The Oil and Gas Addendum

Let’s assume you own 136 acres in Tioga County.  In 2011, you signed a new oil and gas lease with ABC Production (the “2011 Lease”).  The 2011 Lease had a five-year primary term which expired in October 2016.  In 2014, ABC Production drilled and stimulated two horizontal wells under your 136-acre farm (the “Deep Wells”).  The Deep Wells are connected to third-party gathering pipeline system known as the Bull Dog Gathering System:  ABC Production cannot move the hydrocarbons produced from the Deep Wells to the downstream markets without the Bull Dog Gathering System.  You have received production royalties every month since 2015.  Suddenly, in April 2023, your production royalties stop.  ABC Production informs you that the Deep Wells have been taken off-line due to emergency repairs on the Bull Dog Gathering System.  You receive no royalties for six months.  Finally, in November 2023, you receive a modest royalty check from ABC Production for hydrocarbons marketed and sold in October 2023. Given the complete lack of production between April and September, did the 2011 Lease automatically terminate and expire due to non-production?  See, Temporary Cessation of Production: How Much Time Does A Producer Have Under Pennsylvania Law? (March 2011).  A recent decision from the Colorado Supreme Court provides some guidance on the question of whether a temporary cessation of production results in the automatic termination of an oil and gas lease.

At issue in Board of County Commissioners of Boulder County v. Crestone Peak Resources Operating, LLC were two oil and gas leases executed in 1980 and 1982.  The lease signed in 1980, known as the “Haley Lease”, had a primary term of two years and would remain in effect beyond May 14, 1982 “as long thereafter as oil or gas, or either of them, is produced from said land . .  .”  The lease signed in 1982, known as the “Henderson Lease”, also had a primary term of two years and would remain in effect beyond August 20, 1984 “as long as oil or gas of whatsoever nature or kind is produced from said leased premises . . .”  Both leases also contained a temporary cessation of production clause (“TCOP”).  As we have written before, TCOP clauses give the driller a fixed amount of time to resume or restart hydrocarbon production if a well ceases to produce during the lease’s secondary term.  See, North Dakota Supreme Court Rules That Driller Did Not Commence Re-Working Operations In Timely Manner (October 2023). The TCOP clause in the Haley Lease provided that the lease would not terminate if the driller resumed re-working or drilling operations within sixty (60) days:

If, after the expiration of the primary term of this lease, production on the leased premises shall cease from any cause, this lease shall not terminate provided lessee resumes operations for re-working or drilling a well within sixty (60) days from such cessation and this lease shall remain in force during the prosecution of such operations and, if production results thereform [sic], then as long as production continues.

The TCOP clause in the Henderson Lease was similar to the one in the Haley Lease except that it provided for a longer time-period: 90 days. 

Crestone’s predecessor, Encana Oil & Gas (“Encana”), drilled two (2) wells on the Haley Lease and one (1) well on the Henderson Lease (the “Subject Wells”).  Gas produced by the Subject Wells was delivered directly into a sales pipeline owned and operated by Anadako Petroleum (“Anadako”).  In March 2014, Anadako informed Encana that it needed to temporarily close the sales pipeline due to a maintenance issue.  As a result of this closure, Encana was unable to market or sell any gas produced from the Subject Wells for approximately 122 days.  Anadako completed the maintenance repairs in July 2014 and normal production and marketing activities resumed shortly thereafter. 

In 2018, Boulder County filed suit claiming that the 122 day period constituted a cessation of production which triggered application of the TCOP clauses.  In essence, Boulder County argued that “production” requires the actual extraction of hydrocarbons.  And since there was no extraction of hydrocarbons during the 122 day period, the TCOP clauses were implicated.  Because Encana did not commence re-working or new drilling operations within the required window (i.e., sixty (60) days under the Haley Lease and ninety (90) days under the Henderson Lease), Boulder County further argued that both leases automatically terminated and expired in the early summer of 2014.

Crestone filed a motion for summary judgment in 2020 arguing that the TCOP clauses were inapplicable because Encana merely ceased marketing rather than production.  Because the Subject Wells were always capable of producing oil and gas during the 122 day period, the cessation of marketing activities was simply not enough to implicate the TCOP clauses.  The District Court agreed and granted Crestone’s motion for summary judgment.  Boulder County appealed to the Colorado Court of Appeals.

The Court of Appeals affirmed.  The panel adopted the so-called “commercial discovery” rule and opined that, under that rule, the term “production” in Colorado means “capable of producing oil and gas in commercial quantities,” such that the production threshold in the lease’s habendum clause will always be satisfied by the mere discovery of oil and gas.  Under the “commercial discovery” rule, an idle well can maintain an oil and gas lease so long as that well is capable of producing oil and gas in paying quantities.  See, Davis v. Cramer, 837 P.2d 718, 22 (Colo. App. 1992)(“ . . . commercial discovery is sufficient to continue the lease . . .”); See also, Gard v. Kaiser, 582 P.2d. 134, 1313 (Okla. 1978)(“[I]n a jurisdiction where marketing is not required as a part of production . . . commercial discovery of gas well satisfy the habendum clause . . .”).  Applying the “commercial discovery” rule, the Court of Appeals opined that the TCOP clauses would only be triggered if the Subject Wells were no longer capable of producing.  Since the Subject Wells were merely idle, they never ceased producing and the TCOP clauses were simply inapplicable.  See, Bd. of County Commissioners of Boulder County v. Crestone Peak Resources Operating LLC, 493 P.3d 917, 925 (Colo. App. 2021) (“ . . . at all times relevant to the dispute, there remained a commercially viable discovery of oil and gas at the wells.”).  As such, the failure to commence re-working or new drilling operations within 90 days was immaterial.  Boulder County petitioned the Colorado Supreme Court for review of the Court of Appeals ruling.

The Colorado Supreme Court granted certiorari review of one issue:  whether the Court of Appeals erred in adopting the “commercial discovery” rule as a blanket rule applying to every oil and gas lease in Colorado.  Conversely, Boulder County argued that Colorado should instead adopt and apply the so-called “actual production” rule and equate “production” with actual hydrocarbon extraction.  In a mixed ruling, the Colorado Supreme Court rejected broad adoption of both the “commercial discovery” rule and the alternative “actual production” rule.  As detailed below, the Colorado Supreme Court instead observed that the definition of “production” must be analyzed by the particular language in each individual oil and gas lease.

The Colorado Supreme Court rejected the Court of Appeal’s sweeping and universal adoption of the “commercial discovery” rule.  The panel opined that the rule “is most applicable when courts must determine whether sufficient production has been achieved within the primary term to extend the lease to the secondary term.”  Because the Haley Lease and the Henderson Lease were both in their secondary term, it was an error to apply the rule in this instance.  The Supreme Court further explained that “as a practical matter, a cessation of production in the secondary term presents a different problem” than non-production at the end of the primary term.  As such, the panel was hesitant to adopt a “one size fits all” definition of production.  Instead, the Colorado Supreme Court opined that term “production” in an oil and gas lease must be defined and informed by the context in which that term is used in the underlying lease.

For example, the panel observed that the TCOP clauses in both the Haley Lease and the Henderson Lease allowed the lessee to avoid termination of the lease by performing drilling or re-working operations.  The specific remedy identified in the TCOP clauses shed light on the parties’ intent:  the TCOP clause itself is only triggered by a cessation of production that would be permanent unless corrected by new drilling or re-working[1] operations.  In other words, the term “production” in the TCOP clause must be informed by the specific remedy in that clause.  A cessation that is temporary in nature does not require new drilling or re-working operations.  By contrast, a permanent cessation of production can only be corrected or abated by new drilling or re-working operations.  As such, the Colorado Superior Court reasoned that since the 122 day period was temporary, it did not constitute a cessation that triggered the TCOP clauses.  See, Crestone Peak, 2073 Co. 58 (November 20, 2023) (“[H]ere, no amount of re-working or drilling by Encana would have resolved Anadako’s maintenance issue”).  Under such circumstances it was simply unnecessary to perform new drilling or re-working operations to maintain the underlying leases. The Colorado Superior Court essentially reached the same conclusion as the Court of Appeals but without reliance on the purported “commercial discovery” rule:

“[A]lthough the commercial discovery rule may aptly reflect the intentions of the parties to some leases, it is unnecessary and unwise for us to universally impose its definition of “production” in every oil and gas lease, regardless of context”

The author submits that the Colorado Supreme Court arguably made the right call in rejecting rigid application of the “commercial discovery” rule.  The language in the parties’ oil and gas lease must control.  The Supreme Court correctly focused the analysis on the parties’ intent as reflected by the precise language in the TCOP clauses.  Focusing on how and where the term “production” is referenced in an oil and gas lease makes sense.  Nonetheless, the question of whether a cessation of production is truly “temporary” versus “permanent” is fact intensive and must still be addressed on a case-by-case basis.

It is important to note the Pennsylvania has not adopted the “commercial discovery” rule.  In Pennsylvania, the mere discovery of oil and gas in not enough to maintain a lease beyond its primary term See, T.W. Phillips Gas and Oil v. Jedlicka, 42 A.3d 261, 267 (Pa. 2012) (“[I]f development over the agreed upon primary term is unsuccessful, no estate vests in the lessee.  If however, oil or gas is produced, a fee simple determinable is created in the lessee, the lessee’s right to extract oil and gas becomes vested”).  Moreover, Pennsylvania has historically applied the “automatic termination rule” during the secondary term of a lease.  Under this rule, the secondary term of a lease will automatically expire and terminate unless there is a well producing gas in paying quantities.  See, Cassell v. Crothers, 44 A. 446 (Pa. 1899) (“. . .  the moment she failed to produce oil in paying quantities, that moment the tenancy became a tenancy at will . . .”); Brown v. Haight, 755 A.2d 508 (Pa. 1969) (“ . . .  when oil and gas were not produced in paying quantities, the grantee’s fee interest terminated automatically”); White v. Young, 156 A.2d 919 (Pa. 1963) (failure to produce gas in paying quantities results in termination of lease after primary term expired); See also, Non-Production During Secondary Term Results in Termination of Lease (November 2011). 

If you have an oil and gas lease that is currently not producing oil or gas, please contact Robert J. Burnett at 412.288.2221 or rburnett@hh-law.com

[1] “Re-working” operations are typically defined as some activity on the well “reasonably conceived to restore production.” See, Summers Oil and Gas, §14.8 (3d ed.).