023 Amarillo Oil Company v. Energy-Agri Products, Inc.

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., S.W.2d (June 27, 1990), is the only Texas Supreme Court case to address the significant outstanding issues in the oil/gas controversy. For the Texas Panhandle oil and gas industry, it must be considered one of the most significant cases ever decided.
 
It has already been determined that liquids extracted by LTX units may not be counted as oil for purposes of determining the gas/oil ratio. The Harlow case addressed many other significant issues, but on Motion for Rehearing, the Texas Supreme Court withdrew its opinion and set the Harlow case for a second round of oral argument. The parties promptly settled, so that the Harlow case is now of almost no value in predicting or settling the law in Texas. Motion for Rehearing had also been pending in the Energy-Agri case for over a year when the Harlow case settled. It is obvious that the Supreme Court in this opinion is making an effort to write a significant decision that will begin to bring some resolution to the oil/gas controversy.
 
The Energy-Agri case is basically a high-perforations case. Amarillo Oil owned the gas rights and was producing gas from the Brown Dolomite. Energy-Agri owned the oil and casinghead gas rights, completed a well in the Granite Wash, classified the well as an oil well, came up the hole and perforated the Brown Dolomite, and commenced significant gas production. Amarillo Oil sued to quiet title to all of the gas in the Brown Dolomite, to enjoin Energy-Agri from producing gas from the Brown Dolomite, and for damages for the taking of its gas. The holding as to each of Amarillo Oil’s three claims is significant.
 
Held: Amarillo Oil is entitled to judgment quieting its title as against Energy-Agri to gas, other than casinghead gas, produced from the-Brown Dolomite. When oil rights are severed from gas rights in a phase severance, and the parties do not otherwise specify in the conveying instrument, the party who owns the rights to casinghead gas owns only that gas or vapor defined by statute as casinghead gas. Natural Resources Code § 86.002(10) defines casinghead gas as “gas or vapor indigenous to an oil stratum and produced from the stratum with oil. This does not include gas produced from a separate gas stratum through an oil well. A “stratum” is a single layer of rock deposited at roughly the same geological period of time which normally contains only one kind of rock. An “oil stratum” is a stratum that produces one barrel or more of crude petroleum oil to each 100,000 cubic feet of natural gas. “With oil” means gas produced as a necessary incident to the production of oil. To determine whether the substance produced is gas or casinghead gas, each completion must be examined to determine whether the production from that stratum, at that particular location, is sufficient to define it as an “oil stratum,” i.e., a gas/oil ratio of 100,000 cubic feet of gas or less per barrel of oil. If it is an oil stratum, then the gas produced therefrom is casinghead gas.
 
The holding is significant because it reads the statutory definition of casinghead gas into the instrument of severance, absent a contrary intent of the parties apparent from the instrument itself. Because the statute has been virtually unchanged throughout the history of the industry, there is now a reasonably consistent definition to use in construing conveyances, even though many of those instruments are completely silent as to the meaning of “casinghead gas. In a marked departure from its former opinion, the Court deleted all references to extrinsic circumstances. Certainty of land titles is promoted because title will generally turn on the words of the conveyance and the statutory definition. The holding is further significant because it resolves several of the competing interpretations given to the statutory definition.
 
The holding of the Court establishes title to the “gas” in Amarillo Oil, but this holding does little to settle the case. How much, if any, of the gas removed has been casinghead gas, is a question of fact. The Court remands the case to the trial court jury to try it again and to answer that question with the Supreme Court’s newly expanded definition of casinghead gas. The definition has certainly been clarified, but there are still many issues open to dispute. For example, it is not clear who bears the burden of proof in establishing an “oil stratum. The Court also did not expressly address changes of condition over time, or the “original reservoir conditions” argument. The holding is significant because the prior opinion could have been read to hold, as a matter of law, that everything coming out of the Brown Dolomite was “gas.”
 
Held: Amarillo Oil is not entitled to injunctive relief. For so long as production by Energy- Agri is permitted by the Railroad Commission, and if Amarillo Oil does not pursue a direct action against the Railroad Commission, Energy-Agri will apparently be permitted to continue to produce. The Court intends to give great deference to the Railroad Commission’s decision as to the party who should produce the well. However, there is a distinction between the right of possession through the Railroad Commission-granted right to produce, and the right of ownership.
 
The holding is significant because it indicates that suits between parties over title will not be permitted to interfere with the orderly production of oil and gas under the established regulatory scheme. The operator will be permitted to produce the well for so long as permitted by the Commission or until the Commission is reversed. The holding may also portend the Court’s intent to employ a measure of damages other than conversion.
 
Held: Because of a procedural error, the case must be remanded to determine Amarillo Oil’s damages, if any. The Court’s opinion gives no guidance as to the measure of damages. The Court’s prior opinion and the now defunct Harlow case analyzed damages in terms of conversion. Conversion as a theoretical measure of damages creates some difficulties. It may support exemplary damages, and each downstream purchaser may be equally guilty of conversion. A necessary element of conversion is “wrongful” possession, and the Court’s holding that only the Railroad Commission controls the right of possession suggests that conversion may not be the correct legal theory to measure damages. Downstream purchasers in a future case may find themselves off the hook.
 
The holding is significant because it reserves the measure of damages to a future case for resolution, and it puts in doubt the applicability of conversion as the theory for relief.
 
There will be obvious practical difficulties in establishing ownership in wells completed in multiple strata or in which completion techniques introduce artificial communication. “Stratum” is still a term subject to dispute among geologists. Ownership determined by sub-surface conditions will always be more difficult to prove than a simple surface test of the well stream. Finally, only actual production or test results will define and determine the ownership of the substance produced. The case may be construed to hold that ownership may change over time under changing conditions.
 
The case is particularly significant for the Texas Panhandle because it is quite common to find a fundamental severance in the mineral title severing the oil and casinghead gas rights from the gas rights. That is not the only context in which the distinction between oil and gas is significant. It is common to find leases with different royalty provisions, pooling provisions and Pugh clauses that turn on the oil/gas distinction. Farmout agreements, operating agreements, area of interest agreements and assignments of overriding royalty frequently have different provisions that turn on the oil/gas distinction. The characterization of the substance produced is critical in establishing proration units under the state regulatory scheme and in classifying gas under the federal regulatory scheme. Obligations to take gas under state regulations and gas contracts may turn upon the oil/gas distinction.
 
The opinion is not final and may be subject to a renewed motion for rehearing. Nevertheless, the Court has been struggling with these issues for two years, and it appears that some of them are about to be resolved.
 
*          *                                                                        * ERRATUM
The May 1990 edition of the Case Note, reporting on Day Company. Inc. v. Texland Petroleum. Inc., S.W.2d , 33 Tx. S. Ct. J. 297 (March 7, 1990), contained a typographical error which recited:
 

The Court reasoned that the transfer of executive rights is best governed by principles of contract law pertaining to agency and powers of attorney. The executive rights passed under the deed because the deed did not reserve or except the executive rights on the Keaton minerals.

 
The text should have read:
 

The Court reasoned that the transfer of executive rights is best governed by principles of real property and oil and gas law, and not by principles of contract law pertaining to agency and powers of attorney. The executive rights passed under the deed because the deed did not reserve or except the executive rights on the Keaton minerals.