How to Keep Your Lease Alive Under Texas Law When You Can’t Produce Oil

With headlines like “The World Is Running Out of Places to Store Its Oil” and “Oil Market Shows Fear That U.S. Is Running Out of Storage Space,” oil and gas operators are rightly concerned that their pipelines and storage facilities may soon no longer be able to take their production. With no way to transport or store oil, operators may find themselves shutting down production from oil wells on valuable acreage across Texas. Some lessors—hoping to get another bonus payment for their acreage—will undoubtedly follow these events with lease termination claims.

Can operators hold onto their valuable Permian, Eagle Ford, and other Texas leases when they cannot produce oil? Texas law provides numerous avenues for operators to keep their leases alive despite their inability to produce oil. Before giving up on a lease, operators should run through the checklist below to see what options are available.

□ Does your force majeure clause apply?

To state the obvious, the first place you should look in your lease is the force majeure provision. Plenty of ink has been spilled on these clauses by law firms over the last month (including Hogan Thompson LLP, here and here), so I won’t belabor the point. But operators should closely parse these clauses to see if they provide relief and make sure they apply to operations after the lease’s primary term.[1]

□ Does your shut-in royalty clause apply?

While shut-in payments are generally associated with gas wells, operators should read their leases closely to see if you may be able to shut in oil wells too. Many shut-in clauses expressly apply to wells producing either oil or gas.[2] Or a shut-in clause may apply to any well “producing gas,” which could include associated gas produced along with oil. Just be wary of clauses that apply to wells “producing gas only”[3] or only to “gas wells,” which may incorporate the Railroad Commission’s classification of wells.[4]

Many shut-in clauses allow for shut in if a pipeline is not “available.” If an oil well is connected to a pipeline that is refusing to accept deliveries because of a lack of storage, this may allow an operator to shut in the well and still hold the lease.[5]

Two other factors to consider: Is the well producing in paying quantities (as discussed below)? And is there a market for the oil? If your lessor can prove that “the well was either not capable of producing in paying quantities, or that no market existed for the [oil]” the lessor may prevail on a lease termination claim.[6] The Texas Supreme Court’s most recent decision on shut-in clauses, BP America Production Co. v. Red Deer Resources, LLC,[7] made it abundantly clear that shut-in clauses (like other parts of a lease) will be carefully construed, so operators should be hesitant to apply generic “rules” from earlier shut-in clause cases with different language at issue.

□ Does the “temporary cessation” doctrine apply?

The court-created “temporary cessation” doctrine may help operators that have shut down oil production based on a lack of storage or pipeline capacity. “In situations where there are periods of no gas production and no “savings clauses,” the courts imply a “temporary cessation” doctrine, which requires that the cessation must be “‘due to a sudden stoppage of the well or some mechanical breakdown of the equipment used in connection therewith, or the like,’ and production must be resumed within ‘a reasonable time.’”[8]

While older Texas cases suggest that the doctrine did not apply to operators who voluntarily shut down wells, the Texas Supreme Court in 2004 stated that “foreseeability and avoidability are not essential elements of the temporary cessation of production doctrine.”[9] With this change, it may be that a court “would apply the temporary cessation doctrine if a well were shut in for purely economic reasons, such as low oil or gas prices.”[10] And at least one Texas court has held that the doctrine applied to hold a lease after a pipeline operator disconnected the lease from its network.[11] These cases suggest this doctrine may be a good fit for operators that are forced to shut down production due to lack of storage or pipeline capacity.

□ Does your lease allow for a cessation of production?

Many leases have express “temporary cessation” provisions that will outline how long an operator can cease production on a lease and often lay out acceptable reasons for such a cessation. If your lease has such a clause, the implied temporary cessation doctrine will likely not apply to your lease and you will be bound by the lease’s express terms.[12]

□ Can you limit production while still “producing in paying quantities”? In response to limited storage options, operators may be able to ratchet down production and store it on-lease until this storage crunch subsides. But this may lead to challenges from lessors claiming that your lease is no longer “producing in paying quantities” as required under Texas law.

Operators will have defenses to such claims. Recent Texas Supreme Court cases on paying quantities have emphasized that a well’s profitability needs to be examined over a “reasonable period of time,” which leaves flexibility for determining the proper time period for this question.[13] Operators may be able to use this flexibility to ensure that months before the recent storage/price crisis are included.

Even if a well’s production is not covering its costs as outlined above, an operator will not lose its lease if “under all the relevant circumstances a reasonably prudent operator would, for the purpose of making a profit and not merely for speculation, continue to operate [a] well in the manner in which the well in question was operated.”[14] The storage crunch impacting the industry will (hopefully) clear up in the near future. In such a situation, an operator may be able to persuasively argue that a reasonably prudent operator would continue to operate a well at low levels until storage capacity becomes available. Keep in mind, however, that this test may not apply to operators that have completely stopped producing oil and gas from a lease.[15]

Of course, even if the options above may work to extend your lease during these extraordinary times, it is usually the safer course to try and negotiate a lease amendment or extension with your lessor. Lessors understand the unprecedented situation facing operators today and may be more willing to cooperate than in years past.

[1] Compare Sun Operating Ltd. P'ship v. Holt, 984 S.W.2d 277, 286-87 (Tex. App.—Amarillo 1998, pet. denied) (lease’s force majeure clause held lease after primary term), with Gulf Oil Corp. v. Southland Royalty Co., 496 S.W.2d 547, 551 (Tex. 1973) (lease’s force majeure clause did not extend lease’s termination date).

[2] See, e.g., PNP Petroleum I, LP v. Taylor, 438 S.W.3d 723, 736 (Tex. App.—San Antonio 2014, pet. denied) (shut-in clause discussing “oil/gas” wells); Blackmon v. XTO Energy, 276 S.W.3d 600, 605 (Tex. App.—Waco 2008, no pet.) (permitting shut in for well “capable of producing oil or gas”).

[3] See Vernon v. Union Oil Co. of Cal., 270 F.2d 441, 446 (5th Cir. 1959) (discussing shut-in provision with this language and holding it applies to wells producing “negligible quantities of liquid condensate” in addition to dry gas).

[4] See 1 Texas Law of Oil and Gas 4.5 (suggesting use of Railroad Commission classification when drafting shut-in clause for a “gas well”).

[5] See In re MSB Energy, Inc., 438 B.R. 571, 592 (Bankr. S.D. Tex. 2010) (holding operator’s shut in proper when pipeline refused to accept gas from operator and the lease permitted a shut in when there was not an “available pipeline”).

[6] BP Am. Prod. Co. v. Red Deer Res., LLC, 526 S.W.3d 389, 395 (Tex. 2017) (quoting Hydrocarbon Mgmt., Inc. v. Tracker Expl., Inc., 861 S.W.2d 427, 433 (Tex. App.—Amarillo 1993, no writ)).

[7] 526 S.W.3d 389 (Tex. 2017).

[8] Nat. Gas Pipeline Co. of Am. v. Pool, 30 S.W.3d 618, 626 (Tex. App.—Amarillo 2000), rev’d on other grounds, 124 S.W.3d 188 (Tex. 2003).

[9] Ridge Oil Co., Inc. v. Guinn Invs., Inc., 148 S.W.3d 143, 152 (Tex. 2004) (brackets and quotation omitted).

[10] 1 Texas Law of Oil and Gas 4.4 (2019).

[11] Casey v. W. Oil & Gas, Inc., 611 S.W.2d 676, 680 (Tex. Civ. App.—Eastland 1980, writ ref’d n.r.e.).

[12]  Samano v. Sun Oil Co., 621 S.W.2d 580, 581–84 (Tex.1981).

[13] BP Am. Prod. Co. v. Laddex, Ltd., 513 S.W.3d 476, 485-486 (Tex. 2017).

[14] Clifton v. Koontz, 160 Tex. 82, 89, 325 S.W.2d 684, 691 (1959).

[15] Bachler v. Rosenthal, 798 S.W.2d 646, 649 (Tex. App.—Austin 1990, writ denied) (“[L]essors assert that . . . the ‘reasonably prudent operator’ test does not apply in a case where a total physical cessation of production (as distinguished from merely unprofitable production) occurs and continues more than sixty days . . . .  We conclude that the lessors are correct.”).