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The Supreme Court of Texas will be considering an interesting case about oil and gas royalties for a Texas mineral owner. The case is Charles G. Hooks III et al. v. Samson Lone Star L.P.

The case arises from a dispute over oil and gas leases in Jefferson County and Hardin County, Texas. The mineral and land owner is Charles G. Hooks, III, who is also an oil and gas attorney. The Jefferson County lease provided that the lessee, Samson Lone Star LLC pay compensation to Mr. Hooks if drilling occurred within 1,320 feet of his property line. Samson drilled a directional well that bottomed out within that distance, but Samson never compensated Mr. Hooks as the lease required. With the two Hardin County leases, Mr. Hooks gave Samson permission to pool his mineral interests, but Mr. Hooks contended that Samson did not pay him for all production within the pool. Mr. Hooks also claimed that Samson was required to pay both royalties on the sale of oil and gas and on the same oil and gas as it existed in the reservoir, so called “formation production”.

In the trial court, Mr. Hooks was awarded more than $21 million on these claims. The case was appealed to the Houston Court of Appeals, which reversed the judgment of the trial court in a majority decision written by Justice Evelyn V. Keyes in 2012. The Houston Court of Appeals determined that, as to the Jefferson County lease, Mr. Hooks’ claim was barred by the statute of limitations and was based on an incorrect interpretation of his oil and gas lease. The Court noted that surveys on file for this well at the Texas Railroad Commission in 2000 and publicly accessible put Hooks on notice of the location of the bottom of Samson’s directional well, and as an oil and gas lawyer, Hooks should have been aware of his claim if he reviewed both those surveys. Unfortunately, Hooks did not file the lawsuit against Samson until after the four year statute of limitations that applied to his claim had expired.

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A recent case decided by the U.S. Sixth Circuit Court of Appeals holds a cautionary tale for Texas investors or any one who may want to invest in oil and gas. The case is United States v. Smith decided on April 15, 2014.

This case involved the Smith brothers, Michael and Christopher, who operated a company called Target Oil. Target conducted speculative oil drilling in several states, including Texas, but also in Kentucky, West Virginia, and Tennessee. The Smiths told potential investors that certain wells were sure-fire investments, but these wells often produced no oil at all. In fact, some of the wells had not even been drilled. Investigators discovered that from 2003 to 2008, Target Oil received approximately $15.8 million from investors, but only distributed royalties amounting to $460,000. Their operation was a classic Ponzi scheme. That means that the Smith brothers paid new investors from the investment funds of previous investors, rather than from the production proceeds from the wells they were supposed to be drilling. As in all Ponzis, for the first few months the investor thinks they’ve made a good investment. At some point, as in all Ponzis, the fraudsters run out of new investors to scam and the returns to investors stop. The newer investors get nothing at all. These kinds of schemes seem to come out of the woodwork when the price of oil approaches $100 per barrel.

Michael and Christopher Smith were arrested and charged with conspiring with others to defraud investors of millions of dollars. In the trial court, Michael Smith was convicted of conspiracy to commit mail fraud and of 11 substantive counts of mail fraud. He was sentenced to 120 months in prison and ordered to pay $5,506,917 in restitution. Christopher Smith was convicted by the same jury on seven counts of mail fraud. He was sentenced to 60 months in prison and ordered to pay $1,652,075 in restitution. The Sixth Circuit Court of Appeals affirmed the convictions in an opinion written by Justice Ronald Lee Gilman. The Court rejected the Smith brothers’ complaints of insufficient evidence, that the government introduced evidence that effectively amended the indictment, that a defense witness was erroneously excluded, that their sentences were procedurally and substantively unreasonable and that their forfeiture judgment was excessive.

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This blog previously addressed the serious issues presented with the use of water by the oil and gas industry , especially where the water is used for drilling and fracing in drought affected states. It has become an especially pronounced issue in the western states, like Texas, that have both significant oil and gas reserves and a limited water supply. A report from Wood Mackenzie Ltd., using data and analysis from the World Resources Institute (WRI) and published late last year, determined that almost all forms of energy production and power generation are dependent on water, although the impact differs depending on type of energy being produced and the location. The report indicated that the oil and gas industry is expected to use technology to mitigate water-related risks as water supplies become more scarce. The report found that some companies are able to mitigate some water risks by understanding their specific water requirements, identifying the water risk involved and developing a clean water strategy.

heron-1444867-s.jpg The World Resources Institute publishes an Aqueduct Risk Atlas which surveys water risk in the most active energy producing regions of the world. Among the regions found to have the highest water risk were U.S. shale gas plays, coal production (particularly in China), and crude oil production in the Middle East. In the U.S., more than half of the shale plays and gas reserves are in areas of mid to high-level water stress, where the oil and gas industry must compete with agriculture and other industries for water. This is true in Texas for the Eagle Ford Shale play.

The Wood Mackenzie report noted however that hydraulic fracturing requires large amounts of water only for a short period of time, and the rest of the time individual wells do not require a high volume of water. This means that shale gas drillers actually use a smaller percentage of water than many other industries. Still, the report notes, “These short but intense demands add up and can threaten to displace other water users. Over time, freshwater availability in shale development areas could decline as demand from homes and farms starts competing with hydraulic fracturing operations.”

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A day-long conference at George Mason University titled “Old Fuels, New Technology, and Market Dynamics” was held at the Arlington, Virginia campus last week. It was put on by the Law and Economics Center, which is part of the law school.

Rapid growth in the U.S. oil and gas industry, particularly due to hydraulic fracturing and other unconventional oil and gas production, has intensified the discussion on government regulation at all levels. Some speakers noted that states, rather than either federal or local governments, are the best qualified to regulate hydraulic fracturing. One speaker in a panel, Michael L. Krancer, from the Philadelphia law firm Blank Rome LLP and former head of Pennsylvania’s Department of Environmental Protection, said that “(t)here’s no convincing basis for the federal government coming in and trying to regulate fracing. But it’s not a Republican or Democratic issue. Folks of all political stripes are getting involved.”

Mr. Krancer noted that the U.S. Environmental Protection Agency spent millions of dollars investigated drinking water in Dimock, Pennsylvania, Pavillion, Wyoming, and Parker County, Texas, and found no contamination that could be traced to nearby fracing wells. He also noted that state regulation of the oil and gas industry is working well so far, particularly with the State Review of Oil and Natural Gas Environmental Regulations (Stronger) where various stakeholders, including representatives from industry and environmental groups, review waste management programs.

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Not all Texas folks consult an attorney to prepare a will or to review an oil and gas lease or a pipeline easement they have been offered. Maybe they think lawyers are expensive and only for the wealthy or maybe they don’t want to take the time. Fortunately, there are affordable attorneys for virtually all situations, including those who review oil and gas leases. In fact, there are instances where it is critically important to consult a lawyer, and the legal fee for a specific service is often a fraction of what people end up losing by signing boilerplate legal documents without understanding the the documents or the implications those documents may have for their family’s future.

A recent case from Florida highlighted this problem. The case is James Michael Aldrich vs. Laurie Basile et al from the Supreme Court of Florida. The case involved the will of Ann Aldrich. In 2004, she made a will using an “E-Z Legal Form”. The will left her property to her sister, and if her sister died before Ann did, then to her brother. Ms. Aldrich’s sister died first, so her brother was the sole heir to her estate according to the will. However, this “E-Z Legal Form” didn’t have a residuary clause. Ms. Aldrich also left a written note after her sister died leaving her possessions to her brother, except for certain bank accounts that were to be left to this brother’s daughter. But the document only had one witness, which made it invalid as a will under Florida law.

When Ms. Aldrich died, two nieces sued to receive part of the estate. These nieces were the daughters of a different brother of Ms. Aldrich, who had also already died before Ms. Aldrich. Even though these two nieces are not mentioned anywhere in the will, the Florida Supreme Court decided in their favor in a decision written by Justice Peggy Quince. Since the “E-Z Legal Form” did not have a residuary clause, Ms. Aldrich only intended for the property specifically mentioned in the will to be distributed. The Court found that all other assets, such as money acquired after the will was signed in 2004, had to be distributed under the laws of intestacy, which is the law that covers the distribution of property of someone who does not have a will.

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A recent case that was decided by the Texas Court of Appeals in San Antonio illustrates the problems when mineral owners sign a “standard” form for their oil and gas lease and why they should consider getting the opinion of an experienced Texas oil and gas attorney before they sign. Failing to do so could end up costing you money every month.

The decision is Chesapeake Exploration, LLC v. Hyder. The Court, in a unanimous decision written by Justice Sandee Bryan Marion, ruled that, despite the claims of the well operator, post-production costs could not be deducted from the mineral owner’s royalties, based on the specific language of the lease before the Court. This particular lease was most definitely not a standard form and appeared to have been carefully drafted by the Hyder’s attorney.

The Hyder lease was executed on September 1, 2004 with another oil company, and then the lease was assigned to Chesapeake Exploration LLC. The leased premises consisted of two tracts of 1,037 acres and 948 mineral acres in Johnson County and Tarrant County. The lease allowed Chesapeake to drill from existing well sites adjacent to the leased premises, as well as within the leased premises itself. For the wells on the leased premises, the Hyders were paid a precentage royalty. For wells outside the leased premises, the Hyders were to be paid a specified percentage as overriding royalties.

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More Texas oil and gas companies are expanding. In January 2014 Brenham Oil and Gas Inc. announced the purchase of a 100% and 74% revenue interest in the 332 acre Inez field prospect. This prospect is located in Victoria County, Texas. Brenham plans to drill a well to regain the potential of the Yegua, where a well was originally drilled in 1990 by Ken Petroleum Corp. Reserves in the well are estimated at four bcf of gas and 160,000 bbl of condensate. In the new well, Brenham plans to explore several intervals in the Jackson shale to conduct a petrophysical study. Brenham believes it can drill three to four new wells on the Inez lease.

Late last year, FieldPoint Petroleum Corp. and Riley Exploration Group signed a joint exploration agreement to horizontally drill in the Serbin field, which is 50 miles east of Austin, Texas. The Serbin field lies in Lee County and Bastrop County. FieldPoint will have a 25% interest and Riley a 75%. The two companies will pool their lease interests and drill 12 new horizontal wells in 2014. FieldPoint already has a working interest in 72 producing oil and gas wells in this field.

All of this has been continued good news on the growth of the oil and gas industry in our state. Last year at the annual meeting of the Permian Basin Petroleum Association, the Speaker of the Texas House of Representatives, Joe Straus, said, “Every Texan should be grateful for the success of the state’s oil and gas industry. Every child in public school, every family that visits a state park, every business that transports personnel or equipment over roads.” He credited much of Texas’ successful economy and job creation to the oil and gas industry. Speaker Straus noted that all the success and booming economy had created some challenges. In the last decade, Texas’ population has grown by 6 million people, enough people to fill a whole other city the size of Houston.

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The United States Supreme Court recently issued an opinion that effects many Texas property and mineral owners. Specifically, the Court decided the case of Marvin M. Brandt Revocable Trust v. United States in an 8 to 1 decision. The Court determined that certain rights-of-way for railroads revert to private property owners following the railroad’s abandonment of the right-of-way easement. The ownership of the easement may carry with it ownership of the mineral estate. Where it does, and when the easement covers many acres, the mineral interests could be very valuable.

This case is significant for Texans because there are many railroads and railroad rights-of-way throughout Texas. The decision, written by Chief Justice John Roberts, addressed this central question: what happens to the ownership of the right-of-way easement when a railroad abandons its right-of way. In this case, the right-of-way was granted to the railroad under the General Railroad Right-of-Way Act of 1875. This Act gives railroads the right-of-way through public lands in the United States. The land at issue in this case was a ten-mile strip in Wyoming, upon which the right-of-way was created in 1908. Subsequently, in 1976, the federal government conveyed the land to Marvin and Lulu Brandt. The railroad later abandoned the right-of-way, and by 2004 all the track had been removed. In 2006, the U.S. government requested a judicial declaration of their title. The Brandts’ deed (which was a land patent) didn’t specify what would happen if the railroad gave up the right-of-way. Mr. Brandt argued that the right-of-way had been an easement, and that once it was abandoned, it was terminated and the easement area belonged to him. The U.S. government argued that after abandonment, title to the right-of-way land reverts back to the government. The U.S. District Court awarded title to the U.S. government and the Tenth Circuit Court of Appeals affirmed.

train-tracks-1336056-m.jpg Chief Justice Roberts reversed the lower courts’ rulings. The Supreme Court’s majority opinion found that the right-of-way was terminated at the time of the abandonment, and that the Brandts owned the property. The Court found that the language, legislative history, and subsequent administrative interpretation of the 1875 Act supported this decision. The Court cited Great Northern Railway Co. v. United States, decided in 1942, in support of its decision. In that case, also decided that under the 1875 Act, the U.S. government granted the railroad only an easement, not fee simple title in the easement property, and therefore, the easement disappeared once it was abandoned. The Court found that in the Brandts’ case that the railroad abandoned the easement in 2004 and the government did not have any interest in the land after. Title to the easement property reverted to the Brandt Revocable Trust as the current owners of the land.

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In October 2013, the American Petroleum Institute and the American Fuel & Petrochemical Manufacturers (AFPM) submitted information to the Environmental Protection Agency (EPA) asking the EPA to lower the 2013 cellulosic biofuel quota because oil refiners would be forced to buy millions of dollars in unnecessary “credits” for cellulosic biofuel because the actual biofuel was unavailable.

In a very helpful (and surprising) turn, on January 23, 2014, the EPA announced that it would reconsider the 2013 quote due to this new information. The EPA determined the information was relevant and met statutory requirement for granting a reconsideration.

The government has hoped that cellulosic biofuel would replace ethanol, which has caused complaints over driving up prices of corn and the damage to engines. However, costs in producing cellulosic biofuels have delayed production, and so production hasn’t kept pace with government quotas. AFPM President Charles Drevna pointed out that the 2013 quota for cellulosic biofuels was six million gallons, which is absurd when only one million gallons were produced. Since they obviously cannot buy biofuel that doesn’t exist, EPA requires oil refiners to buy “credits” instead. API estimated that buying these credits would cost oil refiners $2.2 million in 2013. Mr. Drevna explained that in March 2013 the EPA set the 2012 quota at zero. In reality, these credits are a penalty for not complying with a law that is impossible to comply with!

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Areas of Texas and the western states where much of the U.S. oil and gas potential is located have been hit by drought in recent years, causing worries about water supplies and the use of water in hydraulic fracturing. Fracing takes a lot of water! But Apache Corporation has created a system to frac in the Wolfcamp shale in west Texas without using fresh water. This is an important shale area: just a few months ago Scott Sheffield, the CEO of Pioneer Natural Resources Co., said: “The Wolfcamp could possibly become the largest oil and gas discovery in the world.”

This new approach couldn’t come at a better time, since Texas has been in a drought since 2010 and in November 2013 Texas voters approved Proposition 6, which allocates $2 billion from the Economic Stabilization Fund to the new Texas Water Implementation Fund.

Apache is working with a closed loop system that only uses brackish and recycled water in the Barnhart project area in Irion County. This water is taken from the Santa Rosa Formation in the Dockum Aquifer and treated to remove substances that could damage pipelines and pumping equipment. The treated water is then stored in retention ponds and then can be pumped directly into drilling sites in the area. There is a significant amount of water that returns to the surface after fracing. The U.S. Environmental Protection Agency estimates between 10% to 70% of the injected water, depending on the geologic formation, is returned to the surface. Reusing water that is produced and recovered from fracing conserves fresh water for drinking and agricultural use, and it also saves Apache money since they don’t have to haul water in and out. That in turn reduces wear on local roads, and eliminates the need for a used water disposal facility. Greg Hicks, Apache’s production engineer manager, said: “It’s a win-win situation for the environment and us.”

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