The First to Capture Rule

Once it became common knowledge that wells located in close proximity to each other were producing oil from the same integrated oil and gas reservoir, it was only logical that the competition for the oil would become a zero-sum game focused on who could recover the highest percentage of oil contained in the reservoir for themselves. The problem was that this form of competition did not fit easily with the “ownership in place” laws that initially governed the oil and gas industry. Under those laws the surface owners had ownership of all the minerals that were located under their land, which meant that any oil and gas under a surface owners land must belong to the surface owner. While this form of law may have been effective for hard minerals which remained in a stationary place until they were mined, it was impractical for fluid resource like oil and gas that could move from one location to another within the larger reservoir. Movement that would be induced by the extraction of oil in any part of the reservoir, which would create a low-pressure area into which oil and gas located in surrounding high-pressure area would automatically flow or seep.

After it was recognised that that oil and gas could move, it was soon accepted that the

“ownership in place” law were an obsolete and unworkable way of determining ownership.

Obsolete because it is a legal doctrine designed for stationary resources. Unworkable because it created irreconcilable separate ownership claims between neighbouring surface owners. The rights of an initial surface owners being directly in conflict with the rights of other surface owners after the oil and gas had moved. Indeed, it was just this sort of dispute that forced the courts to

whether he would have assassinated Lincoln if his wildcat operations had been successful, and he had not lost much of his wealth as a result of the failed venture.

411 It was perhaps because of this pollution that the Holmdem farm was bought for a meagre $4.37 when it was sold at auctioned in 1878.

143 abandon “ownership in place” and adopt a new doctrine which is referred to as the “Pure Capture Rule”.

An irony associated with the movement of oil and gas, is that it only occurs when there is an outside disturbance and it stay in one place for hundreds of thousands, if not millions of years, when undisturbed. As such it can be stated that it is the active disturbance of the reservoir by human forces that created the movement. Putting this movement into context with the hard rock mining laws, such disturbances would be the equivalent of one property owner digging a pit on his property which is so close the border with his neighbour’s property, that the minerals on the neighbour’s property fall into his pit. Under most hard rock mining law this type of action at the very least be considered a tort, as it caused damage to the neighbour’s property,⁴¹² and may have even be considered a criminal act of theft because of the intentional appropriation of the neighbours’ property through active and deliberate human agency. The philosophy of these actions reflecting the notion that such a wrongdoer would not be permitted to make a profit from his own wrong. However, under the new “pure capture rule” not only would such appropriations be legalized, they were actively encouraged. Whether the courts really understood that they were encouraging this unjust appropriation is unclear. Regardless of whether this was the intent, it certainly was the result.

The seminal case that established the “Pure Capture Rule” was the 1889 Supreme Court of Pennsylvania decision in Westmoreland &Cambria Natural Gas Co. V. De Witt.⁴¹³

This case involved a surface landowner named John Brown who executed an oil and gas lease for approximately 140 acres of his land. Included in the lease was a clause that prohibited the lessee from drilling within 300 yards of buildings on the farm. This lease was eventually assigned to Westmoreland Natural Gas Company, which drilled a well into the gas-bearing strata.

However rather than extracting gas from the well, Westmoreland shut the well in by closing the valves at the surface. The purported rational behind this action was to hold the well in reserve in the event one of the company’s other wells experienced failure or low production. Because the well was shut in Brown received no royalties, a situation which Brown was not willing to accept. To remedy this situation Brown ordered Westmoreland off his land and claimed a forfeiture of the lease due to Westmoreland’s failure to make certain payments. He also provided a new lease with DeWitt to drill on the same property. These allegations were disputed by Brown who claimed that the new lease was not for the same property as it provided a licence for drilling within 300 yards of his farm buildings, an area excluded by the earlier lease.

Westmoreland filed suit to prevent the second company from drilling a well.

In its decision the court decided that Brown had leased all his oil and gas rights to Westmoreland and therefore could not lease them to Dewitt. ⁴¹⁴ This lease dispute resolution was however dramatically overshadowed by the courts pronouncement of a new legal doctrine

412 Edwards v. Sims Court of Appeals of Kentucky, 265 Ky. ¤18, 96 S.W.2d 1028 (1936), p 238 “Clearly, the unjust enrichment of the wrongdoer is the gist of the right to bring an action ex contractu”

413 Westmoreland & Cambria Natural Gas Co. v. Dewitt 18 A. 724 (Pa. 1889)

414 Id. at 724 “We have to consider whether the well threatened to be put down was upon the land leased to the plaintiff.' Of this there cannot be the slightest doubt. The lease is of 'all that certain tract of land,' etc. This means the whole tract. The grant is limited as to use, 'for the sole and only purpose of drilling and operating wells.' but it is not limited as to territory. ... The well which the respondents propose to bore is within the prohibited distance, and they claim that Brown, the landlord, and they, as his lessees, have the right to drill wells within that part of the territory. But the clause in question is neither a reservation nor an exception as to the land, but a limitation as to the privilege granted. It does not in any way diminish the area of the land leased; that is still the whole tract; but it restricts the operation of the lessee in putting down wells to the portions outside of the prohibited”

144 which was to be applied to oil and gas industry, the “rule of capture”. The reasons for elucidating this rule in a case that was primarily about a leasing agreement are unclear. But it was likely because the Pennsylvania Supreme Court knew it would have to address the ever-growing number ownership disputes which were occurring in the rapidly developing oil and gas industry and this was the first case that allowed them to do so. As such in its decision it included the following declarations on oil and gas ownership;

'The learned master says gas is a mineral, and while in situ is part of the land, and therefore possession of the land is possession of the gas. But this deduction must be made with some qualifications. Gas, it is true, is a mineral; but it is a mineral with peculiar attributes, which require the application of precedents arising out of ordinary mineral rights, with much more careful consideration of the principles involved than of the mere decisions…. Water and oil, and still more strongly gas, may be classed by themselves, if the analogy be not too fanciful, as minerals feroe naturoe. In common with animals, and unlike other minerals, they have the power and the tendency to escape without the volition of the owner. …. They belong to the owner of the land, and are part of it, so long as they are on or in it, and are subject to his control; but when they escape, and go into other land, or come under another's control, the title of the former owner is gone.

Possession of the land, therefore, is not necessarily possession of the gas.'⁴¹⁵

As can be appreciated from reading this ruling, the court was clearly and dramatically changing the common law treatment of oil and gas rights. Under this ruling any claim the surface owner had to oil and gas under their land was lost the moment that that it left his property. The implication of this were that surface owners would have no legal recourse when oil and gas were siphoned out from underneath their property by their neighbours. This principle was endorsed by the U.S. Supreme Court in Brown v. Spilman,⁴¹⁶ wherein the Court stated;

'Petroleum gas and oil are substances of a peculiar character, and decisions in ordinary cases of mining, for coal and other minerals which have a fixed situs, cannot be applied to contracts concerning them without some qualifications. They belong to the owner of the land, and are part of it, so long as they are on it or in it or subject to his control; but when they escape and go into other land, or come under another's control, the title of the former owner is gone. If an adjoining owner drills his own land, and taps a deposit of oil or gas, extending under his neighbor's field, so that it comes into his well, it becomes his property.'⁴¹⁷.

As far as the oil and gas industry was concerned, this ruling legalised the aggressive behaviour that they had already adopted. By making the ownership of oil and gas resources contingent on the capture of those resources, it encouraged an even more feverish pursuit of the finite resources in any given oil and gas reservoir.

As far as surface owners were concerned, this decision put them at the mercy of the oil companies. For when oil was found in their neighbourhood they would have to immediately

415 Id. at 725

416 Brown v. Spilman, 155 U.S. 665, 669-70 (1895)

417 Id. at 669-70 (citing Brown v. Vandergrift, 80 Pa. St. 142 (1875); Westmoreland & C. Nat. Gas Co. v. De Witt, 18 A, 174 (1889)).

145 license out drilling rights to their property or risk having the oil and gas siphoned away by oil companies operating on their neighbour’s property. Unsurprisingly the oil companies used the treat of this potential loss as a tool to minimise the amount of the royalties they were willing to pay for the leases. A threat that could be easily visualised by drilling wells near the border of the threatened landowner. It was by using this threat that many oil companies were able to acquire oil and gas licenses for a fraction of their true value.⁴¹⁸ In the most abusive cases, once an oil and gas company got a license from all the surrounding farms, they would only drill and produce from the property from which they could pay the lowest royalties. An action that bears a striking similarity to the action that Westmoreland chose to take when they shut in the wells on Browns farm and which was retroactively sanctioned Pennsylvania Supreme Court.

It should be noted that providing the oil companies with the tools to inequitably enrich themselves was not the objective, but rather an unintended consequence for the early cases.⁴¹⁹ For those early courts the primary objective of the capture rule was to provide a new practical method of deciding ownership of this mysterious and mobile resource. It should be remembered that adoption of this rule took place years before there existed any reliable way of determining how much oil was under individual piece of property. So even if the court wanted to maintain the previous rule of ownership on place this was not possible, as there was no way of knowing how much oil and gas was in any given place. It was because of this lack of knowledge that the court had to develop a new method, and what better method for determining ownership could be found than absolute possession.

Although the consequence of the capture rule may have been unintended, this does not mean that they were not litigated. After the adoption of the capture rule there would have been many instances where disputes arose which as a result of oil and gas being siphoned across borders. During the first decade the court's response to these disputes was to uphold the capture rule and recommended that the injured parties engage in defensive drilling which soon became known as the offset drilling rule. The case usually credited with advocating this rule is the1897 Ohio Supreme Court case of Kelley v. Ohio Oil Co.⁴²⁰ In that case the plaintiff was a lessee who sought to enjoin the defendant from drilling twenty-five feet from a property line separating the two. Plaintiff asserted that this particular oil bearing sand would allow for the movement of oil for a distance of at least 200-250 feet any well should be at least the same distance from the border.⁴²¹ The plaintiff further asserted that defendant placed its well with the malicious intent to injure by draining oil from underneath the plaintiffs land.⁴²² The court ruled that the action of the defendant was not one of malicious intent but one which one which adhered to the capture rule. In its ruling it stated;

'Petroleum oil is a mineral, and while in the earth it is part of the realty, and should it move from place to place by percolation or otherwise, it forms part of that tract of land in which it tarries for the time being, and if it moves to the next adjoining tract, it

418 See Pithill Creek description, where the Holmden farm was leased for $2 million but at $10 per barrel the oil the value of the oil was taken out of the ground was worth $40 million.

419 The same cannot be said of many later administrative decisions and court rulings, where there was a decidedly corrupt intention on the part those that oversaw the oil and gas industry. The most obvious example of this corruption was the “Spindle Top Scandal” which is discussed below.

420 Kelley v. Ohio Oil Co, 49 N.E. 399 (Ohio 1897)

421 Id. at 400

422 Id.

146 becomes part and parcel of that tract; and it forms part of some tract, until it reaches a well and is raised to the surface, and then for the first time it becomes the subject of distinct ownership separate from the realty, and becomes personal property.'⁴²³ It further stated that:

'The right to acquire, enjoy and own property carries with it the right to use it as the owner pleases, so long as such use does not interfere with the legal rights of others'⁴²⁴, while at the same time explaining that the owners legal rights as 'the right to drill and produce oil on one's own land is absolute, and cannot be supervised or controlled by a court or an adjoining landowner,'⁴²⁵

In terms of addressing the actual dispute the court stated that and that the sole remedy afforded to neighbours which own property over a common supply was; 'drilling wells on both sides of such a line,'⁴²⁶ and that this provides an 'ample and sufficient remedy' which precludes the need for injunctive relief.⁴²⁷ Of course, this remedy did nothing to lessen the dependency of the surface owners on the oil companies. By advancing the offset drilling rule, the court was saying to surface owners; that if they want to receive any rewards for the oil and gas that may be under their property, their only option was to reach an agreement with an oil company to drill and produce as quickly as possible. All of which dramatically strengthened the bargaining position of oil industry relative to the property owners.

While the adoption of a capture rule may have harmed the bargaining position of surface property owners, it did provide an ideal legal structure for overall advancement of the oil and gas industry. Unconstrained by ownership disputes, the full force of unrestricted capitalism would produce one of the most remarkable expansion of an industry the world had ever seen.

Across the nation and throughout the world the search for oil and gas became a rush. A rush that was bigger and would produce more wealth than any gold rush ever did. However, there was a negative side to that rush. In the haste to find and produce oil, waste became rampant.

The major sources of this waste can be divided into three categories. First there was the outright destruction of resources, which usually involved the burning of the less valuable gas resources in an effort to capture more valuable oil resources. The second was the of waste resulted from over investment in redundant infrastructure which greatly increased the total cost of bringing the resources to the surface. And the third involved the damage that was done to the reservoirs when excessive drilling caused the premature loss of internal pressure making it more difficult to bring the oil and gas to the surface. Although early courts did not know about the third form of waste, they were clearly aware of and usually indifferent to the first two. The offside drilling rule being evidence of their lack of concern for over investment.

As far as the first source of waste is concerned the courts acceptance of this was demonstrated in the 1893 Pennsylvanian appeal court ruling in Hague v Wheeler.⁴²⁸ In that case there were three parties which had legal access to the same oil and gas reservoir. All three had

423 Id.

424 Id. at 401

425 Id.

426 Id.

427 Id.

428 Hague v Wheeler, 27 A. 714 (Pa. 1893)

147 drilled wells and started production, however only two of them had a market for the gas that was being produced from the wells. The third party who did not have a buyer for gas simply let the gas escape into the air or burned it off in a process called flaring, in order to maintain its oil production. It was also alleged that the defendant simply abandoned wells that stopped producing oil, rather than capping them which would help to preserve the internal pressure of the reservoir. The plaintiff contended that because of the defendant’s action the common reservoir was being wasted and so sought an injunction that would prohibit the defendant from continuing these wasteful practices. In making its decision the appeal court first ruled that the third producer was not flaring the gas out of malicious intent⁴²⁹ and that as the rule of capture provided the defendant with absolute ownership of any gas that it brought to the surface, they

147 drilled wells and started production, however only two of them had a market for the gas that was being produced from the wells. The third party who did not have a buyer for gas simply let the gas escape into the air or burned it off in a process called flaring, in order to maintain its oil production. It was also alleged that the defendant simply abandoned wells that stopped producing oil, rather than capping them which would help to preserve the internal pressure of the reservoir. The plaintiff contended that because of the defendant’s action the common reservoir was being wasted and so sought an injunction that would prohibit the defendant from continuing these wasteful practices. In making its decision the appeal court first ruled that the third producer was not flaring the gas out of malicious intent⁴²⁹ and that as the rule of capture provided the defendant with absolute ownership of any gas that it brought to the surface, they