The sharp decline in oil prices over the past year and a half has had a significant impact on operators and mineral lessees in Louisiana and in other oil-producing states. Mineral lessees may be particularly concerned with whether recent production levels have maintained their leases beyond their primary terms.
In Louisiana, as in most jurisdictions, production of oil or gas must be in “paying quantities” to maintain a mineral lease beyond its primary term. Production is in paying quantities when, under all relevant circumstances, production allocable to the lessee’s total original right under the lease is sufficient to induce a reasonably prudent operator to continue production to secure a return on investment or to minimize any loss. Implicit in the term “paying quantities” is the requirement that the lessee show a profit, meaning production revenues must exceed “operating expenses.” In other words, the lessee must continue production for the purpose of making a profit and not merely for speculation.
Paying quantities cases usually focus on what expenses constitute “operating expenses.” “Operating expenses”—or “lifting expenses” as they are sometimes referred—are “ordinary, recurring expenses” that are attributable to the expense of production, after the well is drilled and completed. They include fixed or periodic cash expenditures incurred in the daily operation of a well. In contrast, capital expenditures and expenses that are “extraordinary and largely nonrecurring in nature,” such as drilling and completion costs, are not considered. Other examples of capital expenditures may include equipment costs, overhead, depreciation of original equipment, and workover expenses. The determination of whether or not an expense is an “operating expense” is often a fact-intensive inquiry. Courts generally use an eight to eighteen month lookback period in analyzing whether production has been in paying quantities, but longer periods may be considered reasonable if warranted by the circumstances of the case.
In the current economic climate, slim margins can raise lease maintenance questions concerning production in paying quantities. If a lessee can show a profit sufficient to induce a reasonably prudent operator to continue production to secure a return on its investment or minimize losses–and not merely for speculation–within any eight to eighteen month period, that lessee should feel relatively confident about defeating any such challenges.