A recent ruling by the El Paso Court of Appeals decided the issue of produced water as a mineral vs. a water right between two lessees on 37,000 acres of land in Reeves County. The decision is of particular significance given the transition of produced water from liability to asset.
COG Industries (COG) had been granted mineral leases in 2005, 2010, and 2014, giving it the exclusive right to discover and extract oil and gas on the leased property. In later executed leases, the owners of the surface estate leased the water rights to Cactus Water Services (Cactus), specifically giving the company the right to sell the water produced from the oil and gas wells.
Both companies claimed ownership rights to the produced water under their leases. The trial court decided that produced water was a mineral right as part of the oil and gas extraction process, and the appellate majority agreed. However, the dissenting opinion raises some issues, and the matter could still end up before the Texas Supreme Court.
What is Produced Water?
Produced water is a large volume byproduct of oil and gas extraction operations. The rock that contains oil and gas also contains water which is released during the fracturing process. Produced water is brought to the surface along with the oil and gas. Approximately 21 billion barrels of produced water are generated from U.S. oil and gas operations each year.
Traditionally, produced water has been considered an environmentally toxic waste product with high disposal costs. However, water shortages and new treatment technologies have helped turn produced water into a commodity that can be sold for reuse. Treated produced water can be used in oil and gas operations, for fire control, to generate power, for vehicle and equipment washing, and for non-edible crop irrigation.
Produced Water as a Mineral Right in Texas
In Cactus Water Services vs. COG Industries, the Court of Appeals for the Eighth District focused on the character of the produced water to determine ownership and concluded that produced water was a waste product of oil and gas extraction. It therefore belonged to COG Industries as part of the process of extracting oil and gas under their mineral leases.
Surface use and right-of-way agreements between COG and the surface owners refer to ‘freshwater’ and ‘produced water’ and limit the use of ‘water’ that is on or under the leased property but do not otherwise explain what is intended with regard to the ownership of produced water.
The court looked to see how produced water is generally regarded by existing laws and in the oil and gas industry as well as in the dealings between the parties. The court noted that the Texas Natural Resources Code, Water Code, and Railroad Commission all define oil and gas waste to include ‘produced water.’ Alternatively, the Water Code and Railroad Commission define ‘water’ to mean freshwater, groundwater, and/or surface or subsurface water.
The court then considered how the oil and gas industry has viewed produced water as a significant cost of doing business that requires appropriate disposal to avoid liability. COG had incurred considerable expense disposing of produced water over the course of its leases.
Finally, the court considered how COG and the lessors dealt with the produced water during the course of the leases and found no attempt by the lessors to claim ownership of the produced water until new technology made produced water a valuable asset rather than a costly liability.
2019 Change in the Natural Resources Code Affects Produced Water Ownership Rights
The appellate court recognized a 2019 addition to the Natural Resources Code that addressed the ownership of fluid oil and gas waste while acknowledging the new provision was not retroactive and had no bearing on the matter under consideration.
The change added Section 122.002, which states that unless an oil and gas lease specifically provides otherwise, when fluid oil and gas waste is produced and used by or transferred to a person for the purpose of treating the waste for a subsequent beneficial purpose the waste is considered to be the property of the person who takes possession of it.
Dissenting Justice Argues No Transfer of Water Rights
The dissenting justice argues water is water and points out the well-established law in Texas that, unless expressly conveyed, water rights remain an incidence of surface ownership. Since the leases do not expressly convey the produced water rights to COG, they should remain with the surface estate and thus belong to Cactus.
The dissent sees the issue not as the proper characterization of produced water but as whether the leases transferred the produced water ownership rights to COG. The leases convey either ‘oil and gas and other hydrocarbons’ or just ‘oil and gas.’ They are not claimed to be ambiguous, so there is no reason to look outside the leases to determine what the parties intended.
Citing a Texas Supreme Court case that rejected determining water ownership based on the mineral content of the water, the dissenting opinion said the majority’s characterization of produced water as waste because of its contents did not prevent it from being water. The lessors were under no obligation to specifically reserve any right to produce water in order to preserve their water rights.
Oil and Gas Leases Should Address Produced Water Ownership
Until fairly recently, no one was interested in owning produced water because it had no value. At the time the COG leases were executed, it is likely ownership of produced water wasn’t contemplated to be an issue. Unless the Texas Supreme Court agrees to hear the matter, the decision of the lower appellate court is only binding on lower courts within the same circuit. Nevertheless, it would be wise to address the ownership of produced water in oil and gas leases to avoid any unintended results.
At MehaffyWeber, our energy law attorneys understand the complexities involved in oil and gas leasing and monitor the industry to stay ahead of changing circumstances so our clients get the benefit of the most current legal developments.