Amoco Production Co. v. Alexander
622 S.W.2d 563, 72 Oil & Gas Rep. 125, 18 A.L.R. 4th 1 (1981)
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Rule of Law:
An oil and gas lessee's implied covenant to protect the leasehold requires it to act as a reasonably prudent operator to prevent substantial field-wide drainage, and this duty is not diminished when the lessee is a common lessee also operating the updip leases that are causing the drainage.
Facts:
- The Hastings, West Field is a water-drive oil field where water in the reservoir naturally pushes oil from lower 'downdip' locations to higher 'updip' locations as oil is produced.
- The Alexanders are lessors who own a 1/6th royalty interest in several downdip leases within the field.
- Amoco Production Co. (Amoco) is the lessee of the Alexanders' downdip leases.
- Amoco is also a 'common lessee,' meaning it holds leases on updip properties in the same field, which have a lower royalty rate of 1/8th.
- Amoco increased its oil production on its updip leases while simultaneously decreasing production on the Alexanders' downdip leases.
- This strategy caused the Alexanders' leases to 'water out' (become unproductive) prematurely, while the unproduced oil migrated to Amoco's updip leases where Amoco could capture it and pay a lower royalty.
- Amoco did not drill additional wells or rework existing ones on the Alexander leases to mitigate this drainage, nor did it apply for administrative permits to do so.
Procedural Posture:
- The Alexanders (lessors) sued Amoco (lessee) in a Texas trial court for breach of implied covenants.
- A jury found that Amoco failed to operate the leases as a reasonably prudent operator and had an intentional policy to maximize its own profits at the Alexanders' expense.
- The trial court rendered judgment for the Alexanders, awarding both actual and exemplary (punitive) damages.
- Amoco, as appellant, appealed to the Texas Court of Civil Appeals.
- The Court of Civil Appeals, as an intermediate appellate court, reformed the trial court’s judgment but affirmed Amoco's liability and the damage awards.
- Amoco subsequently appealed to the Supreme Court of Texas.
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Issue:
Does an oil and gas lessee's implied covenant to protect against drainage require the lessee to take actions a reasonably prudent operator would to prevent substantial field-wide drainage, even when the lessee is also the operator of the updip leases causing the drainage?
Opinions:
Majority - Campbell, Justice
Yes. A lessee's implied duty to protect the leasehold from drainage extends to field-wide drainage, not just local drainage. The governing standard is what a reasonably prudent operator would do under the circumstances to protect the lessor's interest from substantial drainage. This duty is not excused or lessened because the lessee is a 'common lessee' with conflicting economic interests; the lessee's conduct must be judged as if the plaintiff's lease were the only one it operated in the field. This duty may require the lessee to drill additional wells, rework existing wells, or seek favorable administrative action, such as applying for drilling permits as an exception to spacing rules. However, a breach of this implied covenant sounds in contract, not tort, so exemplary damages are not recoverable unless a distinct, independent tort is alleged and proven.
Analysis:
This decision significantly clarified Texas oil and gas law by extending the lessee's implied covenant to protect against drainage from the traditional context of 'local drainage' (by a third-party's adjacent well) to the more complex scenario of 'field-wide drainage.' It establishes that a lessee cannot hide behind its status as a common lessee to justify draining one lessor's property to benefit its operations on another. The ruling solidifies the reasonably prudent operator standard as the benchmark for a lessee's conduct in all drainage situations, imposing a duty to take proactive, profitable steps, including navigating regulatory processes, to protect a lessor's interest. By classifying the breach as contractual, the court also limited potential remedies, precluding punitive damages and reinforcing the commercial nature of the lease relationship.
