CO2 is Good

by Gray Reed & McGraw
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… in the right places.

In French vs. Occidental Permian, Ltd. the Texas Supreme Court held that costs associated with injection of carbon dioxide into a reservoir in a tertiary recovery operation were properly deducted from royalties.

This case reflects court’s awareness of improvements in oil recovery created by new technology, in this case CO2 injection for tertiary recovery.

Objects in This Mirror Are Smaller Than They Appear

Royalty cases depend on the language of the lease. Don’t take one result too far. What you can take to the bank is the Texas public policy in favor of secondary recovery of minerals.

Will Johnny Football ever be far from us? An early example of this policy in action is Railroad Commission of Texas v. Manziel, 361 S.W. 361 (Tex. 1962).

The Leases

The Fuller Lease royalty on gas, including casinghead gas was equal to “the market value at the well of … 1/8th of gas so sold or used”. The Cogdell Lease royalty was “1/4th of the net proceeds from the sale” of “gasoline or other products manufactured and sold” from casinghead gas “after deducting the cost of manufacturing the same.” The provisions were from lease forms in common use the time – the late 1940’s.

Operation of the Unit

In the operation of the fieldwide unit, there was a cost for removal of CO2 reinjected into the oil reservoir and returned to the surface in casinghead gas produced with the oil. This was a cost of manufacturing the natural gas liquids and residue gas. Under a Unitization Agreement the lessee had the right and discretion to reinject or process the casinghead gas.

The purpose of the unit was secondary and tertiary recovery operations, which included injecting water. and later in the life of the unit CO2, to increase pressure in the reservoir and ultimately enhance oil recovery. Occidental began a CO2 flood, without which oil production would no longer have been economically viable and more than half the oil in the reservoir would have been left in the ground. The wells also produced water and casinghead gas. The CO2 produced with the casinghead gas was reinjected, along with purchased CO2. Casinghead gas was transported in pipelines from the production wells to the injection wells and pumped back into the reservoir. All of the casinghead gas could have been reinjected rather than adding additional CO2, but the casinghead gas was only 85% CO2, and ideally the injection stream should be more highly concentrated. Occidental processed the gas to remove the CO2 and extract the NGLs. This was the cost at issue.

The trial court awarded French $10,074,262.33 in underpaid royalties.  The court of appeals reversed. See my December 2013 post for a more detailed rendition of the court of appeal opinion, which was mostly about expert testimony.

The Result – Hooray for Tertiary Recovery

The CO2 flood was critical to continued oil production. The casinghead gas stream was more than 85% CO2. Separating the CO2 from the casinghead gas was not necessary for the continued oil production, which was the purpose of the CO2 flood, but it was economically beneficial. The Unitization Agreement gave Occidental the right to reinject the entire production of casinghead gas. Instead of injecting, they decided to process the gas to obtain a more concentrated stream of CO2 for reinjection and to extract the NGLs to be marketed. This benefitted the royalty owners, and thus they were obligated to share in the costs in these market value leases.

After all is said and done, this is what the royalty owners are left with.

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.

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