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Texas royalty owners have sure taken a licking this year. Unfortunately, it’s probably going to get worse before it gets better.

Moody’s Investor’s Service recently lowered its estimates for future average 2015 prices of Brent crude to $55 per barrel, and of West Texas Intermediate (WTI) crude to $50 per barrel. The new 2016 estimates are $57 per barrel for Brent and $52 per barrel for WTI. Meanwhile, the futures markets for September 2015 delivery settled at $43.87/bbl on the New York Market this week.

There are many factors that affect the price of oil. Some of the factors that are in play right now probably include weak global economic growth resulting in weak demand, the increase in the size of oil inventories, the prospect of Iranian oil coming to market in the near future and the increased production by oil companies. In fact, it’s ironic that oil companies are producing more and more oil in large part because the price is so low. They produce and sell more oil at a lower price in order to realize the same income that they received when oil prices were higher.

There are downsides to these low oil prices. Many people who are retired or on fixed incomes depend in part on income from their oil and gas stock or from from mutual funds that hold shares in oil and gas companies. In addition, when the price of oil is lower, oil companies are less likely to explore new fields or try new technologies. They just don’t have the income cushion to be able to take the risk.
However, if there is one thing certain in the oil and gas industry, it’s that it is cyclical. I recall during the 1980’s when the price of oil in Texas neared $10 per barrel. The price eventually went up again, and it surely will in this case.

 

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A recent oil and gas pipeline rupture demonstrates how important it is to have an experienced pipeline attorney review the document to make sure your land is protected to the full extent of the law. In this case, a 24-inch crude oil pipeline owned by Plains All American Pipeline LP (PAA) ruptured on May 19, 2015 in Santa Barbara, California. The pipeline experienced an 82% wall thickness loss at the rupture site. An evaluation released on June 3, 2015 by the U.S. Pipeline and Hazardous Materials Safety Administration (PHMSA) indicated that there was a 6-inch opening running the length of the relevant section of pipeline. Both near the rupture and in other sections of the pipeline, corrosion had reduced the thickness of the pipe to 0.0625 inch. The PHMSA says they have not not yet been able to determine the cause of failure, although it certainly sounds as though the thinning of the pipeline was the culprit.

Conflicting Reports

The results released by PHMSA conflict with a report released by PAA which stated that there was only a 45% wall thickness loss in the area of the pipe rupture. PHMSA ordered PAA to perform another study on the pipeline and the rupture area, and to repair the damaged portion of the pipeline. PHMSA had previously ordered an indefinite shutdown of the pipeline.

Inspections were also conducted on three previously repaired sections of the pipeline near the rupture. The repairs were intended to fix corrosion damage discovered in a 2012 inspection of the pipeline by PAA. PAA used a cathodic protection technique to repair the pipe, which is a technique used to control corrosion of a metal surface. The technique involves using the pipeline as a cathode of an electrochemical cell and coupling the cathode with an anode pairing made from a sacrificial metal that is easily corroded. The intent is to have the corrosion occur at the sacrificial anode, rather than at the protected cathode, i.e., the pipeline. The PHMSA report stated that PAA’s cathodic protection at the failure site and the other three repair points met current industry standards.

Preventative Measures

In response to the leak in the pipeline, the PHMSA placed restrictions on the operation of another one of PAA’s pipelines that contains similar insulation, welding, and corrosion protection as the ruptured pipeline. The operating restrictions require that the pipeline not exceed 80% of the highest rated operating pressure for a continuous 8 hour period. Instead of operating with the restrictions, PAA decided to shut down the second pipeline, which runs 128 miles from the Gavota Pump Station in Santa Barbara County to the Emidio Pump Station in Kern County.

The PHMSA also amended a previous corrective action order to require that PAA list and describe any anomalies discovered after performing an inline inspection of the pipeline. The inline inspection identifies regions that require further inspection or repair under the higher of either current regulatory standards or PAA’s own internal standards. The PHMSA is also requiring that PAA have a third party perform nondestructive testing at the site of each anomaly discovered during the inline inspection. Other mitigation and prevention measures PAA must undertake on both pipelines are daily inspection of pumping stations and weekly inspections of the pipeline right of way.

On June 3, 2015, U.S. Rep. Lois Capps (D-Calif.), whose district includes the region of Santa Barbara where the rupture took place, proposed an amendment that requires federal regulators to finalize the enhanced safety rules for oil pipelines as part of the Transportation and Housing and Urban Development Appropriations Bill. The new rules would require automatic shutoff valves on new pipelines and require the inclusion of leak detection technology on new and existing pipelines.

Pipeline ruptures can result in substantial damages to landowners. Before you sign a pipeline easement or right of way, have an experienced pipeline attorney review the document to make sure your land is protected to the full extent of the law.

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The ownership of oil and natural gas companies may not be what people commonly think it is or expect it to be. The fact is that over 80% of the ownership of oil and gas companies in America is held by private individuals, either in their individual names or through their IRA, mutual fund or pension fund.

Broad Ownership of Public Oil Companies

A report of an investigation by Robert J. Shapiro and Nam D. Pham notes thate oil and gas company officers and managers, the corporate management, own a mere 2.9%. Asset management companies, including mutual funds, own 24.7%. Pension funds control 28.9%. Individual investors, which come in as the third highest portion at 18.7%, control a significant portion of the wealth. Next in line are IRAs, which control 17.9%. Other institutional investors own 6.9% percent.

This data seems to indicate that middle-class households continue to predominate the ownership of publicly-held oil and gas companies. By owning oil and gas company stock, these middle-class investors benefit from the industry’s strong, profitable returns. Stock ownership is providing a sustainable income to these individual investors and retirees.

Ownership Distribution by Industry Segments

The oil industry can be broken up into three segments: integrated (providing a range of functions such as drilling, production, treating, etc.), non-integrated, and services. Of these three categories, integrated companies represent 44.1% of the industry’s market value, or approximately $1.94 trillion in earnings. Non-integrated companies represent 39.8%, and services-related companies represent the remaining 16.1%.

There are twelve publicly-traded, U.S. based, integrated oil and gas companies in the U.S. Once again, the data reveals that corporate insiders, such as executives and directors, have minute ownership shares. These insiders control 0.5% of the integrated companies, whereas private investors own 42.7% of the outstanding shares. Of the 129 domestic publicly-traded non-integrated oil and gas companies, corporate executives own a mere 5.5%, and their ownership has actually declined over recent years. Individual owners account for 18.1% of the ownership. As of May 2014, this segment represents a $772 billion market capitalization. Finally, there are 60 publicly-traded oil and gas service companies, and corporate executives control 3.0% of these companies. Individual investors control 26.9%. The combined market capitalization of these services-related companies is $313.5 billion.

The point is that the critics of the oil industry often characterize oil companies as leviathans and monolithic entities, when the fact is that ordinary individuals, either directly or indirectly, are the owners of a major portion of U.S. oil and gas companies. Oil and gas company income funds the retirement of many older Americans. Of course, this may be another case where the facts are purposely ignored because they don’t further someone’s politically charged narrative!

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There is no denying the importance of the Texas oil and gas industry to the Texas economy. A less obvious impact is the effect of oil and gas prices on Texas land values.

Texas A&M University’s Real Estate Center released an econometric model positing a powerful correlation and interdependence between rural land prices and Texas oil prices. For most landowners, their land is arguably their most valuable possession. Land is also a vital ingredient for the oil industry. In addition, the oil industry is highly competitive in terms of offers to lease mineral rights and make use of the surface. The price of one’s land can be calculated from the value of projected future revenue the landowner receives from an oil company.

Land prices are determined by two factors: expected net revenue and the discount rate applied to future cash flows. The higher the price of oil, the greater the revenue from bonus and royalty income will be for oil and gas producing land. The increase in oil prices also effects oil company workers, shareholders, and executives in the form of increased salaries, bonuses and share prices. With more to spend, the workers and shareholders can pay more for land and so this helps bid up land prices as well.

The Real Estate Center’s model includes data from 1966 to 2013 tracking the price of oil and the price of rural land. The researchers found a seemingly direct relationship in four time periods. First, from 1973 to 1980, as the price per barrel of crude oil increased, so did the cost of rural land. The second period occurred between 1985 and 2000. Oil prices were stagnant, and so were the land prices. The period of 2000 to 2008 brought an upward movement in oil prices. During this third period, crude oil prices reached a high of more than $120 per barrel. Similarly, the rural land market experienced an increase in prices. The fourth period is after 2008. Oil prices dropped dramatically, but bounced back rather quickly. Once again, land prices followed suit.

The Center found the speed in which the land prices followed the trend of oil prices were contingent upon where in Texas the land was located. In Regions 1 and 5, the effect of oil prices on land prices happen more quickly. (Region 1 contains Midland and Ector Counties as well as other counties that are heavily involved in oil production.

The Real Estate Center’s econometric model is updated quarterly. The model may prove to be a useful tool for real estate investors who are trying to get into the market before the next boom in land prices.

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There is a new technology developed by Texas Tech University called “zipper frac.” It is a hydraulic fracturing process, which serves to fracture the subterranean rock formations by using pressurized liquid. Texas Tech University modified the original technique. As the zipper frac process commences, it creates the fractures, or splintering, in a staggered order. Tests have proved the new zipper frac ameliorates the fracturing process; the contact area is able to expand and the fluid production is augmented. The technique calls for two simultaneous parallel horizontal wellbores that are in close proximity of each other.  The Texas Tech researchers report that the modified fracing process will not only cost the same, but more importantly, guarantee a greater return and thus make wells more efficient.

The Zipper Fracing Advantage

The modified zipper fracing process combines the benefits of alternating fracturing and zipper frac. By doing so, modified zipper frac is able to create greater intricacy in the reservoir. The modified process is much simpler and does not require the use of specialized tools. This particular process eliminates some of the risks associated with stress reversal, which typically occurs near the wellbore. There is also the promise of superior long-term fluid production. The objective with the zipper frac technique is to alter the stress field and thereby create a more substantial fracture network, which is important for shale reservoir development.

Disadvantage to the Zipper Frac

The conventional fracturing method is unable to create intricate networks that move away from the wellbore. Unfortunately, the very techniques that were designed by the researchers to modify and enhance the traditional fracturing process, by making it simpler and more effective, does have a disadvantage. Specifically, these techniques are operationally more difficult to perform, even though it is more promising than another process, which designs fractures in an alternating sequence (the “Texas Two Step”).

Texas Tech researchers concede the new process does not account for the mechanical properties of the subterranean formation. After the first stage, drillers must then perform an optimization procedure, which determines the spacing between the hydraulic fractures. After the initial fracture, an assessment is made to determine the placement of ensuing fractures.

See Our Related Blog Posts:

Changing the Conversation about Well Fracing in Texas

Texas Mineral Owners Get More Access to Fracing Info

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The Texas legislature sent a new bill, HB 1436,  to Texas Governor Greg Abbott on May 28, 2015. The new bill aims to provide those dog owners who have been notified by animal control that their dog has been determined to be dangerous the opportunity and ability to appeal the animal control authority’s determination of the “dangerous dog” characterization. Once signed and made law by the Governor, the bill would go into effect on September 1, 2015.

What Is A Dangerous Dog?

Dangerous dog law is a characterization governed by both state and local law, so for each city or county dangerous dog laws might be slightly different. For example, one city might require dog owners to register online if they have certain breeds of dog that are generally considered dangerous, while other cities do not have this requirement. Under Texas Health and Safety Code Section 822.041, a dangerous dog is defined as one that:

● Makes an unprovoked attack on a person that causes such that the attack results in an injury, and the attack must occur somewhere other than in the dog’s enclosure (i.e., somewhere other than the place where the dog is primarily kept to keep the dog safely away from people (such as a pen or a fenced-in area); or
● Commits unprovoked acts in a place other than the dog’s enclosure that would cause a person to reasonably believe that the dog will attack and cause bodily harm or injury to that person (e.g., a dog viciously lunges at a passerby for no apparent reason during a walk along a residential street).

When a dog acts in an dangerous way, those who feel threatened or are harmed by the dog’s actions may file a report with a local animal control authority. The animal control authority will conduct an investigation and make a determination as to whether the dog is dangerous.

What Role Does The New Bill Play In Dangerous Dog Law?

The new bill requires that the animal control authority provide written notification of its determination of the dog’s dangerous characterization to the dog’s owner. Once the owner has been notified in writing, the owner may take steps to appeal the determination of the animal control authority to a justice, county, or municipal authority, and may even be entitled to a jury trial on the matter.

Filing An Appeal Regarding Dangerous Dogs Under the New Bill

Under the new bill, a dog’s owner may file an appeal with the court within 15 days of the animal control authority’s determination that the dog is a dangerous animal. The appeal must include a copy of the written notification the dog’s owner received from the animal control authority concerning the determination that the dog is a dangerous one, and must serve a copy of the appeal on the animal control authority via the US Postal Service.

If the dog’s owner is not satisfied with the result of the appeal, he or she may further appeal the decision to a court of higher authority. The dog’s owner will have 10 days to file the appeal to a higher authority after the appeal decision has been made.

This bill addresses a real problem in Texas jurisprudence: the lack of a dog owner’s right to appeal a dangerous dog determination. This is especially critical where a vindictive neighbor has filed a frivolous complaint.

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There are some relatively new operators in the Texas oil and gas industry. One of these is Parsley Energy, Inc. which was founded in 2008. Run by a relatively young management team, Parsley Energy appears to be establishing a good reputation in an industry which is typically dominated by more seasoned players.

Parsley Energy is an independent natural gas and oil company operating primarily in the Permian Basin and the Midland Basin. Parsley has experienced significant growth since its inception and now operates hundreds of wells and produces over twelve thousand barrels of oil each day.

The Permian Basin

All of Parsley’s leases are in the Permian Basin which is arguably one of the richest oil and gas resource in North America. The Permian Basin is located in the western area of Texas and extends into the southeastern part of New Mexico. This basin is comprised of several other basins, namely the Midland Basin, which is the largest, Delaware Basin, which is the second largest, and Marfa Basin.
The_West_Texas_Permian_Basin.jpg Since the Permian Basin is a rich area, it is not surprising oil and gas companies are actively buying undeveloped property in the area, and Parsley Energy is one such company. For a total of approximately $252 million, Parsley Energy agreed to buy multiple acres of undeveloped and productive land in Reagan County, Texas from numerous sellers. This acquisition involves approximately 5,472 acres. The acreage includes over nine horizontal wells, each at a different development stage, and 100 net horizontal drilling locations. Parsley anticipates drilling the first new horizontal well in 2015.

What Does this Mean for Mineral Owners?

Parsley Energy’s activity in the Permian Basin suggests that mineral owners in this area may receive an oil and gas lease offer. Other property owners, who own only the surface, can expect requests for surface use agreements or requests for pipeline easements. These are inherently complex documents. Do yourself a favor and avoid unpleasant future surprises due to a badly worded lease, surface agreement or easement. Seek out and consult with an experienced oil and gas lawyer to help make sure your interests are being properly represented.

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On May 18, 2015, the Texas Governor Greg Abbott signed HB 40 into law. The law is effective September 1, 2015. This new law effectively prohibits local city and county governments and subdivisions from regulating surface oil and gas activity in their jurisdictions. The law provides that all such regulation is now preempted by the state of Texas. The new law does have an exception, but it is so narrow as to be effectively useless.

This is not a good day for Texas property owners.  I foresee the law of unintended consequences coming into play here. Specifically, as oil and gas activities encroach on residential areas, the market value of those properties will decline, and may decline substantially. That means appraisal districts will have to reappraise these properties at a lower level. That in turn results in lower tax revenues. Texas counties are already pinched financially. Will Texas counties simply increase the tax rate to make up for the lost revenues? Texas property owners already bear huge tax burdens from county and school taxes. Many counties spent like drunken sailors when taxes were buoyed by taxation of oil and gas production during times of high oil and gas prices. Now they have huge overhead and new programs that they cannot pay for. What happens next will depend on how much oil and gas activity occurs in residential areas where it was previously prohibited and what impact that has on local taxes. To be announced.

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As of November 4, 2014 Denton, Texas was the first Texas city to ban fracing inside city limits with a ballot initiative that passed with almost 59 percent of the vote. The next day, the state’s energy lobby, Texas Oil and Gas Association, filed an injunction in response. The Texas General Land Office also separately filed suit to prevent Denton from enacting the ordinance. Arguments in both suits were based on the fact that well completion techniques, which include fracing and disposal, are preempted by the state regulation and that the ban cannot be enforced by a city. Opponents of the ban have also argued that the ban constitutes an unlawful taking of mineral rights. It is unclear if the courts would find the fracing ban to be an unconstitutional taking of property in violation of the Texas Constitution because it is not a ban on gas well drilling, only a ban on one type of gas recovery technique used during production.  More recently, the Texas legislature has prepared legislation that would actually ban all local regulation of oil and gas drilling, and not just fracing.

Implied Preemption in Texas

In Texas there is no doctrine of implied preemption under state law. This means that in order for a city or municipal regulation to be preempted by state law the Texas State Legislature must “with unmistakable clarity” dictate that state law controls. In January 2014, the state of Texas adopted new rules in the Texas Administrative Code relating to hydraulic fracturing in Texas. The new rules do not specifically preempt municipalities from adopting additional regulations.

State Representative Drew Darby, R-San Angelo, recently introduced House Bill 40 (HB40) that provides that cities can regulate surface activity for oil and gas operations if the regulations are “commercially reasonable” and do not prohibit operations. The bill defines “commercially reasonable” as “a condition that would allow a reasonably prudent operator to fully, effectively, and economically exploit, develop, produce, process, and transport oil and gas”. The bill’s definition of “oil and gas operation”  includes activity associated with hydraulic fracture stimulation and disposal operations.

The exceptions to state preemption provided in HB40 relate only to above ground activity relating to fire and emergency response, traffic, lights, noise, and reasonable setback requirements. Jason Modglin, Darby’s chief of staff, has stated that the proposed bill would not overturn the Denton frac ban because it is not retroactive. However, if passed, the bill would prevent other Texas cities and municipalities from enacting similar bans on not just hydraulic fracing and disposal, but any other operation such as drilling.

Two other bills of note that would make it difficult for cities to ban fracing have also been introduced in the Texas legislature. House Bill 539 would require cities to determine how much a frac ban would cost in lost royalties and make the city liable for payment if the bill passes. House Bill 540 would require all referendum and initiative petitions be reviewed by the Texas Attorney General for a determination of whether the proposed action would result in a government taking of mineral rights without compensation, prior to being placed on a city ballot.

Frankly, I have a major problem with these proposed bills, other than the fact that they are clearly being introduced at the behest of the Texas oil and gas industry without regard to the rights of individual homeowners. First, keep in mind that many people sign leases for their mineral rights in which they prohibit surface use of their property. In other words, their minerals are pooled with the minerals from other properties on which the surface can be used. Since most oil and gas wells require some type of pooling unit, sometimes several hundred acres in size, a prohibition of surface use does not automatically mean that a mineral owner can’t realize a return on their mineral interest. Secondly, many folks have bought property and built homes in reliance on a local prohibition against surface or drilling activity found in a municipal or county ordinance or in subdivision regulations. The value of their homes is in part derived from this protection. If drilling activity is allowed anyway, the value of their home and their property can decrease dramatically because of the noise. the smell, the traffic and invasion of privacy that nearby oil and gas operations would involve. This is a form of inverse condemnation, for which compensation should be paid by the oil companies and the mineral owners.

Local governments are in the best position to determine what their citizens want and need. Let’s not add a statewide “one-size-fits-all” solution. And let’s especially not undermine individual homeowners who have bought land and built homes in reliance on a local ordinance! This bill was sent to the Governor for signature on May 6, 2015. Let’s hope he does not sign it.

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The United States Court of Appeals for the Fifth Circuit recently decided the case of Breton Energy, L.L.C., et al. v. Mariner Energy Resources, Inc., et al which concerned claims of waste and drainage against Defendants who were operators of a neighboring mineral lease. The issue was whether the Plaintiffs sufficiently plead a claim for relief against each Defendant. The Fifth Circuit concluded that the claims of drainage against all Defendants should be dismissed, and the claims of waste should be dismissed as to all but one Defendant, IP Petroleum Co. (“IP”).

The Facts
Conn Energy, Inc. (“Conn”) owned a mineral lease named West Cameron 171 (“WC 171”) in the Gulf of Mexico. In 2009, Conn had an agreement with Breton Energy, LLC (“Breton”), allowing Breton to explore WC 171 for hydrocarbons. Conn and Breton sued the owners and operators of a neighboring lease called West Cameron 172 (“WC 172”). It was significant in this case that the WC 171 and the WC 172 shared a hydrocarbon reservoir: the K-1 sands. The other Defendants were other lease owners and operators or predecessors or successors to the current operators.

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