012 Amarillo Oil Co. v. Energy-Agri Products, Inc.

CASE OF THE MONTH

Richard F. Brown

 
The following is not a legal opinion. You should consult your attorney if the case may be of significance to you.
 
Amarillo Oil Company v. Energy-Agri Products. Inc., 32 Tex. S. Ct. J. 252 (Text No. C- 6649, March 8, 1989), is an extremely important case for the Texas Panhandle. The Panhandle Field has been mired in controversy for more than five years as the owners of severed oil and gas rights have sought to clarify their interests. In the Stowers case, the FERC has determined at what price and to whom dedicated “gas” must be sold when the oil and gas rights have been severed. In the long-running Panhandle Field Hearing, the Railroad Commission has released new rules which clarify who can produce “gas” and how they can produce “gas” when the oil and gas rights have been severed. Now, in Energy-Agri, the Texas Supreme Court is defining who owns the “gas” which is produced when the oil and gas rights have been severed.
 
In this case, the oil and casinghead gas rights under a Carson County lease were severed from the gas leasehold estate by a reservation in a farmout of the original oil and gas lease. Amarillo Oil Company owned and operated a prolific gas well on the lease which produced gas and no oil for more than 30 years from the Brown Dolomite formation. Energy-Agri Products, Inc., as the owner of the oil and casinghead gas rights, then drilled two wells through the Brown Dolomite into the Granite Wash near the existing gas well. Energy-Agri perforated at various depths, including the Brown Dolomite, and began production. The Railroad Commission classified Energy-Agri’s wells as oil wells. Amarillo Oil sued to quiet title to the natural gas in the Brown Dolomite formation. The jury found that Energy-Agri’s wells could and did produce crude petroleum oil from the Brown Dolomite, and that the Brown Dolomite was not an horizon productive of natural gas only. The trial court entered a judgment that Amarillo Oil take nothing. On appeal, the appellate court refused to accept any of Amarillo Oil’s arguments that there was no evidence to support the jury’s findings. By a cross-point, Energy-Agri argued that the case should never have gone to trial, but should have been dismissed for lack of jurisdiction. Energy-Agri claimed that Amarillo Oil’s “title claim” was actually an attempt to reclassify Energy-Agri’s oil wells as gas wells, and that only the Railroad Commission has jurisdiction over well classification. The Court of Appeals agreed and dismissed the case for lack of jurisdiction. [Reported in PPROA News Bulletin, July 1987]
 
The Supreme Court held that Amarillo Oil’s suit involved a dispute regarding title and property rights, a matter over which the courts have exclusive jurisdiction. The court repeated its often-stated position that the Railroad Commission has no authority to determine title to land or property rights. The Commission’s classification of the wells as oil wells means that the wells meet the statutory test of at least one barrel of crude oil to each 100,000 cubic feet of natural gas as provided in Tex. Nat. Res. Code Ann. §86.002(b) (Vernon 1978). However, such a classification does not establish that the person who is producing gas from that oil well in fact owns the gas or the gas rights. The well classification system was designed to promote conservation and to protect correlative rights, not to determine the nature of the substances produced or to determine title to those substances.
 
Turning to the title question, the Court concluded that it should give effect to the intent of the parties who originally severed the oil rights from the gas rights under the 1953 farmout assignment. The conveying instrument made no attempt to define “casinghead gas.” The Court held that by failing to insert their own definition of the term “casinghead gas,” the parties evidenced their intent to adopt the definition found in the statutes at the time “casinghead gas” was reserved. That 1953 definition is now codified in Tex. Nat. Res. Code Ann. §86.002(10) (Vernon 1978), which provides that casinghead gas is “any gas and/or vapor indigenous to an oil stratum and produced from such stratum with oil.” The court found an intent favoring the gas operator for the additional reasons that: (1) it was unlikely that the grantor intended to reserve gas from the Brown Dolomite when there was already a producing gas well in the Brown Dolomite, (2) it was unlikely that the parties intended to create non-exclusive rights to compete for the same substance when spacing rules would clearly favor the oil operator, (3) a reservation by the grantor is to be construed in favor of the grantee, and (4) a deed will be construed to confer upon the grantee the greatest estate that the terms of the instrument will permit.
 
In addition to finding that the intent of the original parties favored the gas operator, the Court also found that Energy-Agri could not claim gas produced from its oil wells because “[n]o person in possession of or operating an oil well may produce from the oil well gas found in a horizon productive of gas only. Nat. Res. Code Ann. § 86.097 (Vernon 1978). It is unclear how this statute has any bearing on title as it addresses only possession and operations. It is particularly unclear how the Court disposed of the jury findings, which were that the Brown Dolomite is not a horizon productive of natural gas only and that it would produce crude petroleum oil. The opinion recites that “The questions presented to the jury were only relevant to well classification and not to the title dispute.” Perhaps this means that the jury’s responses support the conclusion that Energy-Agri had the right to produce the well and that the well was properly classified, but the correct issues on title and damages, if any, were not submitted.
 
The Supreme Court sent the case back to the trial court solely for a determination of the damages incurred by Amarillo Oil for any gas converted by Energy-Agri that belonged to Amarillo Oil. Presumably, the jury could still find zero damages, “but Energy-Agri had no right to produce gas from the Brown Dolomite formation, or any other formation which was not an oil stratum.” This, of course, circles right back into the meaning of “stratum” as used in the statutory definition of casinghead gas. The Court then recognizes that “incidental gas,” other than casinghead gas as defined by statute, may be produced from oil wells by owners of oil rights who are acting in good faith. The gas- rights owner is entitled to recover this “incidental gas” in return for paying his share of production costs under a constructive trust theory. “Production” costs are often construed to exclude exploration, drilling and development costs. If this is the meaning intended by the Court, then, under some circumstances (as for example where the gas operator has drilled no well), the gas operator clearly gets a windfall. Further, the Court says that an oil operator who has not produced in good faith is not even entitled to recover production costs.
 
Finally, the Supreme Court also makes reference to the controversy as it relates to other agencies and controversies involving severed oil and gas rights. The relationship between the courts and the Railroad Commission is discussed throughout the opinion, but the Court also notes that a similar result will follow if a case involving “White Oil” or low- temperature extraction (LTX) units reaches the Court. The Court believes its opinion is consistent with the action taken by the FERC in the Stowers case, and the Court rejects a 1940 attorney general opinion relied upon by Energy- Agri.
 
As of this writing, it is expected that motions for rehearing will be filed and several amicus curiae briefs may be filed. Because the decision was 8-0 (Hightower not participating), it is unlikely that the fundamental result will be changed. However, the opinion is significant and yet ambiguous on several key points, so that any opinion on motion for rehearing may also be important. At this time, the most significant points in the opinion are:
 

1. The intent of the parties to the severance document controls the title question, and, if the document is silent, the statutory definition is likely to control the definition of casinghead gas

2. Under the statutory definition, the party who owns the rights to casinghead gas owns only that gas or vapor which is indigenous to an oil stratum and is produced from that stratum along with oil, as contrasted to gas produced from a separate gas stratum through an oil well, e., a well with its bore bottomed in an oil-producing stratum.

3. Gas produced from a well classified by the Railroad Commission as an oil well is not necessarily casinghead gas

4. The measure of damages for good faith conversion of another’s gas is the gas produced net of production costs. The measure of damages for bad faith conversion is the gas produced.