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Should landowners have a seat at the water midstream table?

Legal battles may be looming overhead with implications for water midstream companies and producers operating in Texas.

In the past couple of years, water midstream companies have paid hefty sums to operators for their produced water assets in addition to exclusive rights to manage volumes over large swathes of land. Long-term acreage dedications have been lucrative for operators and water midstream companies alike, but the way they have been structured – excluding landowners from negotiations – may leave those companies open to legal risk down the road.

Litigation is a possibility particularly in Texas, where the surface estate legally owns all underlying water, including produced water, unless those water rights have been severed. Gabriel Collins, a water expert who owns a membership interest in a Permian Basin water development venture, spoke to WiO in a personal capacity and noted that asset sales accompanied by acreage dedications amount to producers essentially promising volumes and encumbering property to which they have no legal right without compensating landowners.

“The amount of upfront consideration paid, at least in a lot of the deals I have looked at, exceeds the capital replacement value of the physical infrastructure by a factor of two and sometimes more,” Collins said. “That starts to illustrate that they’re really paying for an exclusive right to this water volume into the future and not so much paying for the assets themselves.”

A court document filed by WaterBridge Resources, following the termination of a transaction between it and Centennial Resources, seems to bolster the argument that water midstream companies see more value in the produced water volumes than the water infrastructure. One section of the filing reads, “The value to WaterBridge in acquiring the Assets was the revenues to be generated from the produced water volumes under the Services Agreement. Put simply, the deal—including the proposed purchase price for the Assets—was predicated on WaterBridge’s expected revenues under the Services Agreement.”

DETAILS OF SELECTED ASSET AND ACREAGE DEDICATION DEALS

DateAcquirorTargetAssets/acreage dedicationLocationDeal value
Jul-20Solaris Water MidstreamConcho Resources9 SWDs, 80 miles of pipeline, 1 million acre-dedicationDelaware BasinUndisclosed
TerminatedWaterBridge ResourcesCentennial ResourcesProduced water infrastructure, 15-year acreage dedicationDelaware Basin$225 million
Aug-19H2O MidstreamSabalo Energy“9 SWDs, 4 Ellenburger SWD permits, 37 miles of pipeline, 15-year acreage dedication”Midland BasinUndisclosed
Jul-19Solaris Water MidstreamConcho Resources13 SWDs, 40 miles of pipeline, 1.6 million-acre dedicationDelaware Basin“Undisclosed cash + equity”
May-19WaterBridge ResourcesPDC Energy7 SWDs, 82 miles of pipeline, long-term acreage dedicationDelaware Basin$125 million
Jan-19WaterBridge ResourcesConcho Resources3 SWDs, 44 miles of pipeline, long-term acreage dedicationDelaware BasinUndisclosed
Dec-18WaterBridge Resources“Halcón Resources”10 SWDs, 60 miles of pipelines, freshwater wells, recycling facilities, 15-year dedication over 75,000 acresDelaware Basin$325 million
Source: Company news

Isaac Griesbaum, a partner at law firm Winston & Strawn, which represented WaterBridge prior to the deal’s termination, told WiO that the produced water itself has no intrinsic value and that acreage dedications amount to purchases of annuities, as water midstream companies are basically buying the obligation of operators to pay them service fees for produced water handling.

Produced water has historically been considered a liability, which is why it has typically been left to operators and water services providers to transport and dispose of. That perspective continues to prevail, which is one reason why Griesbaum believes it will be difficult for landowners to prove damages, despite having a title claim.

“Without being able to prove damages, surface owners have no economic incentive to pursue,” Griesbaum said. “The courts may give them a victory in name but then say, ‘If you want to enforce your rights, you are going to have to deal with this waste product.’”

Collins contends that some landowners, particularly larger ones in the Delaware Basin, may be interested in exactly that, via a direct stake in the water management business. For those not wanting to become involved in operations, there are of course other approaches available, including royalty and one-time payments.

“Ultimately, what’s going to drive this entire discussion is when does this water have value?” Griesbaum said.

Even if deal prices were not based largely on the value of the revenue from future managed volumes, a case could be made that the water is in fact valuable – and increasingly so – considering that interest in oilfield water recycling has ramped up in the past year and that several groups are now also researching the potential to apply treated produced water for other beneficial uses.

Texas legislators have already made efforts to encourage produced water recycling. House Bill (HB) 3246, which went into effect in September 2019, clarified that titles are transferred with the produced water when it passes from one party to another for treatment and subsequent beneficial reuse.

Nevertheless, Collins believes a strong argument can be made that HB 3246 allows for an uncompensated transfer of private property rights, which is generally unconstitutional. Additionally, the fact that the term “water” is never actually used in the bill’s text, which refers only to “fluid oil & gas waste,” may also have implications for landowners seeking damages.

“I would encourage anybody looking at this issue to […] think about what this means for the broader suite of subsurface water ownership rights in the state of Texas, which collectively affects many billions of dollars in private property,” Collins said. “If we permit the legislature to condemn various slices of private property for the benefit of private economic interests, where does that slippery slope end?”

While Griesbaum is doubtful that HB 3246 can be used to override surface estates’ constitutional rights to underlying water, he does believe that the bill will be tested and further refined through litigation.

“It’s still a very open question as to how it gets resolved, but I think it is something that is going to come to the fore in a more pointed way over the next four to six months,” Collins said. He added that in the coming years, he expects more acreage dedication deals to be structured in a way that considers some form of landowner compensation.

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