On Sept. 2, the Texas Supreme Court granted review in a case that may clarify when a shut-in well’s capacity for production in paying quantities is determined. In BP America Production Company v. Red Deer Resources, LLC, No. 15-0569, the court will be reviewing a ruling from the 7th Court of Appeals (Amarillo) that upheld a judgment terminating a lease on the grounds that it was incapable of production when the last well on the premises was shut-in.
At issue is a 2,113 acre lease taken in 1962 which BP had owned and operated since 2000. By 2009, just one gas well out of the 10 wells drilled on the lease was producing, but only sporadically and at much lower rates than prior months. Red Deer Resources, LLC (Red Deer) had been monitoring production from the well, and recognized that the lease was in danger of lapsing due to its inability to produce in paying quantities. In 2011, Red Deer obtained from the then owners of the minerals top leases that would be enforceable upon the expiration of the BP lease, with plans to drill wells into previously untapped formations. BP had considered developing other formations under the leased premises as production slowed, but BP employees later testified at trial that the “threat of litigation” from Red Deer prevented them from obtaining a partner for the proposed operations.
BP shut in the remaining well on June 12, 2012 after eight consecutive days of non-production. The following day, BP sent notice to the lessors that it was invoking the shut-in clause, along with checks to cover the shut-in royalty payments (which were not negotiated by the lessors). The well has remained shut in since.
Oil and gas leases typically have a shut-in royalty provision that prevents the lease from terminating if the lessee has a well capable of producing in paying quantities, but is unable to get a pipeline connection or find a suitable market. The lessee then makes periodic payments of shut-in royalties as a substitute for production from the well. In this case, the jury was presented with opinion testimony from both BP and Red Deer experts that it was unlikely the well could produce in paying quantities even if the flow of gas were restored, and there probably wasn’t anything that could be done to increase production from the well.
At trial, the jury found that the lease had not failed to produce in paying quantities in the roughly three-year period leading up to BP’s shutting in the well. However, the jury also found that the well was not capable of producing in paying quantities when it was shut-in, and that a reasonably prudent operator would not continue to operate the well in the manner in which it was operating without additional equipment or repairs. As a result of these findings, the lower court entered a judgment in favor of Red Deer declaring that BP’s lease had lapsed and terminated, thus allowing Red Deer to enforce its top leases.
On appeal, BP argued that the lease should not have been terminated as the jury did not find that the well had failed to produce in paying quantities prior to when it was shut-in. BP further argued that there was insufficient evidence to support the jury’s findings regarding capacity for production at shut in, and that a reasonably prudent operator would not continue to operate the well. The 7th Court of Appeals disagreed, finding that there was sufficient evidence to support the jury’s conclusion that it was unlikely the well would return to a profitable state. Noting that a well “capable of production in paying quantities” is required to invoke the shut-in royalty clause, the court upheld the decision that the lease had lapsed.
In its appeal to the Texas Supreme Court, BP contends that a decision in the case would allow the court to determine whether a shut-in well’s ability to produce in paying quantities is measured at the time of shut-in or afterward. BP argues that, if the capability to produce were to be measured after shut-in, any lease maintained by shut-in royalties would be at risk of termination. Red Deer counters in its response that, whether or not the lease had been maintained by production up until the well was shut-in, the well’s inability to produce in paying quantities even if turned back on prevents the lease from being maintained through the shut-in clause.
Oral arguments in the case are scheduled for Nov. 10, 2016. The case is BP America Production Co. v. Red Deer Resources, LLC, case number 15-0569, in the Texas Supreme Court.