You are on page 1of 22

DISPUTES OVER PRODUCTION IN PAYING QUANTITIES

JAMES E. KEY, Fort Worth
Harris, Finley & Bogle, PC

DANIEL H. CHAREST, Dallas
Burns Charest, LLP

State Bar of Texas
OIL AND GAS DISPUTES
January 10-11, 2019
Houston

CHAPTER 15
JAMES EDWARD KEY
HARRIS, FINLEY & BOGLE, P.C.
777 MAIN STREET, SUITE 1800
FORT WORTH, TEXAS 76102
DIRECT DIAL: (817) 870-8735 | FAX: (817) 333-1182 | ELECTRONIC MAIL: jkey@hfblaw.com

BOARD CERTIFIED SPECIALIZATIONS
• Oil, Gas, and Mineral Law

REPRESENTATIVE DECISIONS
• Griswold v. EOG Resources, Inc., 459 S.W.3d
713 (Tex. App.—Fort Worth 2015, no pet.)
• Capitol Wireless, LP v. XTO Energy, Inc., No.
02-12-00351-CV, 2014 WL 3696084 (Tex.
App.—Fort Worth July 24, 2014, no pet.)
• EOG Resources, Inc. vs. Hurt, 357 S.W.3d 144
(Tex. App.—Fort Worth 2011, pet. denied)
Practices
• Trinity East Energy, Inc. vs. St. Paul Surplus Civil Trial Litigation
Lines Insurance Company, Civil No. 4:11-CV- Oil and Gas Litigation
814-Y (N.D. Tex. filed Oct. 19, 2011) Business Litigation
• Rickett v. Lesikar, No. 02-10-00026-CV, 2010
WL 4028102 (Tex. App.—Fort Worth Oct. 14, Education
2010, no pet.) JD, Texas Wesleyan University School of Law,
1999 (Magna Cum Laude)
• Burzynski vs. Range Resources Corporation, Texas Wesleyan Law Review, Articles Editor
Cause No. 30638 (12th Dist. Ct. Grimes County,
Tex. May 11, 2010) MBA, Texas Christian University, 1995
• Burlington Resources Oil & Gas Company, LP Concentration: Finance
v. Dalton Bend Ranch, Ltd., Cause No. C41407
(29th Dist. Ct. Palo Pinto County, Tex. January BBA, Texas Tech University, 1994
3, 2007) Major: Accounting (Cum Laude)

• Roten vs. EOG Resources, Inc., Cause No. Admitted to Practice
C200500394 (413th Dist. Ct. Johnson County, Texas Trial Courts, 1999
Tex. March 5, 2007)
Texas Appellate Courts, 1999
• Stalnaker vs. Thomas W. Lett et al., Cause No.
U.S. District Court for the Northern District of
04-09-0402 M-CV (97th Dist. Ct. Montague
Texas
County, Tex. Nov. 8, 2005)
U.S. District Court for the Eastern District of
• American Stone, Inc. vs. Faulkner et al., Cause
Texas
No. 352-191992-02 (352nd Dist. Ct. Tarrant
County, Tex. Dec. 23, 2003) U.S. District Court for the District of North
Dakota
PROFESSIONAL RECOGNITION AND AWARDS
Pro Hac Vice Admissions in California and
• State Bar of Texas Arkansas
• Tarrant County Bar Association PUBLICATIONS/SPEAKING ENGAGEMENTS
• Tarrant County Young Lawyers Association • Community Leases: A Practioner’s
• Fellow, Texas Bar Foundation Guide, Oil, Gas & Mineral Title
Examinations (2015)
• Barrister, Eldon B. Mahon Inn of Court
• Lease Formation and the Use of Sight
• Harris, Finley & Bogle, P.C. Executive Drafts: So You Think You Have a Deal?,
Committee (2016-present) presented to Fort Worth Association of
• Top Attorney by 360 West magazine (2017-2018) Professional Landmen (2012)
• Advisory Council Member - Texas Parks & • The Right to Royalty: Pooling and the
Wildlife Stewards of the Wild - Fort Worth Capture of Unburdened Interests, 17.
(2015-present) Tex. Wesleyan L. Rev. 69 (2010)
• Top Attorneys (Civil Litigation) - Fort Worth,
Texas magazine (2011)
• Board Member, Cross Timbers Chapter of Quail
Unlimited (2007-2009)
• Executive Committee, Cross Timbers Quail
Coalition (2010-present)
• Founding Member, Cross Timbers Quail
Coalition (2010)
• Named Rising Star by Texas Monthly magazine
(2006-2009)
• Member, Texas Association of Defense Counsel
• Law Clerk to Justice Dixon W. Holman, 2nd
Court of Appeals, Fort Worth, Texas (1999-
2000)
• TCU MBA Alumni Association
BURNS CHAREST LLP
The attorneys at Burns Charest grew up as lawyers trying big cases and getting big cases ready for trial. Winning at
trial stands as their singular focus because nothing resolves cases more than readiness, willingness, and ability to try
cases.
Relevant experience within the Burns Charest firm:
• Co-lead counsel: In re Anadarko Basin Oil and Gas Lease Antitrust Lit., Case No. 5:16-cv-209 (W.D. Okla.).
Representing mineral owners against oil and gas companies for conspiring to rig bids and limit competition
for oil and gas leases.
• Member of five-person executive committee: In re Johnson & Johnson Talcum Powder Products Marketing,
Sales Practices and Products Liability Litigation, Case No. 3:16-md-2738 (D.N.J.). Representing thousands
of women alleging that talcum powder products cause ovarian and uterine cancer.
• Co-liaison counsel: In re: Chesapeake Barnett Royalty Litigation #2, MDL No. 48-000000-15 (48th District
Court, Tarrant County, Texas). Representing royalty and mineral owners in mass action against operator for
royalty underpayments.
• Co-lead counsel: In re: Asbestos, Catalyst, and Silica Toxic Dust Exposure Litigation, Master Docket No.
SX-15-CV-096 (U.S.V.I. Sup. Ct.). Representing several hundred individual workers exposed to asbestos
while working in a refinery on St. Croix, U.S.V.I.
• Executive committee member: In re: Domestic Airlines Antitrust Litigation, Case No. 1:15-mc-1404
(D.D.C.). Representing millions of Americans who overpaid for airline tickets after the nation’s largest
carriers entered into an illegal conspiracy to fix prices and limit airline capacity.
• Co-lead counsel: In re: Crude Oil Commodity Futures Litigation, Case No. 1:11-cv-3600 (S.D.NY.).
Represented thousands of investors who lost money after rogue trading companies manipulated the market
for crude oil. Burns Charest settled the case in 2015 and are administering the settlement.

DANIEL CHAREST
Daniel Charest developed his trial-lawyer skills at a nationally-recognized litigation firm, Susman Godfrey, where he
became a partner, tried cases, and ran his clients’ cases. Over the years, he has developed an effective, efficient
approach to lawyering that focuses on his client’s needs and achieving their desired outcome. He established Burns
Charest LLP in early 2015 to build a trial-ready firm that focuses on complex, commercial litigation with skills,
smarts, and hard work.
While his interest and experience, including past trials and multiple, existing matters reflects a significant focus in oil
and gas matters. For example, Mr. Charest has handled high-profile litigation on behalf of landowners in mineral
rights cases against energy corporations in many of the nation’s major oil & gas regions. But Mr. Charest’s body of
work reaches beyond any particular practice area. He has run cases involving antitrust, breach of contract, oil & gas,
financial-service companies, business torts, such trade secret misappropriation and unfair competition, consumer
protection, class actions, fraud, insurance bad faith, and wrongful death. His work has taken place across the United
States, in both federal and state courts. Mr. Charest’s docket has involved procedural and jurisdictional challenges
such as removal and remand, class certification, transfers, temporary restraining orders, temporary injunctions, and
appeals. In all, the body of work is, simply, high-stakes commercial litigation.
Mr. Charest clerked for Judge Edith Brown Clement on the Fifth Circuit Court of Appeals. And he is admitted to
practice in the District of Columbia., Texas, Virginia, and the U.S. Virgin Islands, as well as numerous federal
districts and appellate courts across the country.
Disputes Over Production in Paying Quantities Chapter 15

TABLE OF CONTENTS

I. INTRODUCTION ............................................................................................................................................. 1

II. THE PRODUCTION IN PAYING QUANTITIES DOCTRINE ...................................................................... 1

III. THE PRODUCTION IN PAYING QUANTITIES TEST – CLIFTON V. KOONTZ ....................................... 2

IV. THE OBJECTIVE PRONG OF THE PRODUCTION IN PAYING QUANTITIES ANALYSIS ................... 3
A. Whether a Well Is Producing in Paying Quantities Is Measured over a Reasonable Period of
Time Absent Lease Language to the Contrary. .......................................................................................... 4
B. The “Income Side” of the Production in Paying Quantities Analysis. ....................................................... 5
C. The “Expense Side” of the Production in Paying Quantities Analysis. ..................................................... 5
1. Royalties ............................................................................................................................................. 6
2. Drilling, Completing, and Reworking Costs ...................................................................................... 6
3. Depreciation on Salvable Equipment ................................................................................................. 7
4. Overhead ............................................................................................................................................ 7
5. Marketing Expenses and the Cost of Building Pipelines ................................................................... 7

V. THE SUBJECTIVE PRONG OF THE PRODUCTION IN PAYING QUANTITIES ANALYSIS ................. 8

VI. PRODUCTION IN PAYING QUANTITIES VS. CAPABLE OF PRODUCTION IN PAYING
QUANTITIES AND OTHER PAYING QUANTITY ISSUES ........................................................................ 8
A. Capable of Producing Gas in Paying Quantities ........................................................................................ 8
B. The Lack of a Market Can Preclude a Finding of Production in Paying Quantities ................................ 10
C. Shut in Royalty......................................................................................................................................... 11
D. The Payment of Shut in Royalty Will Not Extend a Term Royalty Deed That Lacks Shut in
Language .................................................................................................................................................. 12
E. Adverse Possession .................................................................................................................................. 12

VII. SUBMITTING THE PRODUCTION IN PAYING QUANTITIES ISSUE TO THE JURY ......................... 12
A. The Habendum Clause ............................................................................................................................. 12
B. The Shut-In Royalty Clause ..................................................................................................................... 13

VIII. CONCLUSION ................................................................................................................................................ 14

i
Disputes Over Production in Paying Quantities Chapter 15

TABLE OF AUTHORITIES

Federal Cases

Duke v. Sun Oil Co.,
320 F.2d 853 (5th Cir. 1963) .................................................................................................................................. 11

United Central Oil Corp. v. Helm,
11 F.2d 760, 762 (5th Cir. 1926) .............................................................................................................................. 7

State Cases

Abraxas Pet. Corp. v. Hornburg,
20 S.W.3d 741 (Tex. App.—El Paso 2000, no pet.)............................................................................................. 5, 6

Amoco Prod. Co. v. Braslau,
561 S.W.2d 805 (Tex. 1978) .................................................................................................................................... 1

Anadarko Petroleum Corp. v. Thompson,
94 S.W.3d 550 (Tex. 2002) .............................................................................................................................. 1, 8, 9

Archer County v. Webb,
338 S.W.2d 435 (Tex. 1960) .............................................................................................................................. 8, 12

Archer v. Skelly Oil Co.,
314 S.W.2d 655 (Tex. Civ. App.—Amarillo 1958, writ ref’d n.r.e.) ....................................................................... 7

Bachler v. Rosenthal,
798 S.W.2d 646 (Tex. App.—Austin 1990, writ denied) ..................................................................................... 3, 4

Ballanfonte v. Kimbell,
373 S.W.2d 119 (Tex. Civ. App.—Fort Worth 1963, writ ref’d n.r.e.).................................................................... 4

Bell v. Mitchell Energy Corp.,
553 S.W.2d 626 (Tex. Civ. App.—Houston [1st Dist.] 1977, no writ) ................................................................ 4, 5

Blackmon v. XTO Energy Inc.,
276 S.W.3d 600 (Tex. App.—Waco 2008, no pet.) ................................................................................................. 9

Bomar Oil & Gas, Inc. v. Loyd,
No. 10-08-00016-CV, 2009 WL 2136404 (Tex. App.—Waco July 15, 2009) (mem. op.) ................................. 6, 7

BP Am. Prod. Co. v. Red Deer Resources, LLC,
526 S.W.3d 389 (Tex. 2017) ........................................................................................................................... passim

BP America Prod. Co. v. Laddex,
513 S.W.3d 476 (Tex. 2017) ........................................................................................................................... passim

Chesapeake Exploration, Ltd. Partnership v. Corine, Inc.,
No. 10-06-00265-CV, 2007 WL 2447293 (Tex. App.—Waco Aug. 29, 2007), judgm’t
withdrawn, No. 10-06-00265-CV, 2007 WL 2729576 (Tex. App.—Waco 2007, no pet.) ................................ 9, 11

Clifton v. Koontz,
325 S.W.2d 684 (Tex. 1959) ........................................................................................................................... passim

ii
Disputes Over Production in Paying Quantities Chapter 15

Cox v. Miller,
184 S.W.2d 323 (Tex. Civ. App.—Eastland 1944, writ ref’d) ........................................................................... 9, 12

Evans v. Gulf Oil Corp.,
840 S.W.2d 500 (Tex. App.—Corpus Christi 1992, writ denied) ................................................................... passim

Fain Family First Ltd. P’ship v. EOG Resources, Inc.,
No. 02-12-00081-CV, 2013 WL 1668281 (Tex. App.—Fort Worth April 18, 2013, no pet.) ............................... 12

Fike v. Riddle,
677 S.W.2d 722 (Tex. Civ. App.—Tyler 1984, no writ) ........................................................................................ 12

Garcia v. King,
164 S.W.2d 509 (Tex. 1942) ........................................................................................................................... passim

Grinnel v. Munson,
137 S.W.3d 706 (Tex. App.—San Antonio 2004, no pet.)................................................................................... 4, 9

Gulf Oil Corp. v. Reid,
337 S.W.2d 267 (Tex. 1960) ........................................................................................................................... passim

Gulf Oil Corp. v. Southland Royalty Co.,
496 S.W.2d 547 (Tex. 1973) .................................................................................................................................... 1

Hanks v. Magnolia Petroleum Co.,
24 S.W.2d 5 (Tex. Comm’n App. 1930, judgm’t adopted) .............................................................................. 11, 12

Holchak v. Clark,
284 S.W.2d 399 (Tex. Civ. App.—San Antonio 1944, writ ref’d)..................................................................... 8, 10

Hutchison v. Tex-Lee Drilling & Dev. Co., Inc.,
No. 03-96-00453-CV, 1997 WL 703180 (Tex. App.—Austin Nov. 13, 1997, pet. denied) .................................... 6

Hydrocarbon Management, Inc. v. Tracker Exploration, Inc.,
861 S.W.2d 427 (Tex. App.—Amarillo 1993, no writ) ................................................................................ 9, 11, 12

Kidd v. Hoggett,
331 S.W.2d 515 (Tex. Civ. App.—San Antonio 1959, writ ref’d n.r.e.) ............................................................... 11

Ladd Petroleum Corp. v. Eagle Oil & Gas Co.,
695 S.W.2d 99 (Tex. App.—Fort Worth 1985, writ ref’d n.r.e.) ............................................................................. 7

Morgan v. Fox,
536 S.W.2d 644 (Tex. Civ. App.—Corpus Christi 1976, writ ref’d n.r.e.) .............................................................. 6

Natural Gas Pipeline Company v. Pool,
124 S.W.3d 188 (Tex. 2003) .................................................................................................................................. 12

Patton v. Rogers,
417 S.W.2d 470 (Tex. Civ. App.—San Antonio 1967, writ ref’d n.r.e.) ......................................................... 2, 4, 5

Peveto v. Starkey,
645 S.W.2d 770 (Tex. 1982) ........................................................................................................................ 9, 10, 12

Pshigoda v. Texaco, Inc.,
703 S.W.2d 416 (Tex. App.—Amarillo 1986, writ ref’d n.r.e.) ....................................................................... 4, 5, 6

iii
Disputes Over Production in Paying Quantities Chapter 15

Ridenour v. Herrington,
47 S.W.3d 117 (Tex. App.—Waco 2001, pet denied) ...................................................................................... 2, 4, 5

Sellers v. Breidenbach,
300 S.W.2d 178 (Tex. Civ. App.—San Antonio 1957, writ ref’d)......................................................................... 10

Skelly Oil Co. v. Archer,
317 S.W.2d 47 (Tex. 1958) ...................................................................................................................................... 8

Skelly Oil Co. v. Archer,
356 S.W.2d 774 (Tex. 1962) ............................................................................................................................ 2, 6, 7

Stanolind Oil & Gas Co. v. Barnhill,
107 S.W.2d 746 (Tex. Civ. App.—Amarillo 1937, writ ref’d) .......................................................................... 8, 11

Sullivan & Garnett,
308 S.W.2d 891 (Tex. Civ. App.—San Antonio 1957, writ ref’d n.r.e.) ................................................................. 4

Texas Co. v. Davis,
254 S.W. 304 (Tex. 1923) ........................................................................................................................................ 1

Transport Oil Co. v. Exeter Oil Co. Ltd.,
191 P.2d 129 (Cal. Dist. Ct. App. 1948) .................................................................................................................. 5

Union Oil Company of California v. Ogden,
278 S.W.2d 246 (Tex. Civ. App.—El Paso 1955, writ ref’d n.r.e.) ....................................................................... 10

Vortt Expl. Co., Inc. v. EOG Resources, Inc.,
No. 11-07-00159-CV, 2009 WL 1522661 (Tex. App.—Eastland May 29,
2009, no pet.) (mem. op.) ....................................................................................................................................... 12

Miscellaneous

31 Tex. Admin. Code § 9.31 (Aug. 9, 2009) .................................................................................................................. 6

43 Tex. Reg. No. 7494 (Nov. 9, 2018) ............................................................................................................................ 6

1 Ernest E. Smith & Jacqueline Lang Weaver, Texas Law of Oil & Gas § 4.3[A] (June 2018) ..................................... 1

1 Ernest E. Smith & Jacqueline Lang Weaver, Texas Law of Oil & Gas § 4.4[A] (June 2018) ........................... 6, 8, 13

Richard W. Hemingway, The Law of Oil and Gas § 6.5 (2d ed. 1983) ........................................................................ 11

iv
Disputes Over Production in Paying Quantities Chapter 15

DISPUTES OVER PRODUCTION IN Law of Oil & Gas § 4.3[A] (June 2018). Texas courts
have held that an “is produced” habendum clause
PAYING QUANTITIES requires production in paying quantities to extend the
lease during the secondary term. Red Deer Resources,
I. INTRODUCTION 526 S.W.3d at 394 (“The word ‘produce’ in a habendum
What does it mean for an oil or gas well to produce
clause ‘is synonymous with the phrase ‘producing in
in paying quantities? Though it may appear a simple
paying quantities.’”); BP America Prod. Co. v. Laddex,
question, the case law is deceptively thorny. Slight
513 S.W.3d 476, 482 (Tex. 2017); Garcia v. King, 164
factual differences can mean the difference between a
S.W.2d 509, 510-11 (Tex. 1942) (noting that
lease terminating and remaining in force. And the
production, as used in the habendum clause of an oil and
economic impact of these small facts cannot be
gas lease, impliedly means production in paying
overstated: as investors scour mature fields for new
quantities, i.e., profitable production); Reid, 337 S.W.2d
opportunity, the issue will become more poignant, more
at 269-70 (“the word ‘production’ as used in the
hotly contested, and more frequently adjudicated.
habendum clause of this lease is equivalent to the phrase
This paper hopes to answer this fundamental
‘production in paying quantities.’”); Evans v. Gulf Oil
question and arm readers with the tools necessary to
Corp., 840 S.W.2d 500, 502 (Tex. App.—Corpus
navigate the legal thicket that can be Texas oil and gas
Christi 1992, writ denied). Thus, an oil and gas lease
law. First, this paper explains how Texas courts have
automatically terminates if actual production
defined the word “production” in oil and gas leases to
permanently ceases during the secondary term, provided
mean “production in paying quantities.” Second, this
that there are no other lease “savings” clauses. 1
paper untangles the two-pronged approach Texas courts
Thompson, 94 S.W.3d at 554; Amoco Prod. Co. v.
have taken to determine whether an oil and gas lease has
Braslau, 561 S.W.2d 805, 808 (Tex. 1978).
produced in paying quantities. Third, this paper
While the habendum clause generally controls the
addresses some common issues relevant to submitting
mineral estate’s duration, other clauses may extend the
the question of whether an oil or gas lease has produced
habendum clause’s term. Thompson, 94 S.W.3d at 554.
in paying quantities to the jury.
After the primary term, an oil and gas lease generally
may be kept alive by production in paying quantities or
II. THE PRODUCTION IN PAYING
a lease savings-clause such as a shut-in gas well clause,
QUANTITIES DOCTRINE
a drilling operations clause, a continuous operations
Under Texas law, a mineral estate automatically
clause, or a cessation of production clause that requires
terminates if the event upon which it is limited occurs.
additional drilling or reworking within a fixed number
BP Am. Prod. Co. v. Red Deer Resources, LLC, 526
of days. Red Deer Resources, 526 S.W.3d at 394-95.
S.W.3d 389, 394 (Tex. 2017); Anadarko Pet. Corp. v.
When a lease terminates is “‘always a question of
Thompson, 94 S.W.3d 550, 554 (Tex. 2002); Gulf Oil
resolving the intention of the parties from the entire
Corp. v. Reid, 337 S.W.2d 267, 269 (Tex. 1960). In
instrument.’” Thompson, 94 S.W.3d at 554 (quoting
other words, a mineral lease grants a fee simple
Southland Royalty Co., 496 S.W.2d at 552).
determinable estate to the lessee. Texas Co. v. Davis,
A well produces in paying quantities when the well
254 S.W. 304, 309 (Tex. 1923). Therefore, as long as
pays a profit, however small, over operating expenses
the lessee uses the land for its intended purposes, the
even though the income from the well may never be
lessee’s mineral estate may continue indefinitely. Id. at
sufficient to repay its costs. Red Deer Resources, 526
306.
S.W.3d at 394; Clifton v. Koontz, 325 S.W.2d 684, 691
To guard against the indefinite duration of a
(Tex. 1959). The production in paying quantities
mineral lease, the habendum clause generally defines
doctrine is rooted in the objective intent of the lessor’s
the mineral estate’s duration. Gulf Oil Corp. v.
and the lessee’s contract—i.e., the development of the
Southland Royalty Co., 496 S.W.2d 547, 552 (Tex.
mineral estate for the mutual benefit of the parties
1973). For example, a typical habendum clause states
during the primary term of the agreement or during the
that the lease lasts for a relatively short fixed term of
extension of the lease in the secondary term. Garcia,
years (the primary term) and then as long thereafter as
164 S.W.2d at 512; Reid, 337 S.W.2d at 270. That is,
oil or gas is produced (the secondary term). Thompson,
courts must consider the objects and the overall
94 S.W.3d at 554; Reid, 337 S.W.2d at 269 n.1; see also
purposes intended by the parties in entering into an oil
1 Ernest E. Smith & Jacqueline Lang Weaver, Texas
and gas lease in order to properly understand and

1
For example, the habendum clause in Anadarko Petroleum showed that the lease well was capable of production, even
Corp. v. Thompson provided that the lease would last “as long though it was undisputed that the well had failed to produce
thereafter as gas is or can be produced.” Thompson, 94 any gas for a sixty-one day period in 1981 and a ninety-one
S.W.3d at 553 (emphasis added). The Texas Supreme Court day period in 1985 while the gas purchaser conducted pipeline
held that the lease did not terminate where the evidence repairs. Id.
1
Disputes Over Production in Paying Quantities Chapter 15

interpret the habendum clause in an oil and gas lease. the Texas Supreme Court emphasized that “no matter
Garcia, S.W.2d at 512. And as for the lease’s how great the potential production may be or how many
continuation for an indefinite period of time after the million cubic feet of gas may have been flared, there
primary term, no one would argue against the lessee would be no production or production in paying
being afforded the full and complete opportunity to reap quantities unless there was an available market.” 337
all of the fruits of the investments made in developing S.W.2d at 270.
the mineral estate. Yet, when the lease can no longer be A number of questions arise in regards to the
operated at a profit, it stands to reason that there are no production in paying quantities analysis. What if there
more fruits to be reaped and therefore, the lease should is no available market through no fault of the lessee?
be released. Should the lessor be required to suffer a continuation of
While the production in paying quantities doctrine the lease beyond the expiration of the primary term
may involve issues that appear similar to those found in merely for speculative purposes on the part of the
temporary and permanent cessations of production, it is lessee? In regard to the latter question, the Texas
a separate doctrine with its own analysis and tests. Supreme Court has answered “no.” If the lease is no
Laddex, 513 S.W.3d at 485 n.6 (stating that cases longer yielding a profit at the termination of the primary
involving non-production due to sudden stoppage or term, however small, the object of the lease has been
equipment malfunctions and the implied temporary accomplished and the lease has therefore terminated.
cessation of production doctrine are inapposite to Garcia, 164 S.W.2d at 513. While the concept of
situations involving the cessation of production in holding a lease for purposes of making a profit and not
paying quantities, which arise when a well is marginally merely for speculation appears relatively straight
producing); Ridenour v. Herrington, 47 S.W.3d 117, forward, its application has proven difficult.
121-22 (Tex. App.—Waco 2001, pet denied). A
complete cessation of production for the number of days III. THE PRODUCTION IN PAYING
stated in a lease’s cessation of production clause QUANTITIES TEST – CLIFTON V. KOONTZ
automatically terminates the lease, without regard to the The Texas Supreme Court articulated the
reasonableness of the operator’s actions, absent a production in paying quantities test in 1959 in Clifton v.
properly invoked savings clause. Red Deer Resources, Koontz. 4 In that case, the lessors brought suit seeking the
526 S.W.3d at 395-96. And the Texas Supreme Court cancellation of an oil and gas lease on the theory that the
has made clear that this is a ground for lease termination lease had expired in the secondary term due to a
separate and apart from the cessation of production cessation of production. Id. at 687. The lease in Clifton
analysis laid out in Clifton and Skelly Oil Co. v. Archer, contain a reworking-operations savings clause
356 S.W.2d 774 (Tex. 1962). Id. Unlike claims for providing that after the “discovery of oil, gas or other
cessation of production in paying quantities, when a mineral[s] the production thereof should cease from any
party claims that a lease has terminated for a total cause, this lease shall not terminate if lessee commences
cessation of production, 2 the reasonably prudent additional drilling or re-working operations within sixty
operator inquiry does not come into play. Id. at 396. (60) days thereafter.” Id. at 690. The lease, which was
Production in paying quantities issues generally executed in 1940, covered two tracts of land covering
arises in two situations. The first situation involves the 350 acres in Wise County, Texas. Id. at 687-88. A gas
expiration of an oil and gas lease’s primary term. 3 The well was drilled within the lease’s ten-year primary
second situation arises in cases involving a marginal term. Id. at 688. Although the well produced both oil and
well whose production has slowed to the point where oil gas, it was classified as an “associated” gas well. Id. No
or gas is barely being produced. The term “paying other drilling or reworking operations were carried on
quantities” involves not only the amount of production, during the primary term or subsequently until
but also the ability to market the product at a profit. September 12, 1956, when the well was successfully
Clifton, 325 S.W.2d at 691. With that principle in mind, reworked. Id.
there must be an actual, available market in order for The trial court found that the well had continuously
there to be production in paying quantities. Patton v. produced gas in paying quantities, which was affirmed
Rogers, 417 S.W.2d 470, 475 (Tex. Civ. App.—San on appeal. Id. In sustaining the court of appeals’
Antonio 1967, writ ref’d n.r.e.). In Reid, for example, judgment that the lease had not terminated in the

2
A total cessation of production occurs when a well that has a total cessation of production for a period longer than stated
been producing gas ceases to produce any quantity of gas. Red in the lease, and that no other lease savings clauses apply. Id.
3
Deer Resources, 526 S.W.3d at 396. When there has been a The issue in that situation generally involves a well that has
total cessation of production, the two-pronged production in been drilled, but has yet to actually produce any oil or gas for
paying quantity analysis does not apply. Id. Rather, the party a number of reasons, including not being completed, no
seeking to terminate the lease must show that there has been pipeline connection, or a lack of market.
4
325 S.W.2d 684 (Tex. 1959).
2
Disputes Over Production in Paying Quantities Chapter 15

secondary term due to a cessation of production, the lessee should be entitled to the benefit of the standard of
Texas Supreme Court reviewed the question as to the reasonably prudent operator. Id. at 691.
whether there was any evidence to support the The Court also held that a habendum clause
proposition that production in paying quantities had not providing for production “as long as thereafter as oil,
ceased. Id. In answering that question in the affirmative, gas or other minerals is produced from said land” meant
the Court noted that there was evidence that the “production in paying quantities.” Id. The Court then
production was sold for a profit over a reasonable period recited the generally accepted definition of “production
of time to support a finding of production in paying in paying quantities” as follows: “‘[i]f a well pays a
quantities. Id. at 691. profit, even small, over operating expenses, it produces
The lessors based their contention that the in paying quantities, though it may never repay its costs,
well had ceased to produce in paying quantities upon a and the enterprise as a whole may prove unprofitable.’”
showing that for a sixteen month period between June Id. at 691 (quoting Garcia, 164 S.W.2d at 511). The
1955 and September 1956, the lease had generated a net Court went on to articulate the subjective test for
loss of $216.16. Id. at 689. While some months showed production in paying quantities: “[i]n the case of a
a gain, other months showed a loss. Id. The record also marginal well, such as we have here, the standard by
showed a loss during the months of April and May 1956. which paying quantities is determined is whether or not
Id. The evidence was undisputed that the respondent under all the relevant circumstances a reasonably
commenced reworking operations on September 12, prudent operator would, for the purpose of making a
1956, and that such operations resulted in an 1,800 profit and not merely for speculation, continue to
percent increase in production although there had been operate a well in the manner in which the well in
a small operating loss for the period of time in which the question was operated.” Id. And in accordance with that
reworking operations were being conducted. Id. The standard, the Texas Supreme Court held that a trial court
respondent also offered evidence explaining that must necessarily take into consideration all matters
operating at a profit during the period in question which would influence a reasonable and prudent
depended on the oil production, and that two to three operator, including, but not limited to, the depletion of
months were required to accumulate enough oil in a tank the reservoir, the price for which the lessee is able to sell
to sell. Id. The evidenced further showed that the its production, the relative profitableness of other wells
respondent had acquired its interest in the lease in June in the area, the operating and marketing costs of the
1956, and in July 1956, began making financial lease, the lessee’s net profit, the lease provisions, a
arrangements, securing the services of third parties, and reasonable period of time under the circumstances, and
commenced saving oil from the well for reworking whether the lessee is simply holding the lease for
operations. Id. speculative purposes. Id.
The pertinent question in Clifton was whether there Whether there is a reasonable basis for the
was production in paying quantities through July 12, expectation of profitable returns from the lease is the
1956, which was the date 60 days prior to the test, and if the quantity of the production is sufficient to
commencement of reworking operations. Id. Evidence warrant its use in the market, and if the income
as to profit or loss subsequent to that date was therefrom is in excess of the actual marketing and
immaterial in determining whether there was production operating costs, the production satisfies the term “‘in
in paying quantities. Id. Therefore, excluding the date paying quantities.’” Id. Thus, the Texas Supreme Court
that reworking operations began, the Court noted that rejected “absolute termination” and “sudden death” in
the lessee had operated the lease at a profit of $111.25 favor of the following two-pronged approach: (1) an
for the relevant period of time leading up to the objective test, i.e., whether the well has ceased to
reworking operations—the period between June 1955 produce oil and gas in paying quantities; and (2) if yes,
through July 12, 1956. Id. The Court also acknowledged a subjective test, i.e., whether under all of the relevant
that the lease had showed a net profit for the 30 month circumstances, would a reasonably prudent operator
period between January 1954 through June 1956. Id. continue to operate the well in the same manner to make
In rejecting the petitioners’ arguments that the a profit and not merely for purposes of speculation. Id.
lease terminated when its income no longer exceeded at 691; Bachler v. Rosenthal, 798 S.W.2d 646, 649 (Tex.
the costs of its operations in the secondary term, the App.—Austin 1990, writ denied).
Texas Supreme Court expressed that there can be no
limit as to the amount of time, whether it be days, weeks, IV. THE OBJECTIVE PRONG OF THE
or months, to be taken into consideration in determining PRODUCTION IN PAYING QUANTITIES
whether production in paying quantities has ceased. Id. ANALYSIS
at 690. Instead of immediately invoking the provision of The objective prong of the production in paying
various saving clauses such as an operations savings- quantities analysis concerns whether a well has failed to
clause when production ceased to yield a profit, the generate a profit over operating expenses. Clifton, 325
S.W.2d at 690-91; Evans, 840 S.W.2d at 503. Whether
3
Disputes Over Production in Paying Quantities Chapter 15

a well has yielded a profit is a question of fact. Sullivan in Clifton, including the period of time in which the
& Garnett, 308 S.W.2d 891, 893 (Tex. Civ. App.—San analysis should be conducted, the components that
Antonio 1957, writ ref’d n.r.e.); Ballanfonte v. Kimbell, comprise the revenue side of the working interest, and
373 S.W.2d 119, 121 (Tex. Civ. App.—Fort Worth the items that may be properly included into the expense
1963, writ ref’d n.r.e.). For example, in Patton, the San side of the equation.
Antonio Court of Appeals confirmed that the “matter of
allocation and calculation of expenses is a fact A. Whether a Well Is Producing in Paying
question[,]” and that the “question of whether there is Quantities Is Measured over a Reasonable
production in paying quantities is a question of fact for Period of Time Absent Lease Language to the
the jury.” 417 S.W.2d at 476; see also Laddex, 513 Contrary.
S.W.3d at 482. Yet in Evans, the court acknowledged Absent lease language to the contrary, a well’s
that in certain cases, production in paying quantities can profitability is determined over a reasonable period of
be established as a matter of law by showing a profit time that cannot be limited as to any period of months,
from the operation of the well. 840 S.W.2d at 503; see weeks or days. Under the objective prong of the test, i.e.,
also Grinnel v. Munson, 137 S.W.3d 706, 715 (Tex. whether the well has ceased to produce oil and gas in
App.—San Antonio 2004, no pet.) (“Whether an oil or paying quantities, the question often arises as to what
gas well is producing in paying quantities is ordinarily a constitutes a reasonable period of time over which the
question of fact, but where it is shown that a small profit analysis should focus. As a general rule, and absent
has been realized from the operation of the well, it may specific lease language to the contrary, the reasonable
be found as a matter of law that the well is producing in period of time for determining a well’s profit or loss is
paying quantities.”). evaluated under all of the circumstances and the totality
The burden of proof in a production in paying of the evidence presented. What constitutes a reasonable
quantities analysis lies with the lessor to prove that the period of time is a question of law. Pshigoda v. Texaco,
well is not making a profit. Bell v. Mitchell Energy Inc., 703 S.W.2d 416, 419 (Tex. App.—Amarillo 1986,
Corp., 553 S.W.2d 626, 630 (Tex. Civ. App.—Houston writ ref’d n.r.e.) (“Koontz states that the court is to
[1st Dist.] 1977, no writ). And as a general rule, the determine profitability over a ‘reasonable period of time
Austin Court of Appeals has held that a well ceases to under the circumstances.’”); Ballanfonte, 373 S.W.2d at
produce in paying quantities when there has been a total 121 (“Further, the trial court was at liberty to conclude
or complete cessation of production. Bachler, 798 that thirteen months was not a period of sufficient
S.W.2d at 650 (holding that the reasonably prudent length, in view of the evidence on profit and loss, to
operator test set forth in Clifton is not applicable where compel its finding and conclusion that the defendants
the evidence shows that there has been a complete were not making a profit.”).
cessation of production for the number of days stated in The Texas Supreme Court has specified that the
the lease). A total cessation of production normally period over which the trier of fact must determine
arises where the reservoir has been depleted or where whether a lease produces in paying quantities is not
the lessee has evidenced an objective intent to abandon arbitrary. Clifton, 325 S.W.2d at 690. To that end, there
the leasehold. Ridenour, 47 S.W.3d at 122 (“A total, is no limit as to time, whether it be days, weeks or
physical cessation of production conveys an months, to be taken into consideration in determining
unambiguous message: either a well is in need of the question. Laddex, 513 S.W.3d at 483 (citing Clifton,
reworking or repair, or it has permanently drained the 325 S.W.2d at 690). There are many causes for the
reservoir. In either case, it is more reasonable in such slowing of production, and even temporary cessations
circumstances to expect the operator to take immediate of production, which courts have found justifiable given
action or suffer termination of the lease.”). But the result the evidence presented. Clifton, 325 S.W.2d at 690.
is different where the evidence shows that a well was Accordingly, the period over which the analysis is to be
capable of producing oil or gas if turned on, even though conducted should be reflective of the relevant lease
it may have stopped actually producing oil or gas for one language and the totality of the circumstances presented
reason or another. Thompson, 94 S.W.3d at 553 (holding by the evidence. A lessee simply is not required to
that the lease did not terminate where the habendum immediately commence drilling or re-working
clause provided that the lease would last as long as gas operations upon incurring a loss in one month without
is or can be produced). This accords with the principle regard to whether next month’s production might be
that a lessee should be entitled the complete opportunity profitable. Id. And it appears that the trial court will be
to reap the fruits of the investments made in developing afforded wide discretion in deciding the scope and
the mineral estate, provided that those efforts yield a breadth of the evidence to be considered by the fact
profit and are not based solely for purposes of finder at trial. See e.g., Pshigoda, 703 S.W.2d at 419
speculation. (“Koontz states that the court is to determine
A number of questions arises regarding the profitability over a ‘reasonable period of time under the
objective prong of the paying quantity analysis set forth circumstances.’”).
4
Disputes Over Production in Paying Quantities Chapter 15

For example, in Clifton, the Texas Supreme Court court of appeals stated that under those facts, no analysis
rejected the petitioners’ argument that the well had of whether the lease had failed to produce in paying
failed to produce in paying quantities even though the quantities was necessary in order to find that the lease
evidence showed that the well had been operated at a had terminated. Id. at 122. In so holding, the Waco
$216.16 loss for the sixteen month period between June Court of Appeals recognized that a complete cessation
1955 and September 1956. Id. at 688-89. The Court re- of production for the number of consecutive days stated
defined the relevant time period to exclude profits or in the cessation of paying production clause was by
losses incurred subsequent to July 12, 1956, which was itself sufficient to automatically terminate the lease
the date 60 days prior to the commencement of without regard to the reasonableness of the operator’s
reworking operations. Id. at 688-89. In doing so, the actions. Id.; see also Laddex, 513 S.W.3d at 485 n.8
Court essentially harmonized the habendum with the 60 (noting that other lease provisions may affect the
day re-working clause so that neither were rendered paying-production analysis in determining whether
meaningless in light of the parties’ objective intent in paying production has actually ceased).
entering into the oil and gas lease—developing the
mineral estate for the mutual benefit of the parties. The B. The “Income Side” of the Production in Paying
Court then reviewed the thirty month period Quantities Analysis.
immediately preceding the initiation of the 60 day In determining the income side of the production in
reworking clause to determine that the lease had in fact paying quantities equation, should all or only some
operated at a net profit during that period. Id. at 689. portion of the income attributable to the well be
In short, while there are no bright line tests for what considered in the profit and loss analysis? In Clifton, the
constitutes a reasonable period of time over which a Texas Supreme Court stated that courts should consider
well’s profits and losses are to be measured, Clifton only the income attributable to the contractual working
makes clear that the period of time must reflect the interest created by the original lease in determining
circumstances presented and be logically related to any whether the well generated a profit or a loss. 325 S.W.2d
lease savings clauses so that the fruits of the lessee’s at 693 (“The entire income attributable to the
efforts may be fully realized to the extent reasonably contractual working interest created by the original lease
possible. Moreover, in Bell, the First District Court of is to be considered.”); see also Patton v. Rogers, 417
Appeals in Houston affirmed a jury’s verdict finding S.W.2d 470, 475 (Tex. Civ. App.—San Antonio 1967,
that the lease had produced gas in paying quantities by writ ref’d n.r.e.) (discussing generally the plaintiff’s
generating a net profit over lease operating expenses calculations of paying quantities and noting that after
over a forty-four month period despite the fact that a loss taking off the landowner royalty and severance tax, the
was sustained for eight of those months. 553 S.W.2d at monthly expenses would exceed the gross income for
630. In reaching its decision, the court stated that a the working interest). The petitioner in Clifton argued
“mathematical loss occasioned during certain months of that income attributable to an overriding royalty should
a lease does not automatically establish the fact that the be excluded in determining the well’s total income in
lease is not being held by production in paying determining the well’s profitability. The Texas Supreme
quantities.” Id. If a well makes a profit, it is producing Court disagreed and held that the income attributable to
in paying quantities. Id. The court offered no criticism overriding royalty interests should be included in the
as to whether under the evidence presented, forty-four total income attributable to the contractual working
months constituted a reasonable period of time to interest created by the original lease. Id. at 693 (citing
evaluate the well’s profitability. These principles have Transport Oil Co. v. Exeter Oil Co. Ltd., 191 P.2d 129,
recently been affirmed by the Texas Supreme Court. 133 (Cal. Dist. Ct. App. 1948).
Laddex, 513 S.W.3d at 485 (“Narrowing the [jury]
question on paying production to any particular time C. The “Expense Side” of the Production in Paying
period is necessarily ‘arbitrary.’”). Quantities Analysis.
However, when an oil and gas lease contains In determining whether the production from a well
specific language defining the period of time for which has generated a net profit or loss, Texas law is relatively
production in paying quantities is to be measured, the clear that only operating and marketing costs are to be
period expressly stated in the lease controls. In considered. But what are operating and marketing costs?
Ridenour, the Waco Court of Appeals affirmed a Do they include the cost of reworking a well so that
summary judgment that the lease had terminated as a production may be resumed in the event of a production
matter of law where lease language stated that a ceases? Generally speaking, Texas courts have held that
cessation of paying production after the primary term operating costs include things such as taxes, overhead
for a period of sixty days would cause the lease to charges, labor, repairs, and depreciation on salvable
terminate. 47 S.W.3d at 119. In that case, the lessor equipment. Skelly Oil Co., 356 S.W.2d at 780-81;
presented evidence that the lessee had wholly failed to Abraxas Pet. Corp. v. Hornburg, 20 S.W.3d 741, 756
obtain any production within a sixty day period. Id. The (Tex. App.—El Paso 2000, no pet.); Pshigoda, 703
5
Disputes Over Production in Paying Quantities Chapter 15

S.W.2d at 417. These are direct costs of producing a Texas courts hold that the cost and expense of drilling a
well, which generally involves the actual taking of oil or well, or reworking a well, is not included as an
gas from a well in a captive state for either storing or “operating expense” in determining whether a well has
marketing the product for sale. Bomar Oil & Gas, Inc. generated a net profit for purposes of production in
v. Loyd, No. 10-08-00016-CV, 2009 WL 2136404, at *6 paying quantities. Evans, 840 S.W.2d at 503; see also
(Tex. App.—Waco July 15, 2009) (mem. op.), on Morgan, 536 S.W.2d at 650 (stating that drilling and
rehearing, 298 S.W.3d 832 (Tex. App.—Waco 2010, reworking costs are excluded in the calculation of a
pet. denied). On the other hand, one time investment well’s profit or loss in determining paying quantities).
expenses, such as purchasing the well or equipping it, Rather, they are treated as capital expenditures.
are not to be included in the analysis. Id. at *8 The distinction between an operating and
(“BoMar’s purchase of the well equipment was a one- marketing costs and a one-time capital expenditure can
time investment expense assumed by BoMar and be crucial in determining the viability of an oil and gas
excluded from the definition of ‘operating and lease into the secondary term. For example, in Pshigoda,
marketing expenses.’”). the Amarillo Court of Appeals affirmed a jury verdict
finding that the subject lease had produced oil or gas in
1. Royalties paying quantities despite the fact that Texaco had spent
There are only a few cases addressing the issue of approximately $89,000.00 to repair a casing leak. 703
royalties and whether they are included or excluded in S.W.2d at 416-17. In reaching its decision, the court
the production in paying analysis, but it appears that identified the issue as to whether the expenditure to
they are to be deducted. In its discussion of whether a repair the casing leak should be treated as an operating
well was producing in paying quantities in Evans, the expense or a capital expenditure. Id. at 417. The court
Corpus Christi Court of Appeals stated that a well then stated that resolution of the issue could be decided
produces in paying quantities where the oil and gas within the framework of three cases: Garcia; Clifton;
produced from a lease is sufficient to pay the lessee a and Skelly Oil Co. Id. at 418. In that regard, the court
profit, even small, over operating and marketing reasoned: in order to perpetuate a lease in the secondary
expenses, excluding the cost of drilling or reworking a term, there must be production in paying quantities—
well, but including all royalty payments. Evans, 840 Garcia; fixed or periodic cash expenditures incurred in
S.W.2d at 503 (citing Morgan v. Fox, 536 S.W.2d 644, the daily operation of a well are to be classified as
650 (Tex. Civ. App.—Corpus Christi 1976, writ ref’d operating expenses, while one time investment
n.r.e.)). See also Hutchison v. Tex-Lee Drilling & Dev. expenses, such as drilling and equipping costs, are to be
Co., Inc., No. 03-96-00453-CV, 1997 WL 703180, at *3 treated as capital expenditures—Clifton; and drilling
n.4 (Tex. App.—Austin Nov. 13, 1997, pet. denied). costs were not to be included as part of the operating and
Thus, in determining whether production from a lease marketing expenses of a well—Skelly Oil Co. Id. In the
has been sufficient to yield a profit to the lessee, it end, the court acknowledged that it was satisfied that the
appears that royalties should be deducted in determining trial court correctly instructed the jury when it submitted
whether a profit or a loss has been realized. See 1 Ernest the following instruction:
E. Smith & Jacqueline Lang Weaver, Texas Law of Oil
& Gas § 4.4[A][2] (June 2018). In determining ‘operating and marketing
expenses’ as that term is used in this charge, if
2. Drilling, Completing, and Reworking Costs any there be, you may consider such expenses
Are drilling, completing, and reworking costs as taxes, overhead charges, labor, repairs,
deducted in order to determine a well’s profitability? depreciation on salvable equipment, if any,
No. These are one time expenditures and are treated as and other such items of expense, if any. In this
capital expenditures to be recouped over time, if ever. connection, you are instructed not to consider
The term “drilling” has been generally defined to any costs or expenses in connection with the
include activities that are designed and conducted in an original drilling and equipping of the well or
effort to obtain initial production from a well. 43 Tex. a reworking of the well.
Reg. No. 7494 (Nov. 9, 2018) (codified as an
amendment to 31 Tex. Admin. Code § 9.31 (Aug. 9, Id. at 417 (emphasis in original).
2009)) (Tex. R.R. Comm’n General Provisions The court further reasoned in support of its holding
Concerning Maintenance of a State Oil and Gas Lease) that a reworking expenditure is analogous, and closely
(current version at 31 Tex. Admin. Code § 9.31(b)(2) related to, the initial drilling expense. Id. at 418. And
(West 2018)). On the other hand, the term “reworking” that it is usually a one time, single expense item that is
has been described as those types of activities that are treated most often as a capital investment. Id. at 418-19.
designed and conducted on a well in an effort to restore In Abraxas Pet. Corp., the El Paso Court of Appeals
or to enhance production in paying quantities from an cited Pshigoda approvingly while acknowledging, at the
existing well. Id. § 9.31(b)(8) (West 2018). As a result, same time, that periodic cash expenditures incurred in
6
Disputes Over Production in Paying Quantities Chapter 15

the daily operation of a well are generally classified as 4. Overhead
operating expenses, while one-time investment Is overhead included in determining a well’s profit
expenses, such as drilling and equipping costs, are to be or loss? Probably so, as long as the overhead can be
treated as capital expenditures. 20 S.W.3d at 756 traced or tied directly to a well’s production. In United
(stating that “[r]eworking expenses are part of the Central Oil Corp. v. Helm, the Fifth Circuit held that
capital investment.”). This same type of reasoning overhead should have been considered as part of the
applies to the cost of completing a well. Evans, 840 expense of operating a well for purposes of determining
S.W.2d at 504 (“The original costs of drilling, whether it was producing oil in paying quantities. 11
completing, and equipping a well are not deducted in a F.2d 760, 762 (5th Cir. 1926). The Fifth Circuit’s holding
paying quantities analysis.”) (emphasis added). Thus, is consistent with the Texas Supreme Court’s approval
when it comes to whether drilling and reworking of the trial court’s jury instruction in Skelly Oil Co. See
expenses are involved, the issue seems fairly well- Skelly Oil Co., 356 S.W.2d at 781 (“‘In determining
settled that they should not be included in the analysis. ‘operating and marketing expenses,’ as that term is used
in this charge . . . you may consider such expenses as . .
3. Depreciation on Salvable Equipment . overhead charges . . . .’”); see also Bomar Oil & Gas,
Is depreciation included in the operating and Inc., No. 10-08-00016-CV, 2009 WL 2136404, at *6.
marketing expense of a well in determining whether the Indeed, in Skelly Oil Co., the Texas Supreme Court
production from a well has generated a profit or a loss? recognized that overhead should be included in the
Yes, provided that the equipment is salvable. In Clifton, analysis if it is a part of the expense of producing and
the Texas Supreme Court stated that the trial court marketing the gas if it could be traced as an actual
correctly excluded depreciation as an operating expense expense of producing the well’s product. 356 S.W.2d at
in determining whether and when production in paying 781. Yet, in Ladd Petroleum Corp. v. Eagle Oil & Gas
quantities ceases. Id. at 692. The Court reasoned that Co., the Fort Worth Court of Appeals declined to follow
depreciation of equipment is nothing more than an Skelly Oil Co. because it did not directly address the
accounting charge of money actually expensed in issue of district and administrative expenses. 695
purchasing tangible property, and if the investment itself S.W.2d 99, 108-09 (Tex. App.—Fort Worth 1985, writ
is not to be considered in the profit and loss analysis, ref’d n.r.e.). In that case, the Fort Worth Court of
then neither should depreciation. Id. The analysis Appeals held that those kinds of expenses should not be
seemingly turned on whether there was production considered overhead because they would continue
sufficient to yield a return in excess of operating and whether or not the well was producing oil or gas. Id. at
marketing costs even though drilling and equipment 108. The court reasoned that “[o]rdinary business
costs may never be repaid and the undertaking as a experience would indicate that as the elimination of a
whole may be rendered a total loss. Id. The Court further single well would not materially reduce such expense, it
noted that if the rule were otherwise, many leases might should not be included as overhead.” Id. Thus, while it
be terminated and the lessee’s incentive to drill appears that overhead may be charged generally, courts
decreased. Id. Yet, a closer look shows that in its should distinguish between overhead directly related to
discussion of depreciation as an operating and production and overhead involving general
marketing expense, the Court was concerned with the administrative expenses that exists and continue
petitioner’s argument that depreciation of the original whether or not the well is producing. See e.g., Bomar
investment cost should have been taken into Oil & Gas, Inc., No. 10-08-00016-CV, 2009 WL
consideration in determining the profit and loss from the 2136404, at *7.
well. Id. And in that regard, the Court expressly stated
that “[w]e do not have before us the question of whether 5. Marketing Expenses and the Cost of Building
or not depreciation on producing equipment should be Pipelines
charged as an operating expense, and, therefore, do not What about the cost of building out and
decide the question.” Id. Later, in Skelly Oil Co., the constructing a pipeline to get the production to market?
Texas Supreme Court clarified that depreciation on In Archer v. Skelly Oil Co., the Amarillo Court of
salvable equipment should be included if it is a part of Appeals held that the expense of pipe line facilities
the expense of producing and marketing the gas. 356 could create a fact issue regarding whether the lessee
S.W.2d at 781; see also Evans, 840 S.W.2d at 504 had operated the lease at a profit. 314 S.W.2d 655, 663-
(noting that salvable equipment should be depreciated 64 (Tex. Civ. App.—Amarillo 1958, writ ref’d n.r.e.).
where the evidence shows that it is part of the expense However, in refusing error, the Texas Supreme Court
of producing and marketing the production). In order to stated that the “holding that the cost of construction of a
show the depreciation allowed in the paying quantities pipe line for marketing the gas should be included in
calculation, a lessor must show the not only the cost of determining whether the well or wells in question were
the particular piece of equipment, but also its rate of producing oil in paying quantities is not before us, and
depreciation. Id. at 505. we express no opinion thereon.” Skelly Oil Co. v.
7
Disputes Over Production in Paying Quantities Chapter 15

Archer, 317 S.W.2d 47, 47 (Tex. 1958). In any event, it intent of the lessor and the lessee is carried forward—
would seem that the construction of a pipeline is more the full use and development of the mineral estate for
akin to a capital expenditure rather than the type of the mutual benefit of the parties for the term of the lease.
reoccurring expense typically associated with marketing Garcia, 164 S.W.2d at 512.
production from a well, like gathering and
transportation charges, but the issue appears to be VI. PRODUCTION IN PAYING QUANTITIES
unsettled. VS. CAPABLE OF PRODUCTION IN
PAYING QUANTITIES AND OTHER
V. THE SUBJECTIVE PRONG OF THE PAYING QUANTITY ISSUES
PRODUCTION IN PAYING QUANTITIES As noted above, under a “typical” oil and gas lease,
ANALYSIS the term “production” means that the operator must
The subjective prong of the production in paying bring the oil and gas to the surface and use, market or
quantities analysis concerns whether a reasonably store it. 1 Ernest E. Smith & Jacqueline Lang Weaver,
prudent operator, under all of the relevant Texas Law of Oil & Gas § 4.4[A], at 4-34 (June 2018).
circumstances, would continue to operate the well in the The mere discovery of oil or gas which can be produced
manner in which it has been operated for purposes of profitably is not sufficient. Holchak v. Clark, 284
making a profit and not merely for purposes of S.W.2d 399, 401 (Tex. Civ. App.—San Antonio 1944,
speculation. Clifton, 325 S.W.2d at 691. The relevant writ ref’d) (“One can not say that discovery of oil
inquiry is whether there is a reasonable basis for the followed by diligent operations is the equivalent to
expectation of making a profit. Thompson, 94 S.W.3d at production of oil and gas in paying quantities, without
559 (op. on rehearing) (per curium). Again, this prong doing violence to the plan meaning of words in common
of the test is measured over a reasonable period of time use among English speaking peoples. Production has a
presented by the evidence, which, cannot, as a matter of commercial connotation. It means marketable oil or
law, be specific without running afoul of Clifton. gas.”). Smith & Weaver, Texas Law of Oil & Gas §
Laddex, 513 S.W.3d at 486 n.10 (a “‘reasonable period 4.4[A], at 4-34. Rather, the oil or gas generally must be
of time under the circumstances’ is pertinent to the taken from the well in a captive state.
second prong of the Clifton analysis.”). If a well is These principles give rise to a myriad of questions,
profitable under the first part of the test, the lease is including are marketing facilities required in order for a
preserved and the second part of the test has no well to produce in paying quantities? Is the result any
applicability. Evans, 840 S.W.2d at 503 (stating that different where the habendum clause requires that the
“production in paying quantities may be established as lease is for a fixed term and as long thereafter as oil or
a matter of law by showing a profit from the operation gas is produced or is capable of being produced in
of the well.”). paying quantities from the land? What about the lack of
In accordance with the subjective test, the trier of a pipeline connection? Does a well produce in paying
fact must necessarily take into consideration all matters quantities at the expiration of the primary term when it
which would influence a reasonable and prudent is not connected to a pipeline? Is the result any different
operator, including the depletion of the reservoir, the where the habendum clause only requires that capability
price for which the lessee is able to sell its production, of producing oil or gas in paying quantities? Like many
the relative profitableness of other wells in the area, the things in law, the answers to these questions depend on
operating and marketing costs of the lease, the lessee’s many factors, including particularized lease language
net profit, the lease provisions, a reasonable period of and at what point is the paying quantities issue being
time under the circumstances, and whether the lessee is presented—at the expiration of the primary term or later
simply holding the lease for speculative purposes. Id. in the secondary term?
This list is non-exhaustive, and nothing in Clifton
supports the conclusion that these factors are exclusive. A. Capable of Producing Gas in Paying Quantities
Indeed, the Court noted that these were just “some of the The traditional habendum clause generally
factors” to be considered in the analysis. Clifton, 325 provides that the lease will last for a fixed term and then
S.W.2d at 691. “as long as oil or gas is produced.” In considering the
If the answer to the subjective inquiry is “yes,” then meaning and effect of such language, the Texas
the lessee may continue operating the well in the manner Supreme Court has made clear that this is the functional
in which it has previously been operated without risk of equivalent of requiring actual production in
termination. However, if the answer is “no,” the lessee commercially paying quantities and not merely the
must immediately commence drilling or re-working completion of a well capable of producing. Archer
operations as set forth in any lease-saving clauses for the County v. Webb, 338 S.W.2d 435, 437 (Tex. 1960).
specific purpose of restoring production from the lease Thus, unless there is an applicable savings clause, the
or else, run the risk of having the lease terminate lease will terminate at the end of the primary term.
according to its terms. In either situation, the objective Stanolind Oil & Gas Co. v. Barnhill, 107 S.W.2d 746,
8
Disputes Over Production in Paying Quantities Chapter 15

749 (Tex. Civ. App.—Amarillo 1937, writ ref’d) of Appeals in Hydrocarbon Management, Inc. v.
(holding that lease expired at the end of the primary term Tracker Exploration, Inc.:
under an “is produced in paying quantities” habendum
clause where evidence showed that well was capable of We believe that the phrase ‘capable of
producing gas, but that no market existed); Cox v. production in paying quantities’ means a well
Miller, 184 S.W.2d 323, 327-28 (Tex. Civ. App.— that will produce in paying quantities if the
Eastland 1944, writ ref'd). In those situations, it is said well is turned ‘on,’ and it begins flowing,
that the special limitation—the failure to produce—has without additional equipment or repair.
occurred and hence, has resulted in the automatic Conversely, a well would not be capable of
termination of the lease. Indeed, according to the Texas producing in paying quantities if the well
Supreme Court, “no matter how great the potential switch were turned ‘on,’ and the well did not
production may be or how many million cubic feet of flow, because of mechanical problems or
gas may have been flared, there would be no production because the well needs rods, tubing, or
or production in paying quantities unless there was an pumping equipment.
available market.” Reid, 337 S.W.2d at 270. But what
about the habendum clause that provides for “as long as Thompson, 94 S.W.3d at 558 (quoting Hydrocarbon
oil or gas is produced or there is a well capable of Mgt., Inc., 861 S.W.2d 427, 433-34 (Tex. App.—
producing oil or gas?” Is there any meaningful Amarillo 1993, no writ)). The Court noted that this
difference and if so, when is a well capable of producing definition was consistent with existing cases discussing
oil or gas? the differences between actual production and capability
In Anadarko Petroleum Corp. v. Thompson, the of production. Id.
Texas Supreme Court considered those questions and Subsequent courts have followed Thompson’s
recognized a difference between them. The issue in that reasoning. For instance, in Blackmon v. XTO Energy
case was whether a well holding the leased premises was Inc., the Waco Court of Appeals rejected the lessors’
capable of producing gas during a sixty-one day period argument that a well was not capable of production in
and a ninety-one day period where the actual production paying quantities where it needed additional equipment
of gas ceased for a period exceeding sixty days. 94 or repairs in order to produce marketable gas. 276
S.W.3d at 557. Anadarko argued that the well was S.W.3d 600, 603 (Tex. App.—Waco 2008, no pet.). The
capable of producing gas because the well was shut in court stated that the reference to additional equipment
for pipeline repairs. Id. Thompson, on the other hand, or repairs in Thompson obviously focused on equipment
argued that the well was not capable of production or repairs necessary to flow raw gas to the wellhead
because the well would not have produced had it been when the switch was turned on and not on equipment
turned on. Id. In siding with Andarko, the Texas installed downstream to refine the gas into a marketable
Supreme Court held that a well is “capable of form. Id. Thus, the capability to produce in paying
production” where it is capable of producing in paying quantities focuses on a well’s ability to flow gas, and not
quantities without any additional equipment or repairs. the quality of the gas. Likewise, in Grinnell, the court
Id. at 558. According to the Court, “capable of held that the lease did not terminate even though there
production” or “can be produced” does not mean actual had been a complete cessation of production from the
production. Id. at 561 (op. on rehearing) (per curium). lease in the secondary term. 137 S.W.2d at 716-17. In
Instead, in order for a well to be capable of producing that case, the habendum clause provided that the lease
oil or gas in paying quantities, all that is required is that would be extended for “as long thereafter as oil or gas is
the well must be able to flow when turned on, and it capable of being produced,” and there was no evidence
must make economic sense to market and produce the that the well was not capable of producing in paying
gas for purposes of yielding a positive return. quantities without additional equipment or repairs if
In reaching its decision, the Court recognized its turned on. Id. Moreover, in Chesapeake Exploration,
holding in Peveto v. Starkey that the completion of a gas Ltd. Partnership v. Corine, Inc., the Waco Court of
well capable of producing in paying quantities, but shut Appeals held that a well shut in during the primary term
in due to the lack of pipe line facilities or for other was not capable of producing in paying quantities where
reasons, is not considered “production” or “actually the evidence showed that the well in question was not
producing” and therefore, does not sustain a mineral equipped with rods, tubing, or pumping equipment
interest that lasts for “as long as oil or gas is produced.” when the primary term expired and hence, was not able
Id. at 557 (citing Peveto, 645 S.W.2d 770, 771 (Tex. to flow when turned on. No. 10-06-00265-CV, 2007 WL
1982)). The Court went on to discuss the differences 2447293, at *3 (Tex. App.—Waco Aug. 29, 2007),
between “actual production” and the “capability of judgm’t withdrawn, No. 10-06-00265-CV, 2007 WL
production” and in doing so, approved the definition of 2729576 (Tex. App.—Waco 2007, no pet.). These
“capable of production” as stated by the Amarillo Court cases highlight the importance of distinguishing

9
Disputes Over Production in Paying Quantities Chapter 15

between lease language requiring actual production and [a]lthough this well was capable of producing
those that provide for the capability of production. in paying quantities, considerable gas having
been flared and an undisclosed number of
B. The Lack of a Market Can Preclude a Finding barrels of condensate obtained, none was ever
of Production in Paying Quantities sold or used on or off the premises. Therefore,
Whether marketing facilities exist can be an under the authorities cited above there was no
important factor in determining whether a well is production from the well within the meaning
producing or capable of producing in paying quantities. of the lease provisions. It follows, that since
In Gulf Oil Corp. v. Reid, for example, the Texas there had been no production, there could not
Supreme Court warned that the lack of a market is not be a cessation of production, and thus the 60-
an excuse for the failure to produce and absent some day [operations] clause is not available to the
lease savings provision to the contrary, a lease petitioner to extend the term of the lease or to
automatically terminates upon the expiration of the delay the tender of the royalty payment.
primary term. 337 S.W.2d at 270. In doing so, however,
the Court recognized the holding in Union Oil Company Id.
of California v. Ogden in which the El Paso Court of The Court declined to take on the issue and decide
Appeals found that a lessee should have a reasonable whether laying gathering lines and getting the well
time to market the gas even though that time might connected fell into the category of “drilling operations.”
necessarily extend beyond the lease’s primary term. 5 Id. Id. at 270. Moreover, in Peveto, the Texas Supreme
(citing Ogden, 278 S.W.2d 246, 249 (Tex. Civ. App.— Court stated that the payment of shut in royalty for a
El Paso 1955, writ ref’d n.r.e.)). In Reid, the lessee completed gas well that was capable of producing in
capped a well in the secondary term, which was capable paying quantities, but shut in due to the lack of pipe line
of production in paying quantities, due to a lack of facilities or for other reasons, is not considered
marketing facilities. 6 Id. at 268. The lease’s habendum production in paying quantities for purposes of
clause apparently required actual production in order to extending the lease into the secondary term. 645 S.W.2d
extend the lease into the secondary term. See id. at 771. In that case, the habendum clause was for a fixed
Nevertheless, in concluding that the lessee had period of fifteen years and “as long thereafter as oil, gas
failed to extend the lease in the secondary term in Reid, or other minerals, or either of them is produced . . . in
the Texas Supreme Court noted that the lessee’s efforts paying quantities.” Id. Thus, under the authority of
consisted solely of negotiations with the pipe line Peveto, Reid, Holchak, and Sellers, it would appear that
company and no manual operations were conducted a well is not producing oil or gas in paying quantities
until sometime well into the lease’s secondary term. Id. where the well is not connected and there is no pipeline
The Court then cited to Holchak 7 and Sellers v. to get the gas to market.
Breidenbach 8 as additional support for its conclusion However, in denying the motion for rehearing in
that the lease had terminated for failing to produce oil or Thompson, the Texas Supreme Court clarified that it
gas in paying quantities in the secondary term due to a was not overruling or otherwise calling into question
lack of market. Id. There being no gas produced from prior decisions regarding the proper interpretation of the
the premises on the last day of the primary term, and no phrase “production in paying quantities.” 94 S.W.3d at
royalty having been paid on or before that date, the lease 559 (op. on rehearing) (per curium). In that regard, the
lapsed as a matter of law. Id. at 271. The Court even Court reaffirmed the long-standing principle that for a
went so far to state the following: well to produce in paying quantities, or to be capable of
producing in paying quantities, there “must be facilities

5
In Ogden, the court of appeals was faced with two separate and had failed to continue such operations with reasonable
leases, one expressly providing for the payment of $100.00 diligence and dispatch to get the gas to market. Id. at 249.
6
in the event that oil or gas could not be profitably produced The chief issue in that case was whether a so-called shut-in
due to a lack of market at the well or wells, and other simply royalty payment, tendered after a well capable of producing
providing that the lease would last for the fixed primary terms gas in paying quantities had been capped, was timely made so
and so long thereafter as oil or gas was produced. 278 S.W.2d as to extend the term of the oil and gas lease. Id. at 268.
at 247-49. In holding that the first least did not expire, the 7
284 S.W.2d 399.
court recited that there was no market for the gas when the 8
300 S.W.2d 178 (Tex. Civ. App.—San Antonio 1957, writ
well was completed, that the lessee acted diligently in
ref’d). In Sellers, San Antonio Court of Appeals again stated
attempting to secure a pipeline and connection, and that the
that “paying production” does not mean “the completion of a
lease could be maintained for a lack of market by the payment
well capable of producing, it means a well which is actually
of the stated royalty. Id. at 248. As for the second lease, the
producing on the significant date.” Sellers, 300 S.W.2d at
court noted that there was no shut in royalty payment, that the
178.
lessee had failed to begin operations for the laying of pipeline,
10
Disputes Over Production in Paying Quantities Chapter 15

located near enough to the well that it would be connection and actual production were not
economically feasible to establish a connection so that commenced within a reasonable time.
production could be marketed at a profit.” Id. The Court
then cited Clifton to reinforce the proposition that all Id. at 560.
relevant circumstances must be considered in
determining whether there are paying quantities, and C. Shut in Royalty
that the term “paying quantities” involves not only the Where a lessee has drilled a well capable of
amount of production, but the ability to market the production in paying quantities, but cannot obtain a
production at a profit. Id. The test, again articulated by pipeline connection before the end of the primary term,
the Texas Supreme Court, is whether there is a the lease will terminate for a lack of production under
reasonable basis for the expectation of profitable returns an “is produced” habendum clause. Barnhill, 107
from the well. Id. S.W.2d at 749. Shut-in royalty clauses are designed to
The Texas Supreme Court in Thompson went on to keep the lease alive and to prevent termination such
quote Clifton at length in regards to its discussion of the situations.
subjective prong of the paying quantities test, as well as The typical shut-in royalty clause acts as a
the Court’s decision in Hanks v. Magnolia Petroleum substitute or contractual method of production, which
Co., 24 S.W.2d 5 (Tex. Comm’n App. 1930, judgm’t will maintain the lease in force and effect when a gas
adopted). 9 As recognized in Clifton, the Court affirmed well is drilled and for which no market exists. Red Deer
the decision in Hanks that a completed well did not Resources, 526 S.W.3d at 395; Richard W. Hemingway,
produce in paying quantities within the contemplation The Law of Oil and Gas § 6.5, at 304 (2d ed. 1983).
of the lease where the evidence showed that there were Invocation of the shut-in royalty clause is considered
no facilities for marketing the gas, no nearby localities constructive production and will maintain the lease if its
or industries which might have furnished a profitable terms are satisfied. Red Deer Resources, 526 S.W.3d at
market for the gas, and no evidence tending to show that 395. However, for a well to be maintained by the
the well was even situated in such proximity to any payment of shut-in royalties, the party seeking to invoke
prospective market which would justify the construction the provision must strictly comply with the terms of the
of a pipeline. Id. at 691 (citing Hanks, 24 S.W.2d at 5). shut-in clause as set out in the lease. Id. Moreover, in
Clifton was materially different from Hanks because the order for a well to be shut in, and absent lease language
evidence in Clifton supported a finding of marketing to the contrary, the well must be capable of producing
facilities and that the gas had in fact been sold at a profit. gas in paying quantities at the time the well is shut in.
Clifton, 325 S.W.2d at 691. Id.; Hydrocarbon Mgt., Inc., 861 S.W.3d at 432-33;
Like Clifton, the evidence in Thompson showed Kidd v. Hoggett, 331 S.W.2d 515, 519 (Tex. Civ.
that the well had been completed and was connected to App.—San Antonio 1959, writ ref’d n.r.e.); Duke v. Sun
pipeline facilities. 94 S.W.3d at 569. The Court Oil Co., 320 F.2d 853, 860 (5th Cir. 1963). But see
acknowledged that there was “no question that it was Corine, No. 10-06-00265-CV, 2007 WL 2447293, at *3
capable of producing in paying quantities even though (holding that well must have been capable of producing
there were periods during which there was no [actual] gas in paying quantities at the end of the primary term,
production.” Id. The Court then further clarified its not when the well was actually shut in). This holds true
original decision by stating: even where the shut-in royalty clause makes no mention
of paying production. Hydrocarbon Mgmt., Inc., 861
[w]e meant in our original decision that, as a S.W.2d at 433.
practical matter, a lessee will not sustain a Thus, whenever a shut-in royalty clause is invoked,
lease based on a well’s capability of the party seeking to terminate the lease must negate the
production without actual production of the clause by establishing that the well was either not
well because the payment of damages for the capable of producing in paying quantities or that no
failure to reasonably market the gas would be market existed, or both. Red Deer Resources, 526
a strong incentive to connect the well to S.W.3d at 395; Hydrocarbon Mgt., Inc., 861 S.W.2d at
facilities that would permit actual production. 433. While a well is “capable of production” where it
And, in an extraordinary case, when damages will flow gas in paying quantities when it is turned on
would not furnish an adequate remedy, a court without any additional equipment or repairs, as
could conditionally order termination if a measured over a reasonable period of time, Red Deer
Resources, 526 S.W.2d at 397; Thompson, 94 S.W.3d at

9
Hanks was decided by Section B of the Texas Commission as recommended by the Commission. Accordingly, this
of Appeals of the Texas Supreme Court in 1930. The Texas opinion is cited as a “judgment adopted” opinion pursuant to
Supreme Court affirmed the judgment of the court of appeals Rule 5.2.4. of The Greenbook: Texas Rules of Form.
11
Disputes Over Production in Paying Quantities Chapter 15

558; Fain Family First Ltd. P’ship v. EOG Resources, lessee’s continued possession was open, notorious, and
Inc., No. 02-12-00081-CV, 2013 WL 1668281, at *5 hostile to the lessor’s claim that all title and interests had
(Tex. App.—Fort Worth April 18, 2013, no pet.), there reverted to it under the nature of the determinable fee.
must exist pipe lines through which the gas can be 124 S.W.3d 188, 197-98 (Tex. 2003); see also Vortt
marketed in order for it to have any value. Hydrocarbon Expl. Co., Inc. v. EOG Resources, Inc., No. 11-07-
Mgt., Inc., 861 S.W.2d at 433; Reid, 323 S.W.2d at 115, 00159-CV, 2009 WL 1522661, at *8 (Tex. App.—
aff’d, 337 S.W.2d 267 (Tex. 1960). Indeed, a lack of Eastland May 29, 2009, no pet.) (mem. op.) (holding
facilities for marketing the gas is sufficient to show that that summary judgment was not proper on adverse
a well is not capable of producing gas in paying possession claim where evidence presented failed to
quantities. Fain Family First Ltd. P’ship, 2013 WL create a question of fact). Additional questions arise,
1668281, at *5. In Fike v. Riddle, the Tyler Court of including whether the lessee’s open and notorious
Appeals rejected the argument that a well was a possession for purposes of adverse possession needs to
producing oil well simply by the installation of rods, be in paying quantities in order to be effective?
tubing, and other equipment that would render the well
capable of producing oil. 677 S.W.2d 722, 725 (Tex. VII. SUBMITTING THE PRODUCTION IN
Civ. App.—Tyler 1984, no writ). Rather, the court held PAYING QUANTITIES ISSUE TO THE
that a producing well was one where the products are JURY
being producing in paying quantities and sold in the The Texas Supreme Court recently clarified how
market place. Id. at 725-26 (citing Cox, 184 S.W.2d at the production in paying quantities doctrine is to be
327; Hanks v. Magnolia Petroleum Co., 24 S.W.2d 5 submitted in two different contexts: the habendum
(Tex. Comm’n App. 1930, judgm’t adopted)). clause and the shut-in royalty clause.

D. The Payment of Shut in Royalty Will Not A. The Habendum Clause
Extend a Term Royalty Deed That Lacks Shut In BP America Production Co. v. Laddex, the
in Language Texas Supreme Court reviewed the trial court’s jury
In the absence of relevant language expressly charge on a production in paying quantity issue
providing for the payment of shut-in royalties, a involving a marginal well in Roberts County, Texas.
purported payment of shut-in royalties will not act as a 513 S.W.3d 476, 477-78 (Tex. 2017). The lease in
substitute for production in paying quantities in regards Laddex provided for a primary term of five years and
to a term royalty deed. Peveto, 645 S.W.2d at 771; continued thereafter as long as oil or gas was produced.
Archer County, 338 S.W.2d at 437. In Peveto, the Texas Id. at 478. Beginning in August 2005, production from
Supreme Court stated that Texas law was well-settled in the well slowed significantly for approximately fifteen
that the completion of a gas well capable of producing months after which the well resumed producing in
in paying quantities but shut in due to lack of pipe line quantities comparable to those before the slowdown. Id.
facilities or for other reasons is not considered The trial court’s charge asked the jury whether the well
production, or production in paying quantities, under the failed to produce in paying quantities from “August 1,
provisions of a term royalty deed containing no 2005 to October 31, 2006” and whether under all of the
provisions for shut in royalty payments. 645 S.W.2d at relevant circumstances, a reasonably prudent operator
771. In that case, the Court held that a term royalty deed would not continue, for the purpose of making a profit
that provided for a fixed term and as long thereafter as and not merely for speculation, to operate the well in the
oil or gas is produced in paying commercial quantities manner in which it was operated between “August 1,
was not extended by the payment of shut in royalty. Id. 2005 and October 31, 2006,” to which the jury answered
While the lease provided for the payment of shut-in “yes” to both questions. Id. at 479. The court of appeals
royalties, the royalty deed did not and therefore, the held that the trail court erred in limiting the jury’s
royalty under the deed expired. Id. paying-production inquiry to the specific fifteen-month
period in which production slowed. Id.
E. Adverse Possession In affirming the court of appeals’ decision that the
In the case of a marginal well that continues to trial court erred in limiting the jury’s focus to a specific
produce during the secondary term, it is less than clear period of time and did not allow the jury to consider the
as to when or at what point a lease will terminate for well’s return to profitability, the Texas Supreme Court
failing to produce in paying quantities. As a result, a found it important to reiterate the framework under
lessee may seek to establish that it has re-acquired the which claims involving the production in paying
lease through continued production under the three, five, quantities doctrine and to set out the court’s charge. Id.
and ten year statutes of limitations. In Natural Gas at 482-84. BP argued that a reasonable period of time
Pipeline Company v. Pool, the Texas Supreme Court under the evidence presented would have been, at a
held that the lessee had acquired leasehold interests by minimum, the 27 month period preceding the filing of
adverse possession where the evidence showed that the the lawsuit in April 2007. Id. at 484. Laddex contended
12
Disputes Over Production in Paying Quantities Chapter 15

that the trial court acted properly in stating the period relevant times, the Vera Murray #11 gas well was the
over which it was alleged that there had been a failure only well from which any production could have been
to produce in paying quantities, and that evidence of obtained to sustain the lease. Id. at 391-92. In May 2012,
profitability and loss before and after that period was the Vera Murray #11 well experienced a seven-day
presented and thus, the jury was able to consider all of period with no production, at which point it resumed a
the evidence in making its findings. Id. general pattern of flowing gas for a period of time every
The Texas Supreme Court stated that both parties’ other day. Id. at 392. On June 4, 2012, the well produced
positions ran afoul of Clifton. Id. The Court again 10 mcf of gas, and then went eight days with no
reiterated that “‘there can be no limit as to time . . . to be production. On June 12, 2012, BP turned off the well by
taken into consideration in making that determination.’” closing the valve. Id. The next day, BP sent notice to the
Id. at 485 The Court concluded that the rule eviscerated lessors that it had shut in the well and was invoking the
the parties’ contentions about the effect of the well’s shut-in royalty clause beginning as of June 13, 2012. Id.
pre- and post-slowdown profitability: Laddex The Vera Murray #11 well has been shut in since. Id.
erroneously argued that it is immaterial, while BP While the lease contained a sixty-day cessation of
argued that it was dispositive. Id. The trial court production savings clause, the evidence showed that BP
properly allowed the parties to present evidence of did not commence any production operations during the
profitability before, during, and after the slowdown, but sixty days after it closed the valve to the sales line on
ultimately erred in asking the jury to evaluate whether June 12, 2012. Id. Therefore, unless BP had properly
production in paying quantities existed only as to the invoked the shut-in royalty clause to maintain the lease,
specific fifteen month period in which production had it would have terminated in the secondary term for a
slowed. Id. Narrowing the jury question on paying total failure of production or a failure of production in
production to any particular time period was necessarily paying quantities. Id. The shut-in royalty clause
“arbitrary.” Id. (citing 1 Ernest E. Smith & Jacqueline provided:
Lang Weaver, Texas Law of Oil & Gas § 4.4[A][2][b],
at 4-40 (Nov. 2009) (“Unless the lease defines the Where gas from any well or wells capable of
period for which production in paying quantities is producing gas . . . is not sold or used during or
measured, a well’s profitability is not determined by after the primary term and this lease is not
looking at any specific accounting period.”)). The Court otherwise maintained in effect, lessee may pay
concluded that while litigants are entitled to argue and or tender as shut-in royalty . . ., payable
present evidence to focus the jury’s attention to the annually on or before the end of each twelve
period of time they deem reasonable or important, the month period during which such gas is not
charge simply may not ask or instruct the jury about a sold or used and this lease is not otherwise
specific period without unduly influencing them and maintained in force, and if such shut-in
violating Clifton. Id. at 486. royalty is so paid or tendered and while
lessee’s right to pay or tender same is
B. The Shut-In Royalty Clause accruing, it shall be considered that gas is
In BP America Production Co. v. Red Deer being produced in paying quantities, and this
Resources, LLC, the Texas Supreme Court considered lease shall remain in force during each twelve-
whether a jury’s finding that a gas well was incapable or month period for which shut-in royalty is so
production in paying quantities the day after the paid or tendered . . . .
producer closed the valve, and eight days after gas was
last sold, could support a judgment terminating an oil Id.
and gas lease in its secondary term. 526 S.W.3d 389, Red Deer brought suit asserting two theories of
391 (Tex. 2017). In concluding that Red Deer had failed termination. First, that the lease had terminated because
to obtain a finding that the well was incapable of production in paying quantities had not been maintained
producing gas in paying quantities on the material date for a period of time ending on June 12, 2012, the day
under the plain language of the oil and gas lease, the that BP shut in the Vera Murray #11 well. Id. at 393.
Court reversed the court of appeals’ judgment and Second, that the lease terminated from an unexcused,
rendered judgment in favor of the producer that the lease total cessation of production, and that the shut-in clause
had not terminated for failing to produce in paying did not apply because the Vera Murray #11 well was not
quantities within the secondary term. Id. capable of producing in paying quantities on June 13,
This case involved the shutting in of the Vera 2012. Id.
Murray #11 well. Id. at 391. BP operated the Vera Four questions were submitted to the jury. The
Murray #11 gas well under an oil and gas lease executed first two questions concerned whether the lease had
in 1962, which contained a habendum clause providing produced in paying quantities up to June 12, 2012, and
for a five year primary term and “‘as long thereafter as the other two which dealt with whether the well was
oil, gas or other minerals is produced.’” Id. at 391. At all capable of producing in paying quantities when the well
13
Disputes Over Production in Paying Quantities Chapter 15

was shut-in on June 13, 2012. Id. The jury answered
Question 1 “no” (question dealing with whether paying
quantities had been maintained up to June 12, 2012) and
Question 3 “yes.” Id. (whether the Vera Murray #11
well was capable of producing in paying quantities
when it was shut-in on June 13, 2012). The court of
appeals affirmed the trial court’s judgment finding that
the lease had terminated due to the shut-in provision not
being applicable to save the lease, i.e., that the well was
not capable of producing in paying quantities the day
after it was shut in on June 12, 2012. Id.
Red Deer argued that in order for BP to
successfully invoke the shut-in clause, the Vera Murray
#11 well had to be capable of producing gas in paying
quantities when it was shut in on June 13, 2012. Id. at
396. Red Deer argued that because the jury answered
“yes” to Question 3 finding that the well was incapable
of producing gas in paying quantities on that date, the
lease terminated. Id. The Texas Supreme Court held that
Red Deer had the burden of proving that BP failed to
properly invoke the shut-in clause under the terms of the
lease and in that regard, that Red Deer had failed to meet
its burden. Id. at 397. In order to successfully negate the
shut-in royalty clause, Red Deer was required to show
that the well as not capable of production in paying
quantities over a reasonable period of time on the date
that gas was last sold or used, not on the date that BP
shut-in the well. Id. at 397. According to the Court, the
heart of the parties’ dispute was the date on which the
capability of production in paying quantities
determination is to be made. Id.
Because Red Deer failed to obtain a finding on
whether the well was capable of producing in paying
quantities on June 4, 2012, the last day in which gas was
sold or used, Red Deer failed to negate BP’s invocation
of its shut-in royalty rights. Id. at 398. The Court went
on to distinguish its analysis and holding in Thompson
stating that in that case, the phrase “capable of
producing in paying quantities” related to termination
under the lease’s habendum clause, which did not
require a determination of the date on which the well
had to be capable of producing in paying quantities like
it did here in the context of the shut-in clause. Id.

VIII. CONCLUSION
Few questions are more fundamental to oil and
gas law than whether an oil or gas well is producing in
paying quantities. The answer to this question can mean
the difference between a lease terminating and
remaining in force. And yet the answer to this question
is deceptively difficult to untangle. While it is
impossible to summarize all of the case law that is
relevant to answering this question, we hope that this
paper will help you identify the major issues and provide
a starting point for your own research.

14