[co-author: Matthew Wheatley]

We recently discussed failure to produce in paying quantities. Another decision involving the same lessee had a different result. Why?

The question in both cases was whether the well was capable of producing in paying quantities and whether a reasonably prudent operator would continue to operate the well.

In the new case ten wells were on the property. Production declined, and as of June 2012 only one well was producing. Red Deer acquired top leases. BP shut the final well in on June 12 and distributed notice and shut-in royalty checks on June 13. Red Deer sued, claiming the shut-in royalty clause was ineffective because the final well was not capable of producing in paying quantities when it was shut in.

Three Rules    

• A shut-in royalty will not preserve the lease if the well is not capable of production in paying quantities.
• A lessee whose title is wrongfully repudiated by notice that the lease is terminated is excused from any obligation to conduct activities necessary to hold the lease in force until the lease controversy is resolved. Establishing repudiation requires proof of a subsisting lease and the lessor’s “unqualified notice” of lease forfeiture or termination.
• This is important: Repudiation is not available as a defense unless specifically pleaded.

The Result

There was legally sufficient evidence to support the jury’s conclusion that the well was not capable of production in paying quantities at the time it was shut in and that a reasonably prudent operator would not continue to operate the well in the manner BP had been. (Interpretation: That’s what the jury concluded.  Maybe they were right or maybe they weren’t; the appeal court’s job is to determine if there was evidence to support the verdict, not whether it agrees).

There was steady long-term decline in production. The remaining reserves were estimated to be less than one percent of the total reserves. There was testimony that there was nothing BP could do economically to increase the well’s production. At shut-in the well had experienced a five-month period of unprofitable production.

BP did not argue repudiation, and cited no authority for its assertion it “was entitled to shut-in the… well and to keep the well shut in because of Red Deer’s title challenge”. BP’s contention that another well, if drilled, would be a producer was not proof of a well which would support a shut-in royalty.

How is Red Deer Different From Laddex?

Here are a few ways:

• In Red Deer, production had been declining steadily for a long duration (nine other wells had been shut in.) In Laddex the decline was relatively recent. This was part of the reason the Laddex court held that the 15-month period was unreasonable.
• There was evidence in Red Deer of the scarcity of remaining reserves and BP’s inability to increase production. Production in Laddex resumed to pre-slowdown levels prior to suit.
• The Red Deer court held that five months of unprofitability could be probative of a well’s capability to produce. The Laddex court held that limiting the jury’s consideration to a fifteen month period was unreasonable. It seems the Red Deer court gave more weight to factors other than the duration of unprofitability.

A musical interlude.