Oil and Gas- Spring 2011

I. Oil and Gas GeologyA. Accumulation of Oil and Gas

1. Organic Theory of Origin–generally accepted2. Accumulation and Occurrence

Things that make up a Petroleum Reservoir (O&G field)a. carbon and hydrogen from dead lifeb. 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 waterd. 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 Reservoirsa. Dome and Anticlinesb. Fault Traps –due to mvmt under the earth oil is trapped byc. Unconformities –oil moves into another impermeable rockd. Dome and plug trapse. Reef Trapsf. Combination traps

B. Types of Production Processes1. 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 reduceda. 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 oilii. care in completing well iii. rate of oil and gas production from field or reservoir as a whole

C. Drilling a Well1. The Drilling Rig and Related Equipment

Components:a. powerb. housingc. rotatingd. circulating

2. Making Holea. making a connectionb. surface casing concerns

i. groundwater pollution ii. loss of a holeiii. loss or damage to equipmentiv. is a must if:

1. drill bit change2. equip. lost down hole3. well tests4. drill pipe and collars are detached and hoisted out of ground and stored vertically on derrick

c. production casing3. Testing and Completion

1. to chose a casing point:a. give up and plug well based on

indicators ORb. completion attempt

II. OwnershipA. 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 Extraction1. 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 landRule: Whoever had the fee of the soil owned all below the surfacePrinciple: 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 capture2. 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 Extraction1. 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 & TrustIssue: 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 thatEnglish 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 ProcessKinds of Oil and Gas Interests1. People’s Gas Co. v. Tyner

Facts: Tyner seeks an injunction agst. oil company shooting nitroglycerin through a gas wella. public road proximity to residenceb. highly explosive and could destroy life or propertyOwner 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 damagesRule 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 tractsfair 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 spoiled3. 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 Interests1. Mineral interests can be severed from surface interests – can then be

severed and split furtherRights 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 CaptureSpindletop Wells in Pennsylvania everyone was going crazy drilling all sorts of shit started a "frenzy" all over country.

2. ConservationCommon Abuses- Too many wells- Too close together- Producing wells wide openWaste- 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 Drillingii. well completion, and iii. plugging

iv. Production and marketingv. End Use Unit Operationsvi. Environmental Protection

5. Regulating Drilling, Well Completion, and Plugginga. Well PermittingCommon Law

- Law of Capture required no permitToday 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 Welli. Usually only one well per unit may be drilledii. Units are establised with respect to particular common source of supplyiii. exception well –being able to drill an additional well

Purpose:- To prevent surface, underground, and economic wastePooling- 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 87.11. 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 createdHolding: 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 OCC1. 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’nCorp 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 OCC1. 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 Considerationsa. Clean Water Act –clean up liability for oil spills and

hazardous substance spillsb. Endangered Species Act

-Take provisions3. 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 MaterialsNavigable Waters is a Very Broad Definitionb. 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 Protectiona. 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 Considerationsa. 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 propertyii. current operatorsiii. owners/ operators of the property at the time waste was dumpediv. 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 Concernsa. 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 Operations1. Managing Drilling Waste

SWDA --> RCRAEPA- 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 Dischargesa. 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 Revisiteda. Quivira Min. Co. v. U.S. EPAThe 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 Activities1. 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 spillsa. 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 LeaseA. Purpose of Lease; Nature of the Leasehold Interest; Significance of

Classification of Lease Interests1. 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 leasea. 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. –OKMineral 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 Surface1. 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 estate2. 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 estateii. Can only make reasonable useiii. Can’t violate the accommodation doctrine

C. Oklahoma Surface Damage Act: 52 Okla. Stat. Section 318.3318.2- Definitions318.3-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 occurd. 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. StewartYou can combine a tort action w/ you appt of appraiser’s action as long as the ct keeps it separate

4. Anschutz Corp. v. Sanderssays 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. TurnerP 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 Water1. 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 householdHousehold 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 Land1. 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 Lease1. 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 Gas1. 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 OilFrom one barrel of oil (1 barrel=42 gallons)19.50 gallons- gasoline8.61 gallons- fuel oil4..20 gallons- jet fuel11.72 gallons misc. produces including Kerosene and asphalt

H. Lands and Interests Granted by an Oil and Gas Lease1. Fee interest- refers to mineral and surface estates that have not been severed from each other2. 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 benefits3. Bonus payments – granted to lessor when he conveys mineral estate – money paid up front for granting the lease4. Delay payments – usually annual – paid to keep lease alive while land is not being produced and primary term running5. Shut-in Payments – for royalties – used in place of production to keep lease alive6. Royalty – payment owner gets when oil produced7. Interests – lessee owns working interest and lessor owns non-participating royalty interest 8. Royalty deed – conveys fraction of proceeds derived from sale of o&g9. Overriding royalty interest – royalty carved out of working interest10. 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 advance2.      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 existi. 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 terminateii. 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 terminate2. 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 decision3. 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 lease4. 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 expireFactors:

i. cause of cessationii. time for repairsiii. diligence in making repairs

b. if cessaion is voluntary, the cts are very unlikely to view the cessation as temporaryc. if production is interrupted b/ of activities that are mutually advantageous to lessor and lessee then it will most liely be viewed as temporaryFactors for temporariness:

i. accidentsii. price fluctuationsiii. 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 Clausea. 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 producedc. 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 leasee. 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 Clausea. Conflicts between units established by exercise of pooling clause in oil and gas lease and units established by order of conservation agencyb. 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 acceptableOK – 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 clauseb. 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 compensationii. Pugh clause –“embracing a portion of the leased premises” Does the habendum clause cover these lands? Yes. Unless you have a pugh clauseiii.. 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 termiv. Home-Stake Royalty Corp. v. Okla. Corp. Com’nnon-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 participantv. 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 createdvi. 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. HustonWas 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 clarificationiv. 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 materialimplied 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 Brewsterc. 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 relinquishedd. 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 tortb. 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 productionb. 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 Explorea. 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 beforehandb. 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 formationsc. 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 developd. 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 timea. Factors to market: (1) market within a reasonable amount of time (2) market at a reasonable priceb. 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 countryc. 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 faithd.

6. Implied Covenant to Operate Diligently and Properlya. 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 boreb. 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 royaltiesa. 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 PaymentsA. 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:

ProcessingTransportationGathering

- 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 lesseec. OK VIEW - Middlestat -OK case that adopted the marketable product ruled. KS VIEW -Schneburger -KS case that adopted the marketable product rulee. Market value gas royalty clause has two facets:

i. Look at where the point of sale occursii. 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 headiii. 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, MTMinority 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 Production1. 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 all3. 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 owners5. 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 exista. 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. 5402. Production Revenue Standards Act

a. 52 Okla. Stat. sec. 570.13. 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 paymenta. 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 Conveyancesa. “Produced and saved” – connotes grant or reservation of a RIb. “In and under” – grant of MIc. If instrument says both – grant of a MId. To clarify a MI, use “in and under” with language that allows ingress and egress.

9. Characteristics of a MIa. Right to developb. Right to leasec. Right to bonus paymentsd. 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 estate12. 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 question13. 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 interest14. 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 Blackacre1. 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-OKRule: 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 cotenant7. 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 anything8. 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 benefits9. Blanchard case –gives the competing method of accounting, which is the weighted average [ex. p. 372].

E. Partition of Mineral Interests1. 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 owners2. 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 evidenceHeld: 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/ Remaindermen1. 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 interestRule: 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 trust3. Hynson v. Jeffries - beneficiary of trust argued was entitled to entire royalty and not just interest on royalty during her lifetime4. 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 estate7. 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: Mortgages1. 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 Interests1. 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 together2. 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 leases2. 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 power1. Free standing mineral owner interest (nonparticipating) does not have right lease minerals but does have an interest in the land2. 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 Substances1. 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 Rulei. Is the substance a constituent or component of oil or gas?

c. Moser v. United States Steel Corp -TXIssue: 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. ButlerIssue: 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 TribeFacts: 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 Progeny1. 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 operations4. 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 partyc. the grantor purports to convey a mineral interest to himselfd. 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 LeaseA. Proportionate Reduction Clause (a/k/a Lessor Interest Clause)

1. Texas Co. v. ParksFacts: 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 – 1/16Winn – 1/16Jones – OABC Oil Co.- 14/163. 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 royaltiesTwo 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 themselves2. Nonapportionment rule -You do not apportion oilClause 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 interestTherefore, 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 Actions1.      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 trespassTwo 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 interest5 elements P must prove:

i. publication by the Dii. falsity of the publicationiii. maliceiv. financial damagev. an estate or interest in the property slandered

*proof of a lost sale*lack of good faith and probable cause = malice12. 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. KimballFadem 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 ChicagoThe 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.