Production in Paying Quantities

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 541, 93, O&GR 379 (Tex. Ct. App. 1986)). 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.

Buddy Cotten
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Buddy, I was having a discussion about being able to see the books about 6 months ago. State law in ND allows anyone with an interest in a well to "request" to see the books and if refused you can sue. I wanted such a clause as you discussed above as a condition for discussing the ratification of an amended lease.

My own lawyer argued with me saying I didn't need it and showing me where in law (in ND) I could request to see the books and the operator has 30 days to respond. If the operator answers No, I would then have the right to sue. I was looking more for something like my wells on Indian Reservation Land, where I would have the right to review the books any time during business hours at company offices. I did not think much of that lawyer who couldn't comprehend the difference between the right to see the books and the right to sue to see the books, when dealing with someone who has proven they are not to be extended any trust. I suppose from the lawyers point of view, having to sue to see the books before you sue because of what you found in said books is a win-win two-fer for the legal profession. Of course I wouldn't sue to see the books. As you said I would be handicapped doing it in discovery, but I would be handicapped having to sue to see the books in the first place.

End result, settled. No ratification, lease released with 2 profitable wells and two drilling. Lawyer who insisted on taking the case on contingency received nothing and is several thousand dollars out of pocket. Well, that isn't strictly true, the lawyer learned he is not an O&G lawyer and you can't put a price on education. My lawyer thought lawyers were all friends who happened to have clients who had a disagreement. The other side taught him better. He also learned that if an company illegally takes something from you, you have to take it back, they will not simply return it because you point it out. There has to be the threat of a wooden mallet somewhere.

Bob, you are so right.

Your remark on the cost of education is hilarious and the cost of that education can be VERY high. Education can come from experience and if it comes from bad experience, it's cost can be prohibitive.

Best to have things in contract rather than relying on state law, which could be changed. Sort of like the laws of descent and distribution. I find it better to have a will rather than have my estate be bound by the various state laws in effect at the time of my death.

I hate the concept of having to sue someone when it could have been negotiated into contract when everybody still loved each other.

I friend once told me that, "The purpose of the bonus dollars is to fund the impending lawsuit."

Buddy Cotten