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Oil and Gas Leases generally provide that the lease will last for _____ years (primary term) and as long thereafter as oil and/or gas is produced in paying quantities (secondary term).
So what is paying quantities? Generally speaking, paying quantities is an amount sufficient to cover the lifting costs of the produced product and an amount that a reasonably prudent operator would produce under the same or similar circumstances and continue to produce for a profit. Does this mean that the well must be profitable? No, not at all. Operators produce commercial failures all of the time. But the lease provides for the paying quantities standard.
The measuring period is over time....a well can, for example, not be economic one month and then be economic the next month. The courts have held that the standard of paying quantities be measured over time and the prudent operator standard.
This is an extremely complex and fact specific matter --- one that cannot be properly addressed on a blog post. The purpose of the blog post is to point out that there is a standard and a way to manage the situation.
The problem is that the Lessor generally has to sue to find out if the well is producing in paying quantities. Is there a better way? Certainly there is.
Have your attorney or lease negotiator include a clause similar to the following:
"7.2 "Production in paying quantities", "production in commercial quantities", and "production in paying or commercial quantities", shall have the same meaning for the purposes of this Lease, namely production in quantities sufficient to yield a return to the holders of the working interest, after deducting ad valorem and severance taxes, in excess of operating expenses, marketing expenses, and all royalties and burdens of record, which, under Texas law, are from time to time recognized as chargeable against the working interest to determine production in paying or commercial quantities (see El Paso Natural Gas Co. v. American Petrofina of Texas, 733 SW 2nd ...)). The review period for purposes of determining whether production is in paying or commercial quantities shall be two hundred seventy (270) consecutive days. Production in less than paying or commercial quantities shall never be considered as production for purposes of the habendum clause of this lease. "
You will need to go on further on in the lease and provide that the Lessor has the right to inspect the books of the Lessee from time to time in their offices to make certain that the Lessee is in compliance with the terms of the lease. In Texas, you have no such right, implied or otherwise, to examine the records of the Lessee, UNLESS the Lessee grants you such rights in writing -- such as in the Lease Agreement itself. (Oh, or unless the court allows discovery during trial preparation. That is not the conditions under which you want to examine books)
Almost any time that you can make a *thing* more specific, it is a good thing for me.
Production in paying quantities and the like are extremely fact specific. By using a clause like the example clause above, we now have a defined time period for determining the "over time" standard used in earlier cases.