Flaring GasBlawgletter offers the fourth installment in the seven-part series on the Hottest Oil & Gas Claims for 2015. This time, we address whether flaring gas qualifies as "use" on which the operator must pay royalties.

Legal backdrop

Royalty clauses typically require payment of royalty for oil and gas “produced from the Leased Premises and sold or used on or off the Leased Premises”. Chesapeake Expl., L.L.C. v. Hyder, 427 S.W.3d 472, 481 (Tex. App. – San Antonio 2014, pet. granted) (emphasis added).* A compensable “use” includes burning “gas for fuel or other operations”. Id. at 482.

In the Bakken shale area (and other “new” production areas that may lack gathering lines and other infrastructure), “the oil contains significant amounts of natural gas, and because of the geological manner in which the gas is commingled with oil in deposits, operators cannot produce the oil without releasing the gas simultaneously.” Kelly A. Williams and Joshua B. Cannon, Frontier Flaring: Science & Economics, Politics & Regulation – the Future of Flaring, 60 RMMLF-INST 5 at 3-4 (2014).** Does the need to produce gas in order to get oil to the surface make flaring the gas “use” of it for purposes of the royalty clause?

Claim economics

A viable claim for royalties arising from flaring of gas will likely include these traits:

  • Physical necessity of extracting gas to produce oil from the formation;
  • Loss of substantial quantities of gas through flaring;
  • Absence of contractual, regulatory, or statutory language authorizing gas-flaring or restricting remedies; and
  • High wellhead prices during the relevant look-back period (e.g., the length of the statute of limitations) and into the future.

On January 30, 2015, the Supreme Court of Texas granted review in Hyder and set the appeal for argument on March 24, 2015. See Chesapeake Expl., L.L.C. v. Hyder, No. 14-302 (Tex. Jan. 30, 2015).

** A flaring claim under a standard royalty clause may exist apart from other theories. North Dakota law, for instance, requires a producer that flares gas without an exemption to “pay royalties to royalty owners upon the value of the flared gas”, N.D.C.C. § 38-08-06.4, but the statute grants a right only to pursue relief before the North Dakota Industrial Commission, Hansen v. Hunt Oil Co., No. 1:14-cv-00021 (D.N.D. May 14, 2014), aff’d sub nom. Sorenson v. Burlington Resources Oil & Gas Co., L.P., No. 14-2407 (8th Cir. Aug. 19, 2014).  The Louisiana Department of Natural Resources takes the view that “[r]oyalty must still be paid upon the flared/vented gas even with the  Dept. of Conservation approval for flaring.” Royalty Payments Frequently Asked Questions, La. Dept. of Nat. Resources (available at http://dnr.louisiana.gov/index.cfm?md=pagebuilder&tmp=home&pid=406) (as of Jan. 20, 2015). “Not surprisingly, the states have adopted differing approaches to assessing royalties on flared gas, and state policies fall somewhere on the continuum between charging royalties for all gas flared on state leases (e.g., Texas) and charging no royalties for gas legally flared (e.g., Utah).” Frontier Flaring, 60 RMMLF-INST at 10.