Allocation of Production – Springer Ranch v. Jones

In Springer Ranch v. Jones, No. 04-12-00554-CV, 2013 Tex. App. LEXIS 15370 (Dec. 20, 2013), the San Antonio Court of Appeals addressed issues relating to allocation of production from horizontal wells.  The dispute in Springer Ranch arose after Alice Burkholder executed an oil and gas lease covering her ranch of 8,545 acres, which lease continued to remain in effect when the instant dispute arose.  After executing the oil and gas lease, Alice Burkholder subdivided the ranch into three tracts to her children.  Multiple vertical oil and gas wells were drilled on the tracts and acreage from the tracts were included within production units for wells located on the neighboring tracts.  In 1993, a dispute arose among the parties relating to the payment of royalties and the parties entered an agreement regarding the payment of royalties, which, in relevant part, provided:

“[the parties] contract and agree with each of the other parties, that all royalties payable under the above described Oil and Gas Lease from any well or wells on said 8,545.02 acre tract, shall be paid to the owner of the surface estate on which such well or wells are situated, without reference to any production unit on which such well or wells are located. . . .”

Springer Ranch, 2013 Tex. App. LEXIS 15370, at *3.  The royalty agreement affected six vertical wells with two on each of the tracts when it was made.  Id.

The royalty agreement operated effectively between the parties for nearly twenty (20) years before the drilling of the first horizontal well (the “SR2 well”) under the original oil and gas lease.  The SR2 well “begins on Springer Ranch’s property, crosses the boundary line between Springer Ranch’s property and Rosalie Matthews Sullivan’s property, and terminates under Sullivan’s property.”  Id., at *4.  The SR2 well is depicted below:

Springer Ranch v. Jones

Sullivan (Surface Owner B) attempted to negotiate with Springer Ranch (Surface Owner A) to receive a portion of the royalties from the SR2 well, but negotiations failed.  Springer Ranch filed a declaratory judgment action seeking a declaration that it was entitled to all royalties from the SR2 well under the 1993 royalty agreement because the well was located on its surface estate.  The defendants filed a competing motion for summary judgment, which sought to “allocate the royalties to the SR2 well between Springer Ranch and Sullivan based on the location of the productive portions of the well.”  Id., at *5-6.

To resolve the dispute, the Court focused on the meaning of terms in the 1993 royalty agreement and first interpreted the term “well.”  The defendants argued “that ‘well’ should be understood as ‘the entire underground orifice from which oil and gas are produced.”  Id., at *13.  Springer Ranch did not assert a specific definition of a “well,” but its interpretation of the 1993 royalty agreement required that “well” “be only the topmost portion of the hole on the surface where hydrocarbons exit the earth or the structure overlying the well.”  Id.  The Court, considering both legal and technical definitions of the term “well” and the evidence provided by the Defendants’ petroleum engineer expert and concluded that the term “well” included the entire wellbore that was situated on both the Springer Ranch tract and the Sullivan tract.  Id., at *15.

Next, the Court addressed Springer Ranch’s argument that because the 1993 royalty agreement “describes a well ‘on’ a surface estate, it must mean only that part of the well that is visible on the surface of its property.  The Court quickly rejected Springer Ranch’s reliance on the term “on” because “on” is “so versatile” and “denotes other spatial relations, including within the limits or bounds of something.”  Springer Ranch, 2013 Tex. App. LEXIS 15370, at *15-16.

The Court, turning to the term “surface estate” concluded that the royalties from the SR2 well should be allocated between Springer Ranch and Sullivan:

“In light of the contract’s language, physical facts of the mineral and surface estates, and the applicable case law, we conclude that the SR2 well – ‘the shaft or hole bored or sunk in the earth through which the presence of minerals may be detected and their production obtained’ – is situated ‘on’ more than one ‘surface estate,’ consistent with the [the Defendant’s] construction. Royalties from the well therefore should be allocated between Springer Ranch and Sullivan ‘without reference to any production unit on which such well or wells are located.’” (emphasis in original).

Id., at *22-23.

After concluding that royalties should be allocated between the two tracts, the Court considered the method and formula to be used to calculate the amount of royalty to be allocated to each tract.  The Court in rejecting Springer Ranch’s argument that royalties should be allocated based on the length of the wellbore on each parties’ property, explained that “[p]roduction from a well, whether horizontal or vertical, is not obtained from the entire length of the well, but from the part of the well that pierces and drains the reservoir in which hydrocarbons reside.”  Id., at 26.  “A horizontal well only produces hydrocarbons from the part of the well that lies within the hydrocarbon-bearing reservoir, or ‘correlative interval.’”  Id.  Importantly, Springer Ranch “did not dispute the expert’s measurements or calculations, nor did it offer evidence of any other basis for determining how much production was obtained from the parts of the wells on the parties’ respective surface estates.”  Id. at *27.

The Court concluded that “a royalty, as a fraction of production, is only obtainable from the part of the SR2 well actually within the correlative interval.”  Id., at *26.  The Court adopted the Defendant’s expert’s method of calculating the allocation formula by multiplying the one-eighth royalty “by the ratio of the total distance between the first and last takepoints to allocate the royalties.”  Id., at *27.  The Court concluded that each portion of the horizontal wellbore would be equally productive.  However, a court presented with conflicting expert testimony may apply an alternative method and formula for calculating the allocation of royalties or production.

Although the Court’s decision in Springer Ranch turns on the interpretation of a specific agreement between the parties, the decision provides guidance on how courts will address situations when a horizontal wellbore crosses multiple tracts and royalties must be allocated between the parties.  In Springer Ranch, the Court assumed that all producing portions of the wellbore would be equally productive.  Additionally, the Court was not presented with contradictory scientific evidence regarding the productivity of the intervals.  Finally, the Court did not consider a situation involving multiple productive intervals intermixed with non-productive intervals.

Situations similar to Springer Ranch often arise where a portion of a tract subject to an oil and gas lease is burdened by a non-participating royalty interest.  If a well is drilled on the tract burdened by the non-participating royalty interest, then there must be a method and formula used to allocate production to the tract burdened by the non-participating royalty interest in order to pay royalties.  Springer Ranch can provide guidance regarding the allocation of production in those situations.