In two recent cases, the Texas Supreme Court reviewed what are called “retained acreage” clauses in gas and oil leases. Consistent with recent precedent, the Court instructs that these clauses are to be interpreted based on the language used and that the intent of the parties is to be the guiding principle.
In Endeavor Energy Resources, L.P. v. Discovery Operating Inc., the conflict involved the interpretation of so-called “retained acreage” clauses where the parties intended the retained-acreage definition to be based on the plats filed with the Texas Railroad Commission (“RRC”). The Court also decided a companion case, XOG Operating LLC v. Chesapeake Exploration LP, that came to a different conclusion. The difference between the cases hinges on the language in the leases. We will discuss XOG separately.
The Texas Natural Resources Code § 85.201 gives the Texas Railroad Commission (“RRC”) regulatory authority with respect to oil and gas exploration and production in Texas. Under the powers granted, the RRC publishes regulations such as rules imposing minimum distances between wells, well densities, production allowables, and proration units. See 16 Texas Admin. Code, § 3.37 – 3.38.
“Production allowables” refer to the maximum amount of oil and gas that a well may recover as prescribed by the applicable rules. A “proration unit” is the acreage assigned to a well by the well operator for the purpose of assigning production allowables. To designate a well’s acreage and proration unit, an operator files certified plats and other forms with the RRC. Note that the RRC sets the regulations, but the operator actually assigns the acreage for a proration unit.
While the RRC establishes state-wide rules and regulations, the RRC also adopts specific “field rules” which apply to a specific oil and gas field. In the Endeavor case, the specific field involved was the Spraberry Trend Oilfield in west central Texas, covering large parts of six counties and having a total area of approximately 2,500 square miles. For the Spraberry Trend Oilfield, the RRC has adopted field rules providing that 80 acres is the minimum acreage that can be assigned to a proration unit and that the maximum allowable is 160 acres.
Facts of the Endeavor Case
Endeavor acquired mineral leases on two adjoining tracts in Martin County, Texas. Endeavor drilled four wells and for each well filed certified plats with the RRC designating about 80-81 acres around each well as the proration unit. Note that the whole acreage covered by the leases far exceeded the proration units — about 960 total acres.
As usual, each lease had a time limit. However, each lease also allowed Endeavor to retain certain acreage after the leases’ primary terms expired. Specifically, the lease allowed Endeavor to extend the lease term as long as the wells were producing “producing oil or gas in commercial quantities.” In addition, the lease gave Endeavor continuing lease rights within the assigned proration unit acreage. The retained acreage clause stated in pertinent part:
“… lease shall automatically terminate as to all lands and depths covered herein, save and except those lands and depths located within a governmental proration unit assigned to a well … with each such governmental proration unit to contain the number of acres required to comply with the applicable rules and regulations of the Railroad Commission of Texas for obtaining the maximum producing allowable for the particular well.”
The evidence showed — and all agreed — that the leases expired and that Endeavor had not drilled any wells that were producing in commercial quantities outside the area covered by its 80 acre proration units. As a result, the owners of the mineral estate executed new leases with Discovery Operating, Inc. for acreage that fell outside of Endeavor’s proration units. Discovery successfully drilled several wells.
When Endeavor learned that Discovery had begun operations, Endeavor disputed Discovery’s right to drill. Discovery brought a trespass to try title action against Endeavor. In response, Endeavor argued that the retained acreage was 160 acres, the acreage allowed by the RRC field rules. Endeavor asserted that it had mistakenly failed to assign 160 acres to each well and Endeavor filed new proration plats with the RRC assigning 160 acres to each well. The newly assigned acreage included the acreage described in Discovery’s leases. In response, Discovery argued that the retained acreage was the approximate 80 acres as set forth in Endeavor’s various original regulatory filings.
The trial court decided in Discovery’s favor. That decision was affirmed by the Court of Appeals and the Texas Supreme Court.
Texas Supreme Court’s Reasoning
In affirming the lower courts, the Supreme Court held that the leases at issue were not ambiguous. The Court held that the “plain, grammatical language of leases” shows that the parties intended the leases to continue only as to acreage that had been assigned to a well as reflected in the certified plats Endeavor filed with the RRC. Endeavor assigned about 80 acres to each well, and so 80 acres was its retained-acreage under the leases. As the Court noted, “… for Endeavor to retain 160 acres per well, Endeavor would have needed to actually assign 160 acres to each well.”
In further support of its ruling, the Court noted that the operator, not the RRC, assigns the acreage to a given well. The Court also focused on the lease language that stated, “… with each such governmental proration unit to contain the number of acres required to comply with the applicable rules and regulations of the Railroad Commission of Texas for obtaining the maximum producing allowable for the particular well.” Under the relevant field rules, the “number of acres required to comply” in Spraberry Trend was 80 acres. The Court noted that, for Endeavor to exceed the 80-acre-per-well minimum, RRC regulations required Endeavor verify that additional acreage is actually necessary to achieve the maximum allowable production units (515 barrels). Since Endeavor did not verify the need for the additional acreage, the “number of acres required to comply” was 80 acres. For the Court, this confirmed that the intent of the parties was to set the “retained-acreage” based on what Endeavor actually assigned via its certified plats filed with the RRC — that is, 80 acres per well.
Since Discovery’s wells were drilled outside of those various 80-acre retained-acreage areas, the Supreme Court held that the lower courts properly ruled in favor of Discovery.