Oil and Gas

Ernest Smith

Fall 2001

I. Introduction

  1. Theories of origin:
  1. dead dinosaur (microbes) – organic material formed in shallow seas. As organisms die they settle and are covered by other substances. They sink further down and are subject to heat and pressure. Chemical reaction forms petroleum and natural gas. After formed, pressure forces them out into secondary source rocks and maybe onto third and that is where they are found today.
  1. non organic theory (Prof ???) – find methane everywhere in solar system, even where inconceivable was organic life, so methane is building block of ss. Large qtys of methane in core of earth, through intense heat pressure and bacterial action, transferred through chem reaction which creates oil and gas’ appearance of being organic in origin.
  2. Vast majority adhere to organic theory although some say conceivable that non organic could occur sometimes.
  3. Vast maj of reservoirs in middle east, by 2020 if all GWs recommendation correct, still heavily dependent on mid east. If non-org correct, could drill and find methane anywhere and not rely on.
  1. Oil must be in a structure that creates trap to be viable with some rock substance on top and seal underneath (typically water) on bottom to keep in place
  1. Geological models

i)Categories of reservoirs/traps

(1)Stratographic trap – formed by deposits of sedimentation

(a)sand deposited over region, turns into sandstone, migration of hydrocarbon into sandstone, some other substance laid over sand become trap

(b)see 9 on 32

(2)Structural trap – formed by

(a)anticlimb/dome- have gas cap on top, beneath that have oil, beneath that is water, fig 7 p 31. common type throughout us

(b)breaking – risk of drilling higher with faulted reserve than with sincline or anticline. Probably have to drill more wells in faulted field too, especially if traps unconnected as usually are.

(3)Syncline – looks like a reverse dome (opposite looking of struct trap)

(4)Salt dome (Spindletop) – thick stratum o’ salt which has had enormous pressure push down on it (like pushing on both ends of toothpaste tube) and will shoot up in middle. Have been enormously productive historically.

(5)Fracture field/reservoir – consists of hundred o’ discontinuous pockets of oil in a mostly impermeable substance. As costly as anticline but production falls off much faster.

(a)Would rather drill 20 anti than 100 fracture. Middle east is anti, tx is more fracture.

ii)Concept of reserves

(1)Media equates reserves with oil in ground, but are function of three things:

(a)Known oil in ground

(b)Price – if price low, nobody will drill crap fracture wells. Effect of increase in price is to increase reserves b/c become profitable to drill for known areas of oil that wouldn’t be profit at lower price

(c)Cost of extraction – is largely fn of technology, years ago still high rish of not hitting anything but 3d seismic makes more accurate and costs less to explore. Horizontal drilling allows to decrease costs of producing b/c can drill fewer wells and extend it.

  1. Production of Oil
  1. Contents of a reservoir—in the rock you have natural gas, oil and salt water. The substances tend to sort themselves out according to their densities. In the pores at the top of the rock, there is a gas cap. Second form that you may have gas—solution gas. Liquid under pressure absorbs gas. The oil in the reservoir is under extreme pressure and in it you have solution gas. The water tends to settle towards the bottom in filling the pores in the rock. You also have connate or interstitial water—it is present in other parts of the reservoir—with oil and in gas cap. Even though the substances basically separate themselves out, b/c geologists and regulatory agencies work with models, you tend to ignore imperfections and mixing in the model.
  1. Getting oil out of the reservoir: all substances are under enormous pressure. By drilling you connect low pressure surface with high pressure strata with the oil. You end up creating a vacuum so that substances expand and push themselves out to the surfaces.

i)If you want to get max energy out of dome reservoir, you would drill down structure—away from the gas cap b/c you are principally interested in producing oil. So, you want to take advantage of expansion of the gas cap—thus you should drill away from it.

ii)Gas caps: Suppose that you drill into the gas cap. You are interested in producing oil, you want the energy source to be expansion of the gas as the pressure is reduced. The most desirable place is away from the gas cap. You will end up with an enormous initial production of natural gas and oil. But you end up wasting your energy source. This is like shaking up a Coke can.

(1)There are also other bad consequences of drilling into the gas cap

(a)problems with solution gas—end up releasing pressure in all parts of reservoir more quickly than you should. The effect of losing the solution gas—remaining oil is more viscous—thicker and syrupy and so it is much harder to produce.

(b)if you end up with pockets of oil in the gas cap, they become isolated from the rest of the oil and so they become virtually unproduceable. Note that if you produce oil correctly you will get 35-50% of oil in place. If you don't, then you are lucky to get 10% of the oil. Note though that people will drill into the gas cap b/c that is the only place that they have access to drill—where they own property.

(2)Why would you ever drill in gas cap? If that is all you own (land), you have to. Why don’t you get into an agreement with your neighbors (unitization)? Develop it as a single unit. The 1st problem is, what is your fair share? You’ll have holdouts etc. You almost never have voluntary unitization. Most states have compulsory unitization bz there comes a point when the reservoir does not produce efficiently.

(a)Alternative—enter into an agreement with the other surrounding landowners to drill the reservoir correctly. IOW, unitize the reservoir. Unitization rarely happens by voluntary agreement. There is a question about what is your fair share. Will usually only get voluntary unitization in late stages—when decline has been brought to a point where the oil is not really producing any more. More likely to get unitization early on through regulatory unitization—TX does not have forces unitization. Very few will have forced unitization very early in the life of the reservoir.

iii)Water - Another source of energy is water. A reservoir whose primary source of energy is gas cap—it is a gas cap expansion reservoir. May also have solution gas expansion reservoir or a water driven reservoir. Truncated dome reservoir—primary force is the water drive. When water is subject to enormous pressure, it may become compressed. If you reduced the pressure, the expansion of water can provide an enormous driving force. Relying on expansion or hydraulic flow to get the water out. In this type of reservoir the most desirable place to drill is up structure b/c the energy source is at the base. Note that in gas cap, you want to drill down structure. So, you need to know what type of reservoir that you are dealing with so that you can drill efficiently. Drilling in the wrong place in a water drive causes oil to move to pockets where it cannot be recovered. This is called ______??? Note that you also will end up with economic waste—will cost a lot drill a well in any place, but if you drill in a way that will not produce efficiently, it causes economic waste.

  1. All this is primary stage of production. After a while, the internal physics are still working. But the pressure within the reservoir is not powerful to get the oil up in any large quantity. So, you use pumps. The internal movement is not caused by the pumps, it is by the internal energy. This is the primary stage of production. When the energy source is played out to move the substance around, if you want to produce what’s left (90%) you have to go to what is called an Enhanced Method of Production. You try to restore reservoir energy. In a water drive, you may re-inject water to re-create the drive.
D.The Oil Industry
1.Dominated by a few companies, the majors.
2.Also a fair number of independent oil companies.
3.Means the industry is not vertically integrated. Exxon does it all from production to sale. Independents usually only do one or two stages. Maybe E&P (exploration and production).
4.Traditionally, TX has had a large number of independent companies.
i)They are all privately owned.
ii)There are also state owned oil companies. These are analogous to the post office. It is a corp that is entirely owned by the US govt.
5.Regardless of which we are talking about, one factor that they all have to deal with is that E&P is capital intensive. Your major investment is upfront. Once you get production and have the well going, your costs are relatively small. One effect of this capital structure is that there is an inevitable eco incentive to keep producing even if the price of oil goes down. As long as I have a positive cash flow, I am going to keep producing. That is the only way to re-coup and make some income. This partially explains what is an eco history of the oil industry. It goes up, down, up, down, up etc. The economics push towards over-production.
6.Another characteristic: The oil industry is heavily dependent on technology. Historically, it has 1st, enabled companies to E&P reserves that otherwise would not have been discovered or produced. It decreases the cost of producing oil. The concept of reserves is also: can we produce it economically? To the extent tech reduces costs, it makes it more eco to produce.
7.Unique to the American oil industry is the legal system that we have that regulates it.
i)There are 2 things that make American O&G law unique:

(1)Private ownership- If you’re a citizen of Mexico, you may own the surface of the ground, but you don’t own the O&G beneath the ground. Everywhere else, the govt owns the O&G. , it is almost always possible to drill in the proper places. Bz of private ownership, you are going to own enough land to dig into a reservoir. Diff people own the same rights to O&G.

(2)Rule of Capture. If you produce O&G in your own land, it is yours, even if you drained it from someone else’s land.

II. Regulation of Drilling and Production

A.Rule of capture
  1. Background - The rule of capture when coupled with private ownership gives a legal regime in US which is different than anywhere else. There are varying theories of ownership b/c of this—non-ownership but exclusive right to obtain on your land, or competing theory of ownership in place which mean you own oil and gas below land but will lose ownership if it is drilling off through your neighbor's land
2.Rule of captureis a property right.
a)Some TX cases say this. Can take into account that are preexisting cross easements

b)Alternative view – viewed as more correct, says this is a rule of judicial convenience. Nobody know enough about how move to say how know where oil cam from.

  1. What can and can’t you do under the rule of capture?
  1. Can’t trespass and drill under neighbor’s land.
  1. Can put in a ‘super pump’ to suck oil out! Ct said no actionable b/c industry lives by technology. Saying can’t would discourage tech development.
  1. Fracking – inject some fluid under pressure through well that will cause fractures to extend from the well-bore. If have tight sand, which is very impermeable, can do this to increase permeability.
  1. Issue under fracking: if fractures go over prop line, is this protected by rule of capture or is it a trespass?
  1. Kelly v. Ohio Oil (Ohio) – P claims D pulling from his reservoir that were deliberately close to his property line. Arguing conversion of his oil (like sucking car off neighbors driveway). Ct says right to extract oil is absolute.

a)Ct applies rule of capture – as long as well is not physical trespass then have right to produce anything that comes up, even though may have drilled as close to boundary as can get.

b)Nonownership theory – don’t own oil and gas beneath land, unlike solid minerals like gold etc b/c doesn’t stay in one place, don’t own it until produce it. About ½ states are nonownership jurix like OK and La.

c)Alternative theory – ownership theory – ½ states including TX. You own the oil and gas beneath land in fee simple, just as own any other mineral beneath land, but lose title to it as soon as drained from neighbors land. TX adopted this theory b/c of public school financing and tax issue. Tax issue resolved in legislature in states like OK.

  1. Smith says nonownership is more logical
  1. Effect of rule of capture – whatever theory use, basic remedy at private law is self help. Regulations have responded to this problem in part.
  1. Problems with rule of capture

a)Does not permit long-term planning.

(1)Ex. Mar 99 oil at $9 barrel. Today $28. Smith drills well, Carr wants to wait for prices to rise before he drills. Carr has no judicial remedy if Smith takes it all, is no judicial remedy, have to go drill.

(2)Iraq argued Kuwait violated OPEC quota and used self-help.

b)Societal consequences of rule - have lead to heavy reg of oil/gas industry (which occurs almost entirely at state level).

(1)Results in overuse of surface (see spindletop 53), even if best use of land is for other purposes. Could put houses etc there.

(2)Environmental problems. Oil all over place. Risk of spill increase with each add well drill.

(3)Economic waste – more cap investment in industry than needed to produce that much oil. Means if industry is monop/oligo costs passed on to consumer where market controlled. If industry is very competitive, than cant pass on. Also, means will be less money available for r&d technology too.

(i)Premature abandonment - every states allow only certain amt of time can stop producing w/out plugging (leaving unplugged pollutes underground water pollution)

(ii)Argument of problem of overproduction – depresses prices and results in wasteful use of fuel and nonsustainable development. Reach point where the cost of finding and producing new oil is more than the current value of oil. Argue that high prices discourage inefficient use of fuel

  1. Destroys reservoir quickly when have to overdrill.
  1. Compels competitive drilling. Most oil reservoirs on private land in the US were produced badly. So, production from private reservoirs is on a declining curve. A lot of that has to do with the age of the reservoirs, but another reason for the steepness of the curve is the way that they were produced. The decline doesn't mean that there is no more oil there. The problem is to get at the oil, you have to use enhanced recovery techniques—need to change the reservoir mechanics to get at oil that you can't get by using the energy initially in the reservoir. Problems: 1) These enhanced techniques tend to be expensive. 2) In order to do this, you have to unitize—everyone with a mineral interest in the reservoir needs to agree to the plan of enhanced recovery. Unitization is legally difficult and expensive. Even in states that have forced unitization, you have to get an initial high percentage of mineral owners to agree b/4 a regulatory agency will require others to join in. Note that in TX we don't even have any forced unitization.
  1. Correlative rights doctrine – is a common law limitation on rule of capture that says that rule of capture does not protect you in the event you are negligent in destruction.
  1. The correlative rights doctrine provides that each owner of oil and gas in a common reservoir has the right to a fair chance to produce the reservoir substantially in proportion to the quantity of recoverable oil and gas under his land compared to the quantity in the entire reservoir.

(1)Ex. A, B, C have rights that are all in same reservoir. Each has some obligation to respect the reservoir.

(2)First arose in context of intentional waste of reservoir substances.

(i)Where A vents gas as opposed to letting B have it because he doesn’t want to build a well.

(ii)Can’t waste substances for spite. B can enjoin A.

(3)Most common situation where doctrine applied: reckless/negligent conduct. Early method of fracking was to drop nitroglycerin down well, which increased permeability but could destroy reservoir.

(i)Elliff v. Texon Drilling Co (TX) – D operator used improper weight of drilling mud (fluid inject in well as drilling to lubricate drill bit, removes rock particles drilling out and prevents blowouts) that was too light, resulting in a blowout. P brought suit for neg. destruction of oil and gas. D argued rule of capture, because although we are buring this shit, it is on our land. TX SCt said rule of capture is to protect against liability for proper means of production, not where negligently destroy.