Face Challenges Confidently

383 Basic Energy Service, Inc. v. D-S-B Props., Inc.

Thursday, September 3rd, 2015

Richard F. Brown

The following is not a legal opinion. You should consult your attorney if the case may be of significance to you.
Basic Energy Serv., Inc. v. D-S-B Props., Inc., 367 S.W.3d 254 (Tex. App.—Tyler 2011, judgm’t vacated w.r.m.) upheld the award of damages to a royalty owner arising out of irreparable damage to an oil well despite the lack of injury to the underlying oil formation. In 1993, D-S-B Properties, Inc. (“DSB”) purchased two leases, including the Moseley #1 oil well, which had been continuously producing oil since 1946. Shortly after the purchase,  DSB assigned its interest in the leases to six investors and became the well operator.
In September of 2007, when the well encountered mechanical problems, DSB hired Basic Energy Services, Inc. (“Basic”) to repair the well. After Basic determined there was a problem with the tubing, it hired a third party to test the tubing for leaks. During a testing procedure, the testing company’s tool became stuck inside the tubing. The testing company was able to successfully remove the tool, but its retrieval efforts caused the tubing to fall into the wellbore. Basic was unable to retrieve all of the fallen tubing, and the well was irreparably damaged.
When the working interest owners chose not to engage in reworking or drilling operations, the lease terminated in December of 2007. DSB and the royalty owner then filed suit against Basic for negligence, breach of warranty, and violations of the Texas Deceptive Trade Practices Act. The trial court awarded the working interest owners substantial damages based upon the cost of a replacement well and also awarded the royalty owner approximately $71,000 in damages for lost royalties.
Basic appealed, claiming the royalty owner was not entitled to damages for lost royalties absent proof of injury to the underlying oil formation. Basic argued that a royalty owner who recovers damages without proving an injury to the underlying formation may receive double compensation. The court acknowledged the holding in HECI Exploration Co. v. Neel that a royalty owner is entitled to damages for injury to an oil and gas reservoir underlying a lease, but reasoned that in so holding, the Texas Supreme Court did not foreclose other possible measures of damages. The court relied on Clifton v. Koontz and extended its reasoning to hold that a royalty owner may be entitled to damages if the record shows (1) the royalty owner will not recover all of its interest in the particular formation and (2) damages can be determined with reasonable certainty.
The court determined that the Moseley #1 well was unique. In making this determination, the court reviewed expert witness testimony that the Moseley #1 well had continuously produced oil since 1946, the production originated from a channel sand formation meandering below the lease surface, and two dry holes were drilled within one-quarter of a mile from the Moseley #1 well. The court also considered testimony that another operator would be unlikely to drill a new well within the vicinity of the Moseley #1 well due to the Moseley #1 well’s predicted remaining reservoir life which only extended through 2021 and the cost of saltwater disposal. The court then concluded that “the successful drilling and long lasting productivity of the Moseley #1 well was an extraordinary circumstance” that justified an award of damages to the royalty owner based on lost royalties.
How the court calculated those lost royalties is not clear from the opinion. It appears that it used the average monthly production rate during the year prior to the accident, times the average price per barrel during the relevant two year time frame (without explanation as to its relevance), times the months remaining of reservoir life. To reduce the result to net present value, the court reduced the result by 35%; the risk of a dry hole. There is no mention of a decline curve.
The significance of this case is the court’s holding that in extraordinary circumstances a royalty owner may be entitled to damages based on lost royalties without proving damage to the underlying reservoir.