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February 15, 2002

Water Marketing:
Wave of the Future?

By Lana Robinson
Field Editor

Water wizards converged at Texas Farm Bureau's Leadership Conference in San Antonio late last month to expound on the legalities of the state's water laws and related implications for landowners and users of surface and groundwater in Texas. Specifically of interest to TFB leaders is the current trend toward landowners leasing groundwater to companies who in turn sell it to various entities.

While the state has plenty of water, the problem, as one observer put it, seems to be that the water is located in the "wrong" places. To fix water shortages in one area, some think the solution is to buy water rights from others. Some landowners see this as an opportunity to sell a resource, much like oil or gas, while farmers and ranchers, particularly, worry that big cities will drain them of this valuable resource. If water marketing is, indeed, the wave of the future, there are certain precautions landowners should take before jumping in headfirst.

One of those on hand to explain the finer points of marketing and leasing groundwater was Dr. Judon Fam-brough, attorney and senior lecturer with TAMU's Texas Real Estate Center. Fambrough distinguished between "surface water," which in most instances belongs to the State and requires a permit, and "groundwater," which is privately owned.

"State-owned surface water is defined as 'all water in a natural body of water or watercourse,'" said Fambrough. "A watersource has a defined bed, a permanent supply of water—permanent and reoccurring water—and visible banks. Impoundment cannot exceed 200-acre feet, unless it is used for domestic or livestock purposes.

"Groundwater is privately-owned percolating water. Sometimes, as with the Edwards Aquifer, the state tries to claim the water by declaring it an underground stream or lake. But all water is not in an underground stream or lake, and that didn't work."

One question on the minds of landowners these days is, "Who owns Texas groundwater when the minerals have been reserved?" According to Fambrough, the answer is "the surface owner." He said evolving case law recognizes a three-tiered ownership structure, which includes the mineral owner; surface owner, and water owner, in those instances where the land has been sold and water rights retained.

'Rule of Capture' defined

As a matter of clarification, Fambrough said Texas property owners do not actually own the water beneath their land, but they do own the right to search (drill) and pump (capture) it when it's found. The Texas Supreme Court summarized the "rule of capture" last year by stating, "The rule of capture essentially allows, with some exceptions, a landowner to pump as much groundwater as the landowner chooses, without liability to neighbors who claim that the pumping has depleted their wells."

It is the constitutional duty of the Texas legislature, not the courts, to regulate groundwater, although Texas voters empowered the legislature to manage groundwater by streamlining the process for creating groundwater conservation districts.

While statewide rules currently do not limit pumping from water wells, Fambrough noted that groundwater conservation districts have the authority to impose such limits. He further warned that if the rules governing oil and gas production are any indication, there may be other limitations to drilling and pumping water. For example, oil companies must drill wells from locations based on spacing rules. Since 1996, there are now spacing requirements for water wells. Also, oil companies must pump within allowed withdrawal rates set for each oil and gas well. That may also happen with water, he said.

Evolution of water marketing

"Prior to 1997, just about the only water marketing going on was between the cities in West Texas and the big ranches, where they would buy ranchers' rights. I know of a recent instance in which entrepreneurs leased 16,000 acres from 5,000 to 6,000 landowners in Burleson County for the production of water to sell to San Antonio. These leases mirror oil and gas leases," he reported.

Fambrough foresees a possible clash between oil and gas companies and Texas water policies. There is a long-established rule allowing oil producers to use as much water as is reasonably necessary to explore for and produce oil and gas.

In an effort to give guidance to potential sellers of water, the TAMU real estate attorney gave several tips, explaining how language in water leases should be carefully worded to avoid some pitfalls that following the oil and gas lease precedent could pose, because oil and water don't mix.

"The old oil leases used a minimum royalty on a 10-year basis. I have seen language that says the lease will 'last as long as it produces in paying quantities.' Stay away from the 'paying quantities' language. Water is rechargable. Oil and gas is not. That's the difference between water and oil and gas leases," he said, admonishing landowners to resist just "going with the flow" when negotiating. " 'Water estate' is not the dominant estate for surface usage. Look at the surface operation very closely. There is no standard form for water leasing. You must read the contract closely. Avoid ambigious terms, like 'reasonable damages'and 'paying quantitites.' Be careful what you grant. Watch out for `horizontal severance claims.' When you grant a water lease, you cannot use your water for commercial use. What about your commercial cow/calf operation? You need to make sure you aren't signing something that prohibits you from using your water for that. Finally, always preserve the shallow aquifer for your own use and make them go below that to get theirs."

Fambrough noted the difference between a "lease covenant" and a "lease condition," and favored the latter.

"When you have a breach of covenant, the only recourse is a lawsuit. When you have a violation of a condition, this lease terminates. That's what you want," he advised.

The question arose during the discussion regarding the power of "eminent domain" on groundwater. Fambrough cited a case in which the City of Sweetwater condemned land for its water. The court limited the amount paid to the landowner to its surface value, which was far less than the water's value. Fambrough suggested a condition in any potential agreement, stating that if the water is ever condemned, all condemnation proceeds go to the lessee.

During the water debate last legislative session, a Texas Farm Bureau-backed amendment that would have required that the landowner be compensated for the value of the water taken by condemnation rather than market value of the land failed.

Fambrough is currently working on a booklet, Secrets on Negotiating Groundwater Leases.