Dedications in Produced Water Contracts

Recent events in the oil and gas industry are pushing many midstream companies to review their contracts with producers to assess whether such contracts would survive an attempted rejection in bankruptcy. A key consideration in determining the vulnerability of midstream contracts to rejection in bankruptcy is whether the contract includes a dedication that constitutes a covenant running with the land. In particular, there has been a recent focus on dedications under produced water midstream contracts. For additional commercial and bankruptcy considerations from a midstream perspective, see Key Considerations for Midstream Companies Facing Distressed Producers.

In order to achieve the strongest possible dedication, produced water midstream companies should require oil and gas producers to dedicate their interests in the mineral estate and commit to deliver the produced water generated from the production of those mineral interests under the produced water midstream contract. Requiring dedication of a producer’s interests in the mineral estate mitigates several risks, including potentially:

• having the dedication characterized as simply a dedication of personal property rather than a true real property interest – a real possibility if a producer were to simply dedicate hydrocarbons or produced water as and when produced from its operations, as both hydrocarbons and water are personal property after being severed from the land; and
• relying solely on a dedication of the produced water (in situ or as and when produced) that, in Texas, is likely the property of a surface owner.

This note was prompted by some recent commentators claiming that dedications under produced water midstream contracts may be less effective than traditional oil and gas dedications because dedications under produced water contracts dedicate and burden something that the producer does not own – since produced water is generally part of the surface estate in Texas. Of course, the issue here is the unstated assumption that only the produced water is being dedicated, without acknowledgement or consideration of the fact that producers can (and do) dedicate their entire mineral estates under produced water midstream contracts as well as under traditional oil and gas midstream contracts. 

A midstream contract may only cover one product that is produced in the process of producing the mineral estate, but this fact does not somehow impose a requirement that (i) the dedication in that contract be limited strictly to the portion of the mineral estate composed of that product (for example, the entire mineral estate is dedicated to gas gathering contracts, even though the associated oil and liquids are not subject to that contract) or (ii) the product is or was a part of the mineral estate at all, so long as the elements of a covenant running with the land are met, in particular that the dedication “touch and concern” the mineral estate (i.e., that it burdens the mineral estate or affects the nature, quality, or value of the mineral estate).

Regarding the touch and concern element, the similarities between hydrocarbons and produced water make the reasoning simple – as with hydrocarbons, (i) produced water is generated as a part of the process of producing the mineral estate and (ii) the producer must do something with the produced water (store, transport, sell, dispose, recycle, discharge, etc.) in order to continue producing the mineral estate. The producer’s obligations to deliver produced water under the produced water midstream contract and pay related fees burden and affect the value and enjoyment of the mineral estate in the same manner as similar obligations under an oil or gas midstream contract. 

Of course, hydrocarbons and produced water are different in the sense that oil and gas are part of the mineral estate in situ and produced water generally is not (in Texas), but keen observers will note that this difference ends as soon as any of those products are severed and produced. Upon being produced (and prior to delivery to the midstream company), all of these products become personal property, so while this initial difference could potentially be construed as significant, the similarities certainly seem to outweigh these differences for purposes of dedication analysis.

Please contact your Winston & Strawn relationship attorney or the authors if you would like additional information.