Mineral owners in Texas often sign oil and gas leases that include language that requires that oil or gas be produced in commercially paying quantities in order to keep the lease alive. When production falls below that level, the lease may terminate or lapse, and the mineral interest reverts to the landowner, or to other leases with subsequent rights to the property (i.e., top lease holders). In addition, many leases contain what is called a “shut in royalty” clause, which often goes something like this: “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, the lessee may pay or tender … shut-in royalty . . . , 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 each twelve-month period for which shut-in royalty is so paid or tendered . . .” . It is important to notice that the shut in royalty clause can only be invoked if the well in question is capable of producing in paying quantities.
BP America Production Co. v. Red Deer Resources LLC is a case involving a marginal well operated by BP that was producing at very low levels. BP invoked the shut-in royalty clause of their lease with the mineral owners. However, questions arose as to whether BP’s use of the shut in royalty clause was valid and whether the lease had actually terminated.
BP had a lease on over two thousand acres of property in Lipscomb and Hemphill counties in Texas, referred to as the Vera Murray lease. The original lease began in 1962, and according to its terms, continued so long as oil, gas and other minerals were produced from the land in paying quantities. Several wells were drilled on the land, but many of them were plugged or shut in over the years. BP was assigned the lease in 2000 and only a few wells remained in production on the land at that time. Top leases in the property had been taken by Red Deer Resources LLC in 2011, and these top leases became effective if and when the BP lease terminated.
Between 2011 and 2012, BP experienced a sharp decline in production from its remaining wells on the Vera Murray lease, and Red Deer Resources notified BP that it believed that the wells on the property had become non-commercial (i.e., non-paying) and that BP’s lease had terminated.
BP’s lease included a shut-in royalty clause. However, Red Deer Resources sued BP claiming that BP’s lease was terminated because the wells were not producing at paying levels, and since the wells were not capable of producing in payable quantities, the shut-in royalty clause was did not apply and could not save the lease. Red Deer asserted two theories of lease termination at trial: (1) BP’s lease terminated because of a failure of production in paying quantities, measured over a period ending June 12, 2012; and (2) BP’s lease terminated because of a total cessation of production, and the shut-in clause did not save it because the #11 well was incapable of producing in paying quantities on June 13, 2012.
At trial, the court rendered judgement that BP’s lease had terminated, and BP appealed. The Court of Appeals affirmed the trial court and BP appealed once more to the Texas Supreme Court. The Texas Supreme Court decision reversed the Court of Appeals and held that the BP lease had not terminated because Red Deer did not obtain a finding that the well was incapable of production in paying quantities on the material date under the plain language of the lease. Specifically, the Court held that “…to negate BP’s invocation of its shut-in royalty rights, Red Deer bore the burden of proving that the #11 well was incapable of production in paying quantities over a reasonable period of time as of June 4, 2012. However, Red Deer failed to obtain a finding that the #11 well was incapable of production in paying quantities as of that date”. This was the last date that gas was last sold or used, and the Court held that, given the language of this particular lease, that was the critical date. The fact the Red Deer obtained a jury finding that the #11 well “was incapable of producing in paying quantities when it was shut-in on June 13, 2012” did not help.
There is no such thing as a standard lease form, and there is no such thing as a standard shut in royalty clause. If you have a lease in which production is margin or has ceased, it’s important to have an experienced oil and gas attorney review the lease and the facts to determine whether the lease has terminated.