To the majority of the Texas Court of Appeals in El Paso, the answer is waste. It has only been recently that this would be a question at all. Though widely determined to be a waste and a liability, recycling and water treatment technologies have made produced water a potential valuable commodity. The key questions raised with this development are:

• Who owns the produced water?
• Who should benefit? 
• Is it part of the mineral estate – a waste stream as the byproduct of oil and gas production and therefore owned by the mineral lessee/oil and gas operator?
• Is it groundwater so thus part of the surface estate and owned by the surface owner?

The answers to these questions will determine who will benefit from this potentially lucrative new industry in Texas. Cactus Water Services, LLC v. COG Operating, LLC, decided July 28, 2023, seems destined for the Texas Supreme Court and could be just the beginning of a flood of litigation regarding produced water.

CACTUS WATER SERVICES, LLC V. COG OPERATING, LLC

In this case, COG acquired oil and gas leasehold rights covering 37,000 acres in Reeves County, within the Delaware Basin. Thereafter, Cactus Water entered “Produced Water Lease Agreements” with a surface owner covering the same property. The Produced Water Lease Agreements granted ownership to Cactus Water over all water produced from the property.

COG made arrangements to dedicate the produced water from its operations to a third party. Cactus Water made demand on the service provider and then COG filed suit seeking a declaratory judgment that “COG has the right to exclusive possession, custody, and control of the produced water” from the property. Cactus Water countered that COG sold the produced water for profit that belonged to Cactus, contending that the produced water constitutes groundwater under Texas law and belongs to the surface estate. COG’s position is the produced water is not groundwater at all, but a waste byproduct as part of the production stream in its oil and gas operations. The trial court agreed, granting COG summary judgment and Cactus Water appealed.

The divided Court of Appeals in El Paso affirmed. The majority agreed with COG that the mineral leases necessarily convey the oil and gas product stream, which includes the produced water. COG argued that the mineral leases must be construed to effectuate the parties’ general intent to convey oil and gas in their natural form, and since produced water is part of the product stream COG owns it as a waste byproduct. The majority then analyzes the definition of “water” and “produced water” and concludes that since neither term is defined in the leases the statutory and regulatory meanings make clear that produced water is understood as oil and gas waste, not groundwater. The majority then discusses long time industry practice that produced water has always been treated as a waste and liability with the burden and duty of proper disposal on the operator. Since the operator is legally bound to dispose of this waste, it stands to reason that the operator has the exclusive rights to the product stream, including the produced water.

The dissent agrees with Cactus Water – namely that under the express granting language of the leases only oil, gas and hydrocarbons were conveyed, not the water recovered from operations. It is well settled that groundwater is part of the surface estate that can be severed and conveyed similar to the mineral estate (see Gray Reed's article from February 2020). Here, the water was not specifically conveyed “in any form.”  

The dissent also argues that the majority’s characterization of produced water as oil and gas waste does not automatically make it part of the granting clause in the leases. Case law is cited that even deep, mineralized water produced from a well belongs to the surface estate and is only transferred by specific conveyance – noting “water by any name, even mixed with other substances, still remains water.” The dissent observes that the Texas Supreme Court “has not distinguished between different types of groundwater indicating that some water does not belong to the surface estate.”

The dissent also argues that the regulatory framework and industry practice should have nothing to do with ownership of produced water. Just because an operator has a duty dispose of this waste does not mean it has ownership of it.

TAKEAWAYS

Hopefully the Texas Supreme Court will take this case and resolve these questions. There is no argument from any side that recycling and reuse of produced water is good for Texas. Texas’ population continues to grow at a rapid pace and our precious water resources are stretched thin already. Water supply development is one of Texas’ most critical challenges and the production of millions of barrels of produced water each year should be put to good reuse and not just disposed and out of the water cycle as historically been the case. Surface use owners should continue to pay close attention to how produced water is handled and defined in surface use agreements and leases. The regulatory framework and case law can all be overcome by clear definitions and provisions in the contracts.

The ownership of oil and gas waste has never been clearly defined by the courts or the legislature. This case marks the beginning of providing answers. The question has always been who benefits from what was for the longest time considered a liability to today a potentially valuable asset? This divided court says it’s the mineral estate. Time will tell if the Texas Supreme Court thinks differently.