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,
Tex. March 5, 2007)
• Stalnaker vs. Thomas W. Lett et al., Cause No.
04-09-0402 M-CV (97th Dist. Ct. Montague
County, Tex. Nov. 8, 2005)
• American Stone, Inc. vs. Faulkner et al., Cause
No. 352-191992-02 (352nd Dist. Ct. Tarrant
County, Tex. Dec. 23, 2003)
PROFESSIONAL RECOGNITION AND AWARDS
• State Bar of Texas
• Tarrant County Bar Association
• Tarrant County Young Lawyers Association
• Fellow, Texas Bar Foundation
• Barrister, Eldon B. Mahon Inn of Court
• Harris, Finley & Bogle, P.C. Executive
Committee (2016-present)
• Top Attorney by 360 West magazine (2017-2018)
Texas Trial Courts, 1999
Texas Appellate Courts, 1999
U.S. District Court for the Northern District of
Texas
U.S. District Court for the Eastern District of
Texas
U.S. District Court for the District of North
Dakota
Pro Hac Vice Admissions in California and
Arkansas
PUBLICATIONS/SPEAKING ENGAGEMENTS
• Community Leases: A Practioner’s
Guide, Oil, Gas & Mineral Title
Examinations (2015)
• Lease Formation and the Use of Sight
Drafts: So You Think You Have a Deal?,
presented to Fort Worth Association of
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

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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

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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
Corp. v. Thompson provided that the lease would last “as long
thereafter as gas is or can be produced.” Thompson, 94
S.W.3d at 553 (emphasis added). The Texas Supreme Court
held that the lease did not terminate where the evidence
1
showed that the lease well was capable of production, even
though it was undisputed that the well had failed to produce
any gas for a sixty-one day period in 1981 and a ninety-one
day period in 1985 while the gas purchaser conducted pipeline
repairs. Id.
Disputes Over Production in Paying Quantities
interpret the habendum clause in an oil and gas lease.
Garcia, S.W.2d at 512. And as for the lease’s
continuation for an indefinite period of time after the
primary term, no one would argue against the lessee
being afforded the full and complete opportunity to reap
all of the fruits of the investments made in developing
the mineral estate. Yet, when the lease can no longer be
operated at a profit, it stands to reason that there are no
more fruits to be reaped and therefore, the lease should
be released.
While the production in paying quantities doctrine
may involve issues that appear similar to those found in
temporary and permanent cessations of production, it is
a separate doctrine with its own analysis and tests.
Laddex, 513 S.W.3d at 485 n.6 (stating that cases
involving non-production due to sudden stoppage or
equipment malfunctions and the implied temporary
cessation of production doctrine are inapposite to
situations involving the cessation of production in
paying quantities, which arise when a well is marginally
producing); Ridenour v. Herrington, 47 S.W.3d 117,
121-22 (Tex. App.—Waco 2001, pet denied). A
complete cessation of production for the number of days
stated in a lease’s cessation of production clause
automatically terminates the lease, without regard to the
reasonableness of the operator’s actions, absent a
properly invoked savings clause. Red Deer Resources,
526 S.W.3d at 395-96. And the Texas Supreme Court
has made clear that this is a ground for lease termination
separate and apart from the cessation of production
analysis laid out in Clifton and Skelly Oil Co. v. Archer,
356 S.W.2d 774 (Tex. 1962). Id. Unlike claims for
cessation of production in paying quantities, when a
party claims that a lease has terminated for a total
cessation of production, 2 the reasonably prudent
operator inquiry does not come into play. Id. at 396.
Production in paying quantities issues generally
arises in two situations. The first situation involves the
expiration of an oil and gas lease’s primary term. 3 The
second situation arises in cases involving a marginal
well whose production has slowed to the point where oil
or gas is barely being produced. The term “paying
quantities” involves not only the amount of production,
but also the ability to market the product at a profit.
Clifton, 325 S.W.2d at 691. With that principle in mind,
there must be an actual, available market in order for
there to be production in paying quantities. Patton v.
Rogers, 417 S.W.2d 470, 475 (Tex. Civ. App.—San
Antonio 1967, writ ref’d n.r.e.). In Reid, for example,
2
A total cessation of production occurs when a well that has
been producing gas ceases to produce any quantity of gas. Red
Deer Resources, 526 S.W.3d at 396. When there has been a
total cessation of production, the two-pronged production in
paying quantity analysis does not apply. Id. Rather, the party
seeking to terminate the lease must show that there has been
2
Chapter 15
the Texas Supreme Court emphasized that “no matter
how great the potential production may be or how many
million cubic feet of gas may have been flared, there
would be no production or production in paying
quantities unless there was an available market.” 337
S.W.2d at 270.
A number of questions arise in regards to the
production in paying quantities analysis. What if there
is no available market through no fault of the lessee?
Should the lessor be required to suffer a continuation of
the lease beyond the expiration of the primary term
merely for speculative purposes on the part of the
lessee? In regard to the latter question, the Texas
Supreme Court has answered “no.” If the lease is no
longer yielding a profit at the termination of the primary
term, however small, the object of the lease has been
accomplished and the lease has therefore terminated.
Garcia, 164 S.W.2d at 513. While the concept of
holding a lease for purposes of making a profit and not
merely for speculation appears relatively straight
forward, its application has proven difficult.
III. THE PRODUCTION IN PAYING
QUANTITIES TEST – CLIFTON V. KOONTZ
The Texas Supreme Court articulated the
production in paying quantities test in 1959 in Clifton v.
Koontz. 4 In that case, the lessors brought suit seeking the
cancellation of an oil and gas lease on the theory that the
lease had expired in the secondary term due to a
cessation of production. Id. at 687. The lease in Clifton
contain a reworking-operations savings clause
providing that after the “discovery of oil, gas or other
mineral[s] the production thereof should cease from any
cause, this lease shall not terminate if lessee commences
additional drilling or re-working operations within sixty
(60) days thereafter.” Id. at 690. The lease, which was
executed in 1940, covered two tracts of land covering
350 acres in Wise County, Texas. Id. at 687-88. A gas
well was drilled within the lease’s ten-year primary
term. Id. at 688. Although the well produced both oil and
gas, it was classified as an “associated” gas well. Id. No
other drilling or reworking operations were carried on
during the primary term or subsequently until
September 12, 1956, when the well was successfully
reworked. Id.
The trial court found that the well had continuously
produced gas in paying quantities, which was affirmed
on appeal. Id. In sustaining the court of appeals’
judgment that the lease had not terminated in the
a total cessation of production for a period longer than stated
in the lease, and that no other lease savings clauses apply. Id.
3
The issue in that situation generally involves a well that has
been drilled, but has yet to actually produce any oil or gas for
a number of reasons, including not being completed, no
pipeline connection, or a lack of market.
4
325 S.W.2d 684 (Tex. 1959).
Disputes Over Production in Paying Quantities
secondary term due to a cessation of production, the
Texas Supreme Court reviewed the question as to
whether there was any evidence to support the
proposition that production in paying quantities had not
ceased. Id. In answering that question in the affirmative,
the Court noted that there was evidence that the
production was sold for a profit over a reasonable period
of time to support a finding of production in paying
quantities. Id. at 691.
The lessors based their contention that the
well had ceased to produce in paying quantities upon a
showing that for a sixteen month period between June
1955 and September 1956, the lease had generated a net
loss of $216.16. Id. at 689. While some months showed
a gain, other months showed a loss. Id. The record also
showed a loss during the months of April and May 1956.
Id. The evidence was undisputed that the respondent
commenced reworking operations on September 12,
1956, and that such operations resulted in an 1,800
percent increase in production although there had been
a small operating loss for the period of time in which the
reworking operations were being conducted. Id. The
respondent also offered evidence explaining that
operating at a profit during the period in question
depended on the oil production, and that two to three
months were required to accumulate enough oil in a tank
to sell. Id. The evidenced further showed that the
respondent had acquired its interest in the lease in June
1956, and in July 1956, began making financial
arrangements, securing the services of third parties, and
commenced saving oil from the well for reworking
operations. Id.
The pertinent question in Clifton was whether there
was production in paying quantities through July 12,
1956, which was the date 60 days prior to the
commencement of reworking operations. Id. Evidence
as to profit or loss subsequent to that date was
immaterial in determining whether there was production
in paying quantities. Id. Therefore, excluding the date
that reworking operations began, the Court noted that
the lessee had operated the lease at a profit of $111.25
for the relevant period of time leading up to the
reworking operations—the period between June 1955
through July 12, 1956. Id. The Court also acknowledged
that the lease had showed a net profit for the 30 month
period between January 1954 through June 1956. Id.
In rejecting the petitioners’ arguments that the
lease terminated when its income no longer exceeded
the costs of its operations in the secondary term, the
Texas Supreme Court expressed that there can be no
limit as to the amount of time, whether it be days, weeks,
or months, to be taken into consideration in determining
whether production in paying quantities has ceased. Id.
at 690. Instead of immediately invoking the provision of
various saving clauses such as an operations savings-
clause when production ceased to yield a profit, the
3
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lessee should be entitled to the benefit of the standard of
the reasonably prudent operator. Id. at 691.
The Court also held that a habendum clause
providing for production “as long as thereafter as oil,
gas or other minerals is produced from said land” meant
“production in paying quantities.” Id. The Court then
recited the generally accepted definition of “production
in paying quantities” as follows: “‘[i]f a well pays a
profit, even small, over operating expenses, it produces
in paying quantities, though it may never repay its costs,
and the enterprise as a whole may prove unprofitable.’”
Id. at 691 (quoting Garcia, 164 S.W.2d at 511). The
Court went on to articulate the subjective test for
production in paying quantities: “[i]n the case of a
marginal well, such as we have here, the standard by
which paying quantities is determined is whether or not
under all the relevant circumstances a reasonably
prudent operator would, for the purpose of making a
profit and not merely for speculation, continue to
operate a well in the manner in which the well in
question was operated.” Id. And in accordance with that
standard, the Texas Supreme Court held that a trial court
must necessarily take into consideration all matters
which would influence a reasonable and prudent
operator, including, but not limited to, the depletion of
the reservoir, the price for which the lessee is able to sell
its production, the relative profitableness of other wells
in the area, the operating and marketing costs of the
lease, the lessee’s net profit, the lease provisions, a
reasonable period of time under the circumstances, and
whether the lessee is simply holding the lease for
speculative purposes. Id.
Whether there is a reasonable basis for the
expectation of profitable returns from the lease is the
test, and if the quantity of the production is sufficient to
warrant its use in the market, and if the income
therefrom is in excess of the actual marketing and
operating costs, the production satisfies the term “‘in
paying quantities.’” Id. Thus, the Texas Supreme Court
rejected “absolute termination” and “sudden death” in
favor of the following two-pronged approach: (1) an
objective test, i.e., whether the well has ceased to
produce oil and gas in paying quantities; and (2) if yes,
a subjective test, i.e., whether under all of the relevant
circumstances, would a reasonably prudent operator
continue to operate the well in the same manner to make
a profit and not merely for purposes of speculation. Id.
at 691; Bachler v. Rosenthal, 798 S.W.2d 646, 649 (Tex.
App.—Austin 1990, writ denied).
IV. THE OBJECTIVE PRONG OF THE
PRODUCTION IN PAYING QUANTITIES
ANALYSIS
The objective prong of the production in paying
quantities analysis concerns whether a well has failed to
generate a profit over operating expenses. Clifton, 325
S.W.2d at 690-91; Evans, 840 S.W.2d at 503. Whether
Disputes Over Production in Paying Quantities
a well has yielded a profit is a question of fact. Sullivan
& Garnett, 308 S.W.2d 891, 893 (Tex. Civ. App.—San
Antonio 1957, writ ref’d n.r.e.); Ballanfonte v. Kimbell,
373 S.W.2d 119, 121 (Tex. Civ. App.—Fort Worth
1963, writ ref’d n.r.e.). For example, in Patton, the San
Antonio Court of Appeals confirmed that the “matter of
allocation and calculation of expenses is a fact
question[,]” and that the “question of whether there is
production in paying quantities is a question of fact for
the jury.” 417 S.W.2d at 476; see also Laddex, 513
S.W.3d at 482. Yet in Evans, the court acknowledged
that in certain cases, production in paying quantities can
be established as a matter of law by showing a profit
from the operation of the well. 840 S.W.2d at 503; see
also Grinnel v. Munson, 137 S.W.3d 706, 715 (Tex.
App.—San Antonio 2004, no pet.) (“Whether an oil or
gas well is producing in paying quantities is ordinarily a
question of fact, but where it is shown that a small profit
has been realized from the operation of the well, it may
be found as a matter of law that the well is producing in
paying quantities.”).
The burden of proof in a production in paying
quantities analysis lies with the lessor to prove that the
well is not making a profit. Bell v. Mitchell Energy
Corp., 553 S.W.2d 626, 630 (Tex. Civ. App.—Houston
[1st Dist.] 1977, no writ). And as a general rule, the
Austin Court of Appeals has held that a well ceases to
produce in paying quantities when there has been a total
or complete cessation of production. Bachler, 798
S.W.2d at 650 (holding that the reasonably prudent
operator test set forth in Clifton is not applicable where
the evidence shows that there has been a complete
cessation of production for the number of days stated in
the lease). A total cessation of production normally
arises where the reservoir has been depleted or where
the lessee has evidenced an objective intent to abandon
the leasehold. Ridenour, 47 S.W.3d at 122 (“A total,
physical cessation of production conveys an
unambiguous message: either a well is in need of
reworking or repair, or it has permanently drained the
reservoir. In either case, it is more reasonable in such
circumstances to expect the operator to take immediate
action or suffer termination of the lease.”). But the result
is different where the evidence shows that a well was
capable of producing oil or gas if turned on, even though
it may have stopped actually producing oil or gas for one
reason or another. Thompson, 94 S.W.3d at 553 (holding
that the lease did not terminate where the habendum
clause provided that the lease would last as long as gas
is or can be produced). This accords with the principle
that a lessee should be entitled the complete opportunity
to reap the fruits of the investments made in developing
the mineral estate, provided that those efforts yield a
profit and are not based solely for purposes of
speculation.
A number of questions arises regarding the
objective prong of the paying quantity analysis set forth
4
Chapter 15
in Clifton, including the period of time in which the
analysis should be conducted, the components that
comprise the revenue side of the working interest, and
the items that may be properly included into the expense
side of the equation.
A. Whether a Well Is Producing in Paying
Quantities Is Measured over a Reasonable
Period of Time Absent Lease Language to the
Contrary.
Absent lease language to the contrary, a well’s
profitability is determined over a reasonable period of
time that cannot be limited as to any period of months,
weeks or days. Under the objective prong of the test, i.e.,
whether the well has ceased to produce oil and gas in
paying quantities, the question often arises as to what
constitutes a reasonable period of time over which the
analysis should focus. As a general rule, and absent
specific lease language to the contrary, the reasonable
period of time for determining a well’s profit or loss is
evaluated under all of the circumstances and the totality
of the evidence presented. What constitutes a reasonable
period of time is a question of law. Pshigoda v. Texaco,
Inc., 703 S.W.2d 416, 419 (Tex. App.—Amarillo 1986,
writ ref’d n.r.e.) (“Koontz states that the court is to
determine profitability over a ‘reasonable period of time
under the circumstances.’”); Ballanfonte, 373 S.W.2d at
121 (“Further, the trial court was at liberty to conclude
that thirteen months was not a period of sufficient
length, in view of the evidence on profit and loss, to
compel its finding and conclusion that the defendants
were not making a profit.”).
The Texas Supreme Court has specified that the
period over which the trier of fact must determine
whether a lease produces in paying quantities is not
arbitrary. Clifton, 325 S.W.2d at 690. To that end, there
is no limit as to time, whether it be days, weeks or
months, to be taken into consideration in determining
the question. Laddex, 513 S.W.3d at 483 (citing Clifton,
325 S.W.2d at 690). There are many causes for the
slowing of production, and even temporary cessations
of production, which courts have found justifiable given
the evidence presented. Clifton, 325 S.W.2d at 690.
Accordingly, the period over which the analysis is to be
conducted should be reflective of the relevant lease
language and the totality of the circumstances presented
by the evidence. A lessee simply is not required to
immediately commence drilling or re-working
operations upon incurring a loss in one month without
regard to whether next month’s production might be
profitable. Id. And it appears that the trial court will be
afforded wide discretion in deciding the scope and
breadth of the evidence to be considered by the fact
finder at trial. See e.g., Pshigoda, 703 S.W.2d at 419
(“Koontz states that the court is to determine
profitability over a ‘reasonable period of time under the
circumstances.’”).
Disputes Over Production in Paying Quantities
For example, in Clifton, the Texas Supreme Court
rejected the petitioners’ argument that the well had
failed to produce in paying quantities even though the
evidence showed that the well had been operated at a
$216.16 loss for the sixteen month period between June
1955 and September 1956. Id. at 688-89. The Court re-
defined the relevant time period to exclude profits or
losses incurred subsequent to July 12, 1956, which was
the date 60 days prior to the commencement of
reworking operations. Id. at 688-89. In doing so, the
Court essentially harmonized the habendum with the 60
day re-working clause so that neither were rendered
meaningless in light of the parties’ objective intent in
entering into the oil and gas lease—developing the
mineral estate for the mutual benefit of the parties. The
Court then reviewed the thirty month period
immediately preceding the initiation of the 60 day
reworking clause to determine that the lease had in fact
operated at a net profit during that period. Id. at 689.
In short, while there are no bright line tests for what
constitutes a reasonable period of time over which a
well’s profits and losses are to be measured, Clifton
makes clear that the period of time must reflect the
circumstances presented and be logically related to any
lease savings clauses so that the fruits of the lessee’s
efforts may be fully realized to the extent reasonably
possible. Moreover, in Bell, the First District Court of
Appeals in Houston affirmed a jury’s verdict finding
that the lease had produced gas in paying quantities by
generating a net profit over lease operating expenses
over a forty-four month period despite the fact that a loss
was sustained for eight of those months. 553 S.W.2d at
630. In reaching its decision, the court stated that a
“mathematical loss occasioned during certain months of
a lease does not automatically establish the fact that the
lease is not being held by production in paying
quantities.” Id. If a well makes a profit, it is producing
in paying quantities. Id. The court offered no criticism
as to whether under the evidence presented, forty-four
months constituted a reasonable period of time to
evaluate the well’s profitability. These principles have
recently been affirmed by the Texas Supreme Court.
Laddex, 513 S.W.3d at 485 (“Narrowing the [jury]
question on paying production to any particular time
period is necessarily ‘arbitrary.’”).
However, when an oil and gas lease contains
specific language defining the period of time for which
production in paying quantities is to be measured, the
period expressly stated in the lease controls. In
Ridenour, the Waco Court of Appeals affirmed a
summary judgment that the lease had terminated as a
matter of law where lease language stated that a
cessation of paying production after the primary term
for a period of sixty days would cause the lease to
terminate. 47 S.W.3d at 119. In that case, the lessor
presented evidence that the lessee had wholly failed to
obtain any production within a sixty day period. Id. The
5
Chapter 15
court of appeals stated that under those facts, no analysis
of whether the lease had failed to produce in paying
quantities was necessary in order to find that the lease
had terminated. Id. at 122. In so holding, the Waco
Court of Appeals recognized that a complete cessation
of production for the number of consecutive days stated
in the cessation of paying production clause was by
itself sufficient to automatically terminate the lease
without regard to the reasonableness of the operator’s
actions. Id.; see also Laddex, 513 S.W.3d at 485 n.8
(noting that other lease provisions may affect the
paying-production analysis in determining whether
paying production has actually ceased).
B. The “Income Side” of the Production in Paying
Quantities Analysis.
In determining the income side of the production in
paying quantities equation, should all or only some
portion of the income attributable to the well be
considered in the profit and loss analysis? In Clifton, the
Texas Supreme Court stated that courts should consider
only the income attributable to the contractual working
interest created by the original lease in determining
whether the well generated a profit or a loss. 325 S.W.2d
at 693 (“The entire income attributable to the
contractual working interest created by the original lease
is to be considered.”); see also Patton v. Rogers, 417
S.W.2d 470, 475 (Tex. Civ. App.—San Antonio 1967,
writ ref’d n.r.e.) (discussing generally the plaintiff’s
calculations of paying quantities and noting that after
taking off the landowner royalty and severance tax, the
monthly expenses would exceed the gross income for
the working interest). The petitioner in Clifton argued
that income attributable to an overriding royalty should
be excluded in determining the well’s total income in
determining the well’s profitability. The Texas Supreme
Court disagreed and held that the income attributable to
overriding royalty interests should be included in the
total income attributable to the contractual working
interest created by the original lease. Id. at 693 (citing
Transport Oil Co. v. Exeter Oil Co. Ltd., 191 P.2d 129,
133 (Cal. Dist. Ct. App. 1948).
C. The “Expense Side” of the Production in Paying
Quantities Analysis.
In determining whether the production from a well
has generated a net profit or loss, Texas law is relatively
clear that only operating and marketing costs are to be
considered. But what are operating and marketing costs?
Do they include the cost of reworking a well so that
production may be resumed in the event of a production
ceases? Generally speaking, Texas courts have held that
operating costs include things such as taxes, overhead
charges, labor, repairs, and depreciation on salvable
equipment. Skelly Oil Co., 356 S.W.2d at 780-81;
Abraxas Pet. Corp. v. Hornburg, 20 S.W.3d 741, 756
(Tex. App.—El Paso 2000, no pet.); Pshigoda, 703
Disputes Over Production in Paying Quantities
S.W.2d at 417. These are direct costs of producing a
well, which generally involves the actual taking of oil or
gas from a well in a captive state for either storing or
marketing the product for sale. Bomar Oil & Gas, Inc.
v. Loyd, No. 10-08-00016-CV, 2009 WL 2136404, at *6
(Tex. App.—Waco July 15, 2009) (mem. op.), on
rehearing, 298 S.W.3d 832 (Tex. App.—Waco 2010,
pet. denied). On the other hand, one time investment
expenses, such as purchasing the well or equipping it,
are not to be included in the analysis. Id. at *8
(“BoMar’s purchase of the well equipment was a one-
time investment expense assumed by BoMar and
excluded from the definition of ‘operating and
marketing expenses.’”).
1. Royalties
There are only a few cases addressing the issue of
royalties and whether they are included or excluded in
the production in paying analysis, but it appears that
they are to be deducted. In its discussion of whether a
well was producing in paying quantities in Evans, the
Corpus Christi Court of Appeals stated that a well
produces in paying quantities where the oil and gas
produced from a lease is sufficient to pay the lessee a
profit, even small, over operating and marketing
expenses, excluding the cost of drilling or reworking a
well, but including all royalty payments. Evans, 840
S.W.2d at 503 (citing Morgan v. Fox, 536 S.W.2d 644,
650 (Tex. Civ. App.—Corpus Christi 1976, writ ref’d
n.r.e.)). See also Hutchison v. Tex-Lee Drilling & Dev.
Co., Inc., No. 03-96-00453-CV, 1997 WL 703180, at *3
n.4 (Tex. App.—Austin Nov. 13, 1997, pet. denied).
Thus, in determining whether production from a lease
has been sufficient to yield a profit to the lessee, it
appears that royalties should be deducted in determining
whether a profit or a loss has been realized. See 1 Ernest
E. Smith & Jacqueline Lang Weaver, Texas Law of Oil
& Gas § 4.4[A][2] (June 2018).
2. Drilling, Completing, and Reworking Costs
Are drilling, completing, and reworking costs
deducted in order to determine a well’s profitability?
No. These are one time expenditures and are treated as
capital expenditures to be recouped over time, if ever.
The term “drilling” has been generally defined to
include activities that are designed and conducted in an
effort to obtain initial production from a well. 43 Tex.
Reg. No. 7494 (Nov. 9, 2018) (codified as an
amendment to 31 Tex. Admin. Code § 9.31 (Aug. 9,
2009)) (Tex. R.R. Comm’n General Provisions
Concerning Maintenance of a State Oil and Gas Lease)
(current version at 31 Tex. Admin. Code § 9.31(b)(2)
(West 2018)). On the other hand, the term “reworking”
has been described as those types of activities that are
designed and conducted on a well in an effort to restore
or to enhance production in paying quantities from an
existing well. Id. § 9.31(b)(8) (West 2018). As a result,
6
Chapter 15
Texas courts hold that the cost and expense of drilling a
well, or reworking a well, is not included as an
“operating expense” in determining whether a well has
generated a net profit for purposes of production in
paying quantities. Evans, 840 S.W.2d at 503; see also
Morgan, 536 S.W.2d at 650 (stating that drilling and
reworking costs are excluded in the calculation of a
well’s profit or loss in determining paying quantities).
Rather, they are treated as capital expenditures.
The distinction between an operating and
marketing costs and a one-time capital expenditure can
be crucial in determining the viability of an oil and gas
lease into the secondary term. For example, in Pshigoda,
the Amarillo Court of Appeals affirmed a jury verdict
finding that the subject lease had produced oil or gas in
paying quantities despite the fact that Texaco had spent
approximately $89,000.00 to repair a casing leak. 703
S.W.2d at 416-17. In reaching its decision, the court
identified the issue as to whether the expenditure to
repair the casing leak should be treated as an operating
expense or a capital expenditure. Id. at 417. The court
then stated that resolution of the issue could be decided
within the framework of three cases: Garcia; Clifton;
and Skelly Oil Co. Id. at 418. In that regard, the court
reasoned: in order to perpetuate a lease in the secondary
term, there must be production in paying quantities—
Garcia; fixed or periodic cash expenditures incurred in
the daily operation of a well are to be classified as
operating expenses, while one time investment
expenses, such as drilling and equipping costs, are to be
treated as capital expenditures—Clifton; and drilling
costs were not to be included as part of the operating and
marketing expenses of a well—Skelly Oil Co. Id. In the
end, the court acknowledged that it was satisfied that the
trial court correctly instructed the jury when it submitted
the following instruction:
In determining ‘operating and marketing
expenses’ as that term is used in this charge, if
any there be, you may consider such expenses
as taxes, overhead charges, labor, repairs,
depreciation on salvable equipment, if any,
and other such items of expense, if any. In this
connection, you are instructed not to consider
any costs or expenses in connection with the
original drilling and equipping of the well or
a reworking of the well.
Id. at 417 (emphasis in original).
The court further reasoned in support of its holding
that a reworking expenditure is analogous, and closely
related to, the initial drilling expense. Id. at 418. And
that it is usually a one time, single expense item that is
treated most often as a capital investment. Id. at 418-19.
In Abraxas Pet. Corp., the El Paso Court of Appeals
cited Pshigoda approvingly while acknowledging, at the
same time, that periodic cash expenditures incurred in
Disputes Over Production in Paying Quantities
the daily operation of a well are generally classified as
operating expenses, while one-time investment
expenses, such as drilling and equipping costs, are to be
treated as capital expenditures. 20 S.W.3d at 756
(stating that “[r]eworking expenses are part of the
capital investment.”). This same type of reasoning
applies to the cost of completing a well. Evans, 840
S.W.2d at 504 (“The original costs of drilling,
completing, and equipping a well are not deducted in a
paying quantities analysis.”) (emphasis added). Thus,
when it comes to whether drilling and reworking
expenses are involved, the issue seems fairly well-
settled that they should not be included in the analysis.
3. Depreciation on Salvable Equipment
Is depreciation included in the operating and
marketing expense of a well in determining whether the
production from a well has generated a profit or a loss?
Yes, provided that the equipment is salvable. In Clifton,
the Texas Supreme Court stated that the trial court
correctly excluded depreciation as an operating expense
in determining whether and when production in paying
quantities ceases. Id. at 692. The Court reasoned that
depreciation of equipment is nothing more than an
accounting charge of money actually expensed in
purchasing tangible property, and if the investment itself
is not to be considered in the profit and loss analysis,
then neither should depreciation. Id. The analysis
seemingly turned on whether there was production
sufficient to yield a return in excess of operating and
marketing costs even though drilling and equipment
costs may never be repaid and the undertaking as a
whole may be rendered a total loss. Id. The Court further
noted that if the rule were otherwise, many leases might
be terminated and the lessee’s incentive to drill
decreased. Id. Yet, a closer look shows that in its
discussion of depreciation as an operating and
marketing expense, the Court was concerned with the
petitioner’s argument that depreciation of the original
investment cost should have been taken into
consideration in determining the profit and loss from the
well. Id. And in that regard, the Court expressly stated
that “[w]e do not have before us the question of whether
or not depreciation on producing equipment should be
charged as an operating expense, and, therefore, do not
decide the question.” Id. Later, in Skelly Oil Co., the
Texas Supreme Court clarified that depreciation on
salvable equipment should be included if it is a part of
the expense of producing and marketing the gas. 356
S.W.2d at 781; see also Evans, 840 S.W.2d at 504
(noting that salvable equipment should be depreciated
where the evidence shows that it is part of the expense
of producing and marketing the production). In order to
show the depreciation allowed in the paying quantities
calculation, a lessor must show the not only the cost of
the particular piece of equipment, but also its rate of
depreciation. Id. at 505.
7
Chapter 15
4. Overhead
Is overhead included in determining a well’s profit
or loss? Probably so, as long as the overhead can be
traced or tied directly to a well’s production. In United
Central Oil Corp. v. Helm, the Fifth Circuit held that
overhead should have been considered as part of the
expense of operating a well for purposes of determining
whether it was producing oil in paying quantities. 11
F.2d 760, 762 (5th Cir. 1926). The Fifth Circuit’s holding
is consistent with the Texas Supreme Court’s approval
of the trial court’s jury instruction in Skelly Oil Co. See
Skelly Oil Co., 356 S.W.2d at 781 (“‘In determining
‘operating and marketing expenses,’ as that term is used
in this charge . . . you may consider such expenses as . .
. overhead charges . . . .’”); see also Bomar Oil & Gas,
Inc., No. 10-08-00016-CV, 2009 WL 2136404, at *6.
Indeed, in Skelly Oil Co., the Texas Supreme Court
recognized that overhead should be included in the
analysis if it is a part of the expense of producing and
marketing the gas if it could be traced as an actual
expense of producing the well’s product. 356 S.W.2d at
781. Yet, in Ladd Petroleum Corp. v. Eagle Oil & Gas
Co., the Fort Worth Court of Appeals declined to follow
Skelly Oil Co. because it did not directly address the
issue of district and administrative expenses. 695
S.W.2d 99, 108-09 (Tex. App.—Fort Worth 1985, writ
ref’d n.r.e.). In that case, the Fort Worth Court of
Appeals held that those kinds of expenses should not be
considered overhead because they would continue
whether or not the well was producing oil or gas. Id. at
108. The court reasoned that “[o]rdinary business
experience would indicate that as the elimination of a
single well would not materially reduce such expense, it
should not be included as overhead.” Id. Thus, while it
appears that overhead may be charged generally, courts
should distinguish between overhead directly related to
production and overhead involving general
administrative expenses that exists and continue
whether or not the well is producing. See e.g., Bomar
Oil & Gas, Inc., No. 10-08-00016-CV, 2009 WL
2136404, at *7.
5. Marketing Expenses and the Cost of Building
Pipelines
What about the cost of building out and
constructing a pipeline to get the production to market?
In Archer v. Skelly Oil Co., the Amarillo Court of
Appeals held that the expense of pipe line facilities
could create a fact issue regarding whether the lessee
had operated the lease at a profit. 314 S.W.2d 655, 663-
64 (Tex. Civ. App.—Amarillo 1958, writ ref’d n.r.e.).
However, in refusing error, the Texas Supreme Court
stated that the “holding that the cost of construction of a
pipe line for marketing the gas should be included in
determining whether the well or wells in question were
producing oil in paying quantities is not before us, and
we express no opinion thereon.” Skelly Oil Co. v.
Disputes Over Production in Paying Quantities
Archer, 317 S.W.2d 47, 47 (Tex. 1958). In any event, it
would seem that the construction of a pipeline is more
akin to a capital expenditure rather than the type of
reoccurring expense typically associated with marketing
production from a well, like gathering and
transportation charges, but the issue appears to be
unsettled.
V. THE SUBJECTIVE PRONG OF THE
PRODUCTION IN PAYING QUANTITIES
ANALYSIS
The subjective prong of the production in paying
quantities analysis concerns whether a reasonably
prudent operator, under all of the relevant
circumstances, would continue to operate the well in the
manner in which it has been operated for purposes of
making a profit and not merely for purposes of
speculation. Clifton, 325 S.W.2d at 691. The relevant
inquiry is whether there is a reasonable basis for the
expectation of making a profit. Thompson, 94 S.W.3d at
559 (op. on rehearing) (per curium). Again, this prong
of the test is measured over a reasonable period of time
presented by the evidence, which, cannot, as a matter of
law, be specific without running afoul of Clifton.
Laddex, 513 S.W.3d at 486 n.10 (a “‘reasonable period
of time under the circumstances’ is pertinent to the
second prong of the Clifton analysis.”). If a well is
profitable under the first part of the test, the lease is
preserved and the second part of the test has no
applicability. Evans, 840 S.W.2d at 503 (stating that
“production in paying quantities may be established as
a matter of law by showing a profit from the operation
of the well.”).
In accordance with the subjective test, the trier of
fact must necessarily take into consideration all matters
which would influence a reasonable and prudent
operator, including the depletion of the reservoir, the
price for which the lessee is able to sell its production,
the relative profitableness of other wells in the area, the
operating and marketing costs of the lease, the lessee’s
net profit, the lease provisions, a reasonable period of
time under the circumstances, and whether the lessee is
simply holding the lease for speculative purposes. Id.
This list is non-exhaustive, and nothing in Clifton
supports the conclusion that these factors are exclusive.
Indeed, the Court noted that these were just “some of the
factors” to be considered in the analysis. Clifton, 325
S.W.2d at 691.
If the answer to the subjective inquiry is “yes,” then
the lessee may continue operating the well in the manner
in which it has previously been operated without risk of
termination. However, if the answer is “no,” the lessee
must immediately commence drilling or re-working
operations as set forth in any lease-saving clauses for the
specific purpose of restoring production from the lease
or else, run the risk of having the lease terminate
according to its terms. In either situation, the objective
8
Chapter 15
intent of the lessor and the lessee is carried forward—
the full use and development of the mineral estate for
the mutual benefit of the parties for the term of the lease.
Garcia, 164 S.W.2d at 512.
VI. PRODUCTION IN PAYING QUANTITIES
VS. CAPABLE OF PRODUCTION IN
PAYING QUANTITIES AND OTHER
PAYING QUANTITY ISSUES
As noted above, under a “typical” oil and gas lease,
the term “production” means that the operator must
bring the oil and gas to the surface and use, market or
store it. 1 Ernest E. Smith & Jacqueline Lang Weaver,
Texas Law of Oil & Gas § 4.4[A], at 4-34 (June 2018).
The mere discovery of oil or gas which can be produced
profitably is not sufficient. Holchak v. Clark, 284
S.W.2d 399, 401 (Tex. Civ. App.—San Antonio 1944,
writ ref’d) (“One can not say that discovery of oil
followed by diligent operations is the equivalent to
production of oil and gas in paying quantities, without
doing violence to the plan meaning of words in common
use among English speaking peoples. Production has a
commercial connotation. It means marketable oil or
gas.”). Smith & Weaver, Texas Law of Oil & Gas §
4.4[A], at 4-34. Rather, the oil or gas generally must be
taken from the well in a captive state.
These principles give rise to a myriad of questions,
including are marketing facilities required in order for a
well to produce in paying quantities? Is the result any
different where the habendum clause requires that the
lease is for a fixed term and as long thereafter as oil or
gas is produced or is capable of being produced in
paying quantities from the land? What about the lack of
a pipeline connection? Does a well produce in paying
quantities at the expiration of the primary term when it
is not connected to a pipeline? Is the result any different
where the habendum clause only requires that capability
of producing oil or gas in paying quantities? Like many
things in law, the answers to these questions depend on
many factors, including particularized lease language
and at what point is the paying quantities issue being
presented—at the expiration of the primary term or later
in the secondary term?
A. Capable of Producing Gas in Paying Quantities
The traditional habendum clause generally
provides that the lease will last for a fixed term and then
“as long as oil or gas is produced.” In considering the
meaning and effect of such language, the Texas
Supreme Court has made clear that this is the functional
equivalent of requiring actual production in
commercially paying quantities and not merely the
completion of a well capable of producing. Archer
County v. Webb, 338 S.W.2d 435, 437 (Tex. 1960).
Thus, unless there is an applicable savings clause, the
lease will terminate at the end of the primary term.
Stanolind Oil & Gas Co. v. Barnhill, 107 S.W.2d 746,
Disputes Over Production in Paying Quantities
749 (Tex. Civ. App.—Amarillo 1937, writ ref’d)
(holding that lease expired at the end of the primary term
under an “is produced in paying quantities” habendum
clause where evidence showed that well was capable of
producing gas, but that no market existed); Cox v.
Miller, 184 S.W.2d 323, 327-28 (Tex. Civ. App.—
Eastland 1944, writ ref'd). In those situations, it is said
that the special limitation—the failure to produce—has
occurred and hence, has resulted in the automatic
termination of the lease. Indeed, according to the Texas
Supreme Court, “no matter how great the potential
production may be or how many million cubic feet of
gas may have been flared, there would be no production
or production in paying quantities unless there was an
available market.” Reid, 337 S.W.2d at 270. But what
about the habendum clause that provides for “as long as
oil or gas is produced or there is a well capable of
producing oil or gas?” Is there any meaningful
difference and if so, when is a well capable of producing
oil or gas?
In Anadarko Petroleum Corp. v. Thompson, the
Texas Supreme Court considered those questions and
recognized a difference between them. The issue in that
case was whether a well holding the leased premises was
capable of producing gas during a sixty-one day period
and a ninety-one day period where the actual production
of gas ceased for a period exceeding sixty days. 94
S.W.3d at 557. Anadarko argued that the well was
capable of producing gas because the well was shut in
for pipeline repairs. Id. Thompson, on the other hand,
argued that the well was not capable of production
because the well would not have produced had it been
turned on. Id. In siding with Andarko, the Texas
Supreme Court held that a well is “capable of
production” where it is capable of producing in paying
quantities without any additional equipment or repairs.
Id. at 558. According to the Court, “capable of
production” or “can be produced” does not mean actual
production. Id. at 561 (op. on rehearing) (per curium).
Instead, in order for a well to be capable of producing
oil or gas in paying quantities, all that is required is that
the well must be able to flow when turned on, and it
must make economic sense to market and produce the
gas for purposes of yielding a positive return.
In reaching its decision, the Court recognized its
holding in Peveto v. Starkey that the completion of a gas
well capable of producing in paying quantities, but shut
in due to the lack of pipe line facilities or for other
reasons, is not considered “production” or “actually
producing” and therefore, does not sustain a mineral
interest that lasts for “as long as oil or gas is produced.”
Id. at 557 (citing Peveto, 645 S.W.2d 770, 771 (Tex.
1982)). The Court went on to discuss the differences
between “actual production” and the “capability of
production” and in doing so, approved the definition of
“capable of production” as stated by the Amarillo Court
9
Chapter 15
of Appeals in Hydrocarbon Management, Inc. v.
Tracker Exploration, Inc.:
We believe that the phrase ‘capable of
production in paying quantities’ means a well
that will produce in paying quantities if the
well is turned ‘on,’ and it begins flowing,
without additional equipment or repair.
Conversely, a well would not be capable of
producing in paying quantities if the well
switch were turned ‘on,’ and the well did not
flow, because of mechanical problems or
because the well needs rods, tubing, or
pumping equipment.
Thompson, 94 S.W.3d at 558 (quoting Hydrocarbon
Mgt., Inc., 861 S.W.2d 427, 433-34 (Tex. App.—
Amarillo 1993, no writ)). The Court noted that this
definition was consistent with existing cases discussing
the differences between actual production and capability
of production. Id.
Subsequent courts have followed Thompson’s
reasoning. For instance, in Blackmon v. XTO Energy
Inc., the Waco Court of Appeals rejected the lessors’
argument that a well was not capable of production in
paying quantities where it needed additional equipment
or repairs in order to produce marketable gas. 276
S.W.3d 600, 603 (Tex. App.—Waco 2008, no pet.). The
court stated that the reference to additional equipment
or repairs in Thompson obviously focused on equipment
or repairs necessary to flow raw gas to the wellhead
when the switch was turned on and not on equipment
installed downstream to refine the gas into a marketable
form. Id. Thus, the capability to produce in paying
quantities focuses on a well’s ability to flow gas, and not
the quality of the gas. Likewise, in Grinnell, the court
held that the lease did not terminate even though there
had been a complete cessation of production from the
lease in the secondary term. 137 S.W.2d at 716-17. In
that case, the habendum clause provided that the lease
would be extended for “as long thereafter as oil or gas is
capable of being produced,” and there was no evidence
that the well was not capable of producing in paying
quantities without additional equipment or repairs if
turned on. Id. Moreover, in Chesapeake Exploration,
Ltd. Partnership v. Corine, Inc., the Waco Court of
Appeals held that a well shut in during the primary term
was not capable of producing in paying quantities where
the evidence showed that the well in question was not
equipped with rods, tubing, or pumping equipment
when the primary term expired and hence, was not able
to flow when turned on. No. 10-06-00265-CV, 2007 WL
2447293, at *3 (Tex. App.—Waco Aug. 29, 2007),
judgm’t withdrawn, No. 10-06-00265-CV, 2007 WL
2729576 (Tex. App.—Waco 2007, no pet.). These
cases highlight the importance of distinguishing
Disputes Over Production in Paying Quantities
between lease language requiring actual production and
those that provide for the capability of production.
B. The Lack of a Market Can Preclude a Finding
of Production in Paying Quantities
Whether marketing facilities exist can be an
important factor in determining whether a well is
producing or capable of producing in paying quantities.
In Gulf Oil Corp. v. Reid, for example, the Texas
Supreme Court warned that the lack of a market is not
an excuse for the failure to produce and absent some
lease savings provision to the contrary, a lease
automatically terminates upon the expiration of the
primary term. 337 S.W.2d at 270. In doing so, however,
the Court recognized the holding in Union Oil Company
of California v. Ogden in which the El Paso Court of
Appeals found that a lessee should have a reasonable
time to market the gas even though that time might
necessarily extend beyond the lease’s primary term. 5 Id.
(citing Ogden, 278 S.W.2d 246, 249 (Tex. Civ. App.—
El Paso 1955, writ ref’d n.r.e.)). In Reid, the lessee
capped a well in the secondary term, which was capable
of production in paying quantities, due to a lack of
marketing facilities. 6 Id. at 268. The lease’s habendum
clause apparently required actual production in order to
extend the lease into the secondary term. See id.
Nevertheless, in concluding that the lessee had
failed to extend the lease in the secondary term in Reid,
the Texas Supreme Court noted that the lessee’s efforts
consisted solely of negotiations with the pipe line
company and no manual operations were conducted
until sometime well into the lease’s secondary term. Id.
The Court then cited to Holchak 7 and Sellers v.
Breidenbach 8 as additional support for its conclusion
that the lease had terminated for failing to produce oil or
gas in paying quantities in the secondary term due to a
lack of market. Id. There being no gas produced from
the premises on the last day of the primary term, and no
royalty having been paid on or before that date, the lease
lapsed as a matter of law. Id. at 271. The Court even
went so far to state the following:
5
In Ogden, the court of appeals was faced with two separate
leases, one expressly providing for the payment of $100.00
in the event that oil or gas could not be profitably produced
due to a lack of market at the well or wells, and other simply
providing that the lease would last for the fixed primary terms
and so long thereafter as oil or gas was produced. 278 S.W.2d
at 247-49. In holding that the first least did not expire, the
court recited that there was no market for the gas when the
well was completed, that the lessee acted diligently in
attempting to secure a pipeline and connection, and that the
lease could be maintained for a lack of market by the payment
of the stated royalty. Id. at 248. As for the second lease, the
court noted that there was no shut in royalty payment, that the
lessee had failed to begin operations for the laying of pipeline,
10
Chapter 15
[a]lthough this well was capable of producing
in paying quantities, considerable gas having
been flared and an undisclosed number of
barrels of condensate obtained, none was ever
sold or used on or off the premises. Therefore,
under the authorities cited above there was no
production from the well within the meaning
of the lease provisions. It follows, that since
there had been no production, there could not
be a cessation of production, and thus the 60-
day [operations] clause is not available to the
petitioner to extend the term of the lease or to
delay the tender of the royalty payment.
Id.
The Court declined to take on the issue and decide
whether laying gathering lines and getting the well
connected fell into the category of “drilling operations.”
Id. at 270. Moreover, in Peveto, the Texas Supreme
Court stated that the payment of shut in royalty for a
completed gas well that was capable of producing in
paying quantities, but shut in due to the lack of pipe line
facilities or for other reasons, is not considered
production in paying quantities for purposes of
extending the lease into the secondary term. 645 S.W.2d
at 771. In that case, the habendum clause was for a fixed
period of fifteen years and “as long thereafter as oil, gas
or other minerals, or either of them is produced . . . in
paying quantities.” Id. Thus, under the authority of
Peveto, Reid, Holchak, and Sellers, it would appear that
a well is not producing oil or gas in paying quantities
where the well is not connected and there is no pipeline
to get the gas to market.
However, in denying the motion for rehearing in
Thompson, the Texas Supreme Court clarified that it
was not overruling or otherwise calling into question
prior decisions regarding the proper interpretation of the
phrase “production in paying quantities.” 94 S.W.3d at
559 (op. on rehearing) (per curium). In that regard, the
Court reaffirmed the long-standing principle that for a
well to produce in paying quantities, or to be capable of
producing in paying quantities, there “must be facilities
and had failed to continue such operations with reasonable
diligence and dispatch to get the gas to market. Id. at 249.
6
The chief issue in that case was whether a so-called shut-in
royalty payment, tendered after a well capable of producing
gas in paying quantities had been capped, was timely made so
as to extend the term of the oil and gas lease. Id. at 268.
7
284 S.W.2d 399.
8
300 S.W.2d 178 (Tex. Civ. App.—San Antonio 1957, writ
ref’d). In Sellers, San Antonio Court of Appeals again stated
that “paying production” does not mean “the completion of a
well capable of producing, it means a well which is actually
producing on the significant date.” Sellers, 300 S.W.2d at
178.
Disputes Over Production in Paying Quantities
located near enough to the well that it would be
economically feasible to establish a connection so that
production could be marketed at a profit.” Id. The Court
then cited Clifton to reinforce the proposition that all
relevant circumstances must be considered in
determining whether there are paying quantities, and
that the term “paying quantities” involves not only the
amount of production, but the ability to market the
production at a profit. Id. The test, again articulated by
the Texas Supreme Court, is whether there is a
reasonable basis for the expectation of profitable returns
from the well. Id.
The Texas Supreme Court in Thompson went on to
quote Clifton at length in regards to its discussion of the
subjective prong of the paying quantities test, as well as
the Court’s decision in Hanks v. Magnolia Petroleum
Co., 24 S.W.2d 5 (Tex. Comm’n App. 1930, judgm’t
adopted). 9 As recognized in Clifton, the Court affirmed
the decision in Hanks that a completed well did not
produce in paying quantities within the contemplation
of the lease where the evidence showed that there were
no facilities for marketing the gas, no nearby localities
or industries which might have furnished a profitable
market for the gas, and no evidence tending to show that
the well was even situated in such proximity to any
prospective market which would justify the construction
of a pipeline. Id. at 691 (citing Hanks, 24 S.W.2d at 5).
Clifton was materially different from Hanks because the
evidence in Clifton supported a finding of marketing
facilities and that the gas had in fact been sold at a profit.
Clifton, 325 S.W.2d at 691.
Like Clifton, the evidence in Thompson showed
that the well had been completed and was connected to
pipeline facilities. 94 S.W.3d at 569. The Court
acknowledged that there was “no question that it was
capable of producing in paying quantities even though
there were periods during which there was no [actual]
production.” Id. The Court then further clarified its
original decision by stating:
[w]e meant in our original decision that, as a
practical matter, a lessee will not sustain a
lease based on a well’s capability of
production without actual production of the
well because the payment of damages for the
failure to reasonably market the gas would be
a strong incentive to connect the well to
facilities that would permit actual production.
And, in an extraordinary case, when damages
would not furnish an adequate remedy, a court
could conditionally order termination if a
9
Hanks was decided by Section B of the Texas Commission
of Appeals of the Texas Supreme Court in 1930. The Texas
Supreme Court affirmed the judgment of the court of appeals
11
Chapter 15
connection and actual production were not
commenced within a reasonable time.
Id. at 560.
C. Shut in Royalty
Where a lessee has drilled a well capable of
production in paying quantities, but cannot obtain a
pipeline connection before the end of the primary term,
the lease will terminate for a lack of production under
an “is produced” habendum clause. Barnhill, 107
S.W.2d at 749. Shut-in royalty clauses are designed to
keep the lease alive and to prevent termination such
situations.
The typical shut-in royalty clause acts as a
substitute or contractual method of production, which
will maintain the lease in force and effect when a gas
well is drilled and for which no market exists. Red Deer
Resources, 526 S.W.3d at 395; Richard W. Hemingway,
The Law of Oil and Gas § 6.5, at 304 (2d ed. 1983).
Invocation of the shut-in royalty clause is considered
constructive production and will maintain the lease if its
terms are satisfied. Red Deer Resources, 526 S.W.3d at
395. However, for a well to be maintained by the
payment of shut-in royalties, the party seeking to invoke
the provision must strictly comply with the terms of the
shut-in clause as set out in the lease. Id. Moreover, in
order for a well to be shut in, and absent lease language
to the contrary, the well must be capable of producing
gas in paying quantities at the time the well is shut in.
Id.; Hydrocarbon Mgt., Inc., 861 S.W.3d at 432-33;
Kidd v. Hoggett, 331 S.W.2d 515, 519 (Tex. Civ.
App.—San Antonio 1959, writ ref’d n.r.e.); Duke v. Sun
Oil Co., 320 F.2d 853, 860 (5th Cir. 1963). But see
Corine, No. 10-06-00265-CV, 2007 WL 2447293, at *3
(holding that well must have been capable of producing
gas in paying quantities at the end of the primary term,
not when the well was actually shut in). This holds true
even where the shut-in royalty clause makes no mention
of paying production. Hydrocarbon Mgmt., Inc., 861
S.W.2d at 433.
Thus, whenever a shut-in royalty clause is invoked,
the party seeking to terminate the lease must negate the
clause by establishing that the well was either not
capable of producing in paying quantities or that no
market existed, or both. Red Deer Resources, 526
S.W.3d at 395; Hydrocarbon Mgt., Inc., 861 S.W.2d at
433. While a well is “capable of production” where it
will flow gas in paying quantities when it is turned on
without any additional equipment or repairs, as
measured over a reasonable period of time, Red Deer
Resources, 526 S.W.2d at 397; Thompson, 94 S.W.3d at
as recommended by the Commission. Accordingly, this
opinion is cited as a “judgment adopted” opinion pursuant to
Rule 5.2.4. of The Greenbook: Texas Rules of Form.
Disputes Over Production in Paying Quantities
558; Fain Family First Ltd. P’ship v. EOG Resources,
Inc., No. 02-12-00081-CV, 2013 WL 1668281, at *5
(Tex. App.—Fort Worth April 18, 2013, no pet.), there
must exist pipe lines through which the gas can be
marketed in order for it to have any value. Hydrocarbon
Mgt., Inc., 861 S.W.2d at 433; Reid, 323 S.W.2d at 115,
aff’d, 337 S.W.2d 267 (Tex. 1960). Indeed, a lack of
facilities for marketing the gas is sufficient to show that
a well is not capable of producing gas in paying
quantities. Fain Family First Ltd. P’ship, 2013 WL
1668281, at *5. In Fike v. Riddle, the Tyler Court of
Appeals rejected the argument that a well was a
producing oil well simply by the installation of rods,
tubing, and other equipment that would render the well
capable of producing oil. 677 S.W.2d 722, 725 (Tex.
Civ. App.—Tyler 1984, no writ). Rather, the court held
that a producing well was one where the products are
being producing in paying quantities and sold in the
market place. Id. at 725-26 (citing Cox, 184 S.W.2d at
327; Hanks v. Magnolia Petroleum Co., 24 S.W.2d 5
(Tex. Comm’n App. 1930, judgm’t adopted)).
D. The Payment of Shut in Royalty Will Not
Extend a Term Royalty Deed That Lacks Shut
in Language
In the absence of relevant language expressly
providing for the payment of shut-in royalties, a
purported payment of shut-in royalties will not act as a
substitute for production in paying quantities in regards
to a term royalty deed. Peveto, 645 S.W.2d at 771;
Archer County, 338 S.W.2d at 437. In Peveto, the Texas
Supreme Court stated that Texas law was well-settled in
that the completion of a gas well capable of producing
in paying quantities but shut in due to lack of pipe line
facilities or for other reasons is not considered
production, or production in paying quantities, under the
provisions of a term royalty deed containing no
provisions for shut in royalty payments. 645 S.W.2d at
771. In that case, the Court held that a term royalty deed
that provided for a fixed term and as long thereafter as
oil or gas is produced in paying commercial quantities
was not extended by the payment of shut in royalty. Id.
While the lease provided for the payment of shut-in
royalties, the royalty deed did not and therefore, the
royalty under the deed expired. Id.
E. Adverse Possession
In the case of a marginal well that continues to
produce during the secondary term, it is less than clear
as to when or at what point a lease will terminate for
failing to produce in paying quantities. As a result, a
lessee may seek to establish that it has re-acquired the
lease through continued production under the three, five,
and ten year statutes of limitations. In Natural Gas
Pipeline Company v. Pool, the Texas Supreme Court
held that the lessee had acquired leasehold interests by
adverse possession where the evidence showed that the
12
Chapter 15
lessee’s continued possession was open, notorious, and
hostile to the lessor’s claim that all title and interests had
reverted to it under the nature of the determinable fee.
124 S.W.3d 188, 197-98 (Tex. 2003); see also Vortt
Expl. Co., Inc. v. EOG Resources, Inc., No. 11-07-
00159-CV, 2009 WL 1522661, at *8 (Tex. App.—
Eastland May 29, 2009, no pet.) (mem. op.) (holding
that summary judgment was not proper on adverse
possession claim where evidence presented failed to
create a question of fact). Additional questions arise,
including whether the lessee’s open and notorious
possession for purposes of adverse possession needs to
be in paying quantities in order to be effective?
VII. SUBMITTING THE PRODUCTION IN
PAYING QUANTITIES ISSUE TO THE
JURY
The Texas Supreme Court recently clarified how
the production in paying quantities doctrine is to be
submitted in two different contexts: the habendum
clause and the shut-in royalty clause.
A. The Habendum Clause
In BP America Production Co. v. Laddex, the
Texas Supreme Court reviewed the trial court’s jury
charge on a production in paying quantity issue
involving a marginal well in Roberts County, Texas.
513 S.W.3d 476, 477-78 (Tex. 2017). The lease in
Laddex provided for a primary term of five years and
continued thereafter as long as oil or gas was produced.
Id. at 478. Beginning in August 2005, production from
the well slowed significantly for approximately fifteen
months after which the well resumed producing in
quantities comparable to those before the slowdown. Id.
The trial court’s charge asked the jury whether the well
failed to produce in paying quantities from “August 1,
2005 to October 31, 2006” and whether under all of the
relevant circumstances, a reasonably prudent operator
would not continue, for the purpose of making a profit
and not merely for speculation, to operate the well in the
manner in which it was operated between “August 1,
2005 and October 31, 2006,” to which the jury answered
“yes” to both questions. Id. at 479. The court of appeals
held that the trail court erred in limiting the jury’s
paying-production inquiry to the specific fifteen-month
period in which production slowed. Id.
In affirming the court of appeals’ decision that the
trial court erred in limiting the jury’s focus to a specific
period of time and did not allow the jury to consider the
well’s return to profitability, the Texas Supreme Court
found it important to reiterate the framework under
which claims involving the production in paying
quantities doctrine and to set out the court’s charge. Id.
at 482-84. BP argued that a reasonable period of time
under the evidence presented would have been, at a
minimum, the 27 month period preceding the filing of
the lawsuit in April 2007. Id. at 484. Laddex contended
Disputes Over Production in Paying Quantities
that the trial court acted properly in stating the period
over which it was alleged that there had been a failure
to produce in paying quantities, and that evidence of
profitability and loss before and after that period was
presented and thus, the jury was able to consider all of
the evidence in making its findings. Id.
The Texas Supreme Court stated that both parties’
positions ran afoul of Clifton. Id. The Court again
reiterated that “‘there can be no limit as to time . . . to be
taken into consideration in making that determination.’”
Id. at 485 The Court concluded that the rule eviscerated
the parties’ contentions about the effect of the well’s
pre- and post-slowdown profitability: Laddex
erroneously argued that it is immaterial, while BP
argued that it was dispositive. Id. The trial court
properly allowed the parties to present evidence of
profitability before, during, and after the slowdown, but
ultimately erred in asking the jury to evaluate whether
production in paying quantities existed only as to the
specific fifteen month period in which production had
slowed. Id. Narrowing the jury question on paying
production to any particular time period was necessarily
“arbitrary.” Id. (citing 1 Ernest E. Smith & Jacqueline
Lang Weaver, Texas Law of Oil & Gas § 4.4[A][2][b],
at 4-40 (Nov. 2009) (“Unless the lease defines the
period for which production in paying quantities is
measured, a well’s profitability is not determined by
looking at any specific accounting period.”)). The Court
concluded that while litigants are entitled to argue and
present evidence to focus the jury’s attention to the
period of time they deem reasonable or important, the
charge simply may not ask or instruct the jury about a
specific period without unduly influencing them and
violating Clifton. Id. at 486.
B. The Shut-In Royalty Clause
In BP America Production Co. v. Red Deer
Resources, LLC, the Texas Supreme Court considered
whether a jury’s finding that a gas well was incapable or
production in paying quantities the day after the
producer closed the valve, and eight days after gas was
last sold, could support a judgment terminating an oil
and gas lease in its secondary term. 526 S.W.3d 389,
391 (Tex. 2017). In concluding that Red Deer had failed
to obtain a finding that the well was incapable of
producing gas in paying quantities on the material date
under the plain language of the oil and gas lease, the
Court reversed the court of appeals’ judgment and
rendered judgment in favor of the producer that the lease
had not terminated for failing to produce in paying
quantities within the secondary term. Id.
This case involved the shutting in of the Vera
Murray #11 well. Id. at 391. BP operated the Vera
Murray #11 gas well under an oil and gas lease executed
in 1962, which contained a habendum clause providing
for a five year primary term and “‘as long thereafter as
oil, gas or other minerals is produced.’” Id. at 391. At all
13
Chapter 15
relevant times, the Vera Murray #11 gas well was the
only well from which any production could have been
obtained to sustain the lease. Id. at 391-92. In May 2012,
the Vera Murray #11 well experienced a seven-day
period with no production, at which point it resumed a
general pattern of flowing gas for a period of time every
other day. Id. at 392. On June 4, 2012, the well produced
10 mcf of gas, and then went eight days with no
production. On June 12, 2012, BP turned off the well by
closing the valve. Id. The next day, BP sent notice to the
lessors that it had shut in the well and was invoking the
shut-in royalty clause beginning as of June 13, 2012. Id.
The Vera Murray #11 well has been shut in since. Id.
While the lease contained a sixty-day cessation of
production savings clause, the evidence showed that BP
did not commence any production operations during the
sixty days after it closed the valve to the sales line on
June 12, 2012. Id. Therefore, unless BP had properly
invoked the shut-in royalty clause to maintain the lease,
it would have terminated in the secondary term for a
total failure of production or a failure of production in
paying quantities. Id. The shut-in royalty clause
provided:
Where gas from any well or wells capable of
producing gas . . . is not sold or used during or
after the primary term and this lease is not
otherwise maintained in effect, lessee may pay
or tender as shut-in royalty . . ., payable
annually on or before the end of each twelve
month period during which such gas is not
sold or used and this lease is not otherwise
maintained in force, and if such shut-in
royalty is so paid or tendered and while
lessee’s right to pay or tender same is
accruing, it shall be considered that gas is
being produced in paying quantities, and this
lease shall remain in force during each twelve-
month period for which shut-in royalty is so
paid or tendered . . . .
Id.
Red Deer brought suit asserting two theories of
termination. First, that the lease had terminated because
production in paying quantities had not been maintained
for a period of time ending on June 12, 2012, the day
that BP shut in the Vera Murray #11 well. Id. at 393.
Second, that the lease terminated from an unexcused,
total cessation of production, and that the shut-in clause
did not apply because the Vera Murray #11 well was not
capable of producing in paying quantities on June 13,
2012. Id.
Four questions were submitted to the jury. The
first two questions concerned whether the lease had
produced in paying quantities up to June 12, 2012, and
the other two which dealt with whether the well was
capable of producing in paying quantities when the well
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.

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