coal reservation encompassed CBM gas. The most
natural interpretation of coal as used in the Acts was a solid rock
substance and did not encompass CBM gas .- Inconsitent cases; no OK
cases on CBM
L. Overconyenance Duhig and its Progeny
1. Duhig v. Peavy-Moore Lumber Co. - The Duhig Rule, Two-Grant
theory, the Non-Apportionment rule, and Community Leases
a. Duhig rule: If A grants BA to B by warranty deed (and Duhig
only applies if you are dealing with a warranty deed), and A
reserves an undivided fractional intersest in the mineral
estate, but fails to mention in the deed that X already has part
of the mineral interest, then A has to bear out of his share the
proportion that was already granted to X. Looking at the deed
itself, and only the deed, what interest has A purported to
convey to B, and whatever A has purportedly conveyed, B
will get, and A will have to give it up out of his share.
b. Two grant theory: Situation where the owner of the land has
i. granted an oil and gas lease (made a conveyance in the
lease’s granting clause), and then
ii. has made some other grant in the “subject to” clause
c. What factual situation brings into play each doctrine:
i. the Duhig rule:
2. EXAMPLE: X owns Blackacre in fee simple, and grants Blackacre
to B, and X reserves an undivided fractional mineral interest. B becomes a
Duhig grantor when he grants a mineral interest to C (the Duhig grantee).
Now, the problem comes up when B purports to reserve a mineral interest
to himself, and he fails to mention that there is already an outstanding
mineral interest in X. The Duhig rule tells us that you estop B from
asserting that he retains a mineral interest for himself. (Here, say X retained
a ½ mineral interest, and then B also purported to retain a ½ mineral
interest. Under the Duhig rule, we estop B from asserting that he has
retained a ½ interest, since he only had ½ interest to begin with – his
purported reservation is deemed to be the interest of X).
ii. the two-grant theory:
1. In the deed, there is a fraction in the granting
clause, and then somewhere else in the document you have a
different fraction (that most often has to do with some
mineral interest that is outstanding on the property). The
theory is that the instrument then conveys two separate
interests, one in the estate mentioned in the granting clause,
and the other in the fruits of the oil and gas lease.
iii. the non-apportionment rule:
1. Owner of fee simple interest decides to divide a
parcel, selling some fraction and retaining the rest, but all of
the property is under one oil and gas lease. Say the oil
company drills a well on the land that is still retained by the
original owner. Then only that person gets the royalties – they
don’t have to share it with the people who own the land that is
now severed and is not where the oil well was located.
3. Note that in Oklahoma, we often do our drilling on spacing units,
and in that case, the various owners in severalty are apportioned part of the
proceeds from the oil and gas operations
4. To Recognize a Duhig situation :
a. when at the time of the conveyance in question, first the mineral
interest is owned by the third party and the other …
b. no interest is mentioned in deed to third party
c. the grantor purports to convey a mineral interest to himself
d. what the grantor purports to pass to the grantee is what shall
pass instead of the presence or absence of a warranty (sometimes
doesn’t matter if it’s a warrant deed or not)
5. Acoma Oil Corp. v. Wilson - The successor landowners died, and
their sons took over their interest in the property. A dispute arose over the
issue of whether the burden of the 6.5 percent royalty should be shared
proportionately by the mineral deed holders and the sons, or born entirely
by the sons. Held: equitable estoppel and actual or constructive knowledge
of the outstanding 6.5 percent royalty were not applicable to the action,
because the successor landowners owned enough royalty interest in the
tract of land to satisfy the previous royalty assignments without a reduction
of any royalty from the "mineral acres" conveyed to the mineral deed
holders.
 6. Boswell Energy Corp. v. Arrowhead Homes, Inc. -The issue was
whether the words, "Less and except all mineral interests" in the deeds also
reserved the minerals, and the controlling factor was the intent of the
parties. Basically those words suck because they are ambigious and
nobody knows what the hell you are doing.
VIII. Oil and Gas Lease
A. Proportionate Reduction Clause (a/k/a Lessor Interest Clause)
1. Texas Co. v. Parks
Facts: Mr. Parks and his wife own an undivided east half of the section.
They own a net mineral acre interest of 160 acres. Ct said you wrote in you
are going to pay him 160$ rental, so that is what you have to pay for delay
rental. The TX company paid 80$ instead to extend the lease. Therefore,
the lease has expired.
2. Note 3 [p. 455]
Jones and Morales e/ owns an undivided half interest in the mineral estate
in Blackacre, but that Jones’ interest is burdened by a 1/16 nonparticipating
royalty held by Nguyen. Jones and Morales e/ execute separate, but
identical oil and gas leases. E/ lease purpose provides for a 1/8 royalty,
contains a proportionate reduction clause, and purports to cover 100% of
the mineral estate. The lessee drills and obtains production. How much
royalty must the lessee pay? To who is it paid?
Morales – 1/16
Winn – 1/16
Jones – O
ABC Oil Co.- 14/16
3. Note 4
Are we going to apply the lessor interest clause from that 1/16 that was set
out from the 1/8 royalty?
Yes you apply it and you get 1/16.
Then it is subject to the production interest clause.
B. Conveyances “Subject To” an Existing Lease
1. Hoffman v. Magnolia Petroleum Co.
Facts: Mr. and Mrs. Duke own a 320 acre tract. The Dukes own a mineral
interest in half of section 1. Duke and his wife grant an oil and gas lease
covering the whole 320 acres tract to Harvey that provided for a 1/8th
royalty. 8 months later, they grant to Hoffman ½ undivided mineral interest
to Hoffman in a 90 acre tract. Wells are drilled on this lease and Hoffman
is bringing suit for recovery of portion of the royalty on well that were
drilled on a 320 acre tract. He failed to say that the wells were on the 90
acre tract. Issue: Whether the deed gave P a right to participate in any
royalties under the lease, unless production were had from a well upon the
90 acres? Held: He was entitled to sharing the royalties
 - If you don’t put a subject to clause in the lease then you get the royalties
for land that you have leased to another,
- Hoffman gets half the royalties
Two grant theory:
- the leading case on the “subject to” clause-this case-although this
decision has been influential in disputes, it actually involved a conflict
btwn the subject to clause and the granting clause. The court resolved
the conflict by showing that two grants were actually conferred.
- Arose whether there was a 2nd grant that covered an actual physical area.
There was a possibility of reverter w/ respect to the 90 acres and a ½
interest available. Submitted that this ruling as unsound. Holding
construed one instrument as having two grants. The parties may have
never intended to convey anything beyond the 90 acres. Now, they look
to only 90 acres not all of the land; they submit that this is what parties
in Hoffman intended.
2. Concord Oil Co. v. Pennzoil Exploration and Production Co. - Action
was brought to determine size of mineral interest conveyed by deed
executed while grantor's interest was subject to producing lease. It was held
that: (1) deed created single estate of 1/12 of all rentals and royalties,
covering existing lease and any future leases; (2) deed conveyed possessory
interest; and (3) prejudgment interest was not available.
C. The Nonapportionment Rule
1. Japhet v. McRae - Rule: Where the lessor of land for oil and gas,
subsequently to the execution of the lease, but prior to the development of
the land and the production of oil or gas under the lease, sells a portion or
portions of the land to others, and oil and gas are thereafter produced under
the lease from some portion of the leased premises, the royalties there from
belong to the owner of the particular tract upon which the well is located
and the owner or owners of other portions of the leased premises have no
interest therein. Rule: Oil is a part of the realty until brought to the surface
and that it can be sold in place. The only way they have a COA is if there is
draining. It is unjust to take away the property apparently belonging to one
party and give it to another until it is shown that the latter party has been
deprived of it. Courts should not make contracts for people overturning
those they have voluntarily and fairly made for themselves
2. Nonapportionment rule -You do not apportion oil
Clause can be put in a lease to have oil apportioned -entirety (entireties
clause)[p. 482] ex. -if the leased premises are now or shall hereafter be
owned in severalty or in separate tracts, the premises, nevertheless, shall be
developed and operated as one lease, and all royalties accruing hereunder
shall be treated as an entirety and shall be divided among and paid to such
separate owners in the proportion that the acreage owned by e/ such
separate owner bears to the entire leased acreage.
 If there's no entirities clause in the lease, then the nonapportionment rule
applies. If we have a drilling and spacing unit in the fact pattern, then this
communitizes or apportions the royalty interest
Therefore, it is not important to include a clause in OK, b/c most oil and gas
leases are drilled after the OCC has come in and made a drilling and
spacing unit
D. Top Leasing
- A top lease is a lease that will vest if the other lease ever expires.
- Problem with top leases is that they may violate the rule against perpetuities. To
avoid this, include language like Fill out the lease just as you would otherwise, but
include the language: “This lease is granted on the lessor’s reversionary interest in
the leased premises, and is hereby vested in interest, but is subject to a lease
interest recorded in _______ and will become possessory only upon the expiration
of that lease.
1. Practice pointer: if you are asked to create a top lease, be sure not to
cloud the title of the bottom lessee, and write it in some way that doesn’t
violate the rule against perpetuities (say that it vests in interest right now,
but it doesn’t vest in possession until the bottom lease expires.
2. Hamman v. Bright & co. - held that: (1) oil and gas top leases, which
were to become effective if and when existing oil and gas leases expired or
were terminated, violated rule against perpetuities, but (2) perpetual
nonparticipating free royalty interest reserved by grantors in subsequent
deed did not violate rule against perpetuities.
E. Trespass and Related Actions
1. Trespass
a. When the mineral and surface estate are severed, you must
get the permission of the MI owner to explore for minerals. For good
PR, and to just be smart, a person should get the permission of the
surface estate owner as well.
2. One cotenant can validly grant a permit for seismic operations to a
party. The seismic explorer does not have to have the permission of all
cotenants.
3. Geophysical Trespass
a. A geophysical trespasser is one who conducts geophysical
operations on the land of another with out permission or consent.
b. A surface estate owner cannot, by himself, grant permission for
seismic operations to be conducted on the land.
4. Mere vibrations from seismic operations do not constitute a trespass.
There is no physical invasion.
a. This may not be the case if information is gained from the
adjoining tract.
5. A good faith trespasser is liable for the ratable share of market value
or the amount by which the drilling of a dry hole decreases the value of the
mineral estate.
a. If a good faith trespass results in a producing well, the true
owner is entitled to the recovery of the value of the O&G produced.
b. If the trespasser is truly acting in good faith and a producing
well is drilled, they are entitled to retain the costs of drilling the well.
c. A bad faith trespasser does not get to recover anything. This is
a form of punitive damages. They do not have to leave and forfeit
the equipment, but they must leave the equipment that cannot be
recovered with out entry into the well.
6. Enron oil & gas company v. worth - held that: (1) undivided mineral
interest owner can separately convey right of reasonable ingress and egress
upon surface for limited purpose of conducting geophysical exploration; (2)
permits which mineral interest owners executed validly transferred to
permittee right of ingress and egress upon surface for limited purpose of
conducting geophysical exploration; and (3) permission of all fractional
mineral owners is not necessary for owner of undivided interest in mineral
estate to transfer right to conduct seismic exploration to third party.
7. Grynberg v. City of Northglenn -held that: (1) surface estate owner
could not authorize city's exploration of land for minerals where surface
and mineral estates were severed and separately owned; (2) owner of lease
could maintain action against city for unauthorized geophysical
exploration; (3) recording statute did not insulate city from liability; and (4)
genuine issues of material fact existed as to liability of city.
8. Phillips Petroleum Co. v. Cowden -that mineral owner had a cause
of action in trespass only, which, however, could be waived for a suit in
assumpsit for the reasonable market price of the use and occupation, and
that evidence was sufficient to sustain trial court's finding that the damages
per acre amounted to $20 but that district court would have to establish, for
purpose of determining damages, what areas could reasonably be included
in an agreement regarding such an exploration and would have to consider
that compensation would have to be paid only for the area reasonably
regarded as 'occupied' by the survey.'
9. Humble Oil & Refining co. v. Kishi - Good faith trespasser drills a
dry hole will be liable for damages they created during that trespass
Two cotenants entered into the same lease: Kishi owns surface and 3/4 of
minerals; L owns 1/4 minerals, K signs the lease Jan 9, 1920 (it was 1919)
Humble looks as the lease (sees the drilling next door) and says let's take
the position that our date ran at the face of the lease. (good faith position).
They drilled until 1923 from the date of the lease. They drilled a dry hole.
What liability did Humble have? He was a trespasser b/c he asserted a
property right he didn't have then Kishi would've been entitled to 3/4. L
who owned the 1/4 consents
10. p. 510 Wyoming case -If you're a good faith trespasser you get to
deduct your well costs. By drilling the well and making a producer out of it
then you have conferred a benefit to the true owner. However, if you have
already had some wells and it drifted over to this guy's well --then you
haven't conferred a benefit. It's to the extent that he's conferring a benefit
that he gets to recover costs for drilling the well.
a. The bad faith trespasser you don't get to deduct your well
costs. The true owner must send you the money to make you whole
again as the lessee. TX cts - in the face of a pending suit agst the
true owner, if you come on anyway during the pending litigation,
then TX cts will deem you to be a bad faith trespasser.
10. Kennedy v. General Geophysical Co. - The oil company employed
the geophysical company to conduct geophysical operations in connection
with oil exploration. The geophysical company sought the landowner's
permission to conduct the operations on his land. The landowner refused.
The geophysical company conducted the operations on adjoining land. The
court held that the landowner failed to prove physical damage to his land
caused by the vibrations or that appellees obtained information about the
subsurface his land via the geophysical operations, so the landowner was
not entitled to damages for trespass. The court determined that the
landowner could not recover exemplary damages because he failed to prove
malice by appellees.
11. Slander of Title -From the time that the ct. enters judgment that you
are a trespasser, you must surrender possession; Continuing validity of an
oil and gas lease or ownership of an oil and gas interest
5 elements P must prove:
i. publication by the D
ii. falsity of the publication
iii. malice
iv. financial damage
v. an estate or interest in the property slandered
*proof of a lost sale
*lack of good faith and probable cause = malice
12. Kidd v. Hoggett -Hogget and his wife are land owners. There is an
outstanding oil and gas lease who own the lease and they get a well drilled
just before the end of the primary term, however they claimed that that had
completed a well cabable of production, and so they continued the lease by
paying a shutin gas royalty. There is a company that buys gas from
producers and buying gas from wells next door. The Hoggets finally
become suspicious and Kidd and Cherry keep refusing to release the lease
so the Hoggets sue them. So the Hoggets bring a suit to clear the cloud in
the title. If you go after money damages, then you have a claim for slander
of title. The elements of slander of title: Malice is an essential element of
a slander of title suit. Malice means an act of refusal w/ dileberate conduct
without reasonable cause. You need to show a lack of reasonable reason
that they are holding a cloud on the title. The other element, prove "special
damages" -you have lost a specific opportunity to deal w/ your land in a
certain way -lost money or suffered financial detriment for a claim of
damages. Ex. -X having approached the Hoggets that want to lease the
property, and they loose that opportunity based on the cloud on the title.
This is bad faith conduct and they actually reach fraud in this case, but the
ct is quite generous twds them.
13. Adverse Possession –
Elements
a. An actual entry giving exclusive possession that is
b. Open and notorious,
c. Adverse and under claim of right, AND
d. Continuous for the statutory period.
- When a person adversely possess the surface estate, they adversely
possess the unsevered mineral estate as well.
- A production unit does not provide adverse possession if the unit
well is not drilled on the land to be adversely possessed.
- IF the adverse possessor is acting under color of title, then the
mineral estate adversely possessed is what the conveying document
says. If the adverse possessor is a squatter, then only the mineral
estate under the adversely possessed surface estate is adversely
possessed
- A severance of minerals by the lawful owner after adverse entry,
but prior to the completion of the statutory period, does not interrupt
the running of the statute either as to the surface or minerals.
e. diederich v. ware - title had actual and timely notice that oil
was being taken from the tract under the adverse claim and made no
effort within the 15-year statutory period to assert their rights. On
appeal, the court affirmed the judgment because the operation of the
two oil wells for the statutory period cut off the right of anyone else,
including the claimant, to drill for or extract oil on the property.
f. Fadem c. Kimball
Fadem put out some cattle and a fence on the land and proved that
he did adversely possess the land. There was no severance of the
minerals. Kimball's -Fadem's had granted oil and gas leases
themselves, and this was held to exercise dominion over the
property. Mr and Mrs Berry deeded this land to the Fadems, but
they reserved a 1/2 mineral interest. The Fadems would take the 1/2
mineral interest that was never severed.
g. Cornelius v. Moody Bible Institute of Chicago
The adv possessor is Cornelius. Cornelius' mother owned the
interest in question and she conveys this land to her brother and
Cornelius doesn't know this. The brother has leased the land to other
people. Cornelius says since he's received royalties and paid taxes
on the property then this means he has adv possessed it. In this case
it was the lessees that were adv possessing it. He didn't even get the
royalties b/c there was not actual production for the entire 15 yr
period. Cornelius was trying to do a sort of tacting and the ct. didn't
buy it and said that you may not tact with respect to production
elsewhere. The ct. said he had to go through the elements of adv
possession and this wasn't enough to show that he has adversely
possessed the land.
h. Atlantic Richfield v. Tomlinson - (1) mineral leasehold
interest may not be adversely possessed either by drilling of and
production of oil and gas from well drilled on separate tract of land
within drilling and spacing unit created by Corporation Commission
or by possession of oil and gas leasehold under claim of right for
statutory period; (2) jurisdiction to decide quiet title action was
properly with district court; and (3) prior quiet title judgment had no
effect upon defendants' mineral interest rights where they were
neither parties nor privies to quiet title action.