December 2017 Legal Update by George Plauché / Bullen & Plauché

by: Martha Mills at 12/8/2017 6:58:52 PM | Viewed 562 times.

TDX Energy, LLC v. Chesapeake Operating, Inc., 16-30450 (5th Cir. 5/12/2017)

857 F.3d 253

 

By George C. Plauché

Bullen & Plauché

 

            In this case, the United States Court of Appeals, Fifth Circuit considered Chesapeake’s claim as operator of a unit well in DeSoto Parish to recover from TDX, as a lessee of interest unleased by Chesapeake, TDX’s share of drilling costs plus a risk fee of 200%.

A Brief History of Forced Pooling

            The court begins with a brief, but interesting, history of forced pooling in Louisiana. To summarize, the need for forced pooling began to be evident when a well struck oil in 1901 above the Spindletop salt dome, which ultimately led to 440 wells being drilled over 125 acres. The resultant drain of the reservoir was inefficient, wasteful and environmentally damaging. This was the inevitable result of the application of the common law rule of capture which states that a landowner owns oil and gas produced from wells on the owner’s land, regardless of if the oil and gas migrated from his neighbor’s land. As a result, states including Louisiana enacted “forced pooling”, forcing mineral rights owners to be part of a drilling unit in order to protect neighbors’ rights to benefit from their mineral interests and to promote Louisiana’s interest in preventing waste and promoting economic activity.

Forced Pooling in Louisiana

            The Commissioner of Conservation administers the forced pooling regime in Louisiana, designating drilling units when necessary to prevent waste or avoid needless drilling, and appointing an operator for the unit well. The operator is responsible for drilling within the unit, but pays a proportionate share of production to mineral owners within the unit. Louisiana law includes mechanisms for the mineral owners to share drilling risks and costs. As to mineral lessees who have not entered into an agreement with the operator, the operator may give notice of the well, and allow the owners to participate in the risk by paying their share of the estimated drilling costs up front. As to those mineral lessees who elect not to participate, if the well produces, the operator can recover from production each nonparticipating lessee’s share of drilling costs plus a 200% risk fee. The operator is also required to provide cost and production reports to nonparticipating lessees and unleased owners within ninety days of completing a well (“report requirements”). After an additional thirty days from receiving notice of its failure to comply with the report requirements from an owner, the operator cannot collect drilling costs from that owner. The issue in TDX was, to which owners do the risk fee and report requirements apply?

Case Background

            Chesapeake was the operator of a 640-acre unit, over which it held a number of oil and gas leases. On February 5, 2011, Chesapeake spud the unit well, and completed the well on July 19, 2011. When the well was spud, 63 acres of the unit were not leased by Chesapeake or any other party. Touchstone Energy, LLC took leases over the 63 acres with an effective date of July 15, 2011 (before drilling was completed), and recorded the leases between July 22 and September 14 (after the well was completed). Touchstone transferred the leases to TDX who notified Chesapeake in late 2011 of its interest and requested an accounting under the notice requirements discussed above. TDX sent Chesapeake notice that it failed to comply with the notice requirements. Chesapeake did not provide reports, but instead, sent TDX a letter asking TDX to make an election to participate in the well’s risk. TDX responded that the election notice was untimely, therefore, TDX was not required to make an election, and Chesapeake could not collect a risk fee. TDX then wrote Chesapeake that its failure to provide the requested cost and production data prevented Chesapeake from recovering TDX’s proportionate share of drilling costs.

Report Requirement Statutory Framework

            TDX claimed Chesapeake failed to provide the required reports, thus forfeiting its right to deduct drilling costs. The report requirement is found in Louisiana Revised Statutes Title 30, sections 103.1 and 103.2. Section 103.1 states, in relevant part, the following:

Whenever there is included within a drilling unit ... lands producing oil or gas, or both, upon which the operator or producer has no valid oil, gas, or mineral lease, said operator or producer shall issue ... reports to the owners of said interests ...

 

LA. R.S. 30:103.1(A)(emphasis added).

The deadlines and penalty for failing to timely provide the required reports is found in the following section 103.2, which states the following:

Whenever the operator or producer permits ninety calendar days to elapse from completion of the well and thirty additional calendar days to elapse from date of receipt of written notice by certified mail from the owner or owners of unleased oil and gas interests calling attention to failure to comply with the provisions of R.S. 30:103.1, such operator or producer shall forfeit his right to demand contribution from the owner or owners of the unleased oil and gas interests for the costs of the drilling operations of the well.

 

LA. R.S. 30:103.2(emphasis added).

            The issue the court considered was whether “owners of unleased oil and gas interests” in 103.2 includes lessees. Relying on a prior Louisiana Third Circuit Court of Appeals decision, XXI Oil & Gas, LLC v. Hilcorp Energy Co., 206 So.3d 885 (La. App. 3d Cir. 2016), and a broader interpretation of the language in 103.2 in the context of the statutory framework and the language in 103.1, the court held that 103.2 does include lessees.

Risk Fee Statute

            Chesapeake claimed that TDX is required to pay a risk fee because TDX did not elect to participate in the well. The election provision is found in Louisiana Revised Statutes Title 30, section 10(A), which states, in part, the following:

Any owner drilling or intending to drill a unit well, ... on any drilling unit heretofore or hereafter created by the commissioner, may ... notify all other owners in the unit of the drilling or the intent to drill and give each owner an opportunity to elect to participate in the risk and expense of such well.

 

LA. R.S. § 30:10(A)(2)(a)(i). The notice must contain estimates of the cost of the well, proposed well location and depth, and technical data such as logs and core analysis that have not been made public.

            Section 10(A) entitles the operator to recover from production the nonparticipating owner’s “share of the actual reasonable expenditures incurred in drilling, testing, completing, equipping, and operating the unit well, including a charge for supervision, together with a risk charge, which risk charge shall be two hundred percent of such tract’s allocated share of the cost of drilling, testing, and completing the unit well.” An owner not notified still bears its tract’s share of “actual reasonable expenditures,” but owes no risk charge. The risk charge also does not apply to “any unleased interest not subject to an oil, gas, and mineral lease.”

            Although TDX’s leases were dated effective before the well was completed, they were recorded after the well was completed. Under Louisiana’s public records doctrine, the leases were effective as to third parties (including Chesapeake) after the well was completed. As to Chesapeake, the interest leased by TDX was unleased according to the public records when the well was completed and Chesapeake had no reason to send notice of an election to the owner of record because there was no chance of claiming a risk fee.

            The court held that Chesapeake’s election request sent to TDX after the well was completed was untimely. In so doing, the court focused on the language of the statute requiring notice of “drilling or intent to drill”, concluding that the language was not intended to apply to completed wells. As the court pointed out, section 10(A) was amended, effective June 13, 2016, to now state that an owner “drilling, intending to drill, or who has drilled a unit well” may send notice. The court rejected Chesapeake’s argument that the amendment only clarifies the original intent of the statute. Instead, the court stated that the amendment would now lead to a different conclusion if it had been effective prior to the facts at issue in this case.

Conclusion and Discussion

            The court ultimately held that Chesapeake was not entitled to deduct drilling costs from TDX’s share of production because it failed to provide the well cost information TDX requested under 103.1. The court also held that the risk fee statute did not apply under these circumstances. The opinion creates a bit of an anomaly in the law whereby a lease buyer can purchase unleased interest in a unit, and, by waiting to record the leases until after the unit well is completed, may avoid a risk fee and possibly its share of the costs of the well if the operator fails to timely provide the required reports. While the amendment to the election notice and risk fee statute in section 10(A) may remedy the issue after the amendment’s effective date of June 13, 2016, circumstances predating the amendment may be subject to the result in TDX. At the very least, this case highlights some of the problems with the imprecise language (the court referred to it as “ambiguous . . . awkward, and even ungrammatical”) in the report requirements in 103.1 and 103.2 as well as the risk fee statute in 10(A). Perhaps additional amendments to the statutory framework will resolve and clarify the issues such as to avoid the result in TDX, however, until then, it is advisable for operators to be aware of the risk that they may not be able to recover costs and risk fees from lessees’ interest in production in certain circumstances.

 

George C. Plauché is a partner of Bullen & Plauché. George practices commercial and civil litigation and commercial transactions in the petroleum onshore and offshore industries. George graduated magna cum laude from Millsaps College in 1991 with a B.S. in Physics and received his law degree in 1994 from the Paul M. Hebert School of Law at Louisiana State University. He is admitted to practice in Louisiana and Texas in both state and federal courts.

 

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