One Man’s Trash is Another Man’s Treasure: Ownership of Produced Water in Texas

Given that this is a new area of production, the law surrounding the ownership of produced water remains relatively unsettled — and where there is potential money on the table, actual litigation surely follows. On July 28, 2023, in the case Cactus Water Services, LLC v. COG Operating, LLC,¹ the Texas Court of Appeals in El Paso addressed the ownership of produced water. In the Cactus Water case, a majority of the court determined that the mineral interest owners had superior rights to the produced water in dispute. The dissent favored the rights of the surface owners and the case has since been appealed to the Texas Supreme Court.

In this alert, we discuss the Cactus Water case and the legal implications of lithium extraction from produced water.

Cactus Water Case

COG Operating, LLC (“COG”) was the lessee of a property in west Texas. Their leases on the applicable property (the “COG Leases”) involved a grant of “oil, gas and other hydrocarbons” and similar variants. Under the COG Leases and other agreements, the landowner granted rights-of-way and easements to COG so it could transport such produced wastewater off the land. Further, COG handled and paid for the transportation and disposal of the produced water from their operations for years without landowner comment. However, under the COG Leases, COG expressly did not have the right to “use water which is on or under the described land, except it may itself drill a water well and then use the water from that well in its conduct of drilling operations that are conducted on land covered by [the lease.]”

Several years after the landowner leased their interests to COG, the landowner also leased their interest in their water estate to Cactus Water Services, LLC (“Cactus”), including the rights to sell all water “produced from oil and gas wells and formations [on the covered properties.]”

COG and Cactus filed declaratory suit against one another to find out who held the rights to the produced wastewater from the land (as well as the substances contained therein).

The trial court found for COG and the appellate court in this case affirmed, primarily falling back on statutory interpretation, regulatory understanding and industry practice. In their decision, the appellate court held that produced wastewater is not groundwater (which is part of the surface estate), but instead is “oil and gas waste,” which typically under oil and gas leases belongs to and is the obligation of the mineral interest operator. As a result, produced water is within the mineral lessee’s grant of “oil, gas and other hydrocarbons” and the mineral interest lessor had the exclusive right to the produced water under its leases. The court held this (1) even though the COG Leases specified a grant of “oil, gas and other hydrocarbons” rather than the formulation of “oil, gas and minerals”; and (2) despite the limitation on COG’s use of water on the land.

Note that this case does not expressly address lithium and that, for leases executed after June 8, 1983, the determination of “mineral” under Texas law is done on a mineral-by-mineral basis under the “ordinary and natural meaning” test (in the absence of lease language specifying one way or another). However, pending further activity on this item, it would be reasonable to assume that this case lends support to the idea that lithium contained in produced wastewater from oil and gas operations would also belong to the oil and gas operator in the absence of lease language to the contrary.

The dissent in this case took a different view of produced water ownership. The dissent noted that “water” and “oil and gas waste” were not expressly granted under the leases, and that, without express granting language conveying the surface estate’s water rights, Texas law provides that such water remains part of the surface estate. As a result, water would not be impliedly conveyed in the grant of “oil and gas.”

Many commentators expect that ultimately this issue will be determined by the Texas Supreme Court. An appeal has been filed to the Texas Supreme Court as of the writing of this article.

• Considerations Relating to Lithium Extraction in Produced Water

Below are several matters for an oil and gas operator to consider in connection with the development of lithium and other minerals from produced water in connection with its oil and gas operations:

• Granting Language —
  • Regardless of the outcome of the Cactus Water case, the best practice is to explicitly state lithium, cobalt, brine, etc. in the granting language of a lease or severing instrument, and to avoid such minerals being part of the reservation language in a lease or severing instrument.
  • In some cases, depending on the lease-granting language, the rights to lithium and other minerals are more likely to be part of the mineral estate if they are produced in connection with the same operations that are being undertaken to extract oil and gas. However, if an operator were to seek to extract lithium and other minerals as part of operations that do not involve the extraction of oil and gas, then some lease language would provide that such lithium and minerals are not included as part of the lease grant. As a result, it will be important to further consider the lease-granting language if lithium and mineral production will occur separately from oil and gas operations.
• Joint Operating Agreements — Oil and gas production is often subject to joint operating agreements (“JOAs”). An oil and gas operator should consider if the cost and revenue sharing terms under JOAs will apply to lithium and other non-oil and gas mineral extraction, including as to the development of lithium extraction facilities separate from oil and gas production and gathering facilities.
• Produced Water Treatment and Disposal Agreements — Often produced water treatment and disposal agreements contain clauses that grant all right, title and interest in the produced water (including all minerals contained therein) to the party disposing of and treating the water. An oil and gas operator should consider the terms of these agreements and title transfer provisions.
• Royalty Considerations — To what extent does the royalty language in the applicable lease apply to lithium extraction from produced water? Often royalty amounts are different depending on whether the royalty item is a “liquid” or a “mineral.” Given that lithium is contained in the saltwater brine of produced water, it is unclear which applies. Further, given lithium extraction from produced water requires processing, it is unclear where in the production chain the value of the lithium is determined and how the allocation of processing costs are determined. There may be some additional disputes in this area as lithium extraction operations increase.
• Tax Considerations — The Internal Revenue Code and other federal income tax authorities contain a robust set of tax rules relating to both (i) oil and gas drilling, development, and production activities, and (ii) non-oil and gas mineral exploration, development, and operating activities. However, many of the statutory, administrative, and judicial authorities that apply to the oil and gas industry are separate and distinct from those that apply to activities involving non-oil and gas minerals, and those rules were not developed with produced water lithium extraction in mind. As a result, it will be important for taxpayers engaging in both oil and gas operations and produced water lithium extraction to work closely with their tax advisors to determine how to properly allocate and report overlapping exploration, development, and operating activities.

Conclusion

Given the significance of the interests, the Texas Supreme Court will likely consider the Cactus Water case or a similar case shortly and provide further clarification as to the law on its ownership. Regardless of its decision on the ownership matter, a slew of further legal questions are likely to ensue and surface owners and producers alike should keep a keen eye on legal developments in this area.

¹ Cactus Water Services., LLC v. COG Operating, LLC, 676 S.W.3d 733 (Tex. App.—El Paso July 28, 2023, pet. filed) [hereinafter “Cactus Water”].