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
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
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.
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