SCOTX: When An "Offset Well" Is Not An Offset Well
As I wrote in a recent blog post, oil-and-gas leases will often include an offset drilling clause. Such clauses stipulate that, if a well is drilled on a neighboring tract in proximity to the leasehold, the lessee generally has three options:
- drill an offset well to prevent drainage;
- release acreage, so the lessor can independently drill an offset well to prevent drainage; or
- pay the mineral owner the same royalties it would have received if the off-lease well had been spudded on the lease.
Earlier this month, in Murphy Exploration & Production Co. USA v. Adams, a deeply divided Texas Supreme Court departed from the venerable "plain-language rule" of contract construction when it determined that a lease requiring the operator to drill an "offset well" did not require the operator to drill a well designed to protect against drainage. Rather, according to the 5-4 majority opinion, the operator was required only to drill a well—to the contractual depth set forth in the lease—anywhere on the leased tract. The disputed language from the lease is as follows:
It is hereby specifically agreed and stipulated that in the event a well is completed as a producer of oil and/or gas on land adjacent and contiguous to the leased premises, and within 467 feet of the premises covered by this lease, that Lessee herein is hereby obligated to, within 120 days after the completion date of the well or wells on the adjacent acreage, ... commence drilling operations on the leased acreage and thereafter continue the drilling of such offset well or wells with due diligence to a depth adequate to test the same formation from which the well or wells are producing from [sic] on the adjacent acreage ....
Since the above provision does not oblige the operator to drill an "offset well" in a particular location or at a specific distance from the lease boundary, and because it makes no express reference to combating drainage, the majority determined that any well drilled to depth on the leasehold would satisfy the "offset" drilling clause. In this way, the Court effectively disregarded that the phrase "offset well" is a term of art that, for generations, has had a specific and accepted meaning within the oil-and-gas industry. Justice Lehrmann, writing for the majority, explained that "surrounding circumstances" nevertheless compelled the conclusion that an "offset well" need not necessarily protect against drainage. In particular, the Court observed that the subject lease was executed in 2009, when the parties contemplated "unconventional production in tight shale formations," and, in this regard, "commentators have recognized" that "little or no drainage will occur between [adjacent] tracts" in the specific context of a shale play.
Although the Texas Supreme Court apparently limited its holding to horizontal drilling operations, lessees in all environments would be wise to approach existing offset drilling obligations with an eye toward this decision and the case law that will inevitably develop around it. Additionally, when word-smithing offset drilling provisions going forward, drafters should not assume Texas courts will imbue the term "offset well" with any specific or special meaning. To avoid ambiguity and the often brutal law of unintended consequences, drafters should either specifically define "offset well" or, alternatively, explicitly recite: (i) where an offset well must be drilled; and (ii) what function the well is designed to serve. Of course, depending on the specific definitions that the mineral owner champions, it may sometimes inure to the operator's advantage to retain a degree of ambiguity—which may, in turn, afford greater operational flexibility.