Oil and Gas Update

1. Oil and Gas Update Greg W. Curry 214.969.1252 Greg.Curry@tklaw.com

2. Navigant Unconventional Oil and Gas Litigation Trends Report Source: Navigant Consulting, http://www.navigant.com/~/media/WWW/Site/Insights/Energy/NavigantUnconventionalOilGasStudy_Oct13.ashx

3. Source: Navigant Consulting, http://www.navigant.com/~/media/WWW/Site/Insights/Energy/NavigantUnconventionalOilGasStudy_Oct13.ashx

4. Source: Navigant Consulting, http://www.navigant.com/~/media/WWW/Site/Insights/Energy/NavigantUnconventionalOilGasStudy_Oct13.ashx

5. Horizontal Drilling and Hydraulic Fracturing

6. Surface Owner Issues • “Clean, freshwater, is the lifeblood of rural Texas.” Douglas Beveridge, Vice President, King Ranch Minerals • Water will be needed for fracturing process • University of Texas study concludes on a per barrel basis no significant difference • Texas, Oklahoma, and Louisiana are already concerned about water shortages • Controlling the fracturing process to keep water table safe • National Academy of Sciences study found that pollution was either natural or from poor fracking jobs or failed cement jobs

7. Mineral Owner’s Right to Use the Surface • Primarily (but not always) an issue when the mineral rights are severed from the surface . . . but has become more of an issue in historical areas and where the oil fields are meeting the city. • Hostile surface owners: “Get off my land . . . what part of my double barrel shotgun do you not understand?” • Play nice, negotiate compromise, surface damage agreement • Never take matters into your own hands • Injunctive relief and possibly damages related to delay/interference • Same rights to access surface exist even if minerals and surface are not severed, subject to terms of the lease

8. Mineral Owner’s Right to Use the Surface • Scope of mineral owner’s right to use surface • Where mineral estate is severed from surface, mineral estate is dominant • Legal privilege and enforceable right to use and have priority over servient estate to extent reasonably necessary to explore, develop, and transport minerals • When conflict of use arises, and no reasonable alternative, mineral estate’s right to use surface trumps • In Texas, mineral owner not required to pay surface damages provided use is not excessive, negligent, or in violation of lease, but as a practical matter most oil companies do so

9. Mineral Owner’s Right to Use the Surface • Scope of mineral owner’s right cont’d . . . • Many surface owners may not know that mineral owner may be entitled to damages and injunctive relief for improper interference • Right to use surface includes right to construct roads, tanks, pits, flow lines, utilize surface water, conduct seismic, etc., as reasonably necessary to explore, develop, and transport minerals and giving due regard to rights of surface owner • Rights may also be expressly defined by lease language (often overlooked or forgotten until too late)

10. Mineral Owner’s Right to Use the Surface • Limitations on right to use surface estate • May use only amount of surface as “reasonably necessary” to explore, develop, and transport minerals giving “due regard” for the rights of the surface owner • Despite implied doctrine of accommodation, express terms of lease or mineral reservation may trump

11. Mineral Owner’s Right to Use the Surface • Limitations on use surface cont’d • Surface use generally limited to exploration, development, and transport of minerals underlying mineral estate • Must secure easement or right of way to transport off-lease or off-premise production or to access lease or premise to explore adjacent acreage (unless pooled) • Surface use must comply with terms of lease and with applicable statutes, rules, and regulations • Drilling permits, statutory notice requirements, etc.

12. Mineral Owner’s Right to Use the Surface • Surface damages • Many surface owners believe they are entitled to surface damages as a matter of law. • But absent express lease language or statute, mineral owner/lessee generally only exposed to surface damages that are not reasonably necessary to explore/develop minerals • Existence of drill site, roads, pits, noise, etc. that are reasonably necessary and with due regard to the rights of the surface owner do not give rise to surface damages per se

13. Mineral Owner’s Right to Use the Surface • Surface damages cont’d • Potential liability for operations outside the reasonably necessary area used to explore and develop minerals: • Pollution is not “reasonably necessary.” Lessee cannot negligently damage surface • Violations of RRC rules may result in negligence per se finding

14. Mineral Owner’s Right to Use the Surface • Surface damages cont’d • Don’t forget the lease! • Express provisions concerning surface damages: • E.g., Liability for damages to agricultural crops or structures even if operator is acting reasonably or within a justified area necessary for exploration and production • Lease may cap or waive surface damages • Provisions concerning fencing operations or restoration of the surface

15. Mineral Owner’s Right to Use the Surface • Surface damages cont’d • Surface owner may seek breach of contract damages (breach of lease provisions), decreased market value, interference with peace and enjoyment of surface (“nuisance” damages), physical damage to land, loss of crops or livestock, etc. based on excessive or unreasonable use of surface • If not covered by the lease (and not required by state statute), most operators will attempt to negotiate a surface damage agreement upfront

16. Coastal Oil & Gas Corp. v. Garza Energy Trust,268 S.W.3d 1 (Tex. 2008) Almost six years ago, the Texas Supreme Court decided Coastal Oil & Gas Corp. v. Garza Energy Trust Primary Issue: Does subsurface hydraulic fracturing of a natural gas well that extends onto another’s property amount to a trespass for which the value of gas drained may be recovered as damages?

17. Coastal Oil & Gas Corp. v. Garza Energy Trust,268 S.W.3d 1 (Tex. 2008) No.But does that solve all of the operator’s problems?No.

18. Coastal Oil & Gas Corp. v. Garza Energy Trust,268 S.W.3d 1 (Tex. 2008) • Garza sued Coastal for: • Breach of the implied covenant to develop Garza’s tract; • Trespass, alleging that the fracking invaded beneath their tract causing substantial drainage; • Breach of the implied covenant to protect against drainage; and • Bad-faith pooling. At trial, Garza won on all counts and the jury awarded over $15M in total damages.

19. Coastal Oil & Gas Corp. v. Garza Energy Trust,268 S.W.3d 1 (Tex. 2008) Texas Supreme Court: The rule of capture disallows any damages where the only claim of injury is that the fracking allows gas to flow from one tract to another.

20. Coastal Oil & Gas Corp. v. Garza Energy Trust,268 S.W.3d 1 (Tex. 2008) • The Court gave four reasons for not changing the rule of capture: • The law already gives a drained owner full recourse; • Doing so would usurp the power of the RRC; • Determining the value of the drained minerals is not a decision best left to litigation; and • Nobody in the industry wants it to change.

21. Recent Developments: FPL Farming Ltd. v. Environmental Processing Sys.,No. 12-095 (Tex. filed Jan. 18, 2013) • EPS obtained permits from the Texas Commission on Environmental Equality (TCEQ) to operate 2 deep wastewater injection wells on a tract next to land owned by FPL in Liberty County • FPL sued EPS for tort damages and a permanent injunction for physical trespass based on alleged subsurface migration onto its property that contaminated its water supply

22. Recent Developments: FPL Farming Ltd. v. Environmental Processing Sys.,No. 12-095 (Tex. filed Jan. 18, 2013) • Texas Supreme Court: • Reversed, remanded. EPS’ permits from the TCEQ did not shield it from trespass liability. • Beaumont Court of Appeals: • Affirmed; FPL could not recover in tort for trespass damagesbecause the wells were authorized by the TCEQ permits that EPS obtained to operate the wells • Trial court: • Jury found that EPSdid not trespass. • FPL appeals.

23. Recent Developments: FPL Farming Ltd. v. Environmental Processing Sys.,No. 12-095 (Tex. filed Jan. 18, 2013) • The Texas Supreme Court clarified that Garza “did not hold that agency authorization or permission resulted in blanket immunity from trespass liability.” 351 S.W.3d 306, 313 (Tex. 2011). • “The rule of capture, and administrative deference to agency interpretations, was critical to our holding in Garza.” Id. at 314.

24. Recent Developments: FPL Farming Ltd. v. Environmental Processing Sys.,No. 12-095 (Tex. filed Jan. 18, 2013)

25. Recent Developments: Merriman v. XTO Energy, Inc.,407 S.W.3d 244 (Tex. 2013) • Merriman owned the surface estate of a 40-acre tract in Limestone County upon which Merriman’s home, barn, and corrals were located • Once a year, Merriman brought his cattle to the tract in a “roundup” • XTO, the lessee of the tract’s mineral estate, proposed drilling a gas well on the tract, but Merriman opposed • XTO began to construct the well anyway

26. Recent Developments: Merriman v. XTO Energy, Inc.,407 S.W.3d 244 (Tex. 2013) Primary issue Did XTO exceed its rights in the mineral estate by failing to accommodate Merriman’s annual “roundup”?

27. Recent Developments: Merriman v. XTO Energy, Inc.,407 S.W.3d 244 (Tex. 2013) NO. “Evidence that the mineral lessee’s operations result in inconvenience and some unquantified amount of additional expense to the surface owner does not rise to the level of evidence that the surface owner has no reasonable alternative method to maintain the existing use.” Id. at 252.

28. Recent Developments: Merriman v. XTO Energy, Inc.,407 S.W.3d 244 (Tex. 2013) • The surface owner must prove: • The lessee’s use completely precludes or substantially impairs the existing use; • There is no reasonable alternative method available to the surface owner by which the existing use can be continued; and • There are alternative reasonable, customary, and industry-accepted methods available to the lessee which will allow recovery of the minerals and also allow the surface owner to continue the existing use.

29. Recent Developments: Wheeler v. Enbridge Pipelines, L.P., No. 13-0234, 2014 WL 4252273 (Tex. Aug. 29, 2014) Primary Issue What is the proper measure of damages when a landowner sues for destruction of trees?

30. Recent Developments: Wheeler v. Enbridge Pipelines, L.P., No. 13-0234, 2014 WL 4252273 (Tex. Aug. 29, 2014) Texas Supreme Court held: In determining the proper measure of damages to real property, the distinction between permanent and temporary injury applies whether the claim sounds in contract or tort.

31. Recent Developments: Wheeler v. Enbridge Pipelines, L.P., No. 13-0234, 2014 WL 4252273 (Tex. Aug. 29, 2014) • Permanent injury: • Cannot be repaired, restored, or fixed OR • Even if it can be repaired, restored, or fixed, the damage is substantially certain to recur • Temporary injury: • Can be repaired, restored, or fixed AND • Any anticipated recurrence would be only occasional, irregular, intermittent, and not reasonably predictable

32. Recent Developments: Wheeler v. Enbridge Pipelines, L.P., No. 13-0234, 2014 WL 4252273 (Tex. Aug. 29, 2014) • Courts must adequately compensate landowner • Reinforced (and arguably recognized for the first time) the economic feasibility exception in temporary damage cases • Cost of restoration > diminution in property’s fair market value • Recognized right to recover intrinsic value of damaged property even if there is little or no diminution in the property’s fair market value

33. Recent Developments: Key Operating & Equip., Inc. v. Hegar,435 S.W.3d 794 (Tex. 2014) When parts of two mineral leases have been pooled but production is from only one lease, the mineral lessee has the right to use a road across the surface of the lease without production in order to access the producing lease.

34. Recent Developments: Lipsky v. Range Resources Corp. • In 2011, Lipsky sued Range, claiming that 2 horizontal wells near his home polluted his private water supply with methane gas • EPA issued an Emergency Order stating Range’s drilling activities had introduced gases into Lipsky’s water well. EPA later dropped out of the fight. • RRC entered final order concluding that Range had not polluted the water well. • Range filed a counterclaim for conspiracy, defamation, and business disparagement after Lipsky’s video of methane-fueled flames shooting from a hose hooked to his well was uploaded to YouTube

35. Recent Developments: Lipsky v. Range Resources Corp. • Fort Worth Court of Appeals: • Held that Lipsky’s actions were based upon or related to Free Speech • Range met its burden to maintain its claims against Lipsky, but ordered that the conspiracy claim should be dismissed • Both parties sought Texas Supreme Court’s review - oral argument is set for December 2014 • Godwin Lewis will be arguing for the landowner (Lipsky)

36. Parr v. Aruba Petroleum, Inc., Dallas County Court at Law 1 • The Parrs sued Aruba in 2011, claiming spills and emissions from Aruba’s fracking operations contaminated their 40-acre ranch in Decatur, TX and made them sick. • Dallas jury awarded the Parrs $3 million • $275,000 for drop in property value, $2.4 million for past physical suffering and mental anguish, and $250,000 for future harm

37. Crowder et al. v. Chesapeake Operating Inc.,No. 2011-008169-3, Tarrant County Court at Law • Nuisance case where jury rendered $20,000 verdict against Chesapeake • Temporary nuisance = offensive odors and noise • Drilling operations in a field behind the plaintiffs’ houses where Chesapeake had drilled 13 wells

38. Allocation Wells in Texas

39. What is an “allocation well”? An allocation well is a horizontal well that traverses the boundary between two or more leases that have not been pooled and for which no agreement exists among the royalty owners as to how production will be shared.

40. What’s the problem? An operator may drill an allocation well without pooling authority or in contravention of restrictive pooling provisions that make pooling difficult or overly burdensome. • Without a pooling provision or other agreement, how is production allocated to determine royalties?

41. Case Study: Browning Oil Co. v. Luecke, 38 S.W.3d 625 (Tex. App.—Austin 2000, pet. denied) • Lessee was bound by restrictive pooling provisions in lease. • Unable to secure a lease amendment, the lessee filed a pooling instrument purporting to designate a pooled unit that didn’t comply with lease and drilled a horizontal well across the unit. • The lessors sued, claiming lessee breached the pooling provision.

42. Case Study: Browning Oil Co. v. Luecke, 38 S.W.3d 625 (Tex. App.—Austin 2000, pet. denied) • The Lessors claimed that because their tracts weren’t validly pooled, they were entitled to royalty on all production resulting from the two purported pooled units. • The Lessees argued that royalties should be allocated to the Lessors based on the share of production from the wells that could be attributed to their tracts.

43. Case Study: Browning Oil Co. v. Luecke, 38 S.W.3d 625 (Tex. App.—Austin 2000, pet. denied) Under Luecke, a lessee may allocate production on an unpooled basis, provided it can establish with reasonable probability what production originates from the segment(s) of the drainhole within the unpooled lease.

44. Case Study: Browning Oil Co. v. Luecke, 38 S.W.3d 625 (Tex. App.—Austin 2000, pet. denied) Potential methods of measuring production under Luecke’s “reasonable probability” standard: • Length of the lateral • Take-point basis

45. Case Study: Browning Oil Co. v. Luecke, 38 S.W.3d 625 (Tex. App.—Austin 2000, pet. denied) • Lessee has an implied duty to manage/administer a lease, which includes accounting to the lessor as a reasonably prudent operator • Under Luecke, an operator drilling an allocation well has a duty to establish with reasonable probability what production is attributable to a lease. • Narrowly tailor production allocation to lease • Consider geological and engineering conditions surrounding well

46. Joint Ownership Issues

47. Recent Developments: Reeder v. Wood County Energy, LLC, 395 S.W.3d 789 (Tex. 2012) Primary Issue: Does an exculpatory clause in a JOA extend to all alleged breaches of the JOA or is it limited to claims that the operator breached its duty in operating the well?

48. Reeder v. Wood County Energy, LLC It depends. 1977 and 1982 Model Form JOA: Operator “shall conduct all such operations in a good and workmanlike manner . . . .” 1989 Model Form JOA: Operator “shall conduct its activities … under this agreement as a reasonable prudent operator, in a good and workmanlike manner . . . .”

49. Reeder v. Wood County Energy, LLC Clause only applies to claims that operator breached its duty in operations, not to claims that it otherwise breached JOA.” Clause applies to both claims that operator failed to act as reasonably prudent operator AND claims that it breached JOA. 1977 and 1982 Model Form JOA: Operator “shall conduct all such operations in a good and workmanlike manner . . . .” 1989 Model Form JOA: Operator “shall conduct its activities under this agreement as a reasonable prudent operator, in a good and workmanlike manner . . . .”

50. Reeder v. Wood County Energy, LLC “all such operations” vs. “its activities” According to the Texas Supreme Court: “The modifier “such” references operations under the JOA, while the deletion of that word and use of the term “its activities” includes actions under the JOA that are not limited to operations. The modification implicates a broader scope of conduct following the language of the contract. The agreed standard exempts the operator from liability for its activities unless its liability-causing conduct is due to gross negligence or willful misconduct.”