358 Petroleum Synergy Group, Inc. v. Occidental Permian, Ltd

Richard F. Brown
 
The following is not a legal opinion.  You should consult your attorney if the case may be of significance to you.
 
Petroleum Synergy Group, Inc. v. Occidental Permian, Ltd. 331 S.W.3d 14 (Tex. App.–Amarillo 2010, pet. denied), provides an analysis of the implied covenant to protect against drainage of the leasehold.  Occidental (“OPL”), which operated the one-quarter section Snitker Lease and two adjacent leases to the North of the Snitker Lease, drilled two wells on the Snitker Lease.  OPL applied for and obtained two well-spacing exceptions under Statewide Spacing Rule 37, and thereafter drilled, close to the Snitker Lease, a well on each of the two adjacent leases to the North of the Snitker Lease.  The owner of an overriding royalty interest (“ORRI”) that burdened the Snitker Lease filed suit against OPL alleging OPL breached the implied covenant to prevent substantial drainage of the leasehold.  The jury disagreed, and the owner of the ORRI appealed.
 
“A claim for breach of the covenant to protect against drainage of the lease requires the plaintiff to prove substantial drainage and that a reasonable and prudent operator would have acted to prevent the substantial drainage.”  The owner of the ORRI argued that it proved that there was substantial drainage of the Snitker Lease as a matter of law.  “A party attacking the legal sufficiency of an adverse jury finding on an issue on which the party bore the burden of proof must demonstrate all vital facts in support of the issue were established as a matter of law.”  “A proposition is established as a matter of law when a reasonable fact finder could draw only one conclusion from the evidence presented.”
 
In this case, the owner of the ORRI could not establish substantial drainage as a matter of law because more than one conclusion could have been drawn from the competing testimony.  Experts on behalf of the ORRI owner put on testimony to show that there was substantial drainage of the Snitker Lease.  However, a reservoir engineer, testifying for OPL, characterized the field as a water-drive field, and he testified that the “weight of the mile-and-a-half of rock resting on top of the reservoir pressurized the reservoir fluid to 2,600 pounds per square inch.  The volume of oil in the reservoir is small compared to the aquifer, such that production of oil does not cause a significant change in reservoir pressure.”  An engineer for OPL also testified that he saw no evidence of substantial drainage of the Snitker Lease, and it was the engineer’s opinion that the lease had not been substantially drained.  The court of appeals found more than a scintilla of evidence supporting the jury’s finding, and therefore affirmed the trial court’s decision.
 
When applying for the Rule 37 exceptions to drill the wells on the two adjacent leases to the North of the Snitker Lease, because OPL was the operator of the Snitker Lease (and there do not appear to have been any unleased mineral owners) OPL was the only party entitled to notice of the requested exceptions.  The owner of the ORRI that burdened the Snitker Lease appears to have insinuated that OPL was engaged in self-dealing to effectuate a purposeful draining of the Snitker Lease (i.e., perhaps OPL had a higher net revenue interest on the leases that were not burdened by the ORRI).  The ORRI owner appears to have been arguing that OPL’s self-dealing prevented OPL from acting as a reasonably prudent operator.  However, to successfully assert a claim for breach of the covenant to protect against drainage of the lease, the ORRI owner had to prove 1) substantial drainage and 2) that a reasonable and prudent operator would have acted to prevent the substantial drainage.  Here, the court of appeals did not analyze whether a reasonable and prudent operator would have acted to prevent the substantial drainage because the ORRI owner failed to prove that there was substantial drainage.
 
The significance of this case is that it provides an analysis of the Texas common law’s implied duty that leasehold owners have to protect against the substantial drainage of a lease.  The case also outlines a two-part test that plaintiffs must overcome in order to prevail in a claim asserted against a leasehold owner for breaching the implied covenant to protect against drainage of a lease.