One Oil and Gas Right to Rule Them All
43 Pages Posted: 22 Mar 2017 Last revised: 27 May 2018
Date Written: March 19, 2017
The proverbial “bundle of sticks” is an analogy familiar to real property scholars. The analogy compares property ownership to a bundle of sticks — that is, ownership composed of separate and individual property rights — where each “stick” represents a right or stream of benefits available to the property owner. Under the centuries-old common law ad coelum doctrine, real property contained all lands from the core of the earth to the sky. Although this “heaven-to-hell” doctrine is now limited, oil and gas still composes that part of subsurface real property, sometimes called the mineral estate. In oil and gas law, the mineral property bundle is composed of five essential attributes: (1) the right to develop (and the right of ingress and egress); (2) the right to make decisions affecting exploration and development of the mineral estate; (3) the right to receive bonus payments; (4) the right to receive delay rentals; and, (5) the right to receive royalty payments. The right to make decisions affecting exploration and development of the mineral estate is also called the “executive right.”
Commonly, the executive right refers to the right to execute an oil and gas lease, which is both a contract and a conveyance of the subsurface mineral estate. The oil and gas lease not only governs the rights and obligations between the parties; it is also a property construct—either a profit à prendre or a fee simple determinable, depending on the jurisdiction. In states that classify the oil and gas lease as a profit à prendre (e.g., Oklahoma), the lessee — the party that takes the lease — owns an incorporeal and nonpossessory right to take or an irrevocable license. In states that classify the oil and gas lease as a fee simple determinable (e.g., Texas), the lessee owns a mineral property interest in fee simple subject to the condition of continued oil and gas production.6 If actual or constructive production ceases, the oil and gas lease automatically terminates and the mineral estate reverts to the lessor — the party that granted the lease.
Although the executive right is part of the mineral estate’s bundle of sticks, it is, in fact, the most important property right. Without the right to execute an oil and gas lease or self-develop, (1) there is no development of the mineral estate; (2) there is no bonus, which is the amount paid as an incentive to enter into an oil and gas lease; (3) there are no delay rentals, which are the payments made during the primary term of an oil and gas lease that serve as constructive production; and (4) there are no royalty payments, which are a cost-free share of production that arises out of an oil and gas lease. Therefore, the executive right is the most important and governing right of all the mineral property rights. Like the One Ring in Tolkien’s The Lord of the Rings, the executive right rules them all.
The holder of the executive right (the “executive”) obtains the right through a conveyance or deed instrument, which may or may not include an associated mineral or royalty interest. If the executive holds the right absent any associated mineral or royalty interest, he holds a “naked” right. At present, there is not a bright-line “for the characterization of sole ownership of the executive right in Texas.” Few cases involve an executive holding only the right without an associated mineral or royalty interest.11 In fact, the executive right is commonly coupled with a fractional interest in the minerals or royalty.
Challenges arise when the executive right is severed from the subsurface mineral estate. If the intentions of the executive conflict with those of the holder of the associated mineral interest (the “nonexecutive”), tensions form concerning the owed — whether actual or perceived — obligations or duties. For example, whereas an executive with a real estate surface development may desire prohibiting oil and gas operations to satisfy buyer or lender preferences, the nonexecutive mineral or royalty interest owner desires oil and gas development and production to acquire potential future revenues. Analogously, the severed executive right is comparable to one person owning the cake — the mineral interest — and another person owning the right to eat the cake or the right to allow someone else to eat it.
Over the past century, courts have used a standard of conduct approach to review the relationship between the executive and nonexecutive. These standards have varied, moving between ordinary good faith, fiduciary, and good faith and utmost fair dealing. But determining compliance with an inconsistent standard relies primarily on a fact-based analysis, which provides little certainty in oil and gas jurisprudence and mineral title examination.
This Article identifies major issues that arise out of the severance of the executive right from the underlying mineral estate, focusing on scenarios where the preferred outcome of the executive does not harmonize with that of the nonexecutive. That is, when the executive wishes to prohibit oil and gas development and the nonexecutive does not desire the same. First, severance of the executive right violates the basic premise underlying oil and gas jurisprudence—the belief that mineral resources should not be wasted. This fundamental disapproval of waste shapes the producing state’s regulatory system, which essentially codifies this aversion in the rules of the regulating agency. Second, the ownership intentions of a disagreeing executive and nonexecutive cannot be reconciled for mutual benefit. Therefore, the rights of one property owner — usually the nonexecutive — are likely to be disregarded in favor of another — usually the executive. The nonexecutive requires oil and gas production in order to obtain the benefit of his property interest. But an executive interested in surface development likely acquired the executive right to effectuate the intent of his desired goals. Those goals likely do not include oil and gas production. Finally, the loss of a defining characteristic of the mineral estate — the right to execute the oil and gas lease — leads to economic inefficiencies in the ensuing transactions after severance. Therefore, severance of the executive right prevents optimization of the property interest.
To address these issues, this Article examines several resolution mechanisms: (1) prohibition of severance of the executive right from the associated mineral estate (non- retroactive); (2) adverse possession of the executive right by the nonexecutive; (3) adoption of a variable standard of conduct approach; (4) enacting legislation similar to dormant mineral acts, which encourage development of mineral resources by declaring mineral interests abandoned after a prescribed period of time and reuniting the severed mineral and surface estate; and, (5) finding an implied covenant to execute an oil and gas lease in the instrument that severs the executive right from the mineral interest.
Part II of this Article discusses the nature of the executive right and describes the major issues that arise out of executive right severance with non-agreeing property owners. Part III examines standards of conduct and reviews the jurisprudence of executive right decisions. Part IV discusses possible solutions to the problem of the executive right. Part V reviews practical solutions with respect to the executive right, and Part VI concludes this Article. Finally, discussion within the paper shall be limited to the executive right as it pertains to the leasing of the mineral interest. This Article also focuses on Texas law due to the limited (practically non-existent) forced pooling power under the Mineral Interest Pooling Act (“MIPA”).
Keywords: executive right, oil and gas lease, mineral, oil and gas, Keep it in the Ground, implied covenant, adverse possession, dormant mineral act, restraint on alienation, standard of conduct
JEL Classification: K11
Suggested Citation: Suggested Citation