Last summer, we wrote about an interesting case involving offset wells and covenants (both implied and express) to prevent drainage in shale formations. As discussed in our earlier article, the San Antonio Court of Appeals reversed summary judgment for Murphy Exploration and remanded the case back to the trial court. However, the Texas Supreme Court recently reversed that decision on a close 5-4 decision. See Adams v. Murphy Exploration & Production Co.- USA, Case No. 16-0505 (Tex. 2018). You can read the dissenting opinion here.
At issue was whether Murphy Exploration violated its lease with the plaintiff landowners by drilling an offset will that was drilled 1,800 feet away from the pertinent lease line and 2,100 feet from the triggering well on the neighboring property.
The oil & gas lease between the parties required the drilling of an offset well if a producing well was drilled on a neighboring tract. A well was drilled on a neighboring tract and Murphy Exploration then drilled a new well on the leased tract, which it claimed was the required offset well. As noted, the new well was 2,100 feet from the neighbor’s wellhead and 1,800 feet from the property line. In many cases, a well so far from the neighboring well would not have prevented drainage to the neighboring well. The plaintiff did not believe it did, and brought suit claiming that the well drilled by Murphy Exploration did not constitute an “offset well” as that term is defined and understood in the gas and oil industry. The lease between the parties did not define the term “offset well.”
Murphy Exploration argued — and presented expert opinions, reports, and documents — that within a shale formation, distance from the various well and property lines was not determinative of whether an offset well prevents drainage. Murphy Exploration’s experts opined that, first, there is not much drainage to be offset in a shale formation since the petroleum is trapped in the layers of shale, and second, that this well did function as an offset well. The trial court agreed and granted summary judgment for Murphy Exploration.
As noted, the Court of Appeals reversed. The Court of Appeals held that to win summary judgment, Murphy Exploration was required to conclusively prove that the well drilled 2,100 feet from the neighbor’s wellhead was an offset well as a matter of law. The Court of Appeals held that Murphy Exploration had not provided this conclusive proof. However, a closely divided Texas Supreme Court reversed and reinstated summary judgment for the defendant. The majority believed the Court of Appeals committed error by reading into the oil and gas lease a proximity and drainage requirement that was not supported by the unambiguous language of the lease. The majority opinion focused on these salient points:
- The lease did not define “offset well”.
- The lease specifically required only that an offset well be drilled, that it be drilled “on the leased acreage” and that it be drilled to “to a depth adequate to test the same formation” from which the triggering well was producing.
- The lease did not require that the offset well actually prevent drainage — the lease clause did not reference drainage.
- The lease had no proximity requirement in terms of where the offset well was required to be drilled.
Based on the plain language of the lease, and based on the nature of shale oil formations and the horizontal-drilling context in which the lease was executed, the majority held that Murphy Exploration had complied with the offset provision as a matter of law.
The majority opinion discussed this idea of “context” by noting that the “realities” of drilling in shale formation are “part of the facts and circumstances surrounding the contract’s execution” that may “inform” a court’s construction of the lease language. Furthermore, the majority opined that, with respect to the implied covenant imposed on a lessee to prevent oil migration from under one lease to the well of a neighboring lease tract, the implied covenant is different depending on whether the formation is a more traditional oil field or a newer trapped-oil formations. Indeed, the majority noted — without holding — that, within shale formations, there might be “little or no drainage” and, as such, the implied covenant might not be triggered at all.
As noted, four justices filed a long dissenting opinion. Essentially, they agreed with the Court of Appeals that Murphy Exploration did not provide conclusive evidence — as a matter of law — that its well met the definition of an offset well. The dissenting justices would have sent the case back to the trial court for factual determinations with respect to whether the well drilled satisfied the requirements of an “offset well.”
The lesson of this case is clear: the oil and gas lease should define an offset well in detail and be specific about when it is required. Had the lease in this case contained these specifics, there would have been no need for a lawsuit.