Court Opinion

ID: 4688656
Source: CourtListenerOpinion
Date Created: 2021-05-20 17:03:13.40461+00
Date Added: 2024-06-11T08:04:48.979736
License: Public Domain

The summaries of the Colorado Court of Appeals published opinions
  constitute no part of the opinion of the division but have been prepared by
  the division for the convenience of the reader. The summaries may not be
    cited or relied upon as they are not the official language of the division.
  Any discrepancy between the language in the summary and in the opinion
           should be resolved in favor of the language in the opinion.

                                                                   SUMMARY
                                                                 May 13, 2021

                                2021COA67

No. 19CA2040, Board of County Commissioners of Boulder
County v. Crestone Peak Resources Operating LLC — Energy
and Environment — Oil and Gas — Commercial Discovery Rule

     A division of the court of appeals considers the meaning of

“production” as that term is used in oil and gas leases. The division

holds that production means capable of producing oil or gas in

commercial quantities. Applying this definition, the division

concludes that two oil and gas leases never terminated because

wells on the land subject to the leases never stopped producing.

The division therefore affirms the district court’s judgment, granting

summary judgment to the defendant.
COLORADO COURT OF APPEALS                                        2021COA67

Court of Appeals No. 19CA2040
Boulder County District Court No. 18CV30924
Honorable Thomas F. Mulvahill, Judge

Board of County Commissioners of Boulder County, Colorado,

Plaintiff-Appellant,

v.

Crestone Peak Resources Operating LLC,

Defendant-Appellee.

                            JUDGMENT AFFIRMED

                                  Division I
                         Opinion by JUDGE GRAHAM*
                        Tow and Taubman*, JJ., concur

                           Announced May 13, 2021

Ben Pearlman, County Attorney, Katherine A. Burke, Senior Assistant County
Attorney, David Hughes, Deputy County Attorney, Catherine Ruhland, Deputy
County Attorney, Boulder, Colorado; Hamre, Rodriguez, Ostrander & Dingess,
P.C., Steven Louis-Prescott, Denver, Colorado, for Plaintiff-Appellant

Jost Energy Law, P.C., Jamie L. Jost, Kelsey H. Wasylenky, Denver, Colorado;
Wheeler Trigg O’Donnell LLP, Joel S. Neckers, Theresa Wardon Benz, Andrew
W. Myers, Denver, Colorado, for Defendant-Appellee

Julia Guarino, Boulder, Colorado, for Amicus Curiae Getches-Green Natural
Resources and Environmental Law Clinic, University of Colorado Law

*Sitting by assignment of the Chief Justice under provisions of Colo. Const. art.
VI, § 5(3), and § 24-51-1105, C.R.S. 2020.
¶1    This appeal centers on one question: What constitutes

 “production” under an oil and gas lease? The Board of County

 Commissioners of Boulder County (Boulder) sued Crestone Peak

 Resources Operating LLC (Crestone), alleging that wells subject to

 two of Crestone’s oil and gas leases had stopped producing, and

 therefore that the leases had terminated. The district court

 disagreed and granted summary judgment to Crestone.

¶2    We hold that production means capable of producing oil or gas

 in commercial quantities. Thus, the district court correctly

 concluded that Crestone’s wells never stopped producing and,

 consequently, the leases never lapsed. We therefore affirm.

                            I.   Background

                A.    The Haley and Henderson Leases

¶3    This case involves two oil and gas leases that were negotiated

 in the 1980s. Predecessors-in-interest to Boulder and Crestone

 executed an “Oil and Gas Lease” for the Haley property in Boulder

 County (Haley lease). The Haley lease contains a habendum clause,

 stating “this lease shall remain in full force for a term of Two (2)

 years from May 14, 1980 and as long thereafter as oil or gas or

                                    1
 either of them, is produced from said land . . . or the premises are

 being developed or operated.”1

¶4    Similarly, in 1982, the predecessors-in-interest executed an

 “Oil and Gas Lease” for the Henderson property in Boulder County

 (Henderson lease). The Henderson lease’s habendum clause states

 “this lease shall remain in force for a term of two years from this

 date and as long thereafter as oil or gas of whatsoever nature or

 kind is produced from said leased premises or on acreage pooled

 therewith or drilling operations are continued as hereinafter

 provided.”

¶5    Both leases contain cessation of production clauses (cessation

 clauses). The Haley lease provides that “[i]f, after the expiration of

 the primary term of this lease, production on the leased premises

 shall cease from any cause, this lease shall not terminate provided

 lessee resumes operations for re-working or drilling a well within

 sixty (60) days from such cessation.” The Henderson lease contains

 a similar cessation clause that allows for “drilling or re-working” to

 1A habendum clause, generally speaking, defines the duration of
 an oil and gas lease. Davis v. Cramer, 837 P.2d 218, 222 (Colo.
 App. 1992) (Davis II).

                                    2
 save an otherwise nonproducing well, except that the grace period

 is ninety days.

¶6    Both leases contain clauses for shut-in royalties when only

 gas is produced. A well is typically “shut-in” when it is turned off

 temporarily for maintenance or when the sale of hydrocarbons is

 not economically feasible. The Haley lease provides that when gas

 is “not sold or used for a period of one year, lessee shall” make

 payments “on the anniversary date of this lease following the end of

 each such year during which gas is not sold or used, and while said

 royalty is so paid or tendered this lease shall be held as a producing

 property” under the habendum clause. The Henderson lease’s

 shut-in clause is similar:

           Where gas from a well capable of producing
           gas is not sold or used, Lessee may pay or
           tender as royalty to the royalty owners One-
           dollar per year per net royalty acre retained
           hereunder, such payment or tender to be made
           on or before the anniversary date of this lease
           next ensuing after the expiration of 90 days
           from the date such well is shut in and
           thereafter on or before the anniversary date of
           this lease during the period such well is shut
           in. If such payment of tender is made, it will
           be considered that gas is being produced
           within the meaning of this lease.

 (Emphasis added.)

                                   3
                   B.    Lease History and Operation

¶7    Crestone’s predecessor-in-interest was Encana Oil & Gas

 (USA), Inc. (Encana). Encana drilled two wells on the Haley

 property. Both wells contained commercially viable quantities of oil

 and gas, and both have maintained that viability through the

 present lawsuit. The Henderson lease had one well, which also

 contained commercially viable quantities of oil and gas.2 We refer

 to the three wells collectively as “the wells.”

¶8    In 1993, Boulder County voters approved a county-wide sales

 and use tax to fund the acquisition of real property to further the

 county’s conservation efforts. Sometime thereafter, Boulder

 purchased the property and mineral rights subject to the Haley and

 Henderson leases, becoming the successor lessor for both.

 2 Encana permitted one well on the land subject to the Henderson
 lease but never commenced drilling. Instead, Encana signed a
 “Declaration of Unitization” in 1983 that combined operations of the
 property under the Henderson lease with a neighboring property,
 which contained a well. The parties agree that because the
 Henderson lease’s habendum clause is satisfied by production on
 “said leased premises or on acreage pooled therewith,” the
 neighboring property’s well satisfied production under the
 Henderson lease. (Emphasis added.)

                                     4
¶9     Encana did not collect or store the gas produced by the wells

  on site, instead selling and delivering the gas directly to Anadarko

  Petroleum Corporation (Anadarko) through its pipeline, which was

  connected to the wells.

¶ 10   In March 2014, Anadarko informed Encana that it needed to

  temporarily close its sales pipeline due to a maintenance issue. It is

  undisputed that gas and oil were available from Encana’s wells

  during this temporary halt in extraction. Boulder does not allege

  that there was another market for Encana’s gas. During the

  temporary shutdown, Encana still worked the premises, including

  regular site visits, pressure measurements, record keeping, and

  maintenance. One hundred twenty-two days later, Anadarko told

  Encana that repairs were complete, so Encana restarted the flow of

  gas and resumed selling to Anadarko.3

¶ 11   Encana (and later Crestone) continued extracting and

  marketing oil and gas from the Haley and Henderson wells for

  3 The record does not disclose the length of time (if any) between
  Anadarko resuming operations and Encana resuming the extraction
  and marketing of its gas. Crestone states that “Encana promptly
  restarted the flow of gas,” a characterization not challenged by
  Boulder. This factual uncertainty is not material to our analysis.

                                    5
  another six years. (Crestone purchased Encana’s rights under both

  leases in 2015, becoming the successor lessee.) Over this period,

  Boulder accepted tens of thousands of dollars in royalty payments

  from Crestone, including while this lawsuit was pending.

¶ 12   Boulder sued Crestone in February 2019 for failure to

  surrender the leases, surface and mineral trespass, and unjust

  enrichment.4 Boulder’s theory was that the leases terminated

  during the extraction pause in 2014. Crestone filed two motions for

  summary judgment, one pertaining to each lease.

¶ 13   The district court granted both motions for summary

  judgment for the reasons Crestone articulated in its motions.

  Among other things, the district court adopted Crestone’s argument

  that Encana’s temporary extraction pause did not constitute a

  cessation in production under either lease.

                             II.   Analysis

¶ 14   Boulder’s primary contention is that production stopped under

  the leases during the 2014 pause, thereby terminating the leases.

  4 Apparently, the suit was prompted by Crestone’s application with
  the Colorado Oil and Gas Conservation Commission to expand its
  oil and gas operations under the Haley and Henderson leases.

                                   6
  Specifically, Boulder argues that production means extraction of

  hydrocarbons from the ground, which did not occur during the

  pause.

¶ 15    Boulder also advances, but then retracts, a position raised by

  a group of law professors, writing as amici curiae, that production

  requires both the extraction and marketing of hydrocarbons.

  Because Boulder repudiates this position in its reply brief, we

  cannot address it. Galvan v. People, 2020 CO 82, ¶ 45 (holding that

  we must “decide only [the] questions presented by the parties”);

  Gorman v. Tucker, 961 P.2d 1126, 1131 (Colo. 1998) (“We will not

  consider issues raised only by amicus curiae and not by the

  parties.”).

                        A.    Standard of Review

¶ 16    We review oil and gas leases like any other contract. See

  Garman v. Conoco, Inc., 886 P.2d 652, 656-57 (Colo. 1994). “The

  interpretation of a contract presents a question of law.” Sch. Dist.

  No. 1 v. Denver Classroom Tchrs. Ass’n, 2019 CO 5, ¶ 11. Our

  review is therefore de novo. Id.

                                     7
                B.    Interpretation of Oil and Gas Leases

¶ 17   “The fundamental purpose of an oil and gas lease is to provide

  for the exploration, development, production, and operation of the

  property for the mutual benefit of the lessor and lessee.” Davis v.

  Cramer, 808 P.2d 358, 360 (Colo. 1991) (Davis I). An oil and gas

  lease “is properly construed strongly against the lessee.” Mountain

  States Oil Corp. v. Sandoval, 109 Colo. 401, 409, 125 P.2d 964, 967

  (1942) (citation omitted). More fundamentally, oil and gas leases

  “are construed most favorably to development.” Id. (citation

  omitted).

¶ 18   Each oil and gas lease “must be construed to give effect to the

  particular wording that has been agreed to by the parties.” Davis I,

  808 P.2d at 359. More broadly, “[a] court should interpret a

  contract ‘in its entirety . . . seeking to harmonize and to give effect

  to all provisions so that none will be rendered meaningless.’”

  Copper Mountain, Inc. v. Indus. Sys., Inc., 208 P.3d 692, 697 (Colo.

  2009) (citation omitted).

              C.     Production Does Not Include Extraction

¶ 19   A division of this court held that “production” under a

  habendum clause “is satisfied by discovery in commercial

                                      8
  quantities.” Davis v. Cramer, 837 P.2d 218, 222 (Colo. App. 1992)

  (Davis II). The division reasoned further that only in jurisdictions

  “in which marketing is an essential part of production” does

  production require that oil or gas “be removed from the earth.” Id.

  We refer to Davis II’s holding as the commercial discovery rule.

¶ 20   Boulder argues that Davis II is inapplicable here because

  Boulder’s leases, unlike the lease in Davis II, contain a cessation

  clause. We disagree. The question here, as was the question there,

  is the meaning of production. We construe contracts to give

  consistent, harmonious effect to all their parts. Copper Mountain,

  208 P.3d at 697. We therefore construe production the same in the

  cessation clause as we do in the habendum clause, and it makes no

  difference that the contract in Davis II may not have had a cessation

  clause.

¶ 21   Boulder next argues that Davis II’s rationale should not be

  applied here because that case concerned a dispute about the

  primary term of the lease, not the secondary. We reject this

  argument because the distinction is irrelevant. Production is

  production, whether in the primary or secondary term of an oil and

  gas lease.

                                    9
¶ 22   We therefore adopt and apply the commercial discovery rule of

  Davis II. See People v. Smoots, 2013 COA 152, ¶ 20 (“We are not

  obligated to follow the precedent established by another division,”

  but “we give such decisions considerable deference.”), aff’d sub

  nom. Reyna-Abarca v. People, 2017 CO 15.

¶ 23   The specific terms of the Haley and Henderson leases support

  our holding. While the habendum and cessation clauses discuss

  production of hydrocarbons, other clauses explicitly contemplate

  above-ground activity. Under the Haley lease, for example, royalty

  payments are due on oil “produced and saved,” not on production

  alone. The Henderson lease also provides that royalties are due on

  oil “produced and saved.”

¶ 24   Admittedly, the leases do discuss “capable of production,” in

  addition to “production.” But the cessation and shut-in royalties

  clauses in both leases compel the conclusion that those terms are

  functionally synonymous.

¶ 25   The cessation clauses in both leases state that if production

  ceases, the lease will not terminate if the lessee undertakes

  reworking or drilling. A leading treatise interprets this type of

  cessation clause in the following way:

                                    10
             The fact that the event which is designed to
             prevent termination is the commencement of
             drilling or reworking operations gives some
             indication of the purpose of the clause and the
             intention of the parties. It indicates that the
             parties are concerned with a situation where
             cessation of production is of the type that is
             remedied by drilling or reworking operations.
             Thus, the parties must have intended that the
             clause would become operative if a dry well is
             drilled or if a producing well ceases to be
             capable of producing in paying quantities.

  2 Eugene Kuntz, A Treatise on the Law of Oil and Gas § 26.13[b]

  (emphasis added). We agree with the treatise. When drilling or

  reworking operations are stipulated as a remedy for cessation of

  production, the parties must have intended that production meant

  capable of production, such that a well that was no longer capable

  of production could be remedied by reworking or new drilling. See

  id.

¶ 26    Most important to our conclusion is the fact that Boulder’s

  position (that production includes extraction) renders the leases’

  clauses for shut-in royalties inoperative. We must avoid this result

  and instead interpret the leases to give effect to all their contractual

  provisions. Copper Mountain, 208 P.3d at 697 (“[A] court should

  interpret a contract ‘in its entirety . . . seeking to harmonize and to

                                     11
  give effect to all provisions so that none will be rendered

  meaningless.’”) (citation omitted).

¶ 27   The Haley lease’s shut-in clause applies only after gas is not

  sold or used for one year. But here, the lessee’s extraction

  interruption lasted only four months. If production included

  extraction, triggering lease termination under the cessation clause

  after sixty days, then the lessee would never be able to utilize the

  shut-in royalties clause. The Oklahoma Supreme Court recognized

  this problem when analyzing marketing under a similar lease:

             If we were to interpret the cessation of
             production clause to require marketing, then
             the shut-in royalty clause would be rendered
             meaningless. The lessees would not be able to
             shut-in the well and pay shut-in royalties to
             keep the lease viable because the cessation of
             production clause would mandate continuous
             marketing of gas. Thus, such a construction
             of the cessation of production clause would
             nullify the provisions of the shut-in royalty
             clause.

  Pack v. Santa Fe Mins., a Div. of Santa Fe Int’l Corp., 869 P.2d 323,

  330 (Okla. 1994). The Oklahoma Supreme Court’s reasoning is

  equally applicable when considering whether production includes

  extraction.

                                    12
¶ 28   And it is even clearer under the Henderson lease’s shut-in

  royalties clause that production cannot mean extraction. That

  clause permits shut-in royalties “to be made on or before the

  anniversary date of this lease next ensuing after the expiration of 90

  days from the date such well is shut in.” This language clearly

  contemplates the payment of shut-in royalties after ninety days; but

  if production included extraction, the lessee would never be able to

  utilize the clause for shut-in royalties because the cessation

  clause’s ninety-day termination would kick in. That is, if

  production meant extraction, then the lease would terminate by the

  terms of the cessation clause, without ever allowing for the payment

  of shut-in royalties before the next anniversary date.

¶ 29   This result is avoided under the commercial discovery rule;

  both the cessation and shut-in royalties clauses are given effect. A

  lease terminates under the cessation clause if it is incapable of

  producing in paying quantities. If there remains a viable

  commercial discovery of hydrocarbons, but there is no extraction or

  marketing, then the lessee may pay shut-in royalties to satisfy its

  implied duty to market. The Davis II division explained how shut-in

  royalties could function in this type of situation:

                                     13
             [A] shut-in royalty clause can be inserted to
             provide an additional special limitation, which
             requires payment of the shut-in royalty if gas
             is not marketed. It may also be inserted to
             prevent forfeiture for failure of the lessee to
             exercise diligence in marketing, may extend
             the reasonable time within which the lessee is
             required to market the product, or may remove
             doubt regarding the time within which
             marketing must be accomplished . . . .

  837 P.2d at 223.

¶ 30   To illustrate these principles, consider the facts of this case. If

  the Anadarko pipeline interruption had lasted more than a year,

  Encana could have paid shut-in royalties. Under the Henderson

  lease, these payments were discretionary, but Encana could have

  paid them in the event that it was concerned with its failure to

  comply with the implied covenant to market. Under the Haley

  lease, shut-in royalties were mandatory, so Encana would have

  been legally required to make them. In this hypothetical, contrary

  to Boulder’s assertion, the cessation clauses retain full effect: if the

  wells dried up or in some way no longer contained accessible

  commercial quantities of hydrocarbons, production would have

  ceased, triggering the cessation clauses. But that was undisputedly

  not the case here.

                                     14
¶ 31   While Boulder and the amici attempt to classify the

  commercial discovery rule as the minority position — treating

  discovery plus some combination of extraction or marketing as the

  majority position — for the reasons given above, we apply the

  commercial discovery rule.5 In fact, the treatises cited by Boulder

  do not characterize Colorado as a “minority” state. Our review of

  the states dealing with this issue does not reveal a consensus. If it

  is a minority rule, it is nonetheless an approach to production that

  finds support among a number of our sister states. See Hall v.

  Galmor, 2018 OK 59, ¶ 21, 427 P.3d 1052, 1063 (“The shut-in well

  is capable of production in paying quantities such that the lease

  remains viable under the habendum clause . . . .”); Sandtana, Inc. v.

  Wallin Ranch Co., 2003 MT 329, ¶ 37, 80 P.3d 1224, 1231

  (“[D]iscovery of gas within the primary term was sufficient to

  continue the lease and . . . extraction was not necessary where

  there was no present market.”); Greene v. Coffey, 689 S.W.2d 603,

  605 (Ky. Ct. App. 1985) (“‘[P]roduction’ is broadly defined to include

  5In Boulder’s reply brief, it references a number of other definitions
  of production from a variety of sources. Regardless, for the reasons
  articulated in the opinion, those extraneous definitions do not
  dictate a different result.

                                    15
  . . . the discovery of oil during the initial term of the lease coupled

  with the exploitation and removal of the discovered oil within a

  reasonable time thereafter.”); S. Penn Oil Co. v. Snodgrass, 76 S.E.

  961, 967 (W. Va. 1912) (same). But see, e.g., Francis v. Pritchett,

  278 S.W.2d 288, 290 (Tex. Civ. App. 1955) (“It must be noticed that

  a shut-in well is not being produced — in other words, a producing

  well is one where the product therefrom is being sold in the

  market.”).

¶ 32   And it is a rule that accommodates the economic realities of

  the oil and gas industry. See McVicker v. Horn, Robinson & Nathan,

  322 P.2d 410, 412-13 (Okla. 1958) (“[T]he distinction between

  producing and marketing . . . inheres in the nature of the oil and

  gas business . . . .”); Greene, 689 S.W.2d at 606 (“[T]o have adopted

  the appellees’ view would have meant that even had Greene and

  Anderson been pumping 100 barrels of oil a day from the well

  during the entire duration of the lease, they still would have lost

  their leasehold interest . . . had oil not been flowing on October 23,

  1982. Under the appellees’ interpretation, a single mechanical

  failure could have stripped the appellants of their interest had it

  happened to have fallen on the wrong day.”).

                                     16
                  D.   The Commercial Discovery Rule
                        Protects Lessees and Lessors

¶ 33   Undeterred, Boulder argues that the commercial discovery

  rule is bad law because the primary purpose of an oil and gas lease

  is to generate revenue, so a lessee should not be allowed to hold a

  lease by commercial discovery without some royalty-generating

  activity. We agree with Boulder’s premise but not its conclusion.

¶ 34   The commercial discovery rule protects lessees who have

  invested millions of dollars in oil and gas development from losing

  that investment due to temporary extraction pauses. At the same

  time, the rule by no means deprives lessors of their rights to

  royalty-generating activity. As explained below, lessor interests are

  already protected by the common law duty to market.

¶ 35   There are four covenants implied in every oil and gas lease.

  Garman, 886 P.2d at 659; Davis II, 837 P.2d at 222. One such

  covenant is the covenant to operate prudently. Garman, 886 P.2d

  at 659. “Contained within the covenant to operate prudently is the

  duty to market the product.” Davis II, 837 P.2d at 222. This duty

  “obligates the lessee to engage in marketing efforts which ‘would be

  reasonably expected of all operators of ordinary prudence, having

                                    17
  regard to the interests of both lessor and lessee.’” Garman, 886

  P.2d at 659 (quoting Davis I, 808 P.2d at 363). A lessee may not

  “hold his lease indefinitely while no product from the lease is being

  marketed and while diligent efforts are not being made to

  accomplish this.” Davis II, 837 P.2d at 223.

¶ 36   Thus, lessors are already protected against lessees who fail to

  generate royalties. The commercial discovery rule simply protects

  lessees from large financial losses on properties that have fully

  functioning, producing wells, but that sustain a temporary pause in

  extraction and marketing.

¶ 37   The amici argue that the implied duty to market

  “unreasonably complicates the leasing process.” To be sure, an

  equitable factor-based test is always more complicated than a

  yes/no solution like the one advocated by the amici. In this

  context, however, the factor-based test is also fairer, allowing

  lessees a reasonable amount of time to market the product, without

  allowing them to sit on their hands too long. In any event, the law

  of the implied duty to market constitutes binding precedent from

  the Colorado Supreme Court, which we are not at liberty to ignore.

  We decide opinions within the legal framework laid down by our

                                    18
  supreme court. See People v. Allen, 111 P.3d 518, 520 (Colo. App.

  2004).

       E.     The Hayley and Henderson Wells Never Stopped Producing

¶ 38        It is undisputed that, at all times relevant to the dispute, there

  remained a commercially viable discovery of oil and gas at the wells

  under the Haley and Henderson leases. The Kentucky Supreme

  Court’s apt reflection in Hutchinson v. Schneeberger is applicable

  here: “The oil was there and all parties knew it.” 374 S.W.2d 483,

  486 (Ky. 1964). Because, in Colorado, production is satisfied by a

  “discovery in commercial quantities,” Davis II, 837 P.2d at 222, the

  Haley and Henderson wells never stopped producing.

¶ 39        Therefore, the district court correctly concluded that the Haley

  and Henderson leases never terminated and properly granted

  summary judgment to Crestone on that basis.

¶ 40        Because of our disposition, we need not address the district

  court’s alternative bases for granting summary judgment and

  Boulder’s corresponding claims of error.

                                 III.   Conclusion

¶ 41        The district court’s judgment is affirmed.

            JUDGE TOW and JUDGE TAUBMAN concur.

                                         19