STATE OF TEXAS' PERSPECTIVE ON ROYALTY MANAGEMENT AND COLLECTION

• Jurisdiction: United States

Federal and Indian Oil and Gas Royalty Valuation and Management Book 1
(Feb 2004)
CHAPTER 8C
STATE OF TEXAS' PERSPECTIVE ON ROYALTY MANAGEMENT AND COLLECTION
J. David Hall
Deputy Commissioner - Energy Resources
Texas General Land Office
Austin, Texas

I. INTRODUCTION

The Texas General Land Office (GLO) manages State lands and mineral rights totaling approximately 20.4 million acres. The schoolchildren, veterans, and all people of Texas benefit from the GLO's tireless efforts to preserve their history, protect their environment, expand economic opportunity, and maximize State revenue through the administration of State lands and resources. The leasing of State lands generates revenue and royalties that are placed in the Permanent School Fund, an endowment fund for public education in Texas. The GLO leases State land for a variety of purposes, including oil and gas production, commercial development, and sustainable energy development. Major transactions involving the vast portions of State land and minerals are conducted everyday, for the benefit of Texas and, most significantly, for the benefit of Texas' public schools. Every transaction is carefully evaluated and scrutinized to assure maximum productivity in the best interest of the State. This maximum productivity is derived from the royalties derived from the leasing of State owned oil and gas rights.

While O. Henry directs our imaginations to the wheelings and dealings of the sharp-shooting land barons of old, we would ask that all "knavery...bribery... schemes and plots" be set aside for the purposes of the leasing of oil and gas properties from the State. Rather than walking ten paces, turning, and firing, we would propose that much more could be gained from cooperative efforts to learn about the State lease and the law and regulations surrounding it. The State and its lessees should not form two opposing camps, one group wearing the white hats and the other wearing the black ones. They should be corralled together because oil and gas leasing of State properties should not be considered a legal game of cowboys and outlaws. The modern day straight shooter is encouraged to apply, but he or she needs to be aware of the diverse provisions of the State oil and gas lease, as well as the significant responsibility attendant to leasing from the State. Before a potential lessee rides off over State lands into the sunset, he or she would be much obliged to have the general information and guidelines regarding the State leasing process and its subtle distinctions that this paper will provide.

II. STATE LAND AND MINERAL OWNERSHIP

A. General Information

The entirety of the holdings of the State of Texas consists of Public School lands, Permanent University lands, and other State owned lands. ¹ The oil and gas leasing procedures detailed in this paper will be those of the State Public School Lands.

B. The Public School Lands

Public School Land is State land totaling approximately 13,000,000 acres that is dedicated to the Permanent School Fund. There are three broad categories of Public School Land: fee lands, Relinquishment Act lands, and free royalty lands. There are distinct leasing forms and processes for each of these types of lands.

1. Fee Uplands

The State fee uplands consist of approximately 800,000 acres of which the State owns both the surface and mineral estates in perpetuity. These are lands that have been surveyed, but they are unsold and not dedicated to another fund. The major portion of these lands is located in West Texas.

2. Riverbeds, Lakebeds, and Streambeds

The mineral estate under State owned riverbeds, lakebeds, and streambeds is reserved to the State. The Land Office is responsible only for the leasing of submerged lands and does not control the use of the surface waters.

3. Submerged Lands

In State submerged lands, the mineral estate within tidewater limits is reserved to the State. Tidewater limits for Texas extend out three marine leagues and requires its own explanation:

a) Tidelands Controversy

Texas has been involved in offshore disputes since 1945, Texas, California, and Louisiana had total jurisdiction over the mineral resources off their coasts. President Truman changed that by claiming jurisdiction for the federal government over all "the natural resources of the subsoil and subsea bed of the Continental shelf.... contiguous to the United States..." Between 1947 and 1950, the Supreme Court rejected three separate ownership claims by Texas, California, and Louisiana. The states carried their fight into the political arena. The conflict became known as the tidelands controversy. A solution was finally reached in 1953 with the passage of the Outer Continental Shelf Lands Act and the Submerged Lands Act (OCSLA). The Submerged Lands Act restored states' ownership rights to offshore lands within three miles of the coastline. Federal jurisdiction remained in effect over the Outer Continental Shelf (the area beyond the three miles). Another boundary change occurred in 1961 when the Supreme Court extended Texas' ownership three marine leagues (10.4 miles) out into the Gulf of Mexico. This boundary was recognized because of land grants made when Texas was under Spanish rule. The western coastline of Florida is the only other area governed by Spanish Land Grant. In 1978 the OCSLA was amended to reduce the level of state and federal disharmony. Under the amendment, the Secretary of Interior must solicit recommendations from the governor of any state that may be affected by the leasing program. The 8(g) zone, a three mile strip on the federal side of the state federal boundary, was also established.

b) Texas' Ownership

Since the OCSLA amendment in 1978, the Secretaries of the Interior and the Governors of Texas had conflicting views about the requirements of the amendment. Attempts at negotiations floundered and the State of Texas filed suit in 1979 seeking a solution. The State of Texas claimed many things but the suit hinged on a claim of the fair and equitable share of the revenue. After weighing the evidence, the court decided that when the United States offered the tracts for lease, the leases were worth more because exploration of adjacent Texas offshore leases had reduced the uncertainty about whether oil or gas might be present, resulting in lease bonus enhancements. In addition, the court found that another factor to be considered was whether or not drainage had occurred on state lands from federal leases with lower royalty rate.

In the collection and disposition of in-kind offshore royalties the provisions of the OCSLA bind the U.S. Department of the Interior (USDOI). Under the provisions of OCSLA, the coastal states such as Texas are the beneficiaries of the permanent, indefinite appropriation equal to 27 percent of the royalties received from lessees operating in the 8(g) waters, 43 U.S.C. 1337 g(2). Texas has no royalty ownership in leases within the 8(g) zone The federal government is the sole royalty interest owner and is the sole recipient of royalty payments whether in-value or in kind. The State of Texas works hand-in-hand with the Minerals Management Service (MMS) setting up a program for Texas' 8(g) zone and is consulted when and if production volumes from those leases are taken-in-kind.

4. Relinquishment Act Lands

a) State Oil and Gas Leases under the Texas Relinquishment Act

Relinquishment Act Lands consist of approximately 7,000,000 acres. The Relinquishment Act of 1919 applies to lands sold between 1895 and 1931. The mineral estate in these lands is reserved to the State. ² Interestingly, the owner of the surface of the land acts as agent for the State for leasing the State's minerals in exchange for half of the bonus, rentals, and proceeds of production. ³ By employing the surface owner as the agent of the State for the purposes of negotiating and executing an oil and gas lease, and by surrendering to the surface owner one half of the monetary benefits of that lease, an incentive is created for mineral development on peaceful terms between the surface owner and the State lessees. While the bonus, delay rentals, and royalties payable under Relinquishment Act leases are shared equally by the State and its agent, the State must never be paid less than 1/16th of the value of production. ⁴ Delay rentals must be timely paid to both the State and the agent, or the lease will terminate.

Although the surface owner negotiates the terms of the lease, he or she is nevertheless the agent of the State and therefore subject to some direction by the principal. ⁵ The Commissioner has the authority to approve these leases. ⁶ The GLO provides the lease form to be used and can approve or refuse any additional terms proposed by the parties, as well as the fairness and adequacy of the consideration offered. ⁷ A Relinquishment Act lease must recite the "actual and true consideration" paid. ⁸ The lease is not valid until it is filed in the Land Office. ⁹

The surface owner may not further delegate the authority to lease, and may not reserve an interest in any future lease that may be executed after the present surface ownership has ended. ¹⁰ An unreasonably large tract may not be committed to a single lease. In that connection, leases may not cover more than 2,560 acres, four sections of land of 640 acres each. ¹¹ A lease may cover several smaller tracts if they are contiguous or within one half-mile of each other. ¹²

A surface owner may also waive his or her agency rights and benefits. ¹³ If the surface owner has so waived his or her rights or cannot be located, the oil and gas on the tract will be subject to a sealed bid lease sale by the School Land Board. ¹⁴ The State, as sole lessor, will then control the terms and negotiation of the lease and receive all consideration paid. ¹⁵

5. Free Royalty Lands

Free Royalty lands are lands that were sold between 1931...