STCL Houston Energy Newsletter Vol 2: Spring 2018

ENERGY NEWSLETTER South Texas College of Law Houston

Harry L. Reed Institute of Oil & Gas

Oil & Gas Law Society’s Update Developing Trainings, Events, and Energy Students “Today, we (the US) export LNG to 27 nations on five continents,” Rick Perry stated at CERAWeek 2018. The US Secretary of Energy’s comments highlight the focus of 2018 for the Oil & Gas Law Society: Liquefied Natural Gas. This second annual publication of our Energy Newsletter has marked significant developments in the last year. LNG exports continue to increase from the United States to the world, Mexico continues to transform its energy sector, and the supermajors of the industry steadily return home to West Texas for some of the best margins available for hydrocarbon production.

These exciting events have led to an increasing interest in oil and gas legal studies, adding more responsibility to the Officers of the Oil & Gas Law Society (OGLS) as they build new strategic plans for practitioner training and contract negotiation. Mayer Brown’s Jose Valera will be teaching a LNG contracts workshop going through the primary two dozen contracts needed to make an LNG project possible. This training will be the first of its kind, and we are excited to host such an opportunity. The support of Texas LNG’s CEO, Vivek Chandra, has been critical to our success through the donation of LNG fundamental books and workshop training. The OGLS looks forward to developing the skills of its students in LNG into the future.

Since the publication last Spring, 2017 was marked most notably by our International Petroleum Transactions course being taught by the world-renowned negotiator, Eduardo Pereira. His expertise on global affairs made him an excellent resource for our students, and we are grateful for his support. Director Kulander continues to teach the building blocks of American O&G contracts through Domestic Petroleum Transactions while also teaching the Energy Law course.

Professors Michael Jones, Matthew Festa, and Chuck Brownman develop our students’ foundational oil and gas knowledge. Professors Michael Kirby and Randy Sadler continue to teach our students the foundations of land and title.

The OGLS, with the help of the Association of International Petroleum Negotiators, hosted at South Texas College of Law Houston the second annual International Energy Series: North Africa event. King & Spalding’s John Bowman and Nassif & Associates Toufic Nassif spoke to our students about the challenges of contracting in North African O&G. It was an enlightening conversation, and we’d like to thank them again for their support.

Ken Rice and Tim Brown at Anadarko continue to develop our students through their international upstream training courses with a Joint Operating Agreement day scheduled for the summer. We are all looking forward to what is in store for our organization in the rest of 2018.

Spring 2018 Edition

Contents •••

Oil & Gas Law Society’s Update .................................. 1 Letter from the Editor ........ 2 Lightning Oil: The Erosion of Mineral Estate Rights .... 3 ConocoPhillips Co. v.

Koopmann: The RAP and Savings Clauses in Oil & Gas Transactions ................. 7 Sustainability in Contracts: The AIPN Joint Operating Agreement ......................... 12 Mineral and Surface Estates in Conflict: A Scenario Study .................................. 15

Letter from the Editor Editorial Board

Dear Reader,

•••

On behalf of the Editorial Board and the Members of the ENERGY NEWSLETTER, we are pleased to present you Edition 1, Volume 2. The ENERGY NEWSLETTER is a student-run scholarly newsletter committed to bringing to the global energy community timely and unique perspectives in the industry. South Texas College of Law Houston has an extensive student, Energy Alumni association, and general footprint across the world in oil, gas, and all things energy. The ENERGY NEWSLETTER seeks to bring all their perspectives in one place at the center of the global energy community in Houston.

Director SEAN BERWALD

This is the second volume of our ENERGY NEWSLETTER or publication through South Texas College of Law Houston dealing with the energy industry. Having such a center stage in downtown Houston, the newsletter team looks forward to bringing exciting articles coauthored by students and alumni. We look forward to growing the intellectual prowess of the ENERGY NEWSLETTER and South Texas College of Law Houston.

Articles/Note Editors KEVIN SHAGHAGHI MATTHEW GIBSON CLAYTON HART MATTHEW DELGADO KELLI REGAN ELENA BOLONINA RUBEN PRECIADO RYAN HOEFFNER JULISSA ESQUIVEL ALEX BRADEN PHILIP McCRADY

This publication begins with a look at the Lightening Oil case and its impact to the oil and gas industry. Next is the assessment of ConocoPhillips Co. v. Koopmann and how the Texas Supreme Court could drop a serious new angle on mineral right liability. We then turn to the AIPN’s Joint Operating Agreement and Sustainability issues as soft law continues to shape how companies operate in underdeveloped regions around the world. We end this newsletter with a scenario study in how mineral estate owners compete when one owns surface estate rights.

On behalf of the Editorial Board and the Institute of Oil & Gas, we thank the authors who have added their support to this enterprise through their submissions. We would also like to thank South Texas College of Law Houston and all organizations in and surrounding the College for making the ENERGY NEWSLETTER possible.

Sincerely,

Editor-in-Chief VESTITA KUNTZ Managing Editors ROBERT SMALLWOOD BRIAN KOEPPEN

Student Authors ••• JUDE DES BORDES VESTITA KUNTZ SEAN BERWALD MATTHEW GIBSON

Energy Alumni Advisory Council ••• TRACE HOLMES FORD PETERS GEORGE A. OGGERO MICHAEL VARGO

Vestita Kuntz Editor-In-Chief

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By: Jude Des Bordes

incidentally, this decision has dealt a blow to mineral estate rights that may lead to the degradation and decay of traditionally recognized property rights.

Introduction

Legal Background

In the world of mineral extraction, there has necessarily been a balance between the property rights of mineral estate owners and surface estate owners. The balance between these interests has been vital to mineral based industries, not the least of them, the energy industry. There is a longstanding policy in Texas to recognize mineral estates as the dominant estate over the surface estate.1 This doctrine is consistent with the State’s policy to favor maximizing efficient recovery of subsurface mineral resources.2 Thus, surface owners must accommodate the dominant mineral estate and its ability to extract minerals. [3] However, mineral estate owners must also reasonably accommodate existing surface estate uses when alternative courses of action would not unfairly impair the surface estate. [4] This balance between estates is now in jeopardy due to the Lightning Oil case.

This complex balance of rights has been further obscured by the advent of modern directional drilling technology.

These technologies have made it possible to engage in off-site drilling practices, which allow mineral estate lessees to extract minerals from their leased mineral estates via the surface estate of an adjacent tract of land. By doing so, such a party would invariably drill through the mineral estate underlying the surface estate from on which it operates. In May 2017, the Texas Supreme Court issued a decision in Lightning Oil Co. v.

Anadarko E&P Onshore, LLC that marks an apparent shift in the traditionally favored property rights for mineral estate owners. [5] In that case, the Texas Supreme Court ruled that the permission of the surface estate owner, but not that of the mineral estate owner, was necessary to engage in directional drilling to extract from a leased adjacent mineral estate. [6] Further, the Court decided that there was no trespass when an operator drilled through the mineral estate leased by another operator to reach its mineral estate in the adjacent tract. [7] Whether by design or

Traditionally, surface estate owners are the possessors of the real property interests in a tract of land, both above and below the surface. [8] This possessory right exists separately from any rights of mineral estates that may exist. [9] Mineral estate owners do not possess the rights to subsurface land but the rights to the mineral molecules in the land. [10] This estate, however, is not solely a possessory right to the minerals but notably also a right to the reasonable chance to recover minerals that may exist in the land. [11] This mineral right, thus, gives the mineral estate owner the exclusive right to explore the land for mineral deposits. [12] Ordinary real property trespass occurs when one enters or causes a thing to enter the property of another without authorization. [13] A trespass claim is viable even when there is nominal damage or no actual damage to the property. [14] However, the Texas Supreme Court has held that to constitute a trespass to the mineral estate there must be an actual injury to the mineral estate. [15] Such an injury includes destroyed or converted minerals as well as misappropriated information about the mineral estate independent of whether it causes a loss to the speculative value of the estate. [16] This means that even physically non-invasive conduct such as seismic surveying may constitute a trespass. [17] Technological advancements in the field of oil and gas extraction have only served to blur the lines of what constitutes a trespass to mineral estate rights. In a 2011 decision, the Texas Supreme Court attempted to bring some clarity to some of these issues in Coastal Oil & Gas Corp., v. Garza Energy Trust. [18] In that case, the Court applied the rule of capture to determine that an operator may use hydraulic fracturing and lay claim to minerals that drained over into its wellbore from an adjacent tract. [19] The Court further reasoned that title to minerals was not vested in a particular mineral estate until the minerals had been recovered and harvested. [20]

Lightning Oil: The Erosion of Mineral Estate Rights

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It is worth noting though that Coastal did not involve an intentional physical intrusion into the mineral estate of an adjacent tract but the capture of gas reserves that had drained from the adjacent tract. [21] The Court in Lightning relied heavily upon the Coastal Oil & Gas Corp. decision in reaching its conclusion. [22]

opinion, the Court recognized that allowing Anadarko such a right to drill into the subsurface would necessarily extract a portion of the subsurface and interfere with Lightning’s leased mineral estate. [34] The Court, however, went on to state that Lightning’s mineral rights do not include the right to possess the place where minerals are located. [35] Thus, absent interference with the minerals in the land, Anadarko’s actions did not rise to the level of trespass. [36] The Court further denied Lightning’s injunction claim, reasoning that any future harm to Lightning’s right to develop as a result of Anadarko’s subsurface activity was speculative. [37] The Court found that allowing Anadarko to drill did not cause any immediate, irreparable harm to Lightning’s development rights. [38] The Court went on to balance the interests of the two parties. [39] In doing so, the Court reasoned that permitting Anadarko to drill off-site through the subsurface would allow it to harvest the maximum amount of minerals while minimizing waste by reducing minerals lost. [40] On the other hand, while Anadarko’s activity would invariably lead to a loss of minerals in Lightning’s estate, the loss was not great enough to constitute a trespass to the mineral estate. [41] Further, the Court found that that the loss to Lightning was far outweighed by the benefit to the industry and society as a whole. [42] The Court supported this line of reasoning by applying Texas’s longstanding policy of maximizing the efficiency in the production of minerals while avoiding waste. [43] Additionally, the Court determined that its decision to allow the surface owner to authorize Anadarko’s subsurface drilling would not undermine the mineral estate’s dominance. [44] Instead, it concluded that to allow the mineral estate an absolute right to restrict usage of the subsurface would directly conflict with the mineral estate’s duty to reasonably accommodate the surface estate. [45] Finally, the Court held that Anadarko’s plans to drill through the Briscoe subsurface did not constitute tortious interference with a contract. [46]

“This balance between estates is now in jeopardy due to the Lightning Oil case.

The Court’s Decision Lightning Oil Co. v. Anadarko E&P Onshore, LLC involved a dispute between adjacent mineral leaseholders. [23] The petitioner, Lightning Oil Co. (“Lightning”), leased its mineral interest underlying Briscoe Ranch, the Cutlass lease, from the Hurd family. [24] Adjacent to this tract lays the Chaparral Wildlife Management area, owned by the State of Texas and leased to Anadarko E&P Onshore, LLC (“Anadarko”). [25] The surface of this tract was operated and managed by the Texas Parks and Wildlife Department. [26] Anadarko’s lease included a provision that allowed it to practice off-site drilling. [27] In furtherance of this, Anadarko entered into preliminary agreements with the surface estate owners of Briscoe Ranch to drill directionally into the Chaparral lease. [28] Lightning objected to these agreements and brought suit against Anadarko to enjoin the drilling. [29] Anadarko subsequently entered into a Surface Use and Subsurface Easement Agreement authorizing Anadarko to site its wells on the surface of Briscoe Ranch, and directionally drill through the subsurface to reach the Chaparral. [30] The trial court granted Anadarko’s summary judgment holding that the surface owner was authorized to permit Anadarko’s subsurface drilling activity without Lightning’s permission. [31] The Court of Appeals affirmed this decision. [32] The Supreme Court’s analysis of the trespass claim stemmed from whether Lightning was entitled to preclude the surface estate owners from granting a third party a subsurface easement to reach its own leased property. [33] In its 4

Analysis

explore for minerals under Briscoe Ranch, it is incontrovertible that its drilling process would grant it proprietary information about Lightning’s mineral estate. This misappropriation of information in itself is a harm suffered by the mineral estate. [53] The Court’s apparent disregard for the right to exclusive exploration is a further assault on the fundamental property rights of mineral estate owners.

The Texas Supreme Court’s decision, in this case, has garnered some controversy and created uncertainty on the balance of surface and mineral estate interests. While it is unclear whether it is by design or simply a consequential result, the May 2017 ruling appears to devalue the property rights of mineral estate owners.

The Texas Supreme Court’s decision that Anadarko had not trespassed on Lightning’s mineral estate hinged on its finding that there had been little interference with the actual minerals in the land underlying Briscoe Ranch. [47] The Court reasoned that any mineral loss to Lightning was insignificant compared to the overall benefit to the industry and the State’s public policy of waste reduction. [48] The Court recognized that Anadarko would have to build permanent structures on the surface and in the subsurface on the tract but failed to recognize this as the sort of immediate and irreparable harm that would entitle Lightning to injunctive relief. [49] While the Court states that its decision is based on the maximization of production, [50] its ruling could have the opposite effect. This is chiefly due to this decision’s devaluation of the dominance of mineral estates. Specifically, the Court appears to have expanded the accommodation doctrine to compel mineral estates to accommodate new surface estate uses, even when these uses directly conflict with the objectives and purposes of the already existing mineral estate interest. [51] The accommodation doctrine, first established by the court in Getty, has never been meant to be a weapon for surface estate owners but rather a shield to protect surface estates rights from inequitable results. [52] This judgment thus diminishes traditional mineral estate rights in favor of the policy of production maximization. The irony, though, is that a diminution of mineral estate rights would invariably strike a blow against the very same public policy.

The Court further erred by inexplicably failing to address or recognize Lightning Oil’s exclusive right to explore as the mineral estate lessee. This mineral estate right is clearly violated when Anadarko drills through the subsurface.

While it may not be Anadarko’s direct goal to

Conclusion The advent of directional drilling techniques, like many technological advances before it, has brought new challenges for the oil and gas industry and courts to resolve. In Lightning Oil, the Texas Supreme Court’s attempt to settle some of these issues was not without its faults. The Court sought to apply a balancing test to determine whether one party’s interference with another’s mineral estate rose to the level of trespass. [54] While the Court sought to promote the production maximization and efficient use of mineral resources, it muddled some issues in the process. The Court’s ruling in favor of Anadarko comes at the expense of mineral estate rights and raises questions about the balance between mineral and surface estate rights. More shockingly, the Court appeared to completely ignore mineral estate owners’ exclusive right to explore. This decision, or more accurately the lack thereof, opens the door to more litigation between surface and mineral estate owners in the future. While it was always unlikely that a single decision would concisely resolve all the issues surrounding directional drilling, it appears that in the wake of the Court’s Lightning Oil decision, there are more questions than answers.

[1] Harris v. Currie, 176 S.W.2d 302, 305 (Tex. 1943) (“[T]he grant or reservation of minerals carries with it, as a necessary appurtenance thereto, the right to use so much of the surface as may be necessary to enforce and enjoy the mineral estate conveyed or reserved.”).

[2] See TX. CONST. art. XVI, § 59(a) (“The conservation and development of all of the natural resources of this State, . . . and the preservation and conservation of all such natural resources of the State are each and all hereby declared public rights and duties.”).

[3] Harris, 176 S.W.2d at 306.

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[4] See Getty Oil Co. v. Jones, 470 S.W.2d 618, 628 (Tex. 1971).

[5] Lightning Oil Co. v. Anadarko E&P Onshore, 520 S.W.3d 39, 52 (Tex. 2017).

[6] Id. at 53.

[7] Id. [8] See Coastal Oil & Gas Corp., v. Garza Energy Tr., 268 S.W.3d 1, 15 (Tex. 2011).

[9] Id. at 15.

[10] Id. [11] Id. [12] See Greer v. Shook, 503 S.W.3d 571, 578 (Tex. App.—El Paso 2016) (citing Hysaw v. Dawkins, 483 S.W.3d 1, 9 (Tex. 2016)); See also Wilson v. Tex. Co., 237 S.W.2d 649, 650 (Tex. Civ. App.—Fort Worth 1951) (“We recognize the right to enter upon lands of another for the purpose of making geophysical surveys . . . is a valuable property right which belongs exclusively to the owner of land or minerals and that an unauthorized invasion would render the invader a trespasser and liable for damages.”).

[13] Barnes v. Mathis, 353 S.W.3d 760, 764 (Tex. 2011).

[14] Id. [15] Coastal Oil & Gas Corp., 268 S.W.3d at 4.

[16] See Wilson, 237 S.W.2d at 650.

[17] N. Shore Energy, L.L.C. v. Harkins, 501 S.W.3d 598, 605 (Tex. 2016).

[18] Coastal Oil & Gas Corp., 268 S.W.3d at 13-14.

[19] Id. [20] Id. at 14 [21] Id. at 6.

[22] Lightning Oil Co., 520 S.W.3d at 44.

[23] Id. at 43.

[24] Id. [25] Id. [26] Id. [27] Id. [28] Id. [29] Id. [30] Id. at 43-44.

[31] Id. [32] Id. [33] Id. at 46.

[34] Id. [35] Id. at 49.

[36] Id. [37] Id. [38] Id. [39] Id. at 50-51.

[40] Id. at 51.

[41] Id. [42] Id. [43] Id. [44] Id. at 52.

[45] Id. [46] Id. at 53.

[47] Id. at 51.

[48] Id. [49] Id. at 52-53.

[50] Id. at 51.

[51] Id. at 52.

[52] See Getty Oil Co., 470 S.W.2d at 623.

[53] See Wilson, 237 S.W.2d at 650.

[54] Lightning Oil Co. v. Anadarko E&P Onshore, LLC, 520 S.W.3d 39, 48-49 (Tex. 2017).

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ConocoPhillips Co. v. Koopmann: The RAP and Savings Clauses in Oil & Gas Transactions

Court of Texas’ judgment regarding the case.

Finally, Part V concludes the Note.

By: Vestita Kuntz

To understand the effect the Court’s ruling may have on the Texas oil and gas industry and future litigation, it is necessary to review the law leading up to ConocoPhillips Co. v. Koopmann, and more specifically the rule against perpetuities in relation to oil and gas conveyances. A look at leasehold savings clauses will also be helpful.

Background

Introduction Recently, Texas courts have addressed a series of issues related to title in oil and gas transactions and interpreting savings clauses.1 In the oil and gas industry, a non-participating royalty interest (“NPRI”) is understood to be an interest in the overall production of oil, gas, and other minerals carved out of a mineral estate.2 NPRI owners may receive royalties from the production, but do not have the right to participate in the creation of or the delay rental payments to accrue under the oil and gas lease.3

The Rule Against Perpetuities in Oil & Gas Law The Texas Constitution prohibits the remote vesting of interests: “Perpetuities . . . are contrary to the genius of a free government and shall never be allowed.”7 The word “vest” refers to “an immediate, fixed right of present or future enjoyment of the estate or interest.”8 The Rule states that “no interest is valid unless it must vest, if at all, within twenty-one years after the death of some life or lives in being at the time of the conveyance.”9 When a grantor retains a term royalty or mineral interest, the grantee receives an interest analogous to a springing executory interest traditionally subject to the rule against perpetuities.10 A springing executory interest is a future interest held by a third person that arises when a grantor retains title until the subsequent divesting event takes place.11 The following example, nearly identical to the Strieber NPRI, creates a springing executory interest that violates the Rule: O owns a fee simple absolute estate in Blackacre. She conveys the surface estate and ½ of the mineral interest in fee simple absolute to A, reserving to herself ½ of the mineral estate for a period of 20 years and so long thereafter as oil or gas is produced in paying quantities. O would have a fee simple subject to an executory limitation and A would have an executory interest. A owns an executory interest because it is a future interest created in someone other than the grantor that will become possessory by the divesting of a prior freehold estate held by

“…when a grantor reserves an interest for an indefinite term, the grantee receives an interest traditionally invalid under the rule against perpetuities.”

In December of 2017, the Supreme Court of Texas will determine (1) whether a NPRI reservation violates the “rule against 4 perpetuities,” and if not, (2) whether the savings clause in the royalty deed prevents termination of the royalty interest.5 In ConocoPhillips Co. v.

Koopmann, the Thirteenth Court of Appeals determined that (1) the rule against perpetuities did not apply to invalidate a NPRI reservation, and (2) the savings clause in the deed presented fact issues concerning ownership that precluded summary judgment.6 This Note suggests that when a grantor reserves an interest for an indefinite term, the grantee receives an interest traditionally invalid under the rule against perpetuities. Part II of this Note examines the background law leading up to ConocoPhillips Co. v. Koopmann. Part III examines the facts and reasoning in Koopmann.

Part IV then analyzes the implications that its decision may have and predicts the Supreme 7

Many modern oil and gas leases are “paidup” leases, which means that the mineral owner is paid up-front to maintain the lease during the primary term.26 This single payment is equivalent to the yearly rental payments throughout the primary term.27 Shut-in royalties are another type of savings clause that preserve the lease into the secondary term.28 Shut-in royalties consist of payments made at the end of the primary term, or in the secondary term when a well has been shutin for lack of an economically sound market.29

another person. The Rule would invalidate A’s executory interest and leave O with a fee simple absolute.12 However, most courts refuse to apply the Rule when confronted with such deeds.13 In Bagby v. Bredthauer, a grantor reserved a mineral interest for fifteen years and so long thereafter as production continued in paying quantities.14 The Third Court of Appeals explained that a “grantor’s reservation of a royalty interest in a single deed actually implies two grants: (1) a grant of a fee simple absolute of the entire estate to the grantee; and (2) a re-grant of the royalty interest back to the grantor.”15 This “two-grant” theory creates a presently vested future interest in the original grantee not voided by the rule against perpetuities.16 Although this “two-grant” theory is followed by at least two Texas courts of appeal, the Supreme Court of Texas has not expressly adopted or confirmed this theory.17 More recently, the Supreme Court of Texas decided that an original royalty deed for fifteen years and so long thereafter as there was production in paying quantities did not violate the Rule.18 However, the second royalty deed that “shall become effective only upon the expiration of the above described [original deed]” created a springing executory interest which may not vest within the period of the Rule, and therefore was void.19 The Supreme Court’s decision appears to indicate that the Court will apply traditional property principles, including the rule against perpetuities to these types of oil and gas transactions.20

ConocoPhillips Co. v. Koopmann On December 27, 1996, Lois Strieber conveyed a Warranty Deed for the surface and mineral estate of a tract of land to the Koopmanns but reserved a NPRI for herself.30 The NPRI had a term of fifteen years, but could be extended without actual production if a “payment of shut-in royalties or any other similar payments” were made to the Koopmanns.31 In 2007, the Koopmanns entered a three-year oil and gas lease with a ConocoPhillips subsidiary that was set to expire in December 2011.32 A few months before the lease’s expiration, ConocoPhillips paid the Koopmanns $24,000 to extend the lease until October 2012.33 Days before Strieber’s NPRI was set to expire, ConocoPhillips informed the Koopmanns that a well was anticipated to begin producing oil and gas in the first quarter of 2012.34 ConocoPhillips tendered a shut-in royalty payment, which the Koopmanns promptly returned to ConocoPhillips.35 Oil and gas was eventually produced two months after the fifteen-year term ended, but it is unclear when the well was actually capable of producing in paying quantities.36 The Koopmanns then brought an action against Strieber, ConocoPhillips, and its subsidiary to be declared owners of the NPRI, which the trial court granted on summary judgment.37 The Thirteenth Court of Appeals reversed the trial court’s declaratory judgment.38 When analyzing whether the NPRI reservation, as used in the Deed, violated the rule against perpetuities, the court looked to binding and persuasive precedent. The court adopted the Bagby “two-grant” theory and found that Strieber’s reservation of a defeasible term royalty

Leasehold Savings Clause Oil and gas leases are divided into a primary and secondary term.21 The primary term is a fixed period of years, when the lessee has the option either to drill or to pay delay rentals to hold the lease.22 The “thereafter” clause creates the secondary term, which lasts as long as oil and gas is produced from the lease.23 In Texas, actual production is required unless a deed expressly provides otherwise.24 Savings clauses serve as substitutes for actual production and are designed to preserve the lease, absent production.25 8

ambiguous.47 The Thirteenth Court of Appeals held that the fact issue as to whether the $24,000 payment was “similar” to a shut-in royalty precluded summary judgment concerning ownership of the NPRI.48

interest creates a future interest in the Koopmanns that does not violate the Rule.39 The court then contrasted Peveto, where the original grantor’s future interest was expressly conditioned on the termination of the grantee’s interest, which may continue for an indefinite time.40 For that reason, the original grantor’s future interest had a fatal ‘vesting’ problem under the Rule.41 In this case, the Koopmanns’ future interest in the NPRI was created by a single deed, which was not conditioned on the termination of Strieber’s interest.42 Thus, the Thirteenth Court of Appeals held that the rule against perpetuities did not apply to invalidate the Koopmanns’ future interest in the NPRI.43 In addition, the court found that the reserved NPRI could only avoid termination if the lease

Analysis of the Koopmann Rationale Here, the Thirteenth Court of Appeals incorrectly held that the rule against perpetuities is not applicable to the Koopmanns’ future interest in the NPRI.49 The Supreme Court of Texas has emphasized that if a deed is capable of two reasonable interpretations, one of which violates the Rule, courts prefer the interpretation that renders the deed valid.50 “[I]f the meaning is clear, it must be adopted even if the Rule renders the gift so construed illegal, and a forced or unnatural construction may not be made in order to avoid the application of the rule.”51 When Strieber reserved a term NPRI, the Koopmanns received an interest analogous to a springing executory interest subject to the rule against perpetuities.52 Although most courts refuse to apply the Rule when confronted with such deeds,53 case-by-case exceptions, like the Bagby “two-grant” theory, hinder both the Rule’s application and its purpose to increase full commercial development.54 If the Supreme Court of Texas does not find that the Rule invalidates the Koopmanns’ interest, the Court should affirm the Thirteenth Court of Appeals’ holding that the Deed’s savings clause is ambiguous.55 Although Strieber and ConocoPhillips and the Koopmanns construe the savings clause under this Deed quite differently,56 a clause is not ambiguous merely because the parties disagree on its meaning.57 On the other hand, if a clause is subject to two or more reasonable interpretations, the clause is ambiguous.58 The Thirteenth Court of Appeals noted that “a paid-up lease can be similar to or different from a shut-in royalty depending on the criteria used to compare the two types of payments.59 The savings clause in the Deed does not limit “the criteria for comparing these two types of payments, for example, by defining the term ‘similar’. . . or otherwise specifying what types of payments would be similar to a shut-in royalty.”60

“The Supreme Court’s decision appears to indicate that the Court will apply traditional property principles, including the rule against perpetuities to these types of oil and gas transactions.”

was maintained by “shut-in payments or similar payments in lieu of actual production.”44 Strieber and ConocoPhillips argued that a paid-up lease is similar to a shut-in royalty because both payments are permitted by a specific clause to: (i) maintain a lease in lieu of actual production; (ii) extend the lease for a specific amount of time by paying the lessor a predetermined amount not measured by production; and (iii) operate as conditions subsequent because the lease automatically terminates if payments are not timely made.45 The Koopmanns argued that a paid-up lease is too different from a shut-in royalty because a paid-up lease is tied to exploration during the primary term, whereas a shut-in royalty is tied to production at the end of the primary term, or in the secondary term, when a well has been shut-in for lack of a market.46 The court relied on contract interpretation principles to determine whether a payment made to secure a paid-up lease is similar to a shut-in royalty payment. The court found that the savings clause was susceptible to at least two different reasonable interpretations and was therefore 9

Koopmann, 60 Tex. Sup. Ct. J. 1231 (June 16, 2017) [160662].

6 ConocoPhillips Co. v. Koopmann, No. 13-14-00402-CV, 2016 WL 2967689, at *12 (Tex. App. – Corpus Christi May 19, 2016, pet. granted) (mem. op.).

7 TEX. CONST. art. I, § 26.

8 Bagby v. Bredthauer, 627 S.W.2d 190, 194 (Tex. App.— Austin 1981, no writ).

9 Peveto, 645 S.W.2d at 772.

10 Laura Burney, A Pragmatic Approach to Decision Making in the Next Era of Oil and Gas Jurisprudence, 16 J. ENERGY NAT. RESOURCES & ENVTL. L. 1, 48 (1996).

11 Deviney v. NationsBank, 993 S.W.2d 443, 449 (Tex. App.—Waco 1999, pet. denied) (emphasis added).

12 Bruce M. Kramer, Property and Oil & Gas Don’t Mix: The Mangling of Common Law Property Concepts, 33 WASHBURN L. J. 540, 551 (1994).

13 Id. 14 Bagby v. Bredthauer, 627 S.W.2d 190, 197 (Tex. App.— Austin 1981, no writ).

15 Id., at 195-96.

16 Id. 17 See, e.g., ConocoPhillips Co. v. Koopmann, No. 13-1400402-CV, 2016 WL 2967689, *9 (Tex. App. – Corpus Christi May 19, 2016, pet. granted); Walker v. Foss, 930 S.W.2d 701, 705 (Tex. App.—San Antonio 1996, no writ); Bagby v. Bredthauer, 627 S.W.2d 190, 195-96 (Tex. App.—Austin 1981, no writ).

18 Peveto v. Starkey, 645 S.W.2d 770, 771 (Tex. 1982).

19 Id., at 771-72 (emphasis added).

20 Nelson Roach, The Rule Against Perpetuities: The Validity of Oil and Gas Top Leases and Top Deeds in Texas After Peveto v. Starkey, 35 BAYLOR L. REV. 399, 407 (1983).

21 Anadarko Petroleum Corp. v. Thompson, 94 S.W.3d 550, 554 (Tex. 2002).

22 1 EARNEST E. SMITH & JAQUELINE L. WEAVER, TEXAS LAW OF OIL & GAS § 4.3[A] (2d ed. 2012).

23 JOSEPH SHADE, PRIMER ON THE TEXAS LAW OF OIL & GAS 31 (4th ed. 2008).

24 Archer County v. Webb, 338 S.W.2d 435, 437 (Tex. 1960) (requiring actual production, and not merely the completion of a well capable of producing in paying or commercial quantities).

25 Bruce M. Kramer, Keeping Leases Alive in the Era of Horizontal Drilling and Hydraulic Fracturing, 49 WASHBURN L. J. 283, 293 (2010).

26 Kendor P. Jones & Jennifer P. McDowell, Keeping Your Lease Alive In Good Times and In Bad, 55 ROCKY MTN. MIN. L. INST. 23.02[1] (2009).

27 Id. 28 Id., at 23.01.

29 4 EUGENE O. KUNTZ, A TREATISE ON THE LAW OF OIL & GAS § 46.1, at 2 (1972).

30 ConocoPhillips Co. v. Koopmann, No. 13-14-00402-CV, 2016 WL 2967689, *1 (Tex. App. – Corpus Christi May 19, 2016, pet. granted).

31 Id. 32 Id. 33 Id.

When the Supreme Court of Texas hears this issue, the Court should find that a grantor’s reservation for an indefinite term interest creates a springing executory interest in the grantee that is invalid under the rule against perpetuities.61 Thus, the Court will likely hold that the rule against perpetuities voids the Koopmanns’ interest in the NPRI, leaving Strieber with ownership.

Conclusion This Note has attempted to highlight the potential uncertainty as to legal title in oil and gas transactions and leases. When oil and gas titles are unclear, transaction costs rise, and incentives to develop or invest in resources decrease.62 In this case, Strieber reserved a NPRI for a term of fifteen years, which could be extended without actual production if a “payment of shut-in royalties or any other similar payments” were made to the Koopmanns.63 Courts should not allow case-by-case exceptions to circumvent the Texas Constitution’s rule against perpetuities.

The Supreme Court of Texas’ should take the opportunity to provide much-needed guidance as follows: 1. A grantor’s reservation for a given period and as long thereafter as there is production in paying quantities creates a springing executory interest in the grantee, and 2. A springing executory interest following an indefinite term NPRI violates the rule against perpetuities.

1

Recent Developments in Texas and the United States Energy Law, 12 TEX. J. OIL, GAS, & ENERGY L. 121 (2017).

2 Plainsman Trading Co. v. Crews. 898 S.W.2d 786, 789-90 (Tex. 1995).

3 Id., at 789-90.

4 The Rule states that “no interest is valid unless it must vest, if at all, within twenty-one years after the death of some life or lives in being at the time of the conveyance.”

Peveto v. Starkey, 645 S.W.2d 770, 772 (Tex. 1982).

5 The other issues in this case are (3) whether Texas Natural Resources Code section 91.402 precludes a payee from suing a payor for breach of contract or tort theories stemming from the failure to pay royalties, and (4) whether a partially successful non-moving party is the prevailing party under Texas Rule of Civil Procedure 91a and is entitled to recover its fees and costs. ConocoPhillips Co. v.

10

34

54

35

55

Id., at *2.

Id. 36 Id. 37 Id. 38 Id., at *12.

39 Id., at *9.

40 Id., at *11.

41 Id. 42 Id., at *12.

43 Id. 44 Id., at *2 (emphasis added).

45 Id., at *7.

46 Id. 47 Id. 48 Id., at *12.

49 Id. 50 Brooker v. Brooker, 106 S.W.2d 247, 254 (Tex. 1937); see, e.g., Rekdahl v. Long, 417 S.W.2d 387, 389 (Tex. 1967) (where an instrument is equally open to two constructions); Hancock v. Butler, 21 Tex. 804, 806 (1858) (if this deed, or its parts, are equally capable of two constructions).

51 Brooker, at 254.

52 See Laura Burney, A Pragmatic Approach to Decision Making in the Next Era of Oil and Gas Jurisprudence, 16 J. ENERGY NAT. RESOURCES & ENVTL. L. 1, 48 (1996).

53 Bruce M. Kramer, Property and Oil & Gas Don’t Mix: The Mangling of Common Law Property Concepts, 33 WASHBURN L. J. 540, 551 (1994).

Burney, supra note 10, at 53.

ConocoPhillips Co. v. Koopmann, No. 13-14-00402-CV, 2016 WL 2967689, *7 (Tex. App. – Corpus Christi May 19, 2016, pet. granted).

56 Id. 57 See Seagull Energy E & P, Inc. v. Eland Energy, Inc., 207 S.W.3d 342, 345 (Tex. 2006).

58 See J.M. Davidson, Inc. v. Webster, 128 S.W.3d 223, 229 (Tex. 2003).

59 Koopmann, at *7 ([I]f the criteria used to compare these payments focuses on when a shut-in royalty is typically paid during the life of a lease, then a paid-up lease is different from a shut-in royalty because a paid-up lease is paid in the primary term—whereas a shut-in royalty is usually paid during the secondary term. If, on the other hand, the criteria used to compare these payments focuses on what a shut-in royalty accomplishes during the life of a lease, then a paid-up lease is similar to a shut-in royalty— since both payments are made during times of nonproduction for the purpose of maintaining a lease in force and effect.).

60 Id. 61 See Peveto v. Starkey, 645 S.W.2d 770, 772 (Tex. 1982).

62 Laura Burney, A Pragmatic Approach to Decision Making in the Next Era of Oil and Gas Jurisprudence, 16 J. ENERGY NAT. RESOURCES & ENVTL. L. 1, 43 (1996).

63 Koopmann, at *1.

11

abide by the Guiding Principles. This could be because the UN Guiding Principles do not come up on their own in any of the related documents

Sustainability in Contracts: The AIPN Joint Operating Agreement By: Sean Berwald

“These arrangements use the 2011 UN

Introduction

Guiding Principles on Oil and Gas as their

The Association of International Petroleum Negotiators (AIPN) 2012 Model Contract Joint Operating Agreement (JOA) adequately enables companies to manage their sustainability, environmental and regulatory risks in a globally hostile environment while developing new projects in a variety of host government contexts.

The soft law organizations that implement sustainability goals are abided by through most of the major oil and gas companies. The soft law organizations are tasked with mitigating the environmental risks to people around the world directly or indirectly impacted by much of the oil and gas industry.

This Article addresses three main conclusions. First, the JOA does not address sustainability issues in the contract itself. Second, sustainability clauses are unnecessary in today’s model JOA. Third, the Model JOA deals with sustainability without requiring a sustainability clause through a variety of soft law international organizations. However, because this soft law is very much untested, it is certainly still recommended that any company include a full SIA clause in their JOA until the soft law aspects become more enforceable and widely used.

foundation with most major International Oil Companies (IOCs) expressly abiding by this soft law in practice and expressing this commitment on their websites.”

to the oil and gas operation, like the JOA. The Model Contract JOA does not address the issue outside of the Health, Safety, and Environment (HSE) clause. HSE clause deals directly with project related issues on site and not the overall situation or the surrounding environmental, human and regulatory factors. However, because of the “good and prudent petroleum practices,” it seems that the Model Contract JOA does not need a rigid sustainability mechanism since the UN Guiding Principles have mechanisms which adequately deal with nearly every issue which could arise. Some of those issues are government accountability, transparency, refusal to take unfair advantage in negotiations and respect for communities in which the industry operates.

These various issues range from every conceivable problem, but each has a legal remedy that can be better managed separately through other mechanisms than the JOA. The global oil and gas industry carries an enormous amount of risk related to environmental policy. The contracting process for oil and gas projects is one of the best mechanisms for building a plan to mitigate that risk. The AIPN created the first global model contract scheme for oil and gas companies. The intention was to offer the global industry a more collaborative and flexible model contract than the previous forms.

The AIPN JOA was revised in 1990, 1995, 2002 and 2012 with the last revision having very few changes in mitigating the risks related to sustainability, environmental law, and regulatory elements. The low-price environment increases the financial pressure on IOCs and their ability to move forward with large, costly projects.

The AIPN JOA and Sustainability The AIPN Model International JOA 2012 adequately deals with sustainability through the “good and prudent petroleum practices” that have become standard in contract arrangements across the world. These arrangements use the 2011 UN Guiding Principles on Oil and Gas, also known as the Ruggie Doctrine, as their foundation with most major International Oil Companies (IOCs) expressly abiding by this soft law in practice and expressing this commitment on their websites.

Amazingly, many of the top practitioners in the United States have neither heard of nor ever seen this document before despite many of their company websites have the statement that they 12

Investment protection, the highest priority for an energy company, has at its core a list of general priorities of the most effective mechanisms used to protect an investment.

Prioritizing from most important to least important, are: (i) the contract itself, (ii) the hydrocarbon laws of the host country, (iii) multilateral treaties related to the subject issue, (iv) bilateral investment treaties between the two respective nations involved, (v) foreign investment laws, (vi) general laws, and (vii) soft law which has no substantive legal weight. Since the contract is nearly always confidential, it is challenging to determine the effectiveness of the explicit agreement without knowing what has been specifically agreed. Therefore, an analysis of the hydrocarbon laws and international treaties for each country is next on the priority list. The UN Guiding Principles fit into this category under soft law, making it a toothless tiger until broadly applied to the industry. Hard and soft law are two different categories of regulations that overlay the industry in the way it approaches legal limitations on their projects. While hard law is binding, soft law is often non-binding and more like an advisory or guidance opinion by an institution. In the case of sustainability agreements, this nonbinding precedent has been widely adopted in the last five years giving sustainability the potential to punch above its weight. However, when soft law is widely used as a standard in a particular industry, it often becomes part of the legal standard. This is what is now happening with the UN Guiding Principles, which has elevated these principles giving them near-legally binding authority.

Nearly all major JOA activity today is done between a state-owned enterprise (SOE) and a partner IOC or consortium of IOCs to mitigate the financial risk of large projects. The energy industry is plagued by enormous costs, increasing hostility toward business and complex political environments. Balancing the technical, financial and political risks is a full-time task that requires companies work together to mitigate these risks.

Risk mitigation is the central purpose of the JOA, as it seeks to lower costs and allow more efficient production. This translates to a serious need for operator flexibility in a host country when working around complex geopolitical

environments. The challenges of human rights and environmental impact are major issues in most of the country’s energy companies operate.

“The energy industry is plagued by enormous costs, increasing hostility toward business and complex political environments.”

When host governments do business with companies from outside of their country, citizens of that country often perceived that the host government is “in bed” with the government of the company seeking oil and gas rights in the host country. This public policy balance requires governments to be very careful when partnering with energy companies while maintaining a base for elections or authority at home. These national governments often seem to want stricter enforcement plans for environmental or employment requirements than the energy companies because of the careful balance host government must manage. However, it is often a sticking point to find that balance between making money and satisfying the goals of a host government when these national projects are in the national spotlight of the host countries.

One of the clauses for JOA contracting to deal with human rights and environmental impact discussed at the turn of this century was the Sustainability Impact Assessment (SIA) or Sustainability Clause. This clause was consistent with much of the broader employment and environmental goals that existed in the international realm of soft law. However, it was somewhat of a trailblazer in human and environmental awareness in large contracting operations. The clause was intended to ensure fundamental human rights standards at the highest level. The true intent of the drafters of these clauses was often used to the advantage of party interests within the contracting scheme by governments and companies alike. In practice, it had various results ranging from government corruption or lack of transparency through the use of loopholes to negligent activity that cost millions and large amounts of time to remedy.

This resulted in a set of new challenges 13

compounded by a clause that was still quite new to the industry. As a result, the industry groups for oil, gas, and mining backed off from SIA clauses in JOA contracts, and the AIPN Committee for the Model Contract JOA in the early 2000s decided not to add the SIA clause to the contract. The AIPN and other international petroleum organizations have supported the industry by simplifying the contract scheme.

These groups develop foundational frameworks and loosely “codify” the industry standard, without pushing the limits of any particular aspect in the industry, including SIA clauses and environmental regulations. Limiting the SIA clause often leaves soft law as the only viable source of remedy for underdeveloped countries when human rights or environmental events occur related to an oil and gas project.

significant than the sustainability clauses used in most cases today and in the past. The bar has been raised and with it comes higher costs.

However, this is the chance for the energy industry to truly showcase its commitment to the protection of life, environment and the rule of law. This process must be adapted at the highest level and integrated within each related section of the company that can directly or indirectly affect results on the ground in the host country. The company must define, develop, communicate, align internally, and apply the policy commitment through the company chain and in the company relationships with other businesses. The AIPN JOA is relatively consistent in its HSE clause with the Human Rights Impacts of the Guiding Principles. Both are designed to build a systematic approach to assessment, assess the context of operations, draw on outside expertise and consult affected stakeholders consistently.

The UN Guiding Principles go far beyond the Model Contract JOA in every other respect.

The UN Guiding Principles on Oil & Gas The UN is the largest international body that could impact sustainability-related issues, and legal-related documentation often has an impact on the mood of the industry. Energy industry specialists and Non-Governmental groups (NGOs) came to a broad consensus that the UN Guiding Principles were effective in dealing with many of these sustainability issues.

These groups concluded that a sustainability solution must have three elements, which were unanimously agreed to by the UN Human Rights Council in 2011: Protect, Respect, and Remedy.

As stated in the UN Guiding Principles, it is “[t]he state’s duty to protect against human rights abuses” while at the same time ensuring “corporate responsibility to respect human rights [by not] infringing on the rights of others” but instead establishing “the need for greater access to effective remedy for victims.” This standard goes far and above the oil SIA clauses of the early 2000s, making most SIA clauses unnecessary or redundant for the AIPN 2012 Model JOA. The UN Guiding Principles require an enormous amount of due diligence and care. This is especially true given the inevitable publicity and seriousness of financial, environmental, human and reputational risks associated with problems on major projects; much more

“This is the chance for the energy industry to truly showcase its commitment to the protection of life, environment and the rule of law.”

Tougher regulations come when an operator is negligent in environmental concerns. If companies have a robust HSE or SIA program, then they encourage prudence and less regulation, which can decrease long-term costs substantially.

California is the third largest hydrocarbon producer in the United States despite the regulation scheme, evidencing that success can be found even in toughly regulated communities around the world. Getting out in front of these issues and applying the UN Guiding Principles sooner in the process allows a company to operate with consistent frameworks across large energy production companies more effectively.

On the other side, national governments will look to the UN Guiding Principles for their national regulation schemes, making these guidance notes increasingly relevant and prevalent in the global energy industry. Companies would be smart to spend more time making a trust mechanism with the host government as part of their legacy.

14

Mar. 8, 2018), https://www.anadarko.com/Responsibility/GoodGovernance/Approach-to-Human-Rights-/; see also Human Rights, SHELL (last visited Mar. 8, 2018), https://www.shell.com/sustainability/transparency/humanrights.html.

[18] Roberts, supra note 10, at 301-06.

[19] Yves Doz & C.K. Prahalad, How MNCs Cope with Host Gov’t Intervention, HARV. BUS. REV. (Mar. 1980), https://hbr.org/1980/03/how-mncs-cope-with-hostgovernment-intervention.

[20] Id. [21] IPIECA, OIL AND GAS INDUS. GUIDANCE ON VOLUNTARY SUSTAINABILITY REPORTING 121 (3rd ed. 2015), http://www.ipieca.org/media/2849/og_industry_guidance_o n_voluntary_sustainability_reportnig_3rd_ed_2016.pdf.

[22] Stephanie Lomax, Why IOCs Are Paying Attention to Soft Law on Human Rights, LEXOLOGY (June 6, 2013), https://s3.amazonaws.com/documents.lexology.com/d6c251 6b-6036-46b2-aff0-41e256b811fd.pdf.

[23] Id. [24] Id. [25] Id. [26] Id. [27] NAT’L GEOGRAPHIC SOC’Y, Int’l Org. (2012), https://www.nationalgeographic.org/encyclopedia/internatio nal-organization/.

[28] EC-UN Guiding Principles, O&G, 3.

[29] Shift & Inst. for Human Rights & Bus., for the European Comm’n, Oil and Gas Sector Guide on Implementing the UN Guiding Principles on Bus. and Human Rights # (2013), https://www.ihrb.org/pdf/eusector-guidance/EC-Guides/O&G/EC-Guide_O&G.pdf [30] Id. at 5 (emphasis added).

[31] Working Group SIA and Stakeholder Consultation Model Clause JOA, ASS’N INT’L PETROLEUM NEGOTIATORS (AIPN), http://aipn.org (last visited [4/2/2018]).

[32] Shift & Inst. for Human Rights and Bus., supra note 30, at 37.

[33] Rae Lindsay et al., Human Rights Responsibilities in the Oil and Gas Sector: Applying the UN Guiding Principles, 6 J. WORLD ENERGY L. & BUS. 2, 52-54 (2013).

[34] Shift & Inst. for Human Rights and Bus., supra note 30, at 24-25.

[35] Id. at 16.

[36] CHRISTINE COOPER & SHANNON SEDGWICK, THE OIL AND GAS INDUS. IN CAL.: ITS ECON. CONTRIBUTION AND WORKFORCE IN 2013 2 (L.A. Cty. Econ. Dev. Corp., June 2015), https://laedc.org/wpcontent/uploads/2015/09/OG_Industry-andWorkforce_20150731.pdf.

[37] Bus. & Human Rights Res. Ctr., US to develop Nat’l Action Plan Consistent with UN Guiding Principles on Bus. and Human Rights, https://business-humanrights.org/en/usto-develop-national-action-plan-consistent-with-unguiding-principles-on-business-human-rights (last visited Mar. 8, 2018)

Conclusion In summary, the AIPN Model Contract JOA does not need a sustainability clause because the contract requires companies to use “good and prudent petroleum practices” of the industry, which now seems to require the utilization of the UN Guiding Principles or a similar standard in the industry. This soft law mechanism goes far beyond the previous Sustainability clauses in the JOA. However, companies should continue to put in SIA clauses into their contracts to ensure they know exactly what the bargain for sustainability is instead of trusting an arbitration panel to manage the UN Guiding Principles given this soft law has largely been untested. ________________________________________ [1] Model Int’l Joint Operating Agreement 2012, ASS’N INT’L PETROLEUM NEGOTIATORS (AIPN), http://aipn.org (last visited [3/23/18]).

[2] ERNEST E. SMITH, Materials on Int’l Petroleum Transactions 809-11 (3rd ed. 2010).

[3] Thomas Wälde, The Role of Int’l “Soft Law” in Nat. Res. and Energy Inv., 2 OIL, GAS & ENERGY INTELLIGENCE 4, 10-11 (Oct. 2004).

[4] ASS’N INT’L PETROLEUM NEGOTIATORS (AIPN), supra note 1, at 12.

[5] See UN Guiding Principles on Oil and Gas [hereinafter UN Guiding Principles]; John G. Ruggie, Oil and Gas Sector Guide on Implementing the UN Guiding Principles on Business and Human Rights, European Comm’n (2011).

[6] ASS’N INT’L PETROLEUM NEGOTIATORS (AIPN), supra note 1, at 35-36.

[7] Charles McPherson, Ethics, fairness, and anti-corruption in petroleum projects: how far have we come?, 9 J. WORLD ENERGY L. & BUS. 1, 55-63 (2015).

[8] Id. [9] Muhammad Waqas, Hist. and Dev. of JOAs in the Oil and Gas Indus., 11 OIL & GAS FIN. J. 10, 11 (2014).

[10] Peter Roberts, Joint Operating Agreements: A Practical Guide (Globe L. & Bus., London 2015) 20-22.

[11] Id. [12] Id. [13] Id. [14] Id. [15] Id. [16] Stephanie Lomax, Why IOCs Are Paying Attention to Soft Law on Human Rights, LEXOLOGY (June 6, 2013), https://s3.amazonaws.com/documents.lexology.com/d6c251 6b-6036-46b2-aff0-41e256b811fd.pdf.

[17] Anadarko’s responsibility website and Shell’s UN Guiding Principles website are two of many examples of companies applying the soft law as a standard for operations, which the IOC community broadly uses. See Our Approach to Human Rights, ANADARKO (last visited

15

Landowner is an extremely wealthy individual that has almost no knowledge of oil and gas law. Landowner plans on retiring on this land with his wife and building houses for his children to live there as well. The surface is beautiful, and the land is fenced in for privacy.

When initially approached by Operator, Landowner turned down any offer to lease his minerals as he does not want any oil and gas operations on the land.

Of the three other mineral estate owners, only one remains unleased. In Tract 1, Mineral Buyer has leased its 1/8th mineral interest to Operator, but Oil Company is currently in lease negotiations with Operator. In Tract 2, University has leased its 1/2 mineral interest to Operator.

After some consideration, Landowner has contacted a lawyer to understand his options in leasing his minerals. Landowner explains to his lawyer that while he wants to get the full benefit from his mineral rights, his ultimate concern is to not allow any oil and gas operations on the surface of his land. Landowner explains that he will forgo leasing if it means he can protect his land from drilling operations.

Main Issue: Considering the entirety of the situation and Landowner’s goal of realizing the maximum benefit of his mineral rights balanced against Landowner’s paramount concern of prohibiting all surface operations, the lawyer representing Landowner has many bases to cover in informing Landowner of the relevant law and the many options to suggest.

Mineral and Surface Estates in Conflict: A Scenario Study By: Matthew Gibson Framing the Scenario Consider the following situation: Landowner is considering signing an Oil and Gas Lease with Operator. Landowner owns the entire surface and 1/2 the mineral estate of 640 acres made up of two contiguous tracts. Tract 1 is 480 acres, and Tract 2 is 160 acres. These tracts are in an area of Texas that is very active in exploration and production of oil and gas, and Operator has made it known to Landowner that his land is their top leasing priority.

The chain-of-title to Tract 1 is straight forward containing no unique reservations or stipulations regarding the mineral interest. The remaining 1/2 of the mineral interest in Tract 1 is as follows: Mineral Buyer owns a 1/8th mineral interest, and Oil Company owns a 3/8th mineral interest.

The chain-of-title to Tract 2 is not as simple.

University owns the outstanding 1/2 mineral interest in Tract 2. Through a mesne conveyance, a predecessor in title to University conveyed the entire surface and 1/2 the mineral estate while reserving 1/2 the mineral interest. The reservation language in the General Warranty Deed was as follows: There is hereby excepted and reserved unto Grantors, their successors and assigns, onehalf (1/2) of all oil, gas and minerals, provided, however, Grantors waive the right of ingress and egress over and across the surface for the purposes of conducting Oil and Gas activities, and any lease executed by the Grantors covering the Grantors’ reserved mineral interest, shall prohibit the use of the surface of the property for such purposes. [1] The reserved 1/2 mineral interest was ultimately conveyed to University with the following language, “Grantee’s interest is subject expressly to all burdens presently of record covering the interests conveyed.” [2] Further, the surface estate of Tract 2, along with the 1/2 mineral interest that was not reserved, was ultimately conveyed to Landowner.

Mineral Estate Overview Initially, the Landowner needs to be informed that there are distinct differences and rights regarding the mineral estate and surface estate.

Texas has long recognized the “ownership-inplace” theory regarding minerals. [3] The Landowner owns the minerals, which includes oil and gas, under and within the boundaries of his land subject to the rule of capture. [4] The fact that oil and gas can freely move outside the boundaries of the land does not prevent the oil and gas from being considered part of his property and capable of distinct ownership while within the boundaries of such land. [5] Ultimately, the oil and gas under his land are 16

owned by the Landowner while still under his land.

Once the minerals have been severed from the surface, the effect can sometimes create complications between the owners of the now separate surface and mineral estate. If the minerals have not been severed from the surface, there is only one Fee Simple estate that contains both minerals and surface. However, in Texas, “the mineral estate may be severed from the surface estate by a grant of the minerals in a deed or lease, or by reservation in a conveyance.” [6] “A grant or reservation of minerals by the fee owner effects a horizontal severance and the creation of two separate and distinct estates: an estate in the surface and an estate in the minerals.” [7] It is well established in Texas that the mineral estate is the dominant estate. [8] The mineral owner is entitled to use as much of the surface as is reasonably necessary to develop the minerals. [9] Absent this implied right, the mineral estate would be rendered worthless because surface owners would be able to prohibit mineral owners from ever accessing, and realizing the benefit of, their mineral estates. [10] However, the mineral and surface estate owners must show due regard towards the rights of each other. [11] Lawyers should not be surprised if their surface owner clients are not aware of, or do not agree with, the mineral estate being the dominant estate.

Here, because the mineral estate is the dominant estate, Landowner needs to understand that even though he owns the entire surface estate and half of the mineral estate, without a well thought out leasing strategy, there is essentially nothing the Landowner can do to keep other undivided mineral owners from accessing their minerals.

considered a non-operating cotenant. [12] A lessee who drills and produces oil and gas must account to any non-operating cotenants for their proportionate share of the net profits from production. [13] However, the Operator would have the right to deduct a proportionate share of the costs of exploring, drilling and producing from Landowner’s proportionate share of production. [14] Because the Operator is required to account to the Landowner for his share of production, which would be 1/2, prudent operators would not take on this project. This would result in Landowner’s surface estate going untouched.

“While being more burdensome, having to acquire an offsite drill site is common practice

by Operators and can be more beneficial for drilling operations regarding recovery.”

However, going unleased would bar the Landowner from realizing any benefit from his mineral estate. As previously explained, the Operator would not take on a 50% burden. Thus, no production would occur. Also, being the owner of 320 mineral acres (1/2 the mineral estate of 640 acres) in a very active and soughtafter area by operators, Landowner would be due an extremely lucrative signing bonus. He would also be in a position to negotiate a more favorable royalty out of production as well as other favorable provisions in the lease. Therefore, going unleased is not a viable option when considering Landowner’s goal of prohibiting surface use while maximizing the benefit of his mineral rights.

On the other end of the spectrum, Landowner could lease with Operator and rely on the reasonable use of the surface and possibly open himself to the destruction of his beautiful family retirement land. The mineral owner—or his lessee—is entitled to use as much of the surface as is reasonably necessary to develop the minerals. [15] Therefore, once Landowner signs a lease, Operator as the lessee would be allowed to use a reasonable amount of the surface as needed for drilling operations. Even though most practical operators are willing to work with

Landowner’s Options On one end of the spectrum, Landowner could refuse to lease to completely protect his land from surface operations. By refusing to lease, Landowner would effectively make it economically impractical for Operator to conduct drilling operations while possessing only 1/2 the leasehold rights from the other mineral cotenants.

If Landowner opted to go unleased, he would be 17

landowners regarding surface use, this obviously is not an option for Landowner as he will not tolerate any surface use. Further, relying on the accommodation doctrine will not be a viable option either. In establishing the accommodation doctrine, the Supreme Court of Texas held that: Where there is an existing use by the surface owner which would otherwise be precluded or impaired and where under the established practices in the industry there are alternatives available to the lessee where the minerals can be recovered the rules of reasonable usage of the surface may require the adoption of an alternative by the lessee. [16] Here, there is no “existing use” on the surface of Landowner’s land that would force Operator into an alternative drilling site or recovery method.

Therefore, neither going unleased nor leasing without further protection other than relying on the accommodation doctrine will accomplish the optimal balance of both goals of the Landowner.

Refusing to lease will completely protect Landowner’s land from any surface operations.

This would economically bar Operator from conducting drilling operations on the surface, as Operator would have to account to Landowner for 1/2 of the net profits. No prudent operator would consider this an option. Alternatively, relying on reasonable surface use by the Operator after leasing his minerals is not an option for Landowner. No existing use is present that would trigger the accommodation doctrine to bar Operator from using the surface for drilling operations, and Landowner will not tolerate any surface use.

Further steps need to be taken during the negotiations of the lease terms if Landowner wants to realize the maximum benefit from his mineral interest while prohibiting any surface use for drilling operations.

Landholder’s Solution: Prohibiting Surface Use

Leasing

among them. An example of this provision is as follows: Lessee acknowledges and agrees, as an express condition of this lease, that this lease does not include the right to enter upon, use or occupy the surface of the Leased Premises and that Lessee and its employees, contractors, assigns may not and will not enter upon, use, or occupy the surface of the Leased Premises for any purpose whatsoever (and may not authorize others to do so), including conducting seismic operations, drilling for, producing, storing, transporting, or marketing oil or gas, except with the prior written consent of Lessor, which consent may be withheld by Lessor at its sole discretion.

All such rights, if any, which may exist at common law or by statute, are hereby waived as a condition of this lease. Any entrance upon, use, or occupation of the Leased Premises by Lessee, or any of Lessee’s successors or assigns, in violation of this provision hereof, shall result in the immediate termination of this lease, except as to that portion of the Leased Premises (if any) included in a Production Unit.

This provision stipulates that the lease will terminate if the Lessee enters, uses or occupies the surface for any purpose. By also including the language regarding the Lessee’s “assigns,” this ensures that if the Lessee assigns any portion of the lease, the Assignee will also not have the right to enter the land for any purpose. These two specific operations of this provision will allow the Landowner to lease minerals but also protect his surface from any operations.

Because Landowner owns such a large percentage of the minerals in two large-acreage, contiguous tracts, that are in a highly sought after “hot” area, Landowner is in a great position to leverage his percentage of minerals to get Operator to agree to such a term in the lease.

Landowner can present his intention to sign a lease that includes a “no surface use” provision or to not lease his minerals at all. By taking this position, Landowner will economically back Operator into a corner and Operator will be further leveraged into agreeing to no surface use to acquire the lease.

While

An adept oil and gas lawyer would take steps that would allow Landowner to lease his minerals to Operator while simultaneously prohibiting surface use on the entire 640 acres. There are many tools that Landowner’s lawyer could use, a “no surface use” provision being the ideal option 18

By agreeing to no surface use, Operator will have the burden of finding and acquiring an offsite drill site to directionally drill and produce Landowner’s 640 acres. While being more burdensome, having to acquire an offsite drill site is common practice by Operators and can be more beneficial for drilling operations regarding recovery. [17] After Landowner signs a lease with Operator that includes a no surface use provision, there is still a concern about the other 50% mineral owners. These owners or their lessees generally have the right to use the surface to gain access to their minerals. However, this should not be a problem for Landowner if these mineral owners also agree to terms of no surface use in their leases or also lease their interests to the same operator that Landowner leases. This would mean that if Operator did use the surface, this would result in the termination of its lease with Landowner.

grantor retains a fractional interest in and under a tract and gives up the right to bonus and delay rental, but not the right to execute leases, his interest would then be classified as a “fractional mineral fee interest.” [21] Further, each incidental right or attribute is a property right, and each can be severed separately and individually. [22] Here, the right to develop or right of ingress and egress has been waived by the Grantor from the reservation in the conveyance. “Waiver” is the voluntary relinquishment or abandonment— express or implied—of a legal right or advantage.

[23] In this situation, by waiving the right of ingress and egress over and across the surface to conduct oil and gas activities, the Grantor has waived the right to develop and has effectively conveyed that specific incidental right to the Grantee. This leaves the Grantor, their successors and assigns, with a 1/2 undivided fractional mineral fee interest that does not include the right to develop.

Further, the waiver of this right applies to the Grantor’s successors and assigns in the General Warranty Deed. Since the Grantor waived said right, the Grantor relinquished the right and did not possess it from then on. Any subsequent conveyances by the Grantor to its successors and assigns will not include the right to develop because the Grantor cannot convey what it does not own.

University is the ultimate grantee in the chainof-title to the severed mineral rights at issue.

Therefore, University does not possess, within its fractional mineral interest, the right to enter the land to develop its minerals. This ultimately means that in University’s lease with Operator, University cannot convey the right to enter Tract 2 to develop its minerals. Therefore, when Operator acquires its lease from Landowner with a “no surface use” provision, Operator is completely barred from using the surface of Tract 2 for oil and gas development.

Landholder’s Solution: No Development Right for Tract 2 Cotenant Mineral Owners To protect the surface of Tract 1 from drilling activities, Landowner will require a “no surface use” provision in his lease. However, Tract 2 is not a concern regarding surface use. This is based on the reservation language referenced in the chain-of-title for Tract 2. The Grantor conveyed a General Warranty Deed to the Grantee, [18] containing the entire surface and 1/2 of the minerals while reserving 1/2 of the minerals to the Grantor. This reservation language reserves a 1/2 undivided mineral interest in the Grantor.

Specifically, a fractional mineral fee interest in the mineral estate with one exception–the right to develop or right of ingress and egress.

Mineral fee estates contain five “incidental” rights, also called essential or basic attributes: (1) the right to develop (which includes ingress and egress for that purpose), (2) the right to execute oil and gas leases, (3) the right to receive bonus payments, (4) the right to receive delay rentals, and (5) the right to receive royalty. [19] After a conveyance, if the grantee (or grantor) is left with one or more of these rights in addition to the right to share in production, he is usually deemed to have a mineral fee interest. [20] For example, if a

The Intent of the General Warranty Deed A remaining issue is the poor construction of the reservation language. The inclusion of the language “Grantors, their successors and assigns,” portrays that the parties to the General Warranty Deed intend to have the waiver of the 19

right to develop apply to the Grantor’s successors in title. However, the construction of this reservation clause should be written much more precisely. Without a second inclusion of “successors and assigns” there is an interpretation issue. In resolving such issues, the parties’ intent is determined, if possible, by considering the instrument as a whole. [24] “The primary duty of the courts in interpreting a deed is to ascertain the intent of the parties. But it is the intent of the parties as expressed within the four corners of the instrument which controls.” [25] Unless there is an irreconcilable conflict, all provisions of an instrument will be given effect. [26] Apparent contradictory and inconsistent language will be given a construction which harmonizes all provisions in the instrument. [27]

Grantor. Albeit the constructed language of the reservation is not as strong as it should be, the intent is still clear.

Long-Term Solutions The problems and solutions have been identified pertinent to the current leasing situation between Landowner and Operator. However, at some point Landowner’s lease with Operator will expire. Either no production—actual or constructive—will hold the leases past their primary term, or production will occur and then cease causing the lease to expire. These surface use problems with the cotenant mineral owners and future lessees will arise each time Landowner is approached to lease his minerals. Each time, Landowner will have to go through these same issues to secure no surface use without any guarantee of these terms.

There are forward-thinking options for Landowner to ensure absolutely no surface use in the future. First, Landowner could buy the outstanding 50% mineral rights. With total ownership of the mineral estate, all leasing would go through Landowner, and Landowner would control all future use of the surface. However, acquiring the entire 50% minerals from the other mineral owners would be difficult, expensive and take time to negotiate as the other mineral owners would completely lose all rights and benefits of the mineral estate in the future.

Another option for Landowner is to acquire the executive rights to the other 50% mineral rights. Executive rights generally include the right to authorize any actions that affect the exploration and development of the mineral estate. [28] Therefore, executive rights may include the right to carry out exploration, drilling, and production of oil and gas. [29] Specifically, executive rights are mostly known for and correlated with the right to execute leases. [30] In addition, Texas courts recognize the relationship between the right to develop and the right to execute leases.

[31] “Even though conveyance language refers solely to the right to execute leases, Texas courts have deemed the right to develop to be a correlative right that accompanies the leasing right unless clearly expressed to the contrary.”

[32] This shows that when executive rights are

“Buying the executive rights of the outstanding 50% mineral owners would ensure Landowner complete control of the surface of his land.”

In this instance, the parties to the General Warranty Deed clearly intended the Grantor to waive the right to develop, and therefore that incidental right will not pass to any of the Grantor’s successors or heirs through any mechanism. The mineral reservation was conditioned on the Grantor (i) waiving the right to develop and (ii) including a “no surface use” provision in any future lease on the reserved minerals. Clearly, the intent was present that the same “no surface use” provision be included by any successor and heir to the title of the reserved minerals from the Source Deed.

When determining intent, the question to consider is: Why would the Grantee want to bar only the Grantor from being able to develop or have the right of ingress and egress for oil and gas activities, but not bar some subsequent owner of the reserved mineral estate? It is clear the Grantee would not want any owner of the reserved minerals—present or future—to have the right to use the surface to develop their minerals.

This again leads to the conclusion that the reservation language was constructed with the intent that the right to develop not stay with the 20

[9] See Warren Petroleum Corp. v. Martin, 271 S.W.2d 410, 413 (Tex. 1954).

[10] Texaco, Inc. v. Faris, 413 S.W.2d 147, 149 (Tex. Civ. App.—El Paso 1967, writ ref’d n.r.e.).

[11] See Warren Petroleum Corp., 271 S.W.2d at 413.

[12] SMITH & WEAVER § 2.3.

[13] Id. [14] Id. [15] See Warren Petroleum Corp., 271 S.W.2d at 413.

[16] Getty Oil Co. v. Jones, 470 S.W.2d 618, 622 (Tex. 1971).

[17] See John Stavinoha, Andrew Zeve, & Austin Lee, Offsite Drilling: Lightning Oil v. Anadarko and Its Potential Impact on Offsite Surface Use in Horizontal Drilling, BRACEWELL (June 5, 2017), https://www.energylegalblog.com/blog/2017/06/05/offsitedrilling-lightning-oil-v-anadarko-and-its-potential-impactoffsite-surface.

[18] Both being predecessors in title to University.

[19] Altman v. Blake, 712 S.W.2d 117, 118 (Tex. 1986).

[20] SMITH & WEAVER § 3.5.

[21] Id. [22] LAND TITLES AND TITLE EXAMINATION § 14.25 (Texas Practice Series 3d ed. 2017).

[23] BLACK'S LAW DICTIONARY (10th ed. 2014) (definition of “waiver”).

[24] SMITH & WEAVER § 3.4.

[25] Altman v. Blake, 712 S.W.2d 117, 118 (Tex. 1986).

[26] Id. [27] Dodd v. Wiatrek, 2012 Tex. App. LEXIS 8976 (Tex. App.—San Antonio Oct. 31, 2012).

[28] SMITH & WEAVER § 2.6.

[29] See Ernest E. Smith, Implications of a Fiduciary Standard of Conduct for the Holder of the Executive Right, 64 TEX. L. REV. 371, 372 (1985).

[30] SMITH & WEAVER § 2.6.

[31] Id. [32] Id.

conveyed, possibly coupled with them is the right to develop. Therefore, in the usual situation, if a mineral owner does not have the executive rights to their minerals, they also do not have the right to develop those minerals.

Acquiring the executive rights is more feasible than buying the mineral rights outright, as it would be less expensive and simpler to acquire. The other mineral owners would not completely lose the other 50% mineral interest or the bonus or royalties to it. Also, the other mineral owners would only be severed of the right to execute leases and inherently the right to use the surface to develop their minerals. Without the right to execute leases, the other mineral owners have no say in negotiating the terms of future leases, including surface use. Buying the executive rights of the outstanding 50% mineral owners would ensure Landowner complete control of the surface of his land and would most likely be easier to obtain than buying the mineral rights outright. ________________________________________ [1] Grantors being said predecessor in title.

[2] Grantee being University.

[3] 1 ERNEST E. SMITH & JACQUELINE LANG WEAVER, TEXAS LAW OF OIL AND GAS § 1.2 (2017) [hereinafter, SMITH & WEAVER].

[4] Id. [5] Id.; see Texas Co. v. Daugherty, 176 S.W. 717, 720 (Tex. 1915).

[6] Moser v. U.S. Steel Corp., 676 S.W.2d 99, 101 (Tex. 1984).

[7] Acker v. Guinn, 464 S.W.2d 348, 352 (Tex. 1971).

[8] SMITH & WEAVER § 1.2.

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The ENERGY NEWSLETTER is sponsored by the Harry Reed Institute for Oil & Gas at South Texas College of Law Houston

How to Help Support the Oil & Gas Law Institute at South Texas College of Law Houston

South Texas College of Law Houston’s ability to make strategic investments in initiatives such as the Oil & Gas Law Institute hinges on the amount of annual support at its disposal, and the size and strength of our endowment. Last year, the College directed a portion of its annual operating budget to fund the formation of the Institute. This budget has been supplemented by early philanthropic investments in the Institute made by generous friends of the College.

To sustain the Oil & Gas Law Institute for the future and expand its reach through partnerships with industry and other academic thought leaders, new CLE courses, public lectures, and symposia, the ENERGY NEWSLETTER, and additional faculty and staff, the College is seeking to enlist the help of the oil and gas community, its alumni, other corporate and foundation partners and the community at large.

The evolution of oil and gas law — and of the legal education and scholarship behind it — challenges all of us to be more nimble and purposeful. It requires us to innovate, reimagine, and adapt. So too do we understand the growing role philanthropy must play in the life of any educational institution that wishes to lead.

South Texas College of Law Houston would greatly appreciate a philanthropic investment in the Oil & Gas Law Institute. Together, we can ensure the Institute’s place as Houston’s premiere legal teaching and learning resource serving the oil and gas industry.

To make a tax-deductible donation, go to the link below. https://www.stcl.edu/academics/oil-gas-institute/support-us/

For future article submissions or inquiries for professional sponsorship of the ENERGY NEWSLETTER, direct your emails to the address below: stclenergynewsletter.eic@gmail.com South Texas College of Law Houston, Oil & Gas Law Society Office

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