Maintaining an Oil and Gas Lease Beyond the Primary Term

In Hardin-Simmons Univ. v. Hunt Cimarron L.P., No. 07-15-00303-CV, 2017 Tex. App. LEXIS 6934 (Tex. App.-Amarillo July 25, 2017), the court evaluated the terms of an oil and gas lease to determine to what extent the oil and gas lease remained in effect, if at all, due to a lack of production in paying quantities.

In the late 1950s several producing wells were drilled on the leased premises, but production declined. In 1967, the leased premises was included in the Buckshot Unit, a 13,000 acre waterflood unit. In the 1990s, the leased premises fell out of the Buckshot Unit and the owners of entered a new lease that was subsequently assigned to United Oil and Gas (the “United Lease”). At the conclusion of the primary term of the oil and gas lease to United, the lease was released as to all of the leased premises, except for 700 acres, which lease was acquired by Hunt Cimarron LP (“Hunt”).

In 2006, lessors executed an oil and gas lease covering 4,960 acres of land in Cochran County, Texas to Hunt, including the 700 acres held by the United Lease. The 2006 Hunt lease provided for a primary term of five (5) years and included a retained acreage clause and a Pugh clause. The Pugh clause gave Hunt the right to maintain the lease by engaging in a “continuous development program” prior to the end of the primary term. The retained acreage clause gave Hunt the right to maintain the lease as to certain acreage and depths included in a “production unit.” The lease also contained a “reworking” clause that permitted Hunt to maintain the lease beyond the primary term by engaging in “reworking operations.” Under the terms of the lease, Hunt was required to file a written instrument releasing all non-productive acreage within 30 days of the expiration of the primary term.

During the primary term of the lease, “Hunt did not commence drilling on any new wells, convert any of the legacy wells (wells that were in existence prior to execution of the subject lease) into injection wells, nor recomplete any of those legacy wells in a new production zone.” Id., at *12. In July 2011, just before the expiration of the primary term, Hunt began reworking operations on 10 legacy wells. Hardin-Simmons asserted that the lease should be released because the lease terminated due to non-production. Hunt, however, refused to sign a release, and argued the entire lease remained in force and effect due to the reworking clause.

The Court explained that “‘[p]roduction in paying quantities’ means ‘the production is sufficient to pay the lessee a profit, even small, over the operating and marketing expenses, although the cost of drilling the well may never be repaid.'” BP Am. Prod. Co. v. Red Deer Res., LLC, No. 15-0569, 2017 Tex. LEXIS 410, at *8 (Tex. April 28, 2017) (quoting Hydrocarbon Mgmt., Inc. Tracker Expl., Inc., 861 S.W. 427, 432 n.4 (Tex. App.-Amarillo 1993, no writ)). The Texas Supreme Court has developed a two-pronged analysis to determine “whether a well has ceased to produce in paying quantities depends on (1) whether the well shows a profit, even small, over operating expenses, and (2) if not, whether, under all the relevant circumstances a reasonably prudent operator would, for purpose of making a profit and not merely for speculation, continue to operate that well as it has been operated.” Hardin-Simmons, at *19 (citing BP Am. Prod. v. Laddex, Ltd., 513 S.W.3d 476, 482-83 (Tex. 2017)). Generally, reworking operations include “any and all actual acts, work or operations in which an ordinarily competent operator, under the same or similar circumstances, would engage in a good faith effort to cause a well or wells to produce oil or gas in paying quantities.” Cox v. Stowers, 786 S.W.2d 102, 105 (Tex. App.-Amarillo 1990, no writ). Thus, reworking operations must be activities that are reasonably to result in production.

In this case, Hardin-Simmons argued that the reworking clause could not be applied to keep the oil and lease alive beyond the primary term because Hunt did not drill any new wells during the primary term of the lease; thus, there were no wells that Hunt could rework. The Court disagreed and explained that the lease did not provide that the legacy wells on the leased premises were excluded from the potential inventory of wells to be reworked and Hunt was engaged in reworking operations prior to the expiration of the primary term. Hardin-Simmons, at *23. However, the despite Hunt’s arguments, the Court concluded that the reworking clause did not hold the entire oil and gas lease because of the continuous development, retained acreage and Pugh provisions. The Court concluded that “according to the express terms of the Pugh clause and retained acreage clause, at the end of the primary term, the lease continued only as to acreage included within a defined ‘production unit,’ including wells being reworked.” Id., at *25.

Additionally, the Court concluded that Hunt breached its duty under the lease when it failed to execute and file a written release of the acreage and depths no longer subject to the oil and gas lease. Id., at *28. Thus, although many leases may contain a provision regarding execution of a release, which in practice is not always followed, failure to execute and file the release may create a cause of action against the lessee or operator.

The Hardin-Simmons decision is an important reminder to all operators regarding the steps necessary to maintain an oil and gas lease beyond the primary term. Because an oil and gas lease is a contract, courts will construe all provisions in the lease to ascertain the intent of the parties. Red Deer Res., 2017 Tex. LEXIS 410, at *7. As a result, it is important to carefully review all provisions in the oil and gas lease and the interaction between the differing provisions. Thus, an operator should not rely a single provision, as Hunt relied on the reworking clause, but understand how all of the provisions in an oil and gas lease will work together to determine whether a lease is maintained in force and effect beyond the primary term.