Short-payment of royalties

Today we come to number three in Blawgletter's seven-part series on The Hottest Oil & Gas Claims for 2015, a paper that we presented at the 66th Annual Oil & Gas Conference in Houston. The third topic describes an area of legal uncertainty around a common oil and gas term — "well" — that no longer means a vertical hole in the ground.

Legal backdrop

New techniques for drilling, completion, and conducting other operations have the potential for disrupting oil and gas law. Horizontal drilling offers a case in point.

With conventional (vertical) drilling, “well” more or less refers to the wellhead, the place where the basically up-and-down wellbore connects to the surface. Drilling sideways, by contrast, typically taps into oil and gas deposits at multiple “takepoints” or “drain holes”.  See Springer Ranch, Ltd. v. Jones, 421 S.W.3d 273, 289 (Tex. App. – San Antonio 2013, no pet.) (holding that contract between adjoining landowners required apportionment of royalties according to “the ratio of the productive portions of the SR2 well on [the landowners’] respective properties to the entire length of the well, multiplied by the one-eighth lease royalty”); Browning Oil Co. v. Luecke, 38 S.W.3d 625 (Tex. App. – Austin 2000, pet. denied) (discussing allocation of production for purposes of computing royalty under lease that restricted pooling).

The definition of “well” may thus blur. What consequences follow?

Plaintiff's perspective 

A claim over what constitutes a “well” will likely (if not necessarily) involve a contractual relationship, as in the Springer Ranch case, between the plaintiff and the defendant. But that may not present much of a barrier; relationships like that abound in the oil and gas industry.

The standard-form joint operating agreement, for instance, uses “well” dozens of times but does not define it. Oil and gas leases also speak of “wells” but seldom give the word a specific meaning. Landowners or lessees whose tracts adjoin may also work out supplemental lease terms that allow pooling or enter into “production sharing agreements” that provide for horizontal wells crossing two or more tracts. See Clifton A. Squibb, The Age of Allocation: The End of Pooling as We Know It?, 45 Tex. Tech. L. Rev. 929, 940-41 (2013).

What would a good claim over what constitutes a well look like? The factual setting may include these features:

• Large production from and reserves in actual or potential communication with the horizontal wellbore (enhancing the value of any "well" that lies along the wellbore);

• Absence of contractual language defining “well” (making its meaning debatable);

• Contractual language that bars or limits pooling, entitles the mineral owner to royalties or other payments with respect to production from any “well”, or otherwise bases payments on the existence or number of "wells"; and

• High wellhead prices during the relevant look-back period (e.g., the length of the statute of limitations) and into the future.

Enough value?

Recall that the basic economics of pursuing claims (whether in a lawsuit, arbitration, or otherwise) will make some claims more viable than others. In general, the same traits that render a claim attractive to a contingent-fee lawyer will determine whether the potential gain supports risking your own resources (e.g., hourly fees plus expenses) in the endeavor — a good liability case, provable damages, and a wrong-doer that can afford to pay.

The series

You can see the first two posts at Hottest Oil & Gas Claims, Part 1: Busting Leases and Hottest Oil & Gas Claims, Part 2: New Drilling Technology.

Next time, we'll look at whether flaring gas qualifies as "use" for purposes of computing royalties.