The El Paso Court of Appeals recently issued an opinion in Cactus Water Services, LLC v. COG Operating, LLC answering the question of who owns produced water resulting from oil and gas production in Texas. [Read Opinion here.]

Photo by Documerica on Unsplash

Produced Water Basics

This case involves a question of the ownership of produced water. As explained in more detail below, this is water, along with a number of other substances, that travels to the wellbore in the fracing process.  To offer a bit of perspective on the scope of this issue, the Texas Tribune recently reported that in Texas, for ever barrel of oil, an average of seven barrels of water is produced.  In 2019, in the Permian Basin alone, it is estimated 3.9 billion barrels of produced water was produced.  With water scarcity and growing technology, produced water may now be treated and sold for re-use in oil and gas operations.

Background

This case involved 37,000 acres of land in Reeves County, Texas.

COG Leases and Agreements

COG Operating, LLC (“COG”) leases minerals on the land pursuant to four leases.  The surface of the land is owned by two surface owners.  Each mineral lease gives COG the exclusive right to explore for and produce oil and gas on the leased lands.  Relevant here, the leases provide that COG has no right to use water which is on or under the land, except it may drill a water well and use the water from that well in its drilling operations on the land.

COG uses hydraulic fracturing  (“fracing”) in their operations in the region.  “Fracing involves pumping fluid down a well at high pressure so that it is forced out into the formation which creates cracks in the rock that propagate along with azimuth of natural fault lines in an elongated elliptical pattern in opposite directions from the well.”  The fracing fluid contains proppants that keep the cracks open and allow the oil and gas to flow to the wellbore.   What travels to the wellbore includes a number of additional substances in addition to hydrocarbon, including “sodium calcium potassium, stontium, barium, iron, carbon dioxide, and brine, or water molecules mixed with hydrogen sulfide and chloride.” Once the stream reaches the surface, the oil and gas are separated out, and the remaining substance is known as “produced water.”  Because fracing requires so much water per well, it also generates large amounts of produced water.  This is particularly true in the Permian Basin, where the land here is located.  Since COG entered into the leases in 2005, its operations have resulted in over 52 million barrels of produced water.  Given the number of substances included in the produced water, it poses a danger to the environment and other water sources and must be carefully disposed of and there are a number of regulations surrounding this type of disposal.

However, recently, new water treatment technologies have created a new industry in which the produced water can be treated and then sold back to operators for drilling.

COG also has surface use and right-of-way agreements with the surface owners to facilitate its use of the surface estate when it transports product and waste, including produced water, from its wells. The surface use agreement provides that COG can “construct, operate and maintain tank battery sites…for the gathering, storing, and transporting of oil, gas, other petroleum products, water, and/or any other liquids, gasses, or substances which can be transported through a pipeline…” It also expressly allows for produced water lines to be laid on the surface of the land.  The right-of-way agreement likewise allows laying of pipelines for the transportation of oil, gas, petroleum, produced water, and any other oilfield related liquids or gases.

Cactus Leases

In 2019 and 2020, the surface owners transferred all of the surface estates’ water rights on the 37,000 acres to Cactus Water Services, LLC (“Cactus”). The lease agreements give Cactus ownership and the right to sell all water “produced from oil and gas wells and formations on or under” the leased land.  The lease defines “water” as “any and all water contained in and produced from geologic formations under the Subject Property through any wellbores drilled for the production of oil, gas, and natural gas liquids…whether economically productive or not, regardless of salinity.  ‘Water’ excludes all water originating from shallow geological intervals that do not and have never produced oil, other hydrocarbon liquids, and/or natural gas anywhere in the Permian Basin.  ‘Water’ also excludes water purposefully and directly produced from the Ogallala, Pecos Valley Alluvium, Edwards Trinity, Dokum Aquifers or any other freshwater aquifers.”

Litigation

Cactus informed COG of its produced water leases in March 2020.  COG sued, seeking a declaratory judgment that it has the sole right to the produced water by virtue of its mineral leases, surface use and right-of-way agreements, and common law.  Cactus counterclaimed asserting ownership of the produced water based on its water leases.  Thus, the question before the court was whether the mineral leases conveyed the produced water to COG.  If so, the surface owners’ later transfer of the produced water to Cactus is void.  If not, Cactus is the owner of the produced water per its lease with the surface owners.

Both parties moved for summary judgment. The trial court ruled in COG’s favor holding that it owns the produced water by virtue of its mineral leases.  Cactus appealed.

Court of Appeals Opinion

The El Paso Court of Appeals affirmed.  [Read Opinion here.]

Mineral Lease Language

The court started with the language of the mineral leases.  Cactus argued that the mineral leases grant the right to “oil, gas and other hydrocarbons,” which does not encompass all produced water from the oil-and-gas bearing formations.   Cactus also contended that because the mineral leases limit COG’s right to use the surface water, COG cannot sell produced water to third parties for off-premises use.  Conversely, COG argued that the leases must be construed to effectuate the parties’ intent to convey oil and gas in their natural form, which includes produced water.  COG also argued it has an ownership right through its development rights under mineral leases, which includes the right to dispose of waste generated by its wells.

Meaning of Waste and Water

The court said that the real question in this case of whether produced water is part of the mineral estate “depends on whether produced water is, as a matter of law, water or if it is waste.”  Neither the terms “water” nor “waste” is defined in the mineral leases.  Thus, the court looked to statutory and regulatory definitions for the relevant context and meaning.  The court looked to definitions of “oil and gas waste” in the Texas statutes and Railroad Commission regulations.  Statutes provide that oil and gas waste means waste “that arises out of or incidental to the drilling for or producing of oil or gas…including salt water, brine, sludge, drilling mud, and other liquid, semiliquid, or solid waste material.”  Another definition expressly includes “produced water” as being included in the meaning of “fluid oil and gas waste.”  Statutes and regulations define “fresh water” as having bacteriological, physical, and chemical properties which make it suitable and feasible for beneficial use for any lawful purpose” and “groundwater” as “water percolating below the surface of the earth.”

This framework, the court held, “draws a clear distinction between produced water and groundwater.”  Because the legislature defines produced water as oil and gas waste, it cannot also be considered groundwater.  Further, the court noted, “produced water” is a misnomer as it bears little resemblance to water given the numerous constituents it contains beyond water.   The court also noted the regulations on operators to keep oil and gas waste, including produced water, from polluting surface or subsurface water, again indicating a distinction between the two.

In addition, the court stated that characterizing produced water as oil and gas waste is consistent with industry practice.  “Indeed, produced water has long been treated as a liability, not an asset, both throughout the fracing industry and in the context of COG’s operations on the leased land.”  The court explained that the surface owners never tried to claim ownership over the produced water before entering into the lease with Cactus.  “To read the mineral leases as reserving produced water–something that exists separate from oil and gas only after processing and treatment–for the surface estate would give the surface estate (and thus Cactus) the benefit of costs and risks COG voluntarily undertook.”

Holding

Because the mineral leases were negotiated against this backdrop, the court held that the produced water is considered an oil and gas waste rather than water, and nothing in the mineral leases indicates the parties intended to modify this common practice.  The court does note the parties could have done so by express reservation, but did not.  Thus, although the mineral leases restrict COG’s use of “water” on the leased land, that “has no bearing on COG’s right to the oil and gas waste byproduct from its wells.”

The court held that COG has the exclusive right to the oil and gas production stream including the produced water.  The subsequent leases purporting to convey produced water rights to Cactus were void.  The court affirmed.

Potential Appeal

Do note that this opinion was recently issued.  The Texas Supreme Court recently granted an extension of time to file an appeal in this case.  Given the importance of this issue, it seems almost certain an appeal will be forthcoming.

Dissent

Judge Gina M. Palafox wrote a dissenting opinion.   [Read Dissent here.]

She began her dissent by noting it has long been held that water is part of the surface state in Texas, but also understood that the surface estate must accommodate the reasonable use of the water as necessary to effectuate oil and gas production.  However, she said that the majority’s decision “upends this balancing of competing rights and responsibilities.”  She disagreed with the majority’s opinion, and she would interpret the lease language as conveying oil, gas, and hydrocarbons produced from the leased land, but not the water incidentally recovered from the subsurface, from which oil and gas was removed.

The Mineral Leases

Judge Palafox said the question here should not be whether the leases transferred ownership of produced water to COG, but instead whether the entire “product stream” (of which produced water is a part) is conveyed by a granting clause conveying only oil and gas.  She noted that neither produced water nor “oil and gas waste” are mentioned in the mineral leases.  She explained that when land is severed, the surface owner owns the groundwater in place beneath the land.  She also noted that the severance of a mineral estate is typically done by granting or reserving “oil, gas, and other minerals.”  The conveyances here were more limited, granting only “oil, gas, and other hydrocarbons.”  Water does not fall within this category. Unless water is expressly reserved or conveyed, it remains with the surface owner. Here, there was no such express conveyance.  She reasoned that, despite a conveyance, the mineral owner does have an implied right to use the water as reasonably necessary to produce the mineral.  This, she explained, is why the right of COG to use water in its operations was expressly limited by the contract.  “If all of the subsurface water had been granted to COG, there would be no need to include such limiting provision.”

The Surface Use and Right-of-Way Agreements

She disagreed with the majority that these other agreements give COG the right to all produced water.  She noted that the fact that water and produced water are distinctly listed along with oil and gas indicate the parties recognized that they were separate from the oil and gas specifically granted by the lease agreements.  Certainly, the parties could have included additional substance in the granting clauses, but they did not do so. Here, specific substances–oil and gas–were conveyed while others–produced water–were not.

Characterization of Produced Water

She also noted that just because water is produced from an oil and gas well, that does not necessarily change its character. She cites to the Texas Supreme Court’s prior decision in Robinson v. Robbins Petroleum Corp., a case involving a dispute over ownership of salt water produced from a well.  There, the Court rejected a rule that saltwater produced from a well should be treated differently, noting that “the water itself is an incident of surface ownership in the absence of specific conveyancing language to the contrary.” She read the Robinson decision as making clear that even deeper, mineralized water produced from a well belongs to the surface estate absent a specific conveyance.

In squaring this interpretation with the accommodation doctrine, she would hold that while COG has the right to use the produced water as is reasonably necessary to produce the oil and gas, it has no ownership rights to the produced water.  That ownership remains with the surface owner.

Surrounding Facts and Circumstances

She disagreed with the majority’s reliance on statutory and regulatory definitions and industry practices as well.   She noted that at least one of the statutory provisions the majority relies upon listing produced water as a waste product was passed after the mineral leases at issue were signed.  Further, while produced water is listed in the definition of oil and gas waste, it is not otherwise defined.  Similarly, the mere fact that COG has an obligation to safely dispose of waste does not provide any authority to effectuate a transfer of property rights.

Lastly, she stated that even if one party (the surface owner) waives his or her rights to any water included in the produced oil and gas by allowing COG to dispose of such water, that does not necessarily reflect a waiver of ownership rights. The fact that COG undertook the cost and risk of disposal and the parties only recently perceived the waste as having any value are inapplicable here. COG was contractually and statutorily required to dispose of or deal with the produced water so that it would not harm the environment.  This is not the same as the severance of ownership rights to water from the surface estate.

Conclusion

She would hold the oil and gas lease contains no express language conveying water to COG.  Instead, she would conclude the surface owner owned the produced water and conveyed those rights  to Cactus.

Key Takeaways

There are a number of important takeaways from this case.

First, it is a good reminder that changing technologies can sometimes result in legal issues that may not have been foreseen.  As the majority notes, this issue likely would not have arisen until technology allowed to treating the produced water and, thereby, creating a value for such water.  It is also interesting to ponder how this case could impact water law more generally and whether there are other circumstances that might arise where a surface owner is found not to own water in certain circumstances.

Second, the specific language in an oil and gas lease are critical.  Here, the parties are going through the oil and gas leases with fine-tooth combs to determine what the parties may have intended.   This is why I always recommend working with an attorney experienced in oil and gas law when negotiating any oil and gas lease or surface use agreement.

Third, this issue raises an important consideration for any party signing an oil and gas lease or surface use agreement to address the issue of produced water.  Given the market for such water that now exists, all future leases and agreements should expressly state who will have the ownership rights to any produced water.  The parties should also consider what implications that may have with regard to storage, transportation and disposal responsibilities.