In BP America Production Co. v. Red Deer Resources, LLC, the Texas Supreme Court considered the establishment of production in paying quantities in relation to the shut-in royalty provision of a lease. The lease in question was owned by BP and contained a habendum clause providing that it would remain in effect so long as oil or gas was produced in paying quantities. Three wells were drilled on the leased premises pursuant to the lease, two of which had been plugged.
In 2011, Red Deer acquired top leases from the mineral owners and notified BP of its leases, asserting that BP’s wells were “non-commercial”. The remaining gas well produced 10 Mcf of gas on June 4, 2012, and did not produce any additional gas for 8 days. BP shut in the well on June 12, 2012, and invoked the lease’s shut-in royalty clause. Notice and payment thereunder were given on June 13, 2012. Red Deer filed suit against BP in August 2012, seeking a declaratory judgment that BP’s lease had terminated because the lease has not produced in paying quantities on June 12, 2012, and the well was incapable of producing in paying quantities on June 13, 2012, rendering a shut-in payment insufficient to maintain the lease. The trial court jury found that the lease had produced in paying quantities from April 27, 2009 to June 12, 2012, but that the well was incapable of producing in paying quantities when it was shut-in on June 13, 2012. The trial court entered a judgment in favor of Red Deer, holding that the lease had terminated because the well was incapable of producing on the date it was shut-in, and the judgment was affirmed by the court of appeals. BP argued that the jury should not have been allowed to consider the question of the well’s capability to produce on the date of shut-in, given the jury’s finding that the well had not failed to produce in paying quantities through the preceding day, and the case was reviewed by the Supreme Court.
The lease’s shut-in royalty clause reads as follows:
Where gas from any well or wells capable of producing gas . . . is not sold or used during or after the primary term and this lease is not otherwise maintained in effect, lessee may pay or tender as shut-in royalty . . ., payable annually on or before the end of each twelve month period during which such gas is not sold or used and this lease is not otherwise maintained in force, and if such shut-in royalty is so paid or tendered and while lessee’s right to pay or tender same is accruing, it shall be considered that gas is being produced in paying quantities, and this lease shall remain in force during the twelve-month period for which shut-in royalty is so paid or tendered . . . .
The Court found that the shut-in clause provided for preservation of the lease via payment of a shut-in royalties within twelve months after the last day gas was “sold or used” from a well capable of producing gas. Absent a well capable of producing gas in paying quantities, the lease would not be maintained via its shut-in clause. In order to prevail, Red Deer needed to prove that the well was incapable of producing in paying quantities over a reasonable period of time as of June 4, 2012; the Court found that Red Deer’s use of the June 13, 2012 date in its determination of production in paying quantities was the improper date, and therefore the question of production in paying quantities could not have been answered by the original jury.
This case demonstrates that courts will strictly interpret the lease’s actual language to resolve disputes where the lease is unambiguous. The vast majority of shut-in royalty clauses include language stating that payment suffices as constructive production for “one year from the date of payment” or “upon such payment”. The BP America lease included language making shut-in royalty payments retroactive – that payment sufficed as constructive production for a year prior, and only required that payment be made within a year from the date the last gas was sold or used; BP satisfied the terms of the shut-in clause by making payment within 8 days of June 4, 2012. Red Deer erred by using the date of shut-in royalty payment as the determining factor to establish production in paying quantities; because of this error, the question of the well’s capability to produce in paying quantities could not be decided by the jury.
Even though shut-in provisions are well established and common, it is imperative that parties to a lease, their successors in interest, or third parties seeking to involve themselves understand the specificities of leases affecting their interests.
Kuiper Law Firm, PLLC specializes in oil and gas issues; if you have any questions about how the information in this article may apply to you or your operations, do not hesitate to contact us.
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