Amoco Production Co. v. Alexander
| Decision Date | 28 September 1981 |
| Docket Number | No. B-9131,B-9131 |
| Citation | 622 S.W.2d 563 |
| Parties | AMOCO PRODUCTION COMPANY, Petitioners, v. John ALEXANDER et al., Respondents. |
| Court | Texas Supreme Court |
McGinnis, Lochridge & Kilgore, Robert C. McGinnis and John W. Stayton, Jr., Austin, Dean J. Capp and James D. Klutz, Houston, for petitioners.
Scott & Douglass, Frank Douglass and Tom Reavley, Jr., Austin, Leland B. Kee, Angleton, for respondents.
This is an action by royalty owners for damages because of field-wide drainage. The trial court, after a jury verdict, rendered judgment for the Alexanders, lessors, for actual and exemplary damages against Amoco, lessee. The Court of Civil Appeals reformed the trial court's judgment and affirmed the judgment as reformed. 594 S.W.2d 467. We modify the judgment of the Court of Civil Appeals and affirm the judgment as modified.
The Hastings, West Field, in Brazoria County, is a water-drive field. Water and oil are in the same reservoir. Because water is heavier than oil, the water moves to the bottom of the reservoir driving the oil upward. As oil is removed, water moves up to fill the space.
As the oil is produced, the oil-water contact (a measure of the reservoir water level) gradually rises until the wells begin to produce The Hastings, West Field, reservoir is not horizontal. It is highest (closer to the surface) in the southeast part. It is lowest in the northwest. Hence, the reservoir dips downward gradually from the southeast to the northwest. Leases on the higher part of the reservoir are called "updip leases" and on the lower, "downdip leases." The Alexanders' leases with Amoco are downdip. Amoco, with 80% of the field production, also has updip leases. Exxon, Amoco's chief competitor in the field, owns leases generally updip from the Alexanders and downdip from the remainder of the Amoco leases.
water along with oil. As the wells are produced, the fluid from the wells contains increasingly higher percentages of water. When the wells produce almost all water, the wells are abandoned. The wells are then said to be "watered out" or "flooded out."
In water-drive fields, such as the Hastings, West Field, natural underground conditions and production of oil updip work to the disadvantage of downdip leases. As the oil is produced, the oil-water contact rises. The greater the production from updip leases, the sooner the wells on downdip leases will be "watered out" because of the water-drive pushing the oil to the highest part of the reservoir. The downdip leases, therefore, are the first to water out. Moreover, production anywhere in the field will cause the oil-water contact to rise and move from the downdip leases to the updip leases. This is field-wide drainage.
The Alexanders' theory of this lawsuit is that Amoco slowed its production on the Alexander-Amoco downdip leases and increased production on Amoco updip leases causing the Alexander-Amoco downdip leases to "water out" much sooner. Oil not produced from the Alexander leases will eventually be recovered by Amoco as the water pushes the oil to the Amoco updip leases. Their theory of liability is that Amoco owed the Alexanders an obligation to obtain additional oil production from the Alexander leases by drilling additional wells and reworking existing wells to increase production. If Amoco had fulfilled that obligation, additional oil would have been produced from which the Alexanders would have been paid 1/6th royalty. The Amoco updip leases pay 1/8th royalty.
The Alexanders contend they pleaded two legal theories of recovery: (1) in contract, breach of Amoco by its implied obligation to take such steps as a reasonably prudent operator would have taken to protect the Alexander leases from drainage; and (2) in tort; for "intentional acts and omissions" undertaken by Amoco "for the purpose of increasing Amoco's production from its updip leases" and the deliberate waste of the Alexanders' royalty oil. The jury found:
(1) Amoco failed to operate the Alexander leases as a reasonably prudent operator.
(2) Amoco operated its leases under an intentional policy of maximizing its profits by producing less oil from the Alexander leases than would have been produced by a reasonably prudent operator, while increasing the drainage of oil from the Alexander leases by Amoco production on other leases.
The jury awarded actual and exemplary damages.
We must determine whether:
(1) Amoco had a duty to protect from field-wide drainage, or a duty not to drain the Alexander downdip leases by its operations updip.
(2) Amoco had a legal duty under the Alexander leases to apply to the Railroad Commission for permits to drill additional wells at irregular locations, to obtain the permits, and drill the wells
(3) The trial court erred in admitting testimony that the Railroad Commission would have granted exception permits to allow Amoco to drill additional wells on the Alexander leases.
(4) The Alexanders are entitled to recover exemplary damages.
Whether Amoco had a duty to protect the Alexander downdip leases from field-wide drainage, or a duty not to drain the leases by its updip operations has not been considered by the Texas courts. The Court of Civil Appeals held Amoco had a duty to protect the Alexanders from field-wide drainage.
An oil and gas lessee has an implied obligation to protect from local drainage. Local drainage is oil migration from under one lease to the well bore of a producing well on an adjacent lease. Local drainage depends upon production from wells in a specific area in a field. It will begin, increase, or decrease according to production. Local drainage may be in several directions in one field and can be prevented by drilling offset wells. Field-wide drainage in a water-drive field, however, is relatively independent of the location of particular wells. It depends on the water-drive and production from all wells in the field. Protecting from field-wide drainage, therefore, is more difficult than protecting from local drainage.
Amoco urges the Court of Civil Appeals correctly held the drainage in this case was field-wide but the court erred in holding the law imposes an obligation upon Amoco to prevent field-wide drainage, or an obligation not to drain the Alexander leases by its updip operations. Amoco recognizes the obligation to protect from local drainage, but states the Court of Civil Appeals was in error in extending that obligation to require a lessee to protect his lessor from field-wide drainage. Amoco argues this imposes a new implied obligation never previously held to exist.
Has the Court of Civil Appeals imposed a new obligation never previously held to exist? The terms "obligation," "duty," and "covenant" have been used interchangeably in oil and gas cases to describe the performance required of a lessee under an oil and gas lease. Traditionally, matters relating to the development of the lease and the protection of the lessor's interest are not expressly included in the written lease. Since the early history of oil and gas litigation, the courts have held that covenants are implied when an oil and gas lease fails to express the lessee's obligation to develop and to protect the lease. In recent years, implied covenants have been expanded to matters of management of the lease. The words "duty" or "obligation" are best used to express the requirements of a lessee in performance of the implied covenants.
Commentators differ on the classification of implied covenants in oil and gas leases. See R. Hemingway, The Law of Oil and Gas § 8.1 (1971); 5 E. Kuntz, a Treatise on the Law of Oil and Gas § 55.1 (1978); 5 H. Williams & C. Meyers, Oil and Gas Law § 804 (1980); Walker, The Nature of the Property Interests Created by An Oil and Gas Lease in Texas, 11 Texas L.Rev. 399 (1933). These covenants are usually grouped into categories according to the factual basis of the dispute between the lessor and lessee. 5 H. Williams & C. Meyers, Oil and Gas Law § 804 (1980). However, these categories are specific applications of three broad implied covenants to particular controversies. These broad implied covenants are: (1) to develop the premises, (2) to protect the leasehold, and (3) to manage and administer the lease. 1
The standard of care in testing the performance of implied covenants by lessees is that of a reasonably prudent operator under the same or similar facts and Amoco contends the Court of Civil Appeals' holding expands the offset drilling obligation beyond the point of fairness and workability by including within it the obligation to offset field-wide or regional drainage. Field-wide drainage affects all leases in the field; and if the duty exists, each lessee may be required to drill offset wells. The drilling of offset wells increases field-wide drainage and sets off a chain reaction the drilling of each additional well would trigger a field-wide obligation to drill more offsets and each drilling would further accelerate the field-wide drainage. Amoco argues, therefore the end result of carrying out the obligation would be self-defeating.
circumstances. Shell Oil Co. v. Stansbury, 410 S.W.2d 187, 188 (Tex.1966); Texas Pac. Coal & Oil Co. v. Barker, 117 Tex. 418, 431-32, 6 S.W.2d 1031, 1035-36 (1928). The reasonably prudent operator concept is an essential part of every implied covenant. Every claim of improper operation by a lessor against a lessee should be tested against the general duty of the lessee to conduct operations as a reasonably prudent operator in order to carry out the purposes of the oil and gas lease.
Amoco also says that updip leases enjoy a natural advantage over downdip leases. If the natural drainage is to be offset, the only valid way is through field-wide regulation by the Railroad Commission regulating rates of production to protect correlative rights in the field.
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