Coastal Oil & Gas v. Garza Energy Trust

• Decision Date: 29 August 2008
• Docket Number: No. 05-0466.,05-0466.
• Citation: 268 S.W.3d 1
• Parties: COASTAL OIL & GAS CORP. and Coastal Oil & Gas USA, L.P., Petitioners, v. GARZA ENERGY TRUST et al., Respondents.
• Court: Texas Supreme Court

268 S.W.3d 1

COASTAL OIL & GAS CORP. and Coastal Oil & Gas USA, L.P., Petitioners, v. GARZA ENERGY TRUST et al., Respondents.

No. 05-0466.

Supreme Court of Texas.

August 29, 2008.

Rehearing Denied November 14, 2008.

Elizabeth N. Miller, Jane M.N. Webre, Scott Douglass & McConnico, L.L.P., Austin, TX, for Petitioners.

Ramon Garcia, Law Offices of Ramon Garcia, P.C., Edinburg, TX, Michael D. Jones, Clarence E. Reed, Kilburn Jones & Gill, LLP, Houston, TX, George L. Willingham, Law Offices of George L. Willingham, Bennett Stahl, Curl & Stahl, P.C., Roy R. Barrera III, Golden & Barrera, L.L.P., San Antonio, TX, for Respondents.

Jerry Patterson, Texas General Land Office, Rex H. White, Jr., Law Offices of Rex H. White, Jr., John Robert Hayes, Hayes & Owens, Lindil Carol Fowler, Austin, TX, Everard A. Marseglia Jr., Liskow & Lewis, Houston, TX, Raymond B. Roush, Chesapeake Energy Corp., Oklahoma City, OK, David M. Hundley, Dallas, TX, W. Wendell Hall, Fulbright & Jaworski L.L.P., San Antonio, TX, for Amici.

Justice HECHT delivered the opinion of the Court, in which Justice BRISTER, Justice Green, Judge CHRISTOPHER,¹ and Justice PEMBERTON² joined, and in all but Part II-B of which Justice JEFFERSON, Justice MEDINA, Justice JOHNSON, and Justice WILLETT joined.

The primary issue in this appeal is whether subsurface hydraulic fracturing of a natural gas well that extends into another's property is a trespass for which the value of gas drained as a result may be recovered as damages. We hold that the rule of capture bars recovery of such damages. We also hold:

• mineral lessors with a reversionary interest have standing to bring an action for subsurface trespass causing actual injury;

• the measure of damages for breach of the implied covenant to protect against drainage is the value of the minerals lost because of the lessee's failure to act with reasonable prudence, and there is no evidence of that value in this case;

• some evidence supported the jury's finding of breach of the implied covenant to develop, and whether lessors' repudiation of the lease was a defense was, on this record, a matter of law;

• some evidence supported the jury's finding of bad faith pooling • admission into evidence of a memorandum containing a racial slur was reversible error; and

• the trial court did not abuse its discretion in refusing to abate this case for two related cases.

We reverse the judgment of the court of appeals³ and remand the case to the trial court for further proceedings.

I

Respondents,⁴ to whom we shall refer collectively as Salinas, own the minerals in a 748-acre tract of land in Hidalgo County called Share 13, which they and their ancestors have occupied for over a century. At all times material to this case, petitioner Coastal Oil & Gas Corp.⁵ has been the lessee of the minerals in Share 13 and an adjacent tract, Share 15. Coastal was also the lessee of the minerals in Share 12 until it acquired the mineral estate in that 163-acre tract in 1995. A natural gas reservoir, the Vicksburg T formation, lies between 11,688 and 12,610 feet below these tracts. The following schematic depicts the surface area.

NOTE: OPINION CONTAINING TABLE OR OTHER DATA THAT IS NOT VIEWABLE

Title disputes have roiled the area for years. Coastal interpleaded respondents in a 1978 action to resolve disagreements among them over their respective interests in Share 13. Those issues were resolved by an agreed judgment in 1982. Many Share 13 owners sued in 1988⁶ and again in 1995⁷ over their boundary with Share 15. That issue was not resolved until 1999.⁸ The plaintiffs in those cases also claimed that their gas was being drained to wells on Share 15.

From 1978 to 1983, Coastal drilled three wells on Share 13, two of which were productive, the M. Salinas No. 1 and No. 2V, though the other, the B. Salinas No. 1 ("BS1" on the diagram), was not. In 1994, Coastal drilled the M. Salinas No. 3, and it was an exceptional producer. The No. 3 well was about 1,700 feet from Share 12. The closest well on Share 12 was the Pennzoil Fee No. 1 ("P1" on the diagram), but Coastal wanted one closer, so in 1996, Coastal drilled the Coastal Fee No. 1 in the northeast corner of Share 12, as close to Share 13 (and the M. Salinas No. 3) as Texas Railroad Commission's statewide spacing Rule 37 permitted—467 feet from the boundaries to the north and east.⁹ That location was too close to the Pennzoil Fee No. 1,¹⁰ and the Commission refused Coastal an exception because both wells would drain from Share 13. So Coastal shut in the Pennzoil Fee No. 1, a producing well, in order that it could operate the Coastal Fee No. 1 well near Share 13. In February 1997, Coastal drilled the Coastal Fee No. 2, also near Share 13.

In March, Salinas sued Coastal for breach of its implied covenants to develop Share 13 and prevent drainage. Salinas was concerned that Coastal was allowing Share 13 gas, on which Coastal owed Salinas a royalty, to drain to Share 12, where Coastal, as both owner and operator, was entitled to the gas unburdened by a royalty obligation. Salinas's suit prompted a flurry of drilling by Coastal on Share 13— eight wells in fourteen months. Not until late 1999 did Coastal drill again on Share 12.

The Vicksburg T is a "tight" sandstone formation, relatively imporous and impermeable, from which natural gas cannot be commercially produced without hydraulic fracturing stimulation, or "fracing", as the process is known in the industry. This is done by pumping fluid down a well at high pressure so that it is forced out into the formation. The pressure creates cracks in the rock that propagate along the azimuth of natural fault lines in an elongated elliptical pattern in opposite directions from the well. Behind the fluid comes a slurry containing small granules called proppants—sand, ceramic beads, or bauxite are used—that lodge themselves in the cracks, propping them open against the enormous subsurface pressure that would force them shut as soon as the fluid was gone. The fluid is then drained, leaving the cracks open for gas or oil to flow to the wellbore. Fracing in effect increases the well's exposure to the formation, allowing greater production. First used commercially in 1949, fracing is now essential to economic production of oil and gas and commonly used throughout Texas, the United States, and the world.

Engineers design a fracing operation for a particular well, selecting the injection pressure, volumes of material injected, and type of proppant to achieve a desired result based on data regarding the porosity, permeability, and modulus (elasticity) of the rock, and the pressure and other aspects of the reservoir. The design projects the length of the fractures from the well measured three ways: the hydraulic length, which is the distance the fracing fluid will travel, sometimes as far as 3,000 feet from the well; the propped length, which is the slightly shorter distance the proppant will reach; and the effective length, the still shorter distance within which the fracing operation will actually improve production. Estimates of these distances are dependent on available data and are at best imprecise. Clues about the direction in which fractures are likely to run horizontally from the well may be derived from seismic and other data, but virtually nothing can be done to control that direction; the fractures will follow Mother Nature's fault lines in the formation. The vertical dimension of the fracing pattern is confined by barriers—in this case, shale—or other lithological changes above and below the reservoir.

For the Coastal Fee No. 1, the fracing hydraulic length was designed to reach over 1,000 feet from the well. Salinas's expert, Dr. Michael J. Economides, testified he would have designed the operation to extend at least 1,100 to 1,500 feet from the well. The farthest distance from the well to the Share 13 lease line was 660 feet.¹¹ The parties agree that the hydraulic and propped lengths exceeded this distance, but they disagree whether the effective length did. The lengths cannot be measured directly, and each side bases its assertion on the opinions of an eminent engineer long experienced in hydraulic fracturing: Economides for Salinas, and Dr. Stephen Allen Holditch for Coastal. Holditch believed that a shorter effective length was supported by post-fracing production data.

All the wells on Share 12 and Share 13 were fraced. As measured by the amount of proppant injected into the well, the fracing of the Coastal Fee No. 1 and No. 2 wells was, as Economides testified, "massive", much larger than any fracing operation on a well on Share 13. Several months after filing suit, Salinas amended his pleadings to assert a claim for trespass, alleging that Coastal's fracing of the Coastal Fee No. 1 well invaded the reservoir beneath Share 12, causing substantial drainage of gas.

In 1997, Coastal formed an 80-acre unit comprised of just under 73 acres in the southwest corner of Share 13 and a little over seven acres in the southeast corner of Share 12. The unit included the M. Salinas No. 2V and No. 4 wells but did not include a well on Share 12. The unit benefited Salinas by making it possible for the M. Salinas No. 8 to be drilled in the most desirable location, within 1,200 feet of the M. Salinas No. 2-V, which Rule 37 would otherwise have prohibited.¹² But Salinas complained that the unit effectively freed Coastal from its royalty obligation on the amount of gas equal to Share 12's portion of the gas produced from the two unit wells on Share 13, about nine percent (7/80ths), since that amount would be apportioned to Share 12, and that Salinas would have received the same benefit—the No. 8 well—along with higher royalties if Coastal had included only one Share 12 acre in the unit. Salinas added to his lawsuit a claim for bad-faith pooling.

At trial, Salinas claimed that he had lost royalty revenue because of Coastal's delay in...