Royalties from Horizontal Well Should Be Allocated Based on Productive Portion of Well, Not Its Entire Length

On December 20, 2013, the San Antonio Court of Appeals issued a decision concerning the proper construction of a contract used to allocate royalties from a horizontal well that traverses two separate properties. The decision, Springer Ranch, Ltd. v. O.F. Jones III, et al., is important for two reasons. It is the first and only other Texas decision to address the proper method for allocating royalties for horizontal wells since the Austin Court of Appeals’ opinion in Browning Oil Co., Inc. v. Luecke on November 9, 2000. Further, it holds that where a contract requires royalties from a horizontal well to be allocated, they should be allocated based on the productive portion of the well, not its entire length.

The horizontal well at issue in the case (the “SR2 well”) began on the tract of the appellant, Springer Ranch, Ltd. (“Springer Ranch”), but ended under the property of Rosalie Matthews Sullivan, one of the appellees (collectively, “the Matthews”). As a result of a prior dispute over royalties, the parties had executed a contract in 1993 which provided in part that: “all royalties payable under the above described Oil and Gas Lease from any well or wells on said 8,545.02 acre tract, shall be paid to the owner of the surface estate on which such well or wells are situated, without reference to any production unit on which such well or wells are located . . . .” The agreement affected six vertical wells at the time it was made.

Springer Ranch argued in a summary judgment motion that because (i) the SR2 well began on its property, and (ii) the 1993 contract prohibited allocation based on the well’s production unit, it was entitled to 100% of the royalties from the well. The Matthews, however, argued in their own summary judgment motion that the SR2 well was “situated on” both Springer Ranch’s and Sullivan’s property and, thus, royalties should be allocated to each party based on the productive portion of the well on their properties.

In support of their motion, the Matthews submitted the affidavit of a petroleum engineer who calculated the allocation of royalties by measuring the total distance between the SR2 well’s first and last takepoints within the correlative interval, the distance between its first take point and the property line between Sullivan and Springer Ranch’s properties, and the distance between the property line and the well’s last takepoint. The expert then multiplied the one-eighth royalty provided under the lease by the ratio of the total distance between the first and last takepoints to allocate the royalties. Providing this summary judgment evidence was probably prudent given the decision in Luecke, in which the Austin Court of Appeals remanded an invalid pooling case for a new trial on damages where the plaintiff failed to present any evidence allowing for a determination of how much production from a horizontal well crossing multiple tracts was attributable to its own property. Importantly, Springer Ranch did not dispute the Matthews’ expert’s measurements or calculations, nor did it offer evidence of any other basis for determining how much production was obtained from the parties’ respective tracts. The trial court ruled in favor of the Matthews, and Springer Ranch appealed.

The court of appeals affirmed the trial court’s judgment. In doing so, it first analyzed the key terms of the contract—most importantly the term “well”—and concluded that Springer Ranch’s construction of the term conflated the ordinary and technical meaning of the word “well” with “wellhead.” It therefore agreed with the trial court that the SR2 well was “situated on” both the Springer Ranch and Sullivan properties for purposes of the 1993 contract, and that royalties must be allocated to each. The court of appeals next addressed the method of allocation. It found that a royalty is a fraction of production, and that production—whether from a vertical or horizontal well—is not obtained from the entire length of the well, but from the part of the well that pierces and drains the reservoir in which the hydrocarbons reside. Thus, the court of appeals held that the trial court correctly allocated royalties based on the producing portion of the SR2 well, not its whole length.

Although the specific contractual language at issue in Springer Ranch limits the case’s broader application somewhat, the court of appeals’ approval of an allocation method for royalties based on the producing portion of a well, rather than its entire length, at least in the absence of any contractual language to the contrary, provides important clarity to operators of horizontal wells in Texas. A copy of the San Antonio Court of Appeals’ opinion can be found here

Topics:  Contract Drafting, Contract Formation, Energy, Horizontal Wells, Mineral Leases, Oil & Gas

Published In: General Business Updates, Energy & Utilities Updates, Intellectual Property Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Baker Botts | Attorney Advertising

Don't miss a thing! Build a custom news brief:

Read fresh new writing on compliance, cybersecurity, Dodd-Frank, whistleblowers, social media, hiring & firing, patent reform, the NLRB, Obamacare, the SEC…

…or whatever matters the most to you. Follow authors, firms, and topics on JD Supra.

Create your news brief now - it's free and easy »