When a lessor accuses a lessee of breaching the implied covenant to prevent drainage (a/k/a the implied covenant to drill an offset well), the complaint often sounds devastating: “The oil and gas company let my minerals drain away to neighboring properties.” The damages demand follows a seductively simple logic: the lessor wants full royalty from the offset well that they claim should have been drilled.
Luckily for oil and gas companies, Texas law doesn’t work that way anymore—and understanding why gives lessee oil and gas operators substantial leverage in both litigation and settlement negotiations when they are accused of breaching the covenant to prevent drainage.
The Old Rules That Invited Overcompensation
Before 2008, lessors had their choice of two damage theories, both of which systematically overcompensated them. Some courts awarded damages equal to the full royalty the lessor would have received from a hypothetical offset well on their property. See, e.g., Kerr-McGee Corp. v. Helton, 133 S.W.3d 245, 253 (Tex. 2005). Others awarded the value of all gas drained from the lessor's tract. See, e.g., Southeastern Pipe Line Co. v. Tichacek, 977 S.W.2d 393, 399 (Tex. App.--Corpus Christi 1998), aff’d in part and rev’d in part, 997 S.W.2d 166 (Tex. 1999).
Both measures of damages risked over-compensating the lessor. If the hypothetical offset well would have produced more than was actually drained—which is highly dependent on reservoir characteristics, well spacing, and other factors—the first rule gave the lessor a windfall. If not all drainage could have been prevented by drilling an offset well—due to field-wide drainage, regulatory constraints, and other factors—the second rule did the same.
The Texas Supreme Court recognized this tension explicitly in Coastal Oil & Gas Corp. v. Garza Energy Trust, noting that prior formulations “would overcompensate the lessee if production from the offset well exceeded the drainage” or “if not all of the drainage could have been prevented.” 268 S.W.3d 1, 18 (Tex. 2008).
Establishing and Measuring Damages After Coastal Oil
The Coastal Oil Court’s solution established what sounds like a straightforward standard: damages should equal “the value of the royalty lost to the lessor because of the lessee’s failure to act as a reasonably prudent operator”—no more, no less.
This reformulation did more than adjust the arithmetic. It fundamentally shifted the burden of proof in drainage cases in ways that many lessors initially failed to appreciate. After the Coastal Oil opinion, to prosecute a drainage case the lessor must now prove, based on the Court’s opinion in that case and existing case law:
1. That substantial drainage actually occurred from their specific tract. Kerr-McGee Corp., 133 S.W.3d at 253.
2. That a reasonably prudent operator would have drilled an offset well under the circumstances (i.e., that the offset well would have produced in paying quantities). Kerr-McGee Corp., 133 S.W.3d at 253; Amoco Prod. Co. v. Alexander, 622 S.W.2d 563, 568 (Tex. 1981).
3. The value of the royalty lost to the lessor because of the lessee’s failure to act as a reasonably prudent operator. Coastal Oil & Gas Corp. v. Garza Energy Tr., 268 S.W.3d 1, 18-19 (Tex. 2008). This might involve, for example, determining the quantity of minerals that the offset well would have prevented from draining (volume for gas, barrels for oil), the market value of those minerals at the relevant time, and the resulting royalty payment under the lease terms.
Each element requires expert testimony. And here’s what matters for lessees: these aren’t easy questions, even for qualified experts.
Where the Proof Gets Complicated – DAMAGES
Consider the third element—quantifying the value of royalty lost, including how much drainage the hypothetical offset well would have prevented. This requires sophisticated reservoir engineering analysis of factors such as:
• Formation characteristics including but not limited to porosity, permeability, pressure, and fluid properties;
• Reservoir conditions and variations between tracts;
• Pressure gradients and fluid migration patterns;
• Production history of wells in the area;
• The specific location and completion design of both the draining wells and the proposed offset well;
• Regulatory constraints on well spacing and density;
• Economic considerations affecting what a reasonably prudent operator would have done.
The lessor’s expert must reconstruct a counterfactual scenario: what would have happened if a well had been drilled that wasn’t actually drilled. Then the lessor’s expert must be able to ascertain and explain to a judge or jury what drainage could have been prevented and what drainage would have occurred regardless of the lessee’s hypothetical offset well.
There are instances where a lessor’s expert can confidently opine that substantial drainage occurred and a reasonably prudent operator would have drilled an offset well—satisfying the threshold liability questions—but then struggle on cross-examination when asked to quantify exactly how much of that drainage a single offset well would have prevented. Proving that substantial drainage happened establishes the breach, but the lessor still must quantify the specific royalty value lost with reasonable certainty. Vague and speculative testimony about “significant” or “substantial” losses won’t carry the day on damages, which must be proven with reasonable certainty.
The Practical Defense
This expert-intensive standard creates several strategic opportunities for lessees:
Early Case Evaluation Gets Sharper. When evaluating exposure in a drainage claim, the question isn’t just “did drainage occur?” It’s “can the lessor’s expert prove, with reasonable certainty, exactly how much royalty was lost that an offset well would have captured?” Many claims that appear serious at the pleading stage may have proof problems that counsel can identify and exploit throughout the litigation.
Expert Selection Matters More. The lessor likely needs multiple experts to carry their burden: a reservoir engineer who can quantify drainage and build a persuasive model of what the hypothetical offset well would have produced, and an operations or management expert who can testify about what a reasonably prudent operator would have done under the circumstances—addressing industry practices, economic considerations, and operational decision-making. The defense can challenge the reservoir engineer’s model by showing that the assumptions are unreliable or the conclusions speculative. Additionally, the lessee may be able to use its own employees to rebut the lessor’s testimony on the reasonably prudent operator standard, creating a significant cost advantage. Highlighting the range of potential outcomes—the inherent uncertainty in both the reservoir analysis and the operational judgment—serves the defense while multiplying the lessor’s expert costs.
Causation Becomes the Battlefield. Even if substantial drainage occurred, the lessor must prove through expert testimony that a reasonably prudent operator would have drilled the offset well. This opens arguments about economics (would it have been profitable?), regulatory constraints (could it have been permitted?), and timing (when should it have been drilled, and does that affect the damage calculation?).
Settlement Leverage Improves. When lessors realize they face an expensive expert battle with an uncertain outcome, reasonable settlements become more achievable. The lessor who demands full royalty from a hypothetical well should be more willing to settle for a fraction once they understand what Coastal Oil actually requires them to prove.
The Broader Signal
Coastal Oil reflects judicial skepticism of damage rules that overcompensate plaintiffs. The Court explicitly rejected formulations that might give lessors windfalls and insisted on damages that track actual losses. This principle extends beyond offset well cases—it’s worth considering how courts might apply similar reasoning to other implied covenant disputes where damage calculations have been generous to lessors.
The case also illustrates a recurring dynamic in oil and gas litigation: as operational and geological understanding becomes more sophisticated, so do the standards for proving damages. Simple rules give way to complex, expert-driven inquiries. For a lessee, that complexity can often be used to its advantage.