Private Law: Ownership and Leasing

Oil and Gas Law – Komatireddy – Spring 2013

Private Law: Ownership and Leasing

The Ad Coelum Doctrine
The ad coelom doctrine is the general property law idea that the landlord owns everything below and above his land – including the minerals below his land.This doctrine rings especially true for hard minerals (such as coal, gold, etc.) but does not exactly ring true for oil and gas. These volatile hydrocarbons can freely move across one’s land.
This doctrine is modified by the doctrine of extralateral rights. This doctrine allows an owner to mine the veins of hard minerals that extend below the surface of another’s land (Del Monte Mining).
Essentially opens up the idea that you can access something under someone else’s land even though you don’t own the surface of the land. A big step towards the rule of capture.

The Rule of Capture
The rule of capture generally exists to show that one may bring the hydrocarbons below his land to the surface. It establishes, however, that there is no ownership of individual hydrocarbons until they are brought to the surface. As long as an extraction of hydrocarbons is performed on legally owned property, oil can be brought up to the surface even if it was technically also under the land of a neighbor (Kelly v. Ohio Oil).
You have the legal right to drill on your own land and have the legal right to draw up all of that oil even if that oil currently resides under your neighbors land.
The rule of capture greatly limits trespass claims in oil & gas law. Even if a lessee drills next to the land of another, he will still not be in violation of any law due to the rule of capture. This changes if someone is using a slant drilling method (where the drill itself would go under the land of the other party), but this is quite uncommon. An owner of neighboring land cannot sue for the value of oil or gas removed (Kelly).
There is also no trespass under the ground when hydraulic fracturing techniques are used (Coastal Oil and Gas Corp. v. Garza Energy Trust).
Trespass will require a showing of actual, permanent harm to the property. None shown in Coastal. Injury of simply taking oil and gas below you is not injury enough to sustain a suit due to the rule of capture.
The rule of capture technically does not apply when there is a leak of refined or unrefined oil stored on a land where the owner of that oil does not own the mineral rights. If there is a diligent and immediate effort made to re-capture the oil, a person without mineral rights may do so. (Champlin Exploration v. Western Bridge).
If oil or gas is pumped back into the ground to store for later use, this oil is treated as if it is personal property. The actual owners of the oil would be the ones who already brought it up to the surface before. This generally occurs when a reservoir is already depleted and the owner of the oil or gas is using the ground merely as a storage space (Texas American Energy v. Citizens Fidelity Bank).
Non-ownership Theory: Exclusive right to extract hydrocarbons on your own land. Essentially revolves around surface rights and trespass
Ownership in Place Theory: Whoever owns the well owns the gas. Hydrocarbons become personal property once they are brought to the surface, because you would now have actual control over the hydrocarbons.
Policy reasons for Rule of Capture: Hard to measure hydrocarbons, want to encourage production of hydrocarbons, discourages freeloading, huge risk to driller of trespass if it does not exist where the damages are speculative, avoids underproduction, readily available wells, avoidance of litigation
Depends on when you have control over the hydrocarbons. Once they are raised to the surface and captured, it becomes your property since you have brought them up and rendered them to be under your control.

Limits and Obligations of Ownership
Limits on the Rule of Capture: The rule of capture allows for one to drill on his own land and draw gas from the land of another. However, the rule of capture is limited by nuisance, trespass, police power, and the correlative rights doctrine.
You must act properly and safely when drawing gas from a well. You are allowed to shoot and drill as much as you want, but you have to safely store something like nitroglycerine. It cannot be stored closely to a well (would satisfy a nuisance claim) (People’s Gas v. Tyner).
Correlative Rights: Most jurisdictions employ a non-ownership theory of correlative rights. I.e. the owner has the right to extract the gas, and it could have been produced if it was not wasted. Damages are generally awarded for wasted opportunity to remove the hydrocarbons.
Similar to an easement. Someone can damage your easement if you have the right to use a road if said person damages said road. You are suffering harm and your correlative rights have been damaged.
Ownership in place – Surface owner technically owns the hydrocarbons until they are captured
Non-ownership states – Have a right to take them, but do not own the molecules
Essentially, each owner has a right to a fair and equitable share of the oil and gas under his land as well as the right to protection from negligent damage to the producing formation (Eliff v. Texon). In Eliff, Texon’s negligence permitted one of its wells to blow out and drain large quantities from Eliff’s land. This was a violation of conservation, as capture should be in a non-negligent manner only.
Waste:Mineral rights extractors have a duty to the mineral owner to not capture oil and gas in a negligent or wasteful way.
Adverse Possession:When someone who doesn’t own the oil and gas interest on property is making a claim to that mineral interest. Requires an objective notice where the claim must be open, notorious, for as long as the SOL require, and exclusive (Deiderich v. Ware). Basically need to make a claim so the owner has objective notice and the owner has failed to respond in a timely manner to the claimants adverse possession.
Where the surface and mineral interests are not severed, the person would be adversely possessing the entire thing. Not just the mineral rights. The owner could see the person on the land if he just came by to look at it and he would have sufficient notice.
If they are severed, then the claimant trying to get the mineral interest must actually drill or produce the mineral on the land.
Abandonment:Not available to everyone. Only available to people in non-ownership jurisdictions. Requires lack of use of the interest and intent to abandon (Gerhardt v. Stevens). In Gerhardt, the heirs of the estate thought the land was worthless with no value. This constituted an intent to abandon on part of the heirs.
Types of Interests:
Royalty Interest:Share of production or a share of the revenues free of production costs
Fee Interest:Own rights free and clear; both surface and minerals
Mineral Interest:Ownership of oil & gas or right to use the property to search/develop/produce
Leashold Interest: Interest in minerals transferred via lease
Surface Interest:Interest after mineral interest has been severed. This interest will be subservient to the mineral interest and must allow the holder of the mineral interest to access his interest (by using the land).

Common Law Claims
Geophysical and Exploration Trespass: Seismographic technology is generally considered to be a trade secret. It is done normally via a boat or truck with a recorder that picks up sound waves from the ground. All rights comprising the mineral estate are vested in the mineral owner and the mineral owner can authorize a third party to conduct the operations (Enron Oil v. Worth). This is true even when you lease the oil and gas exploration rights as the 3rd party to another party. You still maintain the corollary right for geophysical exploration. An owner cannot claim trespass if someone is shooting seismic around his land if the shooter has the rights to shoot these other tracts. (Kennedy v. General Geophysical). While this may show the potential presence of hydrocarbons, the owner of the land has no right to object. Basically, what is the point of having a mineral interest if you cannot explore the surface?
Multiple Owners: The permission of all fractional owners of a mineral estate is not needed. Each owner has an undivided mineral interest and each has a separate and distinct right to enter and develop his portion (Enron Oil). Similar to tenants-in-common.
Minority: Need 80% or more ownership stake in mineral rights to explore.
Majority:Any owner (no matter percentage) can explore on the land.
Land Damage: In order to maintain damage for geophysical exploration, there needs to be a physical damage to the land. Mere vibrations will not result in physical injury (Kennedy). Emphasis on the fact that the company wasn’t trying to sneakily obtain information about the land but trying to get info about adjacent land that caused vibrations on his land.
Unclear if that played a factor.
Dry Hole Trespass: In dry hole trespass, the person performing geophysical exploration has uncovered the fact that there are no hydrocarbons on the land. The owner would receive the loss of speculative value – the difference between how much the lease could have been forbefore the trespass and how much it is worth after the trespass (Humble Oil v. Kisi).
Wet Hole:Wet hole trespass results when there is actual drilling. A driller intentionally drills on land (but he may not know the land is not part of the lease). The driller brings hydrocarbons up and brings them to market, normally. Here, the wet hole trespasser may be entitled to charge for production as long as it acted in good faith. If it did not act in good faith, some jurisdictions will place punitive damages on the driller (Wronski).
Conversion:
Slander of Title: Slander of title cases are brought when someone is still claiming to have a lease even after the lease period has allegedly ended. There is a duty on the lessee to release an expired oil and gas lease. Slander of title occurs when there is 1) Malicious 2) publication or statement 3) that has false information 4) about another person’s interest in property 5) that causes financial harm or loss of sale. Slander of title must normally include ill will by the lessee. Damages include the loss of speculative value (between value of the lease before and after), assumpsit (value of the lease that should have been obtained by the trespassor), and the difference between the offer lost and the property value (Kidd v. Hoggett).
Shut-in Rule: Most leases have a clause where a well can be “shut in” and closed up for a certain period of time. The well must be capable of actual production and there is normally a time limit on how long it can be shut in (Kidd).
Nuisance: Drilling a well and putting explosive stuff inside a well is not necessarily a nuisance. Surface damage may be a legitimate claim, but removing gas beneath will not satisfy this (Tyner).

Lease of Ownership Interest: Grant, Duration, and Termination
Leases result from the transaction between two private parties. The idea is that the lessee wants to explore without being obligated to own the land.
Hunt Oil v. Kerbaugh: The mineral estate is the dominant estate. The mineral estate has the right to use so much of the surface as reasonably necessary, but must have due regard for the surface rights. There is no right to use more of or do more to the surface estate than reasonably necessary.
Accommodation Doctrine:Where there is an existing use by the surface owner that would otherwise be precluded or impaired, and where there are alternatives available to the lessee, the rules of reasonable use may require the adoption of an alternative.
Granting Clause: This clause sets out = the scopes of the rights granted. It must address:
What rights are given to use the land
What substances are covered (oil, gas, both?)
What land and what interests are subject to the lease
Payment: 1) bonus (initial payment) followed by royalties based on oil and gas production
Habendum Clause: Clause in a lease that allows for the lessee to hold onto a lease as long as there is a producing well. Usually states the time period a well must be in production for.
The majority rule is that most jurisdictions define production as 1) bringing the oil to the surface 2) and bringing it to market. The minority rule is that production means the well merely has the ability to bring the hydrocarbons to the surface (Pack v. Santa Fe Minerals).
Cessation of Production Clause: In most states, this will require the lessee to bring the oil to the surface and bring the hydrocarbons to market. In even minority states, a lessee must still diligently market the oil and gas as to not sit on a well for all eternity.
Lease Classifications:
Profit a Prendre (OK): The lease is incorporeal and non-possessory; the interest may be abandoned and is not subject to the possessory remedies of trespass and ejectment. The interest must be protected by non-possessory actions, such as a quiet title suit.
Fee Simple Estate (TX): Corporeal and possessory in nature. The common law rules of abandonment should not apply, but the possessory remedies of trespass and ejectment will be available.
Lease Termination: A lessee can extend his lease with a working well. Most leases will have a termination clause that states that a lessee can do this. However, the well must be legitimately working. If time goes by and a well is not considered working, a lessee can lose his lease even if he has drilled an actual producing well (Rogers v. Osborn).
Force Majeur Clause: Most leases have force majeur clauses that state that the lessee may stop production due to unforeseen circumstances. However, these circumstances must actually be unforeseen and reasonable effort needs to be put forth to try and bypass them (Perlman v. Pioneer Limited Partnership).
Shut-in Royalty Clause: Allows the company to shut a well in and pay a royalty on it even if it isn’t a currently producing well.

Implied Lease Covenants: To Develop, Market, Protect, and Manage
Every oil and gas lease has these, but parties can still contract out of them!
Covenant to Test: Since royalties are the primary consideration for the lease and no royalties can be paid unless the property is tested, there is an implied covenant to develop. This includes both testing the land, as well
Covenant to Develop:Not triggered until the lease is propelled into the secondary term by production or constructive production. Once oil is discovered, the lessee has an obligation to continue to develop reasonably.
Notice and a reasonable time to act must be given to a lessee prior to cancellation of such rights for a failure to fully develop them. This covenant is imposed to ensure natural resources are fully developed and is viewed as advantageous to the country as a whole. The lessor will generally have the burden of proving that more wells can be drilled, the lessee acted imprudently by failing to drill, and must prove its own damages (Superior Oil v. Devon).
The majority rule is that notice is not required to initiate this lawsuit if you suing for breach of implied covenant and damages. However, if you are seeking cancellation, notice is required since its an equitable remedy.
Covenant to Market:Imposes upon the lessee the duty to use due diligence to market oil and gas produced within a reasonable time and at a reasonable price.
This may impose big time liability on someone who signs a contract to market oil at a certain price. The lessee is under the obligation to the lessor to get the best price possible for the lessor. Damages will normally be given. (Amacco v. First Baptist).
Someone is giving you the heart of the mineral interest. All they want is a royalty. Must protect the property value. To do this, you construe and impose these implied duties upon the lessee. Must act as a reasonably prudent operator would.
When an agreement is silent, the owner of an overriding royalty interest need not pay a share of post-production costs. Every oil and gas lease contains an implied covenant to market, obligating the lessee’s to complete all necessary steps to market gas produced from the leasehold. A royalty is free from “costs of production” but not “costs subsequent to production” (i.e. actually getting the drill ready (Garman v. Conoco).
When is production complete?
Oklahoma (minority): Production is complete when oil or gas is captured and made into a marketable product (compression, transportation, cleaning, and processing costs are deductible after hydrocarbons are made marketable).
Texas (majority): Production is a matter of law. Production is complete when oil or gas are captures. Once captured, all other sots are subsequent.
Covenant to Protect and Manage:There is an implied covenant in the lease that an operator will diligently manage a well. This implied covenant forces the operator to do operate his well diligently in fear of losing the lease. The lessee is held to the same burden of protecting the lessor’s rights to maximum amount of recoverables. By not being safe, there is a huge risk of waste.
Baldwin v. Kuebutz: In this case, the operator was sloppily operating his lease in order to quickly develop the land before he lost his lease due to a suspension clause. While he found oil, he also acted in a dangerous manner – flammable material near gas, defective wiring, etc. This dangerousness violated the implied covenant.
Implied covenant cases often brought as royalty cases because the lessee isn’t making as much money as it should be. Need to remedy the implied covenant and give the holder the money that they should have gotten.

Royalties
Distribution of: In the normal scheme of things, royalties are distributed after the sale of hydrocarbons on the market. There are two rules. The Vela rule (majority) and the Tara rule (minority) (Piney Woods Country Life School v. Shell Oil)
Vela:The general rule is that when a company makes a price for selling oil, it is to abide by that price. Even in long-term contracts. So, when an oil company is distributing profits, the profits must be based on the market value at the time of the actual sale. This creates a disincentive to create long term contracts if there is a risk of price increase.
Tara: Market value is the amount of royalties based on the profits actually recorded by the company. Equivalent to the price assigned in the sale contract. This would seem more fair for the gas companies, but potentially horrible for the lessor if the price goes up in the future.
Division of:The division of royalties generally occurs when the lease is signed. The lessor may reserve a specified quantity of royalties for himself. There is a general number of 1/8th that seems to be the normal amount for these contracts.
However, in odd cases, the lessor is free to assign himself a higher royalty amount when he sells the mineral rights or property rights. In Gavenda v. Strata Energy, the owner reserved for himself a ½ interest in the hydrocarbon royalties. This meant that any subsequent lease must give that owner ½ of all of the royalties. Like in Gavenda, if there is an erroneous division order, recovery can be found through unjust enrichment and other contract law claims.
Remedies for failure to pay: In most cases, there must be an express provision in the lease to terminate a lease for failure to pay (Cannon v. Cassidy). There are other remedies for failure to pay (such as breach of contract claims), so equitable remedies are not required.
There is a public policy reason not to cancel a lease. It is a large endeavor to drill a well, so it is inefficient to remove the operator. This is true even in egregious instances.
Can sue and be made whole without having to cancel a lease
Lessee’s Remedies: Sue for an injunction, monetary damages
Royalties in Kind: Can take royalty in kind (as portion of hydrocarbons).
Can ask for a conversion (more hydrocarbons) or an accounting if you do not feel you are getting enough.
Royalties in Cash: Can take royalty as cash
Can ask for more cash or an accounting here as well

Public Law: Regulation of Operations