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T D X Energy, L.L.C. v. Chesapeake Operating, Inc.

United States Court of Appeals, Fifth Circuit

May 12, 2017

T D X ENERGY, L.L.C., Plaintiff - Appellant Cross-Appellee
CHESAPEAKE OPERATING, INCORPORATED, Defendant-Appellee Cross-Appellant

         Appeals from the United States District Court for the Western District of Louisiana

          Before PRADO, HIGGINSON, and COSTA, Circuit Judges.

          GREGG COSTA, Circuit Judge

         Captain Anthony F. Lucas struck oil in the Spindletop salt dome in Texas in 1901. A black oil plume erupted to twice the height of the drilling derrick, and the well produced a record 800, 000 barrels of oil within nine days. Others rushed to seize a share of the abundance. Wells were "drilled as close together as physically possible"; "on occasion four wells were drilled beneath one derrick floor."[1] In short order, there were 440 wells on Spindletop's 125-acre hill. Another 600 were drilled around the hill.[2] This is how it looked:[3]

         (IMAGE OMITTED)

         Within a few years, most of the wells were dry. As Captain Lucas remarked, the oil was "milked too hard" and "not milked intelligently."[4]

         To prevent this "tragedy of the commons, " states have enacted regulations in the years since Spindletop. Louisiana's "forced pooling" regime is the subject of this case. It allows the government to authorize a single operator to drill for oil and gas even when all parties possessing oil and gas interests in the drilling area have not agreed to go forward. The Louisiana statutory scheme thus has to address a number of issues that contracts usually decide, such as how to allocate costs and risk among those holding interests in the oil and gas. We are presented with questions of statutory interpretation about this scheme's disclosure and risk-fee provisions.


         Although Spindletop is an extreme example, similar wasteful overproduction was once common. A cause was the "rule of capture, " the common law doctrine initially used in hunting disputes to determine ownership of wild animals unconstrained by property borders. Rance L. Craft, Of Reservoir Hogs and Pelt Fiction: Defending the Ferae Naturae Analogy Between Petroleum and Wildlife, 44 Emory L.J. 697, 708-09 (1995). Taught during the first days of law school, the doctrine says if you catch it first, it is yours. See Pierson v. Post, 3 Cai. 175 (N.Y. Sup. Ct. 1805). Courts later applied the doctrine to oil and natural gas, reasoning that they too cross property borders as they seep and spill through crevices underground. See Brown v. Spilman, 155 U.S. 665, 669-70 (1895). In that context, the rule means a landowner has a property right in oil and gas produced from wells on the owner's land, whether or not it migrated from other lands. Id. at 670 ("If an adjoining owner drills his own land, and taps a deposit of oil or gas, extending under his neighbor's field, so that it comes into his well, it becomes his property."); Robert E. Hardwicke, The Rule of Capture and Its Implications As Applied to Oil and Gas, 13 Texas L. Rev. 391, 393 (1935). So, under the common law, one landowner could drain an entire reservoir through wells on the landowner's property, even if the reservoir extended under others' lands. Naturally, surrounding owners usually would not sit idly by while valuable resources drained out from under them; instead, they raced to produce all the oil and gas they could through their own property, often drilling multiple wells to extract resources as quickly as possible. Frank Sylvester & Robert W. Malmsheimer, Oil and Gas Spacing and Forced Pooling Requirements, 40 U. Dayton L. Rev. 47, 49 (2015). At Spindletop and elsewhere, this drove up production costs, reduced oil and gas market prices, and unnecessarily decimated the environment. Id.

         States intervened, creating often complex regimes to regulate drilling. First, they created spacing laws, which prevent wells from being drilled too close together. Id. at 47-48. Then, to protect landowners who, as a result of spacing laws, were no longer able to drill on smaller tracts of land, they created pooling laws, which allow owners of adjacent tracts to combine their interests to form drilling units that meet spacing requirements. Id. Many states also have "forced pooling laws, " which force unwilling owners to be part of a drilling unit in order to protect their neighbors' rights to benefit from their mineral rights and to promote states' interests in preventing waste and promoting economic activity. Id. at 48.

         Louisiana is one such state. Its Commissioner of Conservation designates drilling units whenever necessary to prevent waste or avoid needless drilling, even if owners of oil and gas interests have not agreed to pool their interests. La. R.S. §§ 30:9(B), 30:10(A)(1).[5] Once a unit has been established, the Commissioner may appoint an operator to extract oil and gas from a reservoir.[6] Hunt Oil Co. v. Batchelor, 644 So.2d 191, 196 (La. 1994). The operator is responsible for drilling within the unit but pays a proportionate share of production to owners of oil and gas interests for any acreage on which the operator does not have an oil and gas lease.[7] La. R.S. § 30:10(A)(1)(b); Amoco Prod. Co. v. Thompson, 516 So.2d 376, 392 (La.App. 1 Cir. 1987). If those other owners have leased their mineral interests to another party, operators often pay the lessee in kind and the lessee markets and sells the oil or gas, then pays its lessor royalties; if not, the operator often sells production and makes a cash payment to the owner. King v. Strohe, 673 So.2d 1329, 1338-39 (La.App. 3 Cir. 1996); see also La. R.S. § 30:10(A)(3).

         As a corollary to this scheme for sharing the benefits of unit production in the absence of a contract, Louisiana law contains mechanisms for sharing drilling risks and costs. See Sylvester & Malmsheimer, supra, at 62-67. Each oil and gas interest owner is responsible for a share of development and operation costs. La. R.S. § 30:10(A)(2). To prevent free riding, the statute creates a mechanism for sharing the risk that a well, once drilled, will not produce enough to cover drilling costs. Id. The operator gives notice to oil and gas interest owners regarding the drilling of a well, allowing owners to elect to participate in the risk by contributing to drilling costs up front. Id. § 30:10(A)(2)(a)(i). If an owner does not participate, and the well produces, the operator can recover out of production the nonparticipating owner's share of expenditures along with a risk charge of two hundred percent of the owner's expenditure share. La. R.S. § 30:10(A)(2)(b)(i); see also Keith Hall, Louisiana Oil and Gas Update, 19 Tex. Wesleyan L. Rev. 361, 365-66 (2013).

         The law also requires operators to share information about the costs and production other owners share under this scheme. Section 103.1 of Title 30 creates an obligation for operators to issue upon request reports containing sworn statements about drilling and operating costs, amount of production, and the price received for any sale of production. La. R.S. § 30:103.1. Section 103.2 provides that when an operator does not provide this information within ninety days of completing a well and thirty additional days of receiving notice of its failure to comply with section 103.1, it cannot collect drilling costs. La. R.S. § 30:103.2.


         As part of this forced pooling regime, the Commissioner of Conservation created an approximately 640-acre drilling unit called "HA RA SUH" in DeSoto Parish. Chesapeake, which held a number of oil and gas leases in this unit, was named the operator. The unit well was "spud" (drilling commenced) on February 5, 2011, and was completed on July 19, 2011. When the well was spud, the oil and gas rights for approximately 63 acres in the unit had not been leased to Chesapeake or any other party (that is, the land owners still held their mineral interests). Touchstone Energy LLC acquired those rights through leases dated before drilling was completed (July 15) but not recorded until after drilling ended (between July 22 and September 14). Touchstone later transferred these leases to TDX with an effective date retroactive to the September 14th date of the final recording.

         In late 2011, TDX notified Chesapeake of its interests and requested an accounting in accordance with section 103.1. About six weeks later, TDX followed up, telling Chesapeake that it was failing to comply with the statute. Chesapeake did not provide reports. Instead it sent TDX a letter asking TDX to make an election whether to participate in the well's risk under section 10(A). TDX responded that the notice was untimely, so TDX was not required to make an election, and Chesapeake could not collect a risk charge. Finally, TDX wrote Chesapeake that by not providing the cost and production data, Chesapeake had forfeited its right to contribution for drilling costs.

         TDX filed suit seeking its share of revenues from the unit well without deduction of drilling costs because Chesapeake did not provide the requested reports. It also sought an order directing Chesapeake to provide the reports. In addition to disputing these claims, Chesapeake filed a counterclaim seeking a declaration that it was entitled to recover TDX's share of costs incurred in drilling, testing, completing, equipping, and operating the well, plus a risk charge of two hundred percent of TDX's share because TDX did not elect to pay a risk fee.

         On competing motions for summary judgment, the district court held: (1) section 103.2 was inapplicable because TDX was leasing the oil and gas interests, so Chesapeake's failure to provide the reports did not excuse TDX from paying its share of drilling costs; and (2) section 10(A) did not allow Chesapeake to collect a risk charge because it had not provided TDX timely notice that it was drilling the unit well. Each party appeals the adverse portion of the judgment. We review these questions of statutory interpretation de novo. Woodfield v. Bowman, 193 F.3d 354, 358 (5th Cir. 1999).



         TDX claims that Chesapeake cannot deduct drilling costs because Chesapeake forfeited that right under section ...

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