Category Archives: Oil Law

Oil and gas legal stuff.

Plugging Abandoned Wells

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In a major and surprising ruling, the Kansas Corporation Commission ruled in Docket No. 07-CONS-155-CSHO that a lessee who takes a a new oil and gas lease does not, without more, thereby become responsible for plugging existing wells on the leased premises. The July 16, 2008 order In the Matter to Show Cause … with regards to responsibility under K.S.A. 55-179 for plugging abandoned wells … was a pleasant surprise to operators who, motivated by $100+ oil, have been scrambling to lease up properties with expired leases. They will be responsible for existing wells they rework, as this will fall under the “exercising control” criterion of the statute. However, this was always to be expected. However, the July 16 order represents a virtual reversal of the Commission’s long standing but unofficial policy of holding operators responsible for old wells drilled or operated under a previous lease regardless of whether they were operated under the new lease.

The case started out on a more narrow issue. The old wells on the property in question were oil wells and the new lease was for gas only. The lessee argued that since its new lease did not cover oil, it was not responsible for plugging the old oil wells. This is a logical argument that I thought likely to be persuasive. In past years, when clients got a new lease on property with old wells, we’d sometimes craft the legal description to exclude the well spacing acreage (essentially 2.5 acres in Eastern Kansas, 10 acres in Western) around each old well. If the KCC sought to assert liability, the argument would be that they were not covered under the new lease and, therefore, the client had no liability and, indeed, no right to plug the wells. I never had to test this argument, as the Commission never sought to impose plugging liability on a client with such a lease. But, drafting a lease with this sort of legal description was a pain in the rear end and, frankly, raised other interesting (in an academic way) issues. The issues in the recent case, however, expanded so that the “gas only” lease defense turned out to be unnecessary. It appears that the Commission’s public policy rationale is that the ruling will motivate operators to report old wells they “discover” on their “new” leases, so the State can get a handle on these abandoned wells and take appropriate measures to protect against pollution of groundwater and other potential problems posed by these old unplugged wells.

You can download the order as a pdf file here.

Paying Quantities

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A lot of people subscribe to the myth that an oil and gas lease stays in force as long as the lessee pays the lessor some royalty at least once a year. As a result of this myth, you may see leases going on and on with eighty or so barrels sold off every December. Of course, if the lease itself has a provision that makes this good enough, then so it is. But I’ve never seen such a lease with anything like that as a standard provision, and it’s extremely rare to see it added as a special provision.

In the absence of special provisions, a lease will remain in force so long as it continues to produce in “paying quantities”. There are two facets to this term. The first is the arithmetic of comparing income to expenses to see whether it’s in the red or the black. The second is the time period over which this determination is made. Obviously, a one month period would be too short to get an accurate view, unless it’s otherwise established that it’s a typical month over the long haul. Courts have applied time periods ranging from a few months to a few years. It depends on what’s sufficient to enable the court to say that it would provide a reasonable and prudent operator sufficient data to determine whether the lease should be produced or abandoned.

There’s a standard litany of cases seen in virtually every brief on the issue of whether a lease has terminated for lack of production in paying quantities. The basic brief reads something like this:

“Paying quantities” means production of quantities of oil or gas sufficient to yield a profit to the lessee over operating expenses, even though the drilling costs, or equipping costs, are never recovered, and even though the undertaking as a whole may result in a loss to the lessee. Reese Enterprises, Inc. v. Lawson, 220 Kan. 300, 553 P.2d 885 (1976).

The question of whether the requisite profit has been made is answered by using an objective mathematical test. In order to apply the test an appropriate accounting period must be selected, and the proper income and expense items must be identified. These elements were considered at length in Texaco, Inc. v. Fox, 228 Kan. 589, 618 P.2d 844 (1980).

If there is production in paying quantities, then the lease is valid and continues in force; if production in paying quantities has permanently ceased, then the lease has expired of its own effect under the terms of the habendum clause. Kelwood Farms, Inc. v. Ritchie, 1 Kan. App. 2d 472, 571 P.2d 338 (1977).

An oil and gas lessee, temporarily ceasing production, thereafter has only a reasonable time, under all the circumstances, to return the leasehold to production in paying quantities. Wrestler v. Colt, 7 Kan. App. 2d 553, 644 P.2d 1342 (1982).

A mere temporary cessation of production because of necessary developments or operation does not result in the termination of an oil or gas lease or the extinguishment of rights acquired under its terms. Whether the cessation of production at an oil or gas leasehold is temporary or permanent is a question of fact to be determined by the trial court. Eichman v. Leavell Resources Corp., 19 Kan.App.2d 710, 876 P.2d 171 (1994).

A load of oil a year may or may not amount to paying quantities. The bigger issue is, actually, the subject of a different covenant, one that you generally won’t see actually written in the lease. We’ll talk about this implied covenant in a later article.

Landowner’s Guide to Oil and Gas Development

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Speaking of landowners, I recently came across the Oil & Gas Accountability Project website. They’re an activist organization aligned with the environmentalist camp, looking to recruit and build on a landowner constituency. They offer a publication entitled “Oil and Gas at Your Door? A Landowner’s Guide to Oil and Gas Development”. It’s a biased presentation of the horrible things that accompany oil and gas development. For example, their Coalbed Methane Project is a campaign “for the protection of critical ecosystems, private ranch lands, and people’s health from the devastating impacts of coalbed methane development.” I have some clients doing CBM development, and haven’t seen anything quite approaching “devastating”. Introductory remarks in the guide state “OGAP has prepared this guide to assist those facing oil and gas development on their land and in their communities”. They should have said, “We’ve prepared this guide to scare you out of leasing your land for oil or gas development and to teach you how to make life for developers so difficult they’ll go away.” Nevertheless, they do manage to cover a lot of oil and gas topics, terminology and law. For that reason I’ve reluctantly included it on the list of reading materials to which I can refer virgin landowners who come to me with the standard question, “How does this lease affect my rights?” To which I start by saying, “It’ll take about a day to cover the important subjects and I charge $xxx an hour, were you planning to spend that much?” Usually they weren’t, so I have to do the quick tour, barely scratching the surface, then try to point them somewhere they can try to educate themselves.

The problem is there’s not much out there that’s both informative and written in terms the uninitiated can digest. There’s an outline called “Oil and Gas Law Outline – Fall 2000” that I downloaded once upon a time while surfing the net. I was later told it was from a course at Texas Tech School of Law taught by Prof. Bruce Kramer. However, Prof. Kramer told me he didn’t write it and didn’t know who the author was. There’s also an IRS training document aimed at educating examiners about oil and gas. They can be downloaded from my Yahoo Briefcase. The OGAP Landowners Guide paints a picture of the worst case scenario which, admittedly, could happen. It fails, however, to describe the more likely scenarios, and definitely omits the best case scenario. After reading it, a landowner who might have signed a lease may decide not to and, as a result, miss out on the retirement income his neighbors are getting in the form of monthly royalties. Someday if I can find the time I’ll search for a publication that’s equally extreme on the other side to balance things out. I suspect such a treatment doesn’t exist. One of my oil clients and I were commiserating recently about the prevalent attitudes toward our respective vocations. We didn’t resolve which are perceived as the greater shysters, only that if we wanted to move up in peoples’ eyes, we should start a used car business.

2009/10/18 Update: Yahoo shut down the “briefcase” feature, so the above link no longer works. The items that were there can now be downloaded with these links: Oil and Gas Law Outline, Oil and Gas IRS Manual, Oil and Gas At Your Door.

2010/02/11 Update: Another resource item: NY Coop Extension Landowners Guide.

2020/04/19 Update: The Oil & Gas Accountability Project (OGAP), which “champions drilling impacted communities in their fights with too-often unresponsive governments (and corporations)”, is now found on the Earthworks website. They still offer the publication, Oil and Gas at Your Door? A Landowner’s Guide to Oil and Gas Development, though apparently downloadable a chapter at a time.