Introduction A Road Less Traveled. Factual Background The Rocky Road to the Highest Court in Texas

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1 27 February 2014 Practice Groups: Oil & Gas Energy Energy, Infrastructure and Resources Environmental, Land and Natural Resources Houston, We May Have a Problem! Surface Owner Who Put up Roadblock to Oil Driller s Use of Property to Service Wells in a Pooled Unit Arrives at Texas Supreme Court By John F. Sullivan III, George A. Bibikos, Cleve J. Glenn, Bryan D. Rohm Introduction A Road Less Traveled The Texas Supreme Court s anticipated ruling in the case of Key Operating Equipment Inc. v. Will Hegar and Loree Hegar could significantly impact the ability of oil and gas producers to gain access to wells that are part of pooled units. 1 The key issue before the Court is whether a landowner whose minerals had been severed and later leased and pooled 2 with oil and gas leases on adjacent property can prevent a lessee-operator from using a road owned by the landowner to service wells on an adjacent property, where those wells are part of the same pooled unit. A court of appeals in Houston answered yes, affirming the trial court s injunction that prevented Key Operating Equipment Inc. ( Key Operating ), a lesseeoperator, from using the road owned by Will and Loree Hegar (the Hegars ) to access its wells on the adjacent property. 3 The Texas Supreme Court, having recently heard oral argument, is now reviewing the court of appeals decision. Industry experts and stakeholders are concerned that the court of appeals decision, if allowed to stand, would result in extraordinary burden and expense to lessees whose wells in pooled units would become trapped by surrounding properties and also undermine clear Texas jurisprudence on the rights of dominant mineral estates in pooled units vis-a-vis the rights of servient surface estate owners. 4 Given the recent boom in domestic oil production, the implications of the Texas Supreme Court s forthcoming decision could be far-reaching. The United States is on track to become one of the largest oil-producing countries in the world by , and the State of Texas accounts for 36% of domestic oil production. 6 An industry expert estimates that as much as 60% of the state s production is from pooled units. 7 Therefore, the legal rights of mineral lessees to access wells on pooled units are critical to the country s oil and gas industry as a whole, not to mention the State of Texas and its economy. 8 Factual Background The Rocky Road to the Highest Court in Texas Key Operating produces oil on two adjacent tracts referred to as the Richardson tract and the Rosenbaum Curbo tract. 9 Since 1987, Key Operating has operated wells on the Richardson tract pursuant to an oil and gas lease. 10

2 The Curbo Tract and the Road In 1994, Key Operating obtained an oil and gas lease on the Rosenbaum Curbo tract (the Rosenbaum Curbo Lease ) from Randy Boatright. 11 After acquiring the Rosenbaum Curbo Lease, Key Operating built a road across the Curbo tract; 12 the Curbo tract is a subpart of the Rosenbaum Curbo tract. 13 Since 1994, Key Operating has used the road to operate wells located on the Curbo and Richardson tracts. 14 When the well on the Curbo tract ceased production, the Rosenbaum Curbo Lease terminated. 15 Key Operating s owners, brothers Thomas and Kenneth Key, then acquired Randy Boatright s one-sixteenth interest in the Curbo tract mineral estate. 16 The Key brothers then leased their mineral interest in the Curbo tract to Key Operating. 17 The lease authorized pooling. 18 Key Operating Pools its Mineral Interests In 2000, Key Operating created a 40 acre pooled unit by pooling its mineral leasehold interests in the Richardson and Curbo tracts. 19 The pooled unit is comprised of 30 acres from the Richardson tract and 10 acres from the Curbo tract. 20 Key Operating produces from the pooled unit via wells located on the Richardson tract, which it accesses by using the road across the Curbo tract. 21 The Hegars Purchase the Curbo Tract In 2002, the Hegars purchased the surface estate and a one-fourth mineral interest in the Curbo tract. 22 The Hegars built a new house and used part of the road as a driveway to access their home. 23 The Hegars knew when they bought the property that it was subject to oil and gas leases and that Key Operating used the road to service its wells on the adjoining Richardson tract. 24 The Hegars tolerated Key Operating s use of the road until Key Operating drilled a new well on the Richardson tract that increased its use of the road. 25 What Happened at Trial? The Hegars sued Key Operating for trespass and sought a permanent injunction against Key Operating s continued use of the road. 26 After a bench trial, a judge issued an injunction against Key Operating using the road. 27 Key Operating appealed, and in October 2011, a Court of Appeals in Houston initially reversed the trial court s judgment and rendered judgment for Key Operating. 28 The Hegars filed a motion for rehearing, however, and the court of appeals withdrew its opinion and issued a new decision affirming the trial court s judgment for the Hegars. 29 The Houston Court of Appeals Decision The crux of the court of appeals opinion lies in its handling of the Hegars argument that Key Operating s use of the surface estate is limited to those rights that existed when the Boatright mineral estate was first severed from the surface estate. That event occurred before the Hegars purchased the Curbo tract and before the Key brothers leased their mineral interests in the Curbo tract to Key Operating with the pooling clause. 30 2

3 The court reasoned that [i]f the Key brothers lease, which authorizes Key Operating to pool the Curbo tract, had been executed before or at the time the mineral and surface estates were severed, this lease would have been part of the Hegars chain of title and the Hegars would have taken their title to the surface estate subject to the lease 31 The court opined further that in the absence of a pooling or similar agreement to which the Hegars consented or to which they or their title are otherwise subject, Key Operating has no right to use the roadway across the Hegars land [i.e., the Curbo tract] to produce oil exclusively from the Richardson tract. 32 According to the court of appeals, the central issue was whether Key Operating can use the road in a manner that is indivisible and reasonably necessary for both the Curbo and the Richardson mineral estates. 33 The court of appeals concluded that Key Operating has the same implied easement for use of the Hegars surface estate that existed when it became a lessee of the Curbo tract s mineral estate: the Hegars may not interfere with Key Operating s right to use the servient estate for the purposes of the easement i.e., for the purpose of exploring and producing oil from the Curbo tract. 34 The appellate court held that subject to the accommodation doctrine, Key Operating s common law surface easement gives it the right to use the road on the Curbo tract to produce oil from the Richardson Curbo pool so long as that production includes production from the Curbo tract. 35 Arguments Presented to the Texas Supreme Court In the Texas Supreme Court, Key Operating argues that the court of appeals erred in applying the accommodation doctrine 36 because it was neither raised nor proved by the Hegars. 37 Key Operating argues further that the Hegars had notice in their chain of title that the mineral estate on the Curbo tract had been conveyed to Boatright. Thus, the Hegars purchased the surface estate subject to all of the rights conveyed to Boatright who, in turn, could convey all those rights to his successors in interest, namely, the Key brothers and Key Operating. 38 Finally, Key Operating contends that there are competing rights of use of the surface estate and that the Hegars bore the burden of establishing a greater right of use but failed to do so. 39 In particular, Key Operating asserts that the Hegars failed to introduce the necessary evidence (i.e., the severing document to Boatright) to determine whether the pooling rights of Key Operating had been circumscribed; therefore, the Hegars trespass claim must fail. 40 In response, the Hegars contend that the court of appeals did not base its decision on the accommodation doctrine but instead relied on certain determinative findings of fact, including the key finding that no minerals were being extracted from beneath the Curbo tract by wells located on an adjacent tract. 41 The Hegars argue further that the Key brothers (i.e., the prior owners of the mineral interests now owned by Key Operating) never acquired, owned or leased any portion of the surface estate, and therefore, it cannot burden an estate that they have never owned any part of. 42 Finally, the Hegars allege that Key Operating cannot rely on its absence of the severing document argument because Key Operating raised this argument for the first time in its petition for review with the Texas Supreme Court. 43 The Texas Oil & Gas Association ( TXOGA ) filed an Amicus Brief in the Texas Supreme Court arguing that the court of appeals opinion is fundamentally flawed in its treatment of the 3

4 right of mineral lessees to access wells via surface estates in pooled units. 44 The TXOGA argues that the court of appeals requirement that a lessee must prove with geologic certainty that the well is draining minerals from the beneath the acreage it wishes to use to access the well in a pooled unit is not only inconsistent with the established body of oil and gas law in Texas, but would also cause uncertainty in the industry, considerable litigation and significant expense to mineral lessees producing from pooled units. 45 The Road Ahead The Texas Supreme Court is expected to issue an opinion in a few months. While it is difficult to predict how the Court will rule, a favorable ruling for the Hegars could have a significant impact on lessees across the state. Such a ruling could embolden landowners in pooled units to more frequently challenge the access rights of lessee-operators and require them to provide evidence of actual production from beneath the landowners properties. This increased level of risk for lessee-operators may lead to an overall increase in operation costs, making it economically unfeasible for some lessee-operators to maintain operations in certain pooled units. Other lessee-operators may try to pass the cost increases along to lessors in the form of lower royalty payments. Bottom line, the Texas Supreme Court s ruling could have broad implications for lessees and lessors of mineral interests, surface owners and the oil and gas industry as a whole. Oil and gas industry participants should therefore closely monitor this case. 46 Authors: John F. Sullivan III john.sullivan@klgates.com George A. Bibikos george.bibikos@klgates.com Cleve J. Glenn cleve.glenn@klgates.com Bryan D. Rohm bryan.rohm@klgates.com Anchorage Austin Beijing Berlin Boston Brisbane Brussels Charleston Charlotte Chicago Dallas Doha Dubai Fort Worth Frankfurt Harrisburg Hong Kong Houston London Los Angeles Melbourne Miami Milan Moscow Newark New York Orange County Palo Alto Paris Perth Pittsburgh Portland Raleigh Research Triangle Park San Diego San Francisco São Paulo Seattle Seoul Shanghai Singapore Spokane Sydney Taipei Tokyo Warsaw Washington, D.C. Wilmington 4

5 K&L Gates practices out of 48 fully integrated offices located in the United States, Asia, Australia, Europe, the Middle East and South America and represents leading global corporations, growth and middle-market companies, capital markets participants and entrepreneurs in every major industry group as well as public sector entities, educational institutions, philanthropic organizations and individuals. For more information about K&L Gates or its locations, practices and registrations, visit This publication is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer K&L Gates LLP. All Rights Reserved. 1 See 2 Pooling involves the bringing together of small tracts sufficient for the granting of a well permit under applicable spacing rules and is important in the prevention of drilling unnecessary and uneconomic wells which result in physical and economic waste. See Patrick H. Martin & Bruce M. Kramer, Williams & Meyers, Oil and Gas Law, 780 (15th ed. 2012). The primary legal consequence of pooling is that production and operations anywhere on the pooled unit are treated as if they have taken place on each tract within the unit. See Southeastern Pipe Line Co., Inc. v. Tichacek, 997 S.W.2d 166, 170 (Tex. 1999). A well located in a pooled unit is deemed to be a well on each pooled tract, and production from the unit well is deemed to have taken place on all pooled leases. 2 See id. 3 Key Operating & Equipment, Inc. v. Hegar, 403 S.W. 3d 318 (Tex. App. Houston [1st Dist.] 2013). 4 See Brief of Amicus Curiae of Texas Oil & Gas Association, Key Operating Equipment, Inc. v. Will Hegar and Loree Hegar, Case No , at p. 2-5 (November 20, 2013). 5 See 6 Id. In fact, several publications have dubbed the state Saudi Texas, referring to Saudi Arabia, which has always been the oil and gas world giant, but that title is moving closer and closer to Texas. Id. 7 See Brief of Amicus Curiae of Texas Oil & Gas Association at p.5, fn See Brief of Amicus Curiae of Texas Oil & Gas Association, at p Key Operating & Equipment, Inc., 403 S.W. 3d at Id. at Id. 12 Id. 13 Id. 14 Id. 15 Id. 16 Id. 17 Id. 18 Id. 19 Id. 20 Id. 21 Id. 22 Id. 23 Id. 24 Id. 25 Id. 26 Id. Will Hegar testified, We re trying to raise a family and we can t do it with a highway going through our property. Id. at Key Operating & Equipment, Inc., 403 S.W. 3d at Id. at Id. 30 Id. at Id. at Id. at Id. at Id. at 332 (emphasis added). 35 Id. at 327 (emphasis added). 36 Under the accommodation doctrine, when a mineral estate lessee s intended use of the surface estate would preclude or impair an existing use of the surface by the surface owner, the rules of reasonable usage require the mineral estate owner to adopt an alternative means of exploration or production if such an alternative is available under established industry practices. See Lesley v. Veterans Land Bd. of State, 352 S.W. 3d 479, 492 & n. 79 (Tex. 2011); Tarrant Cnty. Water Control, 854 S.W. 2d at 911; Getty Oil Co. v. Jones, 470 S.W. 2d 618, 621 (Tex. 1971). 37 Petition for Review, Key Operating & Equipment, Inc., v. Will Hegar and Loree Hegar, Case No , at p. 5-7 (Tex. March 25, 2013). 38 Id., at p Id., at p

6 40 Id., at p Response to Petition for Review, Key Operating & Equipment, Inc., v. Will Hegar and Loree Hegar, Case No , at p. 8 (Tex. May 13, 2013) (emphasis added). 42 Id., at p Id., at p Brief of Amicus Curiae Texas Oil & Gas Association, at p Id. This court has never adopted the novel rule announced in the court s Opinion, and, as the preeminent authority in oil and gas law, both in Texas and beyond our borders, this Court should not permit to stand uncorrected any opinion that so egregiously misstates and misconstrues basic oil and gas principles, including the rule of capture and the laws of pooling, particularly a holding so incompatible with established Texas commercial oil and gas practices. Id. at 5 (citing, Ernest E. Smith, Implications of a Fiduciary Standard of Conduct for the Holder of Executive Right, 64 Tex. L. Rev. 371, 375 (1985)). 46 In light of the court of appeals opinion and the uncertainty of how the Texas Supreme Court will rule, it might even be prudent for some lessees to review their leases and well locations in pooled units and take appropriate steps to ensure that they will still have access to wells if the Texas Supreme Court affirms the court of appeals decision. 6