By Dave Seely
Royalty owners are sometimes surprised to learn that an oil or gas well for which they have been receiving royalty payments has ceased producing oil or gas. Sometimes that discovery is made out in the field, by seeing a pump jack sitting motionless, an oil tank whose level does not change, or a gas meter that no longer records production. Sometimes that discovery comes in the form of a royalty statement that shows no production (and no payment) from a well that previously produced minerals and generated royalty revenue. Rarely does the lessee who operates the well contact its royalty owners regarding cessation of production.
Cessation of production can be significant, not only because of lost royalty income but because it could potentially lead to the termination of the oil and gas lease. An oil and gas lease typically includes a specific time period or “primary term”, as well as a “thereafter” clause that extends the life of the lease for as long as oil or gas is produced. This means that if the primary term has expired and the lease is being perpetuated by production, the cessation of production could result in the termination of the lease. However, under Kansas law, it may be sufficient that the well is physically capable of producing in paying quantities, which means that it could (if operating) produce quantities of oil or gas sufficient to generate revenues in excess of operating expenses. Determining that capability can sometimes be a complicated and hotly-disputed process, resulting in litigation and requiring the testimony of expert witnesses.
A cessation of production might be only temporary, or it could be long-term or even permanent, depending on the cause. During the spring and summer months, the demand for natural gas typically declines (and the price often declines as well), as consumers stop heating their homes. The discovery and development of new supplies of natural gas may also have an impact on demand for gas from existing wells. Declining demand can make it difficult for lessees to sell gas during the summer months. In some instances, the lack of a market for gas may cause a producer to stop producing from a gas well. In such instances, the payment of shut-in royalties may be used to perpetuate the lease. However, the producer has a duty to use reasonable diligence in marketing the gas. The upside is that gas that is not produced and sold during a period of market decline should still be available to be produced and sold when market conditions have improved, and may yield a higher price.
Production of oil or gas may cease due to mechanical problems with the well and related equipment. When prices and demand are low, it may be more difficult for a lessee to pay substantial repair costs. But repairs and maintenance are among the costs that the lessee is obligated to incur to keep the well capable of producing oil or gas in paying quantities. Most oil and gas leases include a cessation of production clause which gives the lessee a specific period of time in which to commence reworking or redrilling in order to restore production. 120 days is a fairly common period in which to commence such activities and avoid termination of the lease due to lack of production. At a minimum, a lessee is entitled to a reasonable time to make repairs and restore the well to productive status with reasonable diligence.
It is important to understand that not every interruption of production will result in the termination of an oil and gas lease. The particular circumstances are important, as are the provisions of the lease. If there is more than one well on the leased premises, or on a tract unitized with the leased premises, production from any such well will perpetuate the lease. Even if there is only one well, the temporary cessation clause may apply and continue the lease in existence, provided that the required activities are commenced within the prescribed period. Even in the absence of a cessation of production clause, repairs made with reasonable diligence that restore production will perpetuate a lease. If the lease contains a shut-in gas royalty clause, payment of shut-in royalties may perpetuate the lease. However, the language of some shut-in royalty clauses may continue a lease in existence, even if payments are not timely made. Even when a well is not actually producing, it may be enough that it is physically capable of producing gas in paying quantities.
Because oil and gas deposits are finite resources, they will eventually be depleted by ongoing production. Thus, production will diminish and decline over time, even from a good producing well. Eventually, as production and revenues decline, the costs of operating a well may exceed the revenues that can be obtained. At that point, the producer may decide to stop incurring expenses and abandon the well. Although KCC regulations provide that, within 90 days after operations cease on a well, the operator must either plug the well or file an application for temporary abandonment, there is an exemption, up to one year, for wells that are fully equipped for production and are immediately capable of resuming production, and are subject to a valid, continuing oil and gas lease. K.A.R. 82-3-111(e).
When production has permanently ceased, or the lessee has abandoned efforts to restore production or otherwise comply with the lease, Kansas law provides a procedure for obtaining a release of the oil and gas lease (see Kan. Stat. Ann. 55-201). The lessee is obligated to formally surrender the lease, in writing, within 60 days of abandonment. If he fails to do so, the royalty owner may either send the lessee a letter by registered mail declaring that the lease is void and demanding release, or else publish a similar notice for three consecutive weeks in a county newspaper. Twenty days after service of notice (or the last date of newspaper publication) the lessee can then file an affidavit with the register of deeds for the county where the lease is located, declaring the lease forfeited. If the lessee still does not provide a release of the lease voluntarily in response to these efforts, the lessor has a right under Kan. Stat. Ann. 55-202 to file an action in court to have the lease declared forfeited and released. The lessor can also recover their attorney fees and monetary damages in such an action.
Once an oil and gas lease has been forfeited and released, the owner of the mineral rights is free to enter into a new lease with a different oil and gas producer. The new lessee may attempt to use the existing wellbore, or may drill a completely new well.
If you discover that your well is not producing, do not hesitate to contact your producer and ask them to explain what is going on. Ask them the reason for the shut-down. Ask them how long the well has been shut down. Ask them how long the well will continue to be shut down. Ask them about their plans and efforts to get the well back into operation. If they do not intend to resume production, ask them to give you a written release of the oil and gas lease. If you do not receive satisfactory explanations, contact a lawyer.
Mr. Seely regularly represents landowners and royalty owners. He currently serves as General Counsel to the Southwest Kansas Royalty Owners Association and the Eastern Kansas Royalty Owners Association.
Fleeson Gooing's natural resources and energy law practice encompasses the entire range of activities related to mineral exploration and development. Our firm has acquired a national reputation in matters relating to the production, regulation and sale of natural gas. Contact us today.