1986 issue of the Landman magazine.
date (“the primary term”) and for so long thereafter as oil or gas of whatsoever nature is produced from the leased premises.” In Texas, such a habendum clause requires actual production in paying quantities . More significantly, although the habendum clause generally controls the mineral estate’s duration, other clauses found in an oil and gas lease may extend the habendum clause’s term. The issue of when a lease terminates is always a question of resolving the intention of the parties based upon all of the terms and provisions contained in the oil and gas lease. PRODUCING IN PAYING QUANTITIES: Producing in paying quantities (“PPQx”) is not just an issue of whether lease/unit expenses have or have not exceeded lease/unit revenues over a given period of time. Legally, PPQx has a very specific and focused meaning as this article will clearly point out. It is not enough to use company/industry definitions of these words and assume that a management decision premised on such definitions will allow for the continuation of the underlying impacted oil and gas leases. PPQx (as applied to oil and gas wells) in Texas is defined as: 1. 1. The standard for determining whether a lease(s), either on an individual basis or as part of a pooled unit, and otherwise beyond its (their) primary term(s), is being maintained in full force and effect by the production of oil and/or gas, is whether such production is in paying quantities.. ( Garcia v. King , 164 S.W. 2d. 509 (Tex. 1942); Clifton v. Koontz , 325 S.W. 2d. 684 (Tex. 1959)). This standard is implied in every oil and gas lease UNLESS the lease expressly provides otherwise. ( Skelly Oil Co. v. Archer, 356 S.W.2d 774 (Tex. 1961); Anadarko Petroleum Corp. v. Thompson, 94 S.W.3d 550 (Tex. 2003)) 1. 2. Lease/unit production must be analyzed over a reasonable period of time to determine if the lease/unit production yielded a profit, no matter how small, over operating and marketing expenses although total revenues may never repay the cost of drilling the well ( Garcia v. King , 164 S.W. 2d. 509 (Tex. 1942)). (“Part I” of the PPQx test)
1. 2. This paper will not address the implied covenant to market other than to point out the disparate positions of the parties ie the lessee has other potential sources of production revenue whereas the lessor may only have this source of production income, which income source will be severely reduced initially with the price reduction and thereafter by subsequent lease/unit oil production reduction by the lessee. RISK DECISION: The lessee will have to make a risk decision that it can make a successful legal argument, in the short term, despite the relative un-equal production revenue positions of it and its lessor, that: (i) both parties will ultimately benefit from short term oil production reduction coupled (ii) with a correct legal conclusion that the oil production rate ultimately decided upon is sufficient to allow it to successfully claim that oil continued to be produced on a lease/unit basis in paying quantities after the oil production reduction.
PRELIMINARY LEGAL PRINCIPLES
Texas, being unique among the several producing states, has several initial legal principles that must be kept in mind at all times when evaluating the production in paying quantities issue. These principles are reviewed more fully in Anadarko Petroleum Corp. v. Thompson, 94 S.W.3d 550 (Tex. 2003) and are set out below without further citation. First, and foremost, a Texas mineral lease grants a fee simple determinable interest in the oil and gas to the lessee. The lessee’s fee simple determinable estate may continue for so long as the lessee uses the leased premises for its intended purpose ie production of oil and gas. A lessee’s mineral/leasehold estate will automatically terminate if the event upon which it is limited occurs ie cessation of production of oil and gas. An oil and gas lease habendum clause defines the mineral/leasehold estate’s duration. For example, a typical habendum clause may provide:
“Subject to the other provisions as contained herein, this lease shall be for a term of ??? years from this
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N a t i o n a l A s s o c i a t i o n o f D i v i s i o n O r d e r A n a l y s t s
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