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Oil and Gas Update Greg W. Curry 214.969.1252

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1 Oil and Gas Update Greg W. Curry

2 2 Navigant Unconventional Oil and Gas Litigation Trends Report Source: Navigant Consulting,

3 3

4 4

5 5 Horizontal Drilling and Hydraulic Fracturing

6 “Clean, freshwater, is the lifeblood of rural Texas.” Douglas Beveridge, Vice President, King Ranch Minerals Water will be needed for fracturing process › University of Texas study concludes on a per barrel basis no significant difference Texas, Oklahoma, and Louisiana are already concerned about water shortages Controlling the fracturing process to keep water table safe › National Academy of Sciences study found that pollution was either natural or from poor fracking jobs or failed cement jobs 6 Surface Owner Issues

7 Primarily (but not always) an issue when the mineral rights are severed from the surface... but has become more of an issue in historical areas and where the oil fields are meeting the city. › Hostile surface owners: “Get off my land... what part of my double barrel shotgun do you not understand?” − Play nice, negotiate compromise, surface damage agreement − Never take matters into your own hands − Injunctive relief and possibly damages related to delay/interference › Same rights to access surface exist even if minerals and surface are not severed, subject to terms of the lease 7 Mineral Owner’s Right to Use the Surface

8 Scope of mineral owner’s right to use surface › Where mineral estate is severed from surface, mineral estate is dominant › Legal privilege and enforceable right to use and have priority over servient estate to extent reasonably necessary to explore, develop, and transport minerals − When conflict of use arises, and no reasonable alternative, mineral estate’s right to use surface trumps − In Texas, mineral owner not required to pay surface damages provided use is not excessive, negligent, or in violation of lease, but as a practical matter most oil companies do so 8 Mineral Owner’s Right to Use the Surface

9 Scope of mineral owner’s right cont’d... › Many surface owners may not know that mineral owner may be entitled to damages and injunctive relief for improper interference › Right to use surface includes right to construct roads, tanks, pits, flow lines, utilize surface water, conduct seismic, etc., as reasonably necessary to explore, develop, and transport minerals and giving due regard to rights of surface owner › Rights may also be expressly defined by lease language (often overlooked or forgotten until too late) 9 Mineral Owner’s Right to Use the Surface

10 Limitations on right to use surface estate › May use only amount of surface as “reasonably necessary” to explore, develop, and transport minerals giving “due regard” for the rights of the surface owner › Despite implied doctrine of accommodation, express terms of lease or mineral reservation may trump 10 Mineral Owner’s Right to Use the Surface

11 Limitations on use surface cont’d › Surface use generally limited to exploration, development, and transport of minerals underlying mineral estate − Must secure easement or right of way to transport off- lease or off-premise production or to access lease or premise to explore adjacent acreage (unless pooled) › Surface use must comply with terms of lease and with applicable statutes, rules, and regulations − Drilling permits, statutory notice requirements, etc. 11 Mineral Owner’s Right to Use the Surface

12 Surface damages › Many surface owners believe they are entitled to surface damages as a matter of law. − But absent express lease language or statute, mineral owner/lessee generally only exposed to surface damages that are not reasonably necessary to explore/develop minerals − Existence of drill site, roads, pits, noise, etc. that are reasonably necessary and with due regard to the rights of the surface owner do not give rise to surface damages per se 12 Mineral Owner’s Right to Use the Surface

13 Surface damages cont’d › Potential liability for operations outside the reasonably necessary area used to explore and develop minerals: − Pollution is not “reasonably necessary.” Lessee cannot negligently damage surface − Violations of RRC rules may result in negligence per se finding 13 Mineral Owner’s Right to Use the Surface

14 Surface damages cont’d › Don’t forget the lease! › Express provisions concerning surface damages: − E.g., Liability for damages to agricultural crops or structures even if operator is acting reasonably or within a justified area necessary for exploration and production − Lease may cap or waive surface damages − Provisions concerning fencing operations or restoration of the surface 14 Mineral Owner’s Right to Use the Surface

15 Surface damages cont’d › Surface owner may seek breach of contract damages (breach of lease provisions), decreased market value, interference with peace and enjoyment of surface (“nuisance” damages), physical damage to land, loss of crops or livestock, etc. based on excessive or unreasonable use of surface › If not covered by the lease (and not required by state statute), most operators will attempt to negotiate a surface damage agreement upfront 15 Mineral Owner’s Right to Use the Surface

16 Almost six years ago, the Texas Supreme Court decided Coastal Oil & Gas Corp. v. Garza Energy Trust Primary Issue: Does subsurface hydraulic fracturing of a natural gas well that extends onto another’s property amount to a trespass for which the value of gas drained may be recovered as damages? 16 Coastal Oil & Gas Corp. v. Garza Energy Trust, 268 S.W.3d 1 (Tex. 2008)

17 No. But does that solve all of the operator’s problems? No. 17 Coastal Oil & Gas Corp. v. Garza Energy Trust, 268 S.W.3d 1 (Tex. 2008)

18 Garza sued Coastal for: › Breach of the implied covenant to develop Garza’s tract; › Trespass, alleging that the fracking invaded beneath their tract causing substantial drainage; › Breach of the implied covenant to protect against drainage; and › Bad-faith pooling. At trial, Garza won on all counts and the jury awarded over $15M in total damages. 18 Coastal Oil & Gas Corp. v. Garza Energy Trust, 268 S.W.3d 1 (Tex. 2008)

19 Texas Supreme Court: The rule of capture disallows any damages where the only claim of injury is that the fracking allows gas to flow from one tract to another. 19 Coastal Oil & Gas Corp. v. Garza Energy Trust, 268 S.W.3d 1 (Tex. 2008)

20 The Court gave four reasons for not changing the rule of capture: 1.The law already gives a drained owner full recourse; 2.Doing so would usurp the power of the RRC; 3.Determining the value of the drained minerals is not a decision best left to litigation; and 4.Nobody in the industry wants it to change. 20 Coastal Oil & Gas Corp. v. Garza Energy Trust, 268 S.W.3d 1 (Tex. 2008)

21 EPS obtained permits from the Texas Commission on Environmental Equality (TCEQ) to operate 2 deep wastewater injection wells on a tract next to land owned by FPL in Liberty County FPL sued EPS for tort damages and a permanent injunction for physical trespass based on alleged subsurface migration onto its property that contaminated its water supply 21 Recent Developments: FPL Farming Ltd. v. Environmental Processing Sys., No (Tex. filed Jan. 18, 2013)

22 22 Recent Developments: FPL Farming Ltd. v. Environmental Processing Sys., No (Tex. filed Jan. 18, 2013) Trial court: EPS did not trespass Jury found that EPS did not trespass. FPL appeals. Beaumont Court of Appeals: FPL could not recover in tort for trespass damages Affirmed; FPL could not recover in tort for trespass damages because the wells were authorized by the TCEQ permits that EPS obtained to operate the wells Texas Supreme Court: permits from the TCEQ did not shield it from trespass liability Reversed, remanded. EPS’ permits from the TCEQ did not shield it from trespass liability.

23 The Texas Supreme Court clarified that Garza “did not hold that agency authorization or permission resulted in blanket immunity from trespass liability.” 351 S.W.3d 306, 313 (Tex. 2011). “The rule of capture, and administrative deference to agency interpretations, was critical to our holding in Garza.” Id. at Recent Developments: FPL Farming Ltd. v. Environmental Processing Sys., No (Tex. filed Jan. 18, 2013)

24 24 Recent Developments: FPL Farming Ltd. v. Environmental Processing Sys., No (Tex. filed Jan. 18, 2013) On remand, Beaumont Court of Appeals: Wastewater migration in deep, subsurface formations may constitute a trespass. EPS appeals. Texas Supreme Court: Decision pending Decision pending.

25 Merriman owned the surface estate of a 40-acre tract in Limestone County upon which Merriman’s home, barn, and corrals were located Once a year, Merriman brought his cattle to the tract in a “roundup” XTO, the lessee of the tract’s mineral estate, proposed drilling a gas well on the tract, but Merriman opposed XTO began to construct the well anyway 25 Recent Developments: Merriman v. XTO Energy, Inc., 407 S.W.3d 244 (Tex. 2013)

26 Primary issue Did XTO exceed its rights in the mineral estate by failing to accommodate Merriman’s annual “roundup”? 26 Recent Developments: Merriman v. XTO Energy, Inc., 407 S.W.3d 244 (Tex. 2013)

27 NO. “Evidence that the mineral lessee’s operations result in inconvenience and some unquantified amount of additional expense to the surface owner does not rise to the level of evidence that the surface owner has no reasonable alternative method to maintain the existing use.” Id. at Recent Developments: Merriman v. XTO Energy, Inc., 407 S.W.3d 244 (Tex. 2013)

28 The surface owner must prove: › The lessee’s use completely precludes or substantially impairs the existing use; › There is no reasonable alternative method available to the surface owner by which the existing use can be continued; and › There are alternative reasonable, customary, and industry-accepted methods available to the lessee which will allow recovery of the minerals and also allow the surface owner to continue the existing use. 28 Recent Developments: Merriman v. XTO Energy, Inc., 407 S.W.3d 244 (Tex. 2013)

29 Primary Issue What is the proper measure of damages when a landowner sues for destruction of trees? 29 Recent Developments: Wheeler v. Enbridge Pipelines, L.P., No , 2014 WL (Tex. Aug. 29, 2014)

30 Texas Supreme Court held: In determining the proper measure of damages to real property, the distinction between permanent and temporary injury applies whether the claim sounds in contract or tort. 30 Recent Developments: Wheeler v. Enbridge Pipelines, L.P., No , 2014 WL (Tex. Aug. 29, 2014)

31 Permanent injury: › Cannot be repaired, restored, or fixed OR › Even if it can be repaired, restored, or fixed, the damage is substantially certain to recur Temporary injury: › Can be repaired, restored, or fixed AND › Any anticipated recurrence would be only occasional, irregular, intermittent, and not reasonably predictable 31 Recent Developments: Wheeler v. Enbridge Pipelines, L.P., No , 2014 WL (Tex. Aug. 29, 2014)

32 Courts must adequately compensate landowner Reinforced (and arguably recognized for the first time) the economic feasibility exception in temporary damage cases › Cost of restoration > diminution in property’s fair market value Recognized right to recover intrinsic value of damaged property even if there is little or no diminution in the property’s fair market value 32 Recent Developments: Wheeler v. Enbridge Pipelines, L.P., No , 2014 WL (Tex. Aug. 29, 2014)

33 When parts of two mineral leases have been pooled but production is from only one lease, the mineral lessee has the right to use a road across the surface of the lease without production in order to access the producing lease. 33 Recent Developments: Key Operating & Equip., Inc. v. Hegar, 435 S.W.3d 794 (Tex. 2014)

34 In 2011, Lipsky sued Range, claiming that 2 horizontal wells near his home polluted his private water supply with methane gas EPA issued an Emergency Order stating Range’s drilling activities had introduced gases into Lipsky’s water well. EPA later dropped out of the fight. RRC entered final order concluding that Range had not polluted the water well. Range filed a counterclaim for conspiracy, defamation, and business disparagement after Lipsky’s video of methane-fueled flames shooting from a hose hooked to his well was uploaded to YouTube 34 Recent Developments: Lipsky v. Range Resources Corp.

35 Fort Worth Court of Appeals: › Held that Lipsky’s actions were based upon or related to Free Speech › Range met its burden to maintain its claims against Lipsky, but ordered that the conspiracy claim should be dismissed Both parties sought Texas Supreme Court’s review - oral argument is set for December 2014 › Godwin Lewis will be arguing for the landowner (Lipsky) 35 Recent Developments: Lipsky v. Range Resources Corp.

36 The Parrs sued Aruba in 2011, claiming spills and emissions from Aruba’s fracking operations contaminated their 40-acre ranch in Decatur, TX and made them sick. Dallas jury awarded the Parrs $3 million › $275,000 for drop in property value, $2.4 million for past physical suffering and mental anguish, and $250,000 for future harm 36 Parr v. Aruba Petroleum, Inc., Dallas County Court at Law 1

37 Nuisance case where jury rendered $20,000 verdict against Chesapeake › Temporary nuisance = offensive odors and noise › Drilling operations in a field behind the plaintiffs’ houses where Chesapeake had drilled 13 wells 37 Crowder et al. v. Chesapeake Operating Inc., No , Tarrant County Court at Law

38 38 Allocation Wells in Texas

39 An allocation well is a horizontal well that traverses the boundary between two or more leases that have not been pooled and for which no agreement exists among the royalty owners as to how production will be shared. 39 What is an “allocation well”?

40 An operator may drill an allocation well without pooling authority or in contravention of restrictive pooling provisions that make pooling difficult or overly burdensome. Without a pooling provision or other agreement, how is production allocated to determine royalties? 40 What’s the problem?

41 Lessee was bound by restrictive pooling provisions in lease. Unable to secure a lease amendment, the lessee filed a pooling instrument purporting to designate a pooled unit that didn’t comply with lease and drilled a horizontal well across the unit. The lessors sued, claiming lessee breached the pooling provision. 41 Case Study: Browning Oil Co. v. Luecke, 38 S.W.3d 625 (Tex. App.—Austin 2000, pet. denied)

42 The Lessors claimed that because their tracts weren’t validly pooled, they were entitled to royalty on all production resulting from the two purported pooled units. The Lessees argued that royalties should be allocated to the Lessors based on the share of production from the wells that could be attributed to their tracts. 42 Case Study: Browning Oil Co. v. Luecke, 38 S.W.3d 625 (Tex. App.—Austin 2000, pet. denied)

43 Under Luecke, a lessee may allocate production on an unpooled basis, provided it can establish with reasonable probability what production originates from the segment(s) of the drainhole within the unpooled lease. 43 Case Study: Browning Oil Co. v. Luecke, 38 S.W.3d 625 (Tex. App.—Austin 2000, pet. denied)

44 Potential methods of measuring production under Luecke’s “reasonable probability” standard: 1.Length of the lateral 2.Take-point basis 44 Case Study: Browning Oil Co. v. Luecke, 38 S.W.3d 625 (Tex. App.—Austin 2000, pet. denied)

45 Lessee has an implied duty to manage/administer a lease, which includes accounting to the lessor as a reasonably prudent operator Under Luecke, an operator drilling an allocation well has a duty to establish with reasonable probability what production is attributable to a lease. › Narrowly tailor production allocation to lease › Consider geological and engineering conditions surrounding well 45 Case Study: Browning Oil Co. v. Luecke, 38 S.W.3d 625 (Tex. App.—Austin 2000, pet. denied)

46 46 Joint Ownership Issues

47 Primary Issue: Does an exculpatory clause in a JOA extend to all alleged breaches of the JOA or is it limited to claims that the operator breached its duty in operating the well? 47 Recent Developments: Reeder v. Wood County Energy, LLC, 395 S.W.3d 789 (Tex. 2012)

48 1977 and 1982 Model Form JOA: Operator “shall conduct all such operations in a good and workmanlike manner....” 1989 Model Form JOA: Operator “shall conduct its activities … under this agreement as a reasonable prudent operator, in a good and workmanlike manner....” 48 Reeder v. Wood County Energy, LLC It depends.

49 1977 and 1982 Model Form JOA: Operator “shall conduct all such operations in a good and workmanlike manner....” 1989 Model Form JOA: Operator “shall conduct its activities under this agreement as a reasonable prudent operator, in a good and workmanlike manner....” 49 Reeder v. Wood County Energy, LLC Clause only applies to claims that operator breached its duty in operations, not to claims that it otherwise breached JOA.” Clause applies to both claims that operator failed to act as reasonably prudent operator AND claims that it breached JOA.

50 “all such operations” vs. “its activities” 50 Reeder v. Wood County Energy, LLC According to the Texas Supreme Court: “The modifier “such” references operations under the JOA, while the deletion of that word and use of the term “its activities” includes actions under the JOA that are not limited to operations. The modification implicates a broader scope of conduct following the language of the contract. The agreed standard exempts the operator from liability for its activities unless its liability-causing conduct is due to gross negligence or willful misconduct.”

51 So what does this mean? A JOA with an exculpatory clause with the phrase “its activities” gives broader protection to operators! Example: JOA contains exculpatory clause that states that operator “shall conduct its activities... in a good and workmanlike manner.” Operator breaches the JOA by failing to maintain production in paying quantities. Working- interest holders sue operator for breach. Operator is not liable unless its breach is due to gross negligence or willful misconduct. 51 Reeder v. Wood County Energy, LLC

52 Texas Supreme Court: › Confirms that contractual waivers for future gross negligence are void › States a contractual provisions exempting a party from tort liability for harm caused intentionally or recklessly is unenforceable – but the same may be said of contract liability › Calls into question on public policy grounds contractual waivers that seek to insulate a party from future, deliberate, wrongful conduct 52 Zachry Construction Corp. v. Port of Houston, No , 2014 WL (Tex. Aug. 29, 2014)

53 Preferential rights Payment of joint interest billings › Audit › Suspend rights › Foreclosure › Drill a partner out 53 Other Areas of Dispute

54 Primary Issue: Are claims based on environmental contamination and surface damage caused by oilfield operations proper subjects of arbitration? Or are such claims within the exclusive jurisdiction of the Texas Railroad Commission? 54 Recent Developments: Forest Oil Corp. v. El Rucio Land & Cattle Co., Inc., No CV, 2014 WL (Tex. App.—Houston [1st Dist.] July 24, 2014, no pet.)

55 Such claims are not within the exclusive jurisdiction of the RRC, and therefore can properly be subject to arbitration. 55 Forest Oil Corp. v. El Rucio Land & Cattle Co., Inc.

56 Forest Oil operated a plant and drilled and produced gas on a ranch in Hidalgo County The ranch-owners sued Forest Oil for environmental damage caused by Forest Oil’s operations Forest Oil moved to compel arbitration based on an earlier, unrelated settlement agreement The trial court sent the case to arbitration where 2 of 3 arbitrators found in favor of the ranch-owners The trial court refused to vacate the arbitration award, so Forest Oil appealed, arguing that the trial court erred in refusing to vacate because the RRC had exclusive, or alternatively primary, jurisdiction over the dispute 56 Forest Oil Corp. v. El Rucio Land & Cattle Co., Inc.

57 The Houston [1st Dist.] Court of Appeals held: › The RRC did not have exclusive jurisdiction over the dispute because the Legislature did not intend for the RRC’s regulatory scheme to abrogate a landowner’s right to obtain common-law relief for injuries caused to his property for environmental contamination. › The doctrine of primary jurisdiction did not apply because the ranch-owners’ common-law claims and declaratory relief did not require the RRC’s expertise or a uniform interpretation of its rules or regulations. 57 Forest Oil Corp. v. El Rucio Land & Cattle Co., Inc.

58 58 Cases on the Horizon and Other Hot Topics

59 Steadfast Financial, LLC v. Bradshaw, No › Duty to non-participating royalty owner › Argued Oct. 15, 2014 Hooks v. Samson Lone Star, L.P., No › $21 million judgment against Samson for fraudulent conduct reversed by court of appeals on various grounds, including limitations › Argued Sept. 17, Cases Pending in the Texas Supreme Court…

60 Phillips v. Carlton Energy Group, LLC, No › Lost market value damages in case involving breach of agreement to explore coal-bed methane in Bulgaria. › Argued Sept. 11, 2013 In re Deepwater Horizon, No › Certified question from Fifth Circuit regarding liability- insurance coverage for the Deepwater Horizon drilling-rig disaster › Argued Sept. 16, Cases Pending in the Texas Supreme Court…

61 Gas flaring cases Earthquakes Royalty owner cases Lease termination and fighting old documents 61 Other Hot Topics Continued…

62 62 Thank you Greg W. Curry


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