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Produced Water: Legislative History and Current Controversies Part II
By Bobby Biedrzycki, Peter Hosey, and Reagan Marble
Introduction: Part I of this article discussed the legal framework that treats produced water as wastewater and explained that the value and utility of produced water changed in the last decade. Part II now explores how the Texas Legislature and Texas courts have addressed the changing dynamics between surface owners and mineral estate owners.
Recent Legislation
In 2013, the Texas Legislature passed HB 2767—adding Section 122 to the Natural Resources Code—to encourage the recycling of produced water. Prior to HB 2767, neither legislation nor Texas courts prescribed the ownership of oil and gas waste, mainly because produced water was viewed as waste to be disposed. The Texas Legislature passed HB 2767 to clarify ambiguity and provide recyclers comfort that once they take possession of oil and gas waste, they own it. Notably, Section 122 includes “produced water” in the statutory definition of “fluid oil and gas waste.” Section 122 provides that when a person takes possession of produced water to treat it for a subsequent beneficial use, that produced water becomes that person’s property.
In 2019, HB 3246 amended Section 122 to provide a carve-out for oil or gas leases and surface use agreements. HB 3246 also changed Section 122.002 to include—as owners of fluid oil and gas waste— operators that reuse produced water for beneficial use. While sparse case law strongly suggests produced water is part of the groundwater estate, and thus the property of the surface owner, HB 2767 and 3246, in effect, transferred ownership of what is a real property right from one party (the surface owner) to another party (the operator or recycler).
Now that produced water has become a commodity with economic value, surface owners want—and deserve—compensation. Where surface owners or groundwater lessees are not compensated, disputes arise.
As discussed in Part I, the dominant mineral estate comes with an implied right to use as much of the surface—including groundwater— as is reasonably necessary to extract and produce the minerals. As part of that implied right, operators have a duty to dispose of the waste, including the produced water that is a byproduct of the oil and gas process. Typically, disposal occurs when the produced water is treated and injected into an injection well. Nevertheless, one man’s trash is another man’s treasure. Now that produced water has become a commodity with economic value, surface owners want—and deserve— compensation. Where surface owners or groundwater lessees are not compensated, disputes arise.
Present Litigation Landscape
For those in the oil patch, the case to watch is COG Operating LLC (COG) v. Cactus Water Services, LLC (Cactus Water). In Cactus Water, COG acquired oil and gas leasehold rights in 37,000 acres in the Delaware Basin (the COG Leases). After COG entered the COG Leases, Cactus Water entered “Produced Water Lease Agreements” with a surface owner for underground water in depths covering the same acreage covered by the COG Leases. Under the Produced Water Lease Agreements, Cactus Water would pay the surface owner a royalty for such water once monetized. Simultaneously, COG received payment for dedicating its produced water to a third-party service provider. Thereafter, Cactus Water made demand on COG’s service providers and COG filed suit. Cactus Water did not dispute COG’s leasehold rights, but claimed COG improperly profited from the sale of produced water rightfully belonging to the surface owner, who had already leased the produced water to Cactus Water. COG maintained that, under Section 122, produced water is not groundwater, but ordinary oil and gas waste. Therefore, COG argued that the possessor of the produced water was the owner and party obligated to dispose, or to treat and reuse, the produced water.
The Reeves County District Court granted COG’s motion for summary judgment, giving COG ownership rights in the disputed produced water and holding that COG: (1) owns, among other things, the oil, gas, and other products contained in the commercial oil and gas bearing formations from COG wells on four leases; and (2) has the right to exclusive possession, custody, control, and disposition of the product stream, including water produced from COG’s oil and gas wells. The court’s decision was based largely on an examination of the granting clause in the COG Leases, which provided COG the right of “investigating, exploring, prospecting, drilling, mining and operating for oil and gas and other hydrocarbons” and for “laying pipelines . . . and building tanks, power stations and other structures thereon, to produce, save, take care of, store and treat products produced hereunder, and then transport those products from the land.”
On appeal to the Eighth Court of Appeals in El Paso, Cactus Water argued that produced water in the formation was not encompassed by the right to “oil, gas and other hydrocarbons” conveyed in the oil and gas leases. Cactus Water contended that the leases’ limitations regarding use of surface water prohibited COG from selling produced water to third parties for off-premises use. In response, COG argued that by conveying the right to “oil, gas and other hydrocarbons,” the parties intended to convey oil and gas in all forms—including the hydrocarbons contained within produced water. COG maintained its development rights include the right to dispose of waste generated by its wells.
The court of appeals took a different approach. Specifically, the court of appeals stated that the issue of whether produced water is part of the mineral estate “depends on whether produced water is, as a matter of law, water or if it is waste.”1 The Texas Natural Resources Code provides that oil and gas waste means waste “that arises out of or incidental to the drilling for or producing of oil or gas . . . includ[ing] salt water, brine, sludge, drilling mud, and other liquid, semiliquid, or solid waste material.”2 Another provision includes “produced water” in the meaning of “fluid oil and gas waste.”3 The Texas Water Code defines “groundwater” as “water percolating below the surface of the earth.” The court of appeals explained that this statutory and regulatory framework “draws a clear distinction between produced water and groundwater.”4
Additionally, the court of appeals stated that treating produced water as oil and gas waste remains consistent with industry practice: “Indeed, produced water has long been treated as a liability, not an asset, both throughout the fracing industry and in the context of COG’s operations on the Leased Land.”5 The court explained that the surface owners never claimed ownership over the produced water before entering a lease with Cactus Water: “To read the mineral leases as reserving produced water— something that exists separate from oil and gas only after processing and treatment—for the surface estate would give the surface estate (and thus Cactus Water) the benefit of costs and risks [COG] voluntarily undertook.”6 The court of appeals affirmed the trial court’s summary judgment, holding the lease restriction of COG’s use of “water” on the leased land “has no bearing on COG’s right to the oil and gas waste byproduct from its wells.”7 Therefore, the subsequent leases conveying produced water to Cactus Water were void.
Nevertheless, the opinion was not unanimous and drew a lengthy dissent from the Court’s most senior justice—Justice Gena M. Palafox. The dissent begins by recognizing that water has long been part of the surface in Texas. Justice Palafox, however, disagreed with the majority and characterized the majority opinion as “upend[ing] this balancing of competing rights and responsibilities.”8 Justice Palafox would interpret the lease language as conveying oil, gas, and hydrocarbons produced from the leased land, but not the produced water. Reasoning that, because the lease does not mention either “produced water” or “oil and gas waste,” the question is whether the entire “product stream” is conveyed by a granting clause conveying only oil and gas,9 Justice Palafox noted that although typical reservation language addressed “oil, gas, and other minerals, here the reservation language only addressed ‘oil, gas, and other hydrocarbons’”10—a stricter limitation within which water does not fall. Thus, unless expressly reserved or conveyed, water remains with the surface owner.
Relying on Robinson v. Robbins Petroleum Corporation, Justice Palafox reasoned that just because water is produced from an oil and gas well, that does not necessarily change its character. Based on Robinson’s reasoning that “the water itself is an incident of surface ownership in the absence of specific conveyancing language to the contrary,”11 Justice Palafox harmonized this approach with the accommodation doctrine, reasoning that COG had the right to use as much of the produced water as necessary to produce the underlying minerals. Finally, Justice Palafox reasoned that the fact that the parties only recently perceived the produced water as having any value is inapplicable. That COG contractually agreed to dispose of, or deal with, the produced water does not change the severance of the mineral and surface estates.
Constitutionality of Section 122
Unfortunately, Cactus Water does not fully address the constitutionality of Section 122 and the effect of HB 2767 and HB 3246, saving the inevitable constitutional fight for another day. Future disputes over produced water will implicate the constitutionality of this legislation. Considering the Supreme Court of the United States’ admission that “[c]ases attempting to decide when a regulation becomes a taking are among the most litigated and perplexing in current law,”12 the produced water issue rises quickly. As a result, those in the oil patch had best brush up on regulatory takings under the Fifth Amendment. Although not exhaustive, the following discussion serves as a refresher of how the Supreme Court of the United States and the Supreme Court of Texas have addressed regulatory takings:
The Takings Clause. The Takings Clause of the Fifth Amendment to the United States Constitution, made applicable to the States through the Fourteenth Amendment, provides that private property shall not “be taken for public use, without just compensation.”13 The Takings Clause “does not prohibit the taking of private property, but instead places a condition on the exercise of that power.”14 In other words, the Takings Clause “is designed not to limit the governmental interference with property rights per se, but rather to secure compensation in the event of otherwise proper interference amounting to a taking.”15
The Texas constitutional guarantee, though comparable, is worded differently. The Texas Constitution provides that “[n]o person’s property shall be taken, damaged or destroyed for or applied to public use without adequate compensation being made. . . .” The Takings Clause of the Fifth Amendment states: “nor shall private property be taken for public use without just compensation.”16 The Supreme Court of Texas has acknowledged that “[o]ne could argue that the differences in the wording of the two provisions are significant.”17 Accordingly, an examination of federal and Texas law is necessary.
The Federal Approach. The paradigmatic taking requiring just compensation is a direct government appropriation or physical invasion of private property.18 Until Pennsylvania Coal Company v. Mahon, 19 “it was generally thought that the Takings Clause reached only a ‘direct appropriation’ of property, or the functional equivalent of a ‘practical ouster of [the owner’s] possession.’”20 Beginning with Mahon, the Supreme Court of the United States recognized that government regulation of private property may, in some instances, be so onerous that its effect is tantamount to a direct appropriation or ouster—and that such “regulatory takings” may be compensable under the Fifth Amendment. As Justice Holmes opined, “[W]hile property may be regulated to a certain extent, if regulation goes too far it will be recognized as a taking.”21 This article focuses on regulatory takings.
Supreme Court precedents stake out two categories of regulatory action that generally constitute per se takings for Fifth Amendment purposes. The first category is where the government requires an owner to suffer a permanent physical invasion of the owner’s property; in this category, however minor the invasion, the government must provide just compensation.22 The second category applies to total regulatory takings—those that completely deprive an owner of “all economically beneficial us[e]” of her property.23 For this category, the government must pay just compensation for such “total regulatory takings,” except to the extent that “background principles of nuisance and property law” independently restrict the owner’s intended use of the property.24
Outside these two categories (and the special context of land-use exactions), the standards set forth in Penn Central Transportation Company v. New York City25 apply to regulatory takings challenges. In Penn Central, the Court acknowledged that it had previously been “unable to develop any ‘set formula’” for evaluating regulatory takings claims but identified “several factors that have particular significance.”26 Foremost among those factors are “[t]he economic impact of the regulation on the claimant and, particularly, the extent to which the regulation has interfered with distinct investment-backed expectations.”27 Additionally, the “character of the governmental action”—for instance whether it amounts to a physical invasion, or instead merely affects property interests through “some public program adjusting the benefits and burdens of economic life to promote the common good”—may be relevant in discerning whether a taking has occurred.28
The Penn Central factors—though each has given rise to vexing subsidiary questions—have served as the principal guidelines for resolving regulatory takings claims that do not fall within the physical takings or the Lucas rules.29 Regulatory takings jurisprudence is not unified, but the inquiries reflected in Loretto, Lucas, and Penn Central share a common goal. The Penn Central inquiry turns in large part, albeit not exclusively, upon the magnitude of a regulation’s economic impact and the degree to which it interferes with legitimate property interests.
The Texas Approach. Although the property protection offered under the Texas Constitution differs slightly from that under the United States Constitution, Texas courts follow and apply the standards laid out in Penn Central. Unfortunately, Texas state law does not simplify takings cases. In fact, the Supreme Court of Texas has called such disputes as “a ‘sophistic Miltonian Serbonian Bog,’”30 although it has also acknowledged that “[t]here are small islands in the bog.”31 Lower courts follow the Supreme Court of Texas’s categories of per se and total regulatory takings,32 while also recognizing the federal admonition that a regulation “effects a taking if [it] does not substantially advance legitimate state interests.”33 In determining whether a regulation has gone “too far” and has become too much like a physical taking requiring compensation, Texas courts must carefully analyze how the regulation affects the balance between the public’s interest and that of private landowners.
In short, both the Supreme Court of the United States and the Supreme Court of Texas look to the following factors: (1) “the economic impact of the regulation on the claimant”; (2) “the extent to which the regulation has interfered with distinct investment-backed expectations”; and (3) “the character of the governmental action.”34 Nevertheless, the Courts have cautioned that these factors do not comprise a formulaic test: “Penn Central does not supply mathematically precise variables, but instead provides important guideposts that lead to the ultimate determination whether just compensation is required.”35 For example, the economic impact of a regulation may indicate a taking even if the landowner has not been deprived of all economically beneficial use of his property. Moreover, the three Penn Central factors are not exclusive in determining whether the burden of regulation ought “in all fairness and justice” to be borne by the public.36 Whether a regulatory taking has occurred, “necessarily requires a weighing of private and public interests”37 and a “careful examination and weighing of all the relevant circumstances in this context.”38 Accordingly, the Supreme Court of Texas has stated, “We consider all of the surrounding circumstances”39 in applying “a fact-sensitive test of reasonableness.”40
While determining whether a property regulation is constitutional requires the consideration of factual issues and surrounding circumstances—and the appellate courts depend on the district court to resolve disputed facts regarding the extent of the governmental intrusion on the property—the ultimate determination of whether the facts are sufficient to constitute a taking is a question of law,41 and more than a decade ago the Supreme Court of Texas anticipated the likelihood of the legal battle:
Suppose a landowner were prohibited from all access to groundwater. In its brief, the State concedes: “Given that there is a property interest in groundwater, some manner and degree of groundwater regulation could, under some facts, effect a compensable taking of property.” We agree, but the example demonstrates the validity of Day’s claim. Groundwater rights are property rights subject to constitutional protection, whatever difficulties may lie in determining adequate compensation for a taking.42
Analytical Framework
If courts decide that title to the produced water belongs to a landowner (or a lessee pursuant to a lease agreement with a landowner), then the laws passed in 2013 and 2019 must be narrowly construed to exclude produced water to avoid a takings challenge. If “fluid oil and gas waste” includes produced water, as stated in Section 122, and courts disagree and decide produced water is groundwater owned by a landowner (or groundwater lessee), then Section 122 would violate the Fifth Amendment’s Takings Clause. The authors’ views about the result of the application of the Penn Central factors follows:
Deprivation of Economic Use. The first consideration is whether all economically viable use of a property has been denied. This determination “entails a relatively simple analysis of whether value remains in the property after the governmental action.”43 It is difficult to see how selling and transferring away a surface owner’s water does not deprive the surface owner of economic use. In Texas, groundwater is a vested property interest. Like any vested property interest, it is specific, has value, and is transferable. Injecting and back-flowing groundwater and renaming it “produced water” does not change title.
Treating produced water is typically a three-phase process by which the recycler separates—among other things—raw oil and gas products from water. These minerals are counted by the operators in total production and sent to the refinery. Co-mingling minerals with water does not change who holds title—the operator holds title. Logically, if the operator uses but does not own groundwater—as is its right under an oil and gas lease—the water separated from the oil and gas during recycling should return to the surface owner.
Prior to the economic viability of produced water, the operator’s use of the water ended once all minerals were extracted. Historic practices dictated that the water was disposed of through injection into injection wells. Nevertheless, ownership remained unchanged and, through time, operators and water recyclers created a market for recycled fracing water. Unquestionably, the Texas Legislature intended to clarify the responsibility for disposal of produced water by passing HB 2767 and HB 3246; but just as the minerals in produced water have economic value, so does the remaining treated produced water. When produced water is injected into disposal wells, sold, or reused by the operator on another lease, the surface owner is left without economic value of the property—thus, a regulatory taking occurs. The question then becomes whether the taking advances a legitimate state interest.
Legitimate State Interest. The government may affect a partial taking, if the taking serves a “substantially legitimate government interest.”44 Water recycling likely serves a substantially legitimate government interest, but HB 2767 and HB 3246 did not partially deprive landowners of their water; instead, the legislation completely deprived a surface owner of any continual enjoyment and use.
According to bill analysis, the legislature proposed that operators would be less likely to recycle water if there was no basis for them to profit from it.45 Unquestionably, the state has an interest in recycling produced water, seeing operators reuse produced water in fracing operations, and therefore reducing the amount of potable water necessary to produce future wells. But the Legislature’s reasoning was flawed for two reasons. First, one of the primary reasons for treating and recycling produced water is to extract the last remaining traces of oil and gas, which the operator then sells to the refiner. Second, the rising value of produced water incentivizes operators to use more ground water in fracing operations, knowing that doing so increases the amount of produced water in their control that can later be sold.
Proper Exercise of Police Power. There are no unfettered rights— let alone property rights—as “[a]ll property is held subject to the valid exercise of the police power.”46 The authors do not question whether the legislature may regulate the exploration and exploitation of the state’s natural resources. As shown in Edwards Aquifer Authority. v. Day, 47 Texas has protected—and continues to protect—water as a natural and finite resource. The Supreme Court of Texas, however, also knows the fight over groundwater is coming;48 and the Court has previously shown that it will protect the groundwater rights of surface owners much the same as it does the oil and gas rights of the mineral estate owner.49 Accordingly, it seems a complete economic deprivation of a surface owner’s groundwater rights—simply because the groundwater has been injected into a well or was percolating in an oil producing strata—appears to be government overreach.
Conclusion
How landowners and operators should respond varies and depends largely on the date and terms of applicable oil and gas leases. If currently bound by a lease, the lease terms will govern since HB 3246 provides a carve-out to the ownership section, allowing a contractual provision to override the statutory provision. Nevertheless, the carve-out does not affect surface use agreements that are silent on the issue. Alternatively, operators and surface owners may consider entering new leases that add language affording them the right, but not the obligation, to take the produced water in kind for their purposes. Either way, produced water’s ongoing transformation from liability to asset is certain to create litigation until the constitutionality of HB 2767 and HB 3246 is resolved.
Endnotes
1Cactus Water Services, LLC v. COG Operating, LLC, 676 S.W.3d 733, 738 (Tex. App.‒El Paso 2023, pet. filed).
2Tex. Nat. Res. Code Ann. § 91.1011.
3Id. at § 122.001(2).
4Cactus Water, 676 S.W.3d at 739.
5Id. at 740.
6Id.
7Id. at 741.
8Id. at 742 (Palafox, J., dissenting).
9Id. at 743.
10Id.
11Id. at 746.
12Eastern Enters. v. Apfel, 524 U.S. 498, 541 (1998)
13See Chicago, B. & Q.R. Co. v. Chicago, 166 U.S. 226 (1897).
14First English Evangelical Lutheran Church of Glendale v. County of Los Angeles, 482 U.S. 304, 314 (1987).
15Id. at 315 (emphasis in original).
16Tex. Const. art. I, § 17. U.S. Const. amend. V.
17Sheffield Dev. Co. v. City of Glenn Heights, 140 S.W.3d 660, 669 (Tex. 2004).
18See, e.g., United States v. Pewee Coal Co., 341 U.S. 114 (1951) (government seizure and operation of a coal mine to prevent a national strike of coal miners effected a taking).
19260 U.S. 393 (1922).
20Lucas v. South Carolina Coastal Council, 505 U.S. 1003 (1992) (citations omitted and emphasis added; brackets in original); Id. at 1028, n.15(“[E]arly constitutional theorists did not believe the Takings Clause embraced regulations of property at all”).
21Mahon, 260 U.S. at 415.
22Loretto v. Teleprompter Manhattan CATV Corp., 458 U.S. 419 (1982) (state law requiring landlords to permit cable companies to install cable facilities in apartment buildings effected a taking).
23Lucas, 505 U.S. at 1019 (emphasis in original)
24Id. at 1026–32
25438 U.S. 104 (1978).
26Id. at 124
27Id.
28Id.
29See, e.g., Palazzolo v. Rhode Island, 533 U.S. 606, 617–18 (2001); id. at 632–34 (O’Connor, J., concurring).
30City of Austin v. Teague, 570 S.W.2d 389, 391 (Tex. 1978) (quoting Brazos River Auth. v. City of Graham, 354 S.W.2d 99, 105 (Tex. 1962))
31Sheffield, 140 S.W.3d at 671.
32Id.
33Agins v. City of Tiburon, 447 U.S. 255, 260 (1980) (citation omitted); see also Mayhew, 964 S.W.2d at 933–34
34Connolly v. Pension Benefits Guar. Corp., 475 U.S. 211, 225 (1986) (quoting Penn Cent. Transp. Co. v. City of New York, 438 U.S. at 124).
35Palazzolo, 533 U.S. at 634 (O’Connor, J., concurring).
36See, e.g., Teague, 570 S.W.2d at 393 (“There is still another test which is sometimes helpful. It allows recovery of damages when the government’s action against an economic interest of an owner is for its own advantage.”).
37Agins, 447 U.S. at 261.
38See Tahoe-Sierra Preservation Council v. Tahoe Regional Planning Agency, 535 U.S. 302 326-27 (2002) (quoting Palazzolo, 533 U.S. at 636 (O’Connor, J., concurring)).
39Mayhew v. Town of Sunnyvale, 964 S.W.2d 922, 933 (Tex. 1998)
40City of College Station v. Turtle Rock Corp., 680 S.W.2d 802, 804 (Tex. 1984).
41Mayhew, 964 S.W.2d at 932–33.
42Edwards Aquifer Auth. v. Day, 369 S.W.3d 814, 833 (Tex. 2012).
43Id. at 935.
44Sheffield, 140 S.W.3d at 670.
45See generally House Comm. on Energy Resources, Bill Analysis, Tex. H.B. 3246, 86th Leg., R.S. (2019).
46Sheffield, 140 S.W.3d at 670.
47Day, 369 S.W.3d at 835.
48Id.
49Id.; Robinson v. Robbins Petroleum Corp, 501 S.W.2d 865 (Tex. 1973); Humble Oil & Ref. Co. v. West, 508 S.W.2d 812 (Tex. 1974).
