The Effect of Current Oil Crisis on Oil and Gas Lease in Light of Recent Court Decisions
Authors: Kelkar B.G. 
Published: December 2007

SPE Member

The current oil crisis has drastically reduced the oil prices across the United States. This reduction in oil prices may also lead to premature terminations of several oil and gas leases where the production and profits are marginal; especially in Oklahoma and Texas. This is a direct result of recent court decisions in Oklahoma and Texas, which have interpreted one of the important clauses in an oil and gas lease against the operator.

An oil and gas lease contains several clauses to protect both the mineral owner (the lessor) and the operator (the lessee). One of such clauses is the cessation of production clause which allows the operator to explore for other formations once the producing formation is exhausted. However, the recent court decisions have stated the purpose of this clause otherwise. The courts have strictly construed the clause against the operator and ruled that, as a result of this clause, even if the production stops temporarily, the lease will be terminated. This is inconsistent with business reality of oil and gas lease, because everyone related to oil and gas industry knows that the oil and gas wells do not produce continuously; and therefore, do not make profit every month. However, the recent decisions imply that the operator may have to start drilling or reworking operations to save the lease, if he doesn't make a profit over a state period of time (typically, two months).

This work details the current status of relevant laws in Oklahoma, Texas, and other hydrocarbon producing states. The work analyzes the engineer's perspective of these laws, and suggests solutions which will bring these laws closer to business realities. The solutions include suggestions regarding how to avoid such problems in the future, and how to raise possible defenses under present conditions.

Introduction

As the oil crisis looms over the entire oil industry, another legal crisis is brewing as a result of recent court decisions in Oklahoma and Texas. Recently the Oklahoma Supreme Court considered the effect of an important clause in oil and gas lease; namely, the cessation 0 f production clause on the validity of the lease. The Court strictly construed the lease against the operator (in this case, Tenneco Oil Co.), and ruled that as a result of the cessation of production clause, the lease had terminated, because Tenneco Oil Co. failed to drill another well within two months after the production had stopped. The Texas Supreme Court rendered a similar decision against Sun Oil Co., where Sun Oil Co. did not commence any drilling or reworking operations, as required by the cessation of production clause 2 within sixty days after the production had stopped.

The implication of this decision could be severe. Especially under the current oil crisis, many leases may be lost, if a lessee does not make a profit over stated period in the cessation of production clause, unless he commences a required action. The required action may include either drilling or some reworking operations. A typical stated period in cessation of production clause is two months. Translated, if the operator doesn't make a profit over a period of two months, he will have to commence drilling or reworking operations to save the lease.

This investigation analyzes the current status of laws in Oklahoma, Texas, and other hydrocarbon producing states, and suggests possible solutions to avoid premature termination of the lease.

Background

Before we discuss the implications of the cessation of production clause, we need to understand another important clause in the oil and gas lease; i.e., the habendum clause.

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