This document provides a summary of key provisions in oil and gas leases, including continuous development provisions and shut-in royalty provisions. Continuous development provisions aim to allow lessees to complete wells begun during the primary term and continue the lease without production. Shut-in royalty provisions provide for constructive production when wells are capable of producing but shut-in. Both provisions contain ambiguous terms that have been subject to litigation regarding their precise meaning and requirements. The document advises lessees to clearly define terms in their leases to avoid disputes.

1. LESSONS IN LEASE MAINTENANCE
Kene Chinweze, Senior Counsel
Burleson LLP

2. TOPICS
• CONTINUOUS DEVELOPMENT PROVISIONS
• SHUT-IN ROYALTY PROVISIONS
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3. GENERAL LEASE TIPS
• Know your lease!
• Define terms in your lease that generally have
multiple meanings and interpretations.
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4. CONTINUOUS DEVELOPMENT PROVISIONS
Example:
“At the expiration of the primary term, should lessee then be engaged in drilling or
reworking operations, for purposes of this Paragraph and the continuous
development period provided for herein only, to be limited to operations occurring
between commencement and completion upon the leased premises or lands pooled
therewith (whether as a dry hole or as a producer) within immediately preceding 180
days, this lease shall continue in full force and effect as to all the acreage covered
hereby until 180 consecutive calendar days have elapsed without drilling or
reworking operations being conducted on the leased premises or lands pooled
therewith (i) after the completion of any well as to which drilling or reworking
operations occurring at the expiration of the primary term or, (ii) in the absence of
drilling or reworking operations occurring at the expiration of the primary term, after
the completion of the last well, if any, completed within the 180 day period
immediately preceding expiration of the primary term.”
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5. CONTINUOUS DEVELOPMENT PROVISIONS,
cont’d
• Purposes
1. To permit a lessee to complete wells begun during the
primary term.
2. To permit a lessee to continue a lease past its primary
term even if there is no production.
3. To give a lessee additional and specific incentive to fully
develop a lease.
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6. CONTINUOUS DEVELOPMENT PROVISIONS,
cont’d
• Ambiguous terminology
– “Operations”/ “Drilling operations”
– “Commencement”
– “Reworking”
– “Completion”
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7. CONTINUOUS DEVELOPMENT PROVISIONS,
cont’d
• “Operations”/ “Drilling operations”
– Courts have had a difficult time harmonizing the differences between
terms such as “operations”, “drilling” and “drilling operations”; therefore,
courts apply a fact-intensive analysis to each action undertaken by a
lessee.
• Physical activities must be aimed at obtaining production.
• Operators must diligently seek production.
– It is important that lessees understand the heightened level of physical
activity triggered by terminology used in a lease.
• “Operations” < “Drilling operations” < “Actual drilling operations”
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8. CONTINUOUS DEVELOPMENT PROVISIONS,
cont’d
• “Operations”/ “Drilling operations”, cont’d
– Drilling operations rather than operations must be “preliminary to the
actual work of drilling.” Bargsley v. Pryor Petroleum Corp., 196 S.W.3d 823,
826 (Tex. App.—Eastland 2006, pet. denied).
• Ct defined the following activities as “operations” but not “drilling
operations” as a matter of law:
– Laying a pipeline to gas wells
– Long stroking an existing well
– Installing, checking and repairing flow lines
– Court found that a lease that defines “operations” as “drilling, testing,
completing, reworking, recompleting, deepening, plugging back or
repairing a well in search for or in an endeavor to obtain production” is
actually defining “drilling operations.” Veritas Energy LLC v. Brayton
Operating Corp., 13-06-061-CV, 2008 WL 384169 (Tex. App.—Corpus
Christi Feb. 14, 2008, pet. denied).
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9. CONTINUOUS DEVELOPMENT PROVISIONS,
cont’d
• “Commencement”
– Term is generally used in combination with “operations” or a related term
– Examples when combined with “drilling operations” :
• Entering a drill bit into the ground
• The determination of the wellbore entry point combined with on-the-
ground work
• Some level of dirt work
– Avoid all futile “place holder” activities.
• Drilling a rig that is not capable of reaching the depths needed to produce
• Performing reworking operations not aimed at initiating or restoring
production
– WARNING: If the provision requires the commencement of “additional” or
“subsequent” wells, it is possible that additional horizontal laterals would
not suffice.
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10. CONTINUOUS DEVELOPMENT PROVISIONS,
cont’d
• “Reworking”
– Definition – “any and all actual acts, work, or operations in which an
ordinarily competent operator, under the same or similar circumstances,
would engage in a good-faith effort to cause a well or wells to produce oil
or gas in paying quantities” (Pattern Jury Charges from Texas State Bar’s
Oil, Gas & Energy Resources Section)
– Purpose – to restore or increase production
– Reworking operations involve activities conducted by the lessee to
maintain the lease which are of the nature that would cause the well to
produce. Hydrocarbon Mgmt., Inc. v. Trucker Exploration, Inc., 861 S.W.2d
427, 438 (Tex. App.—Amarillo 1993, no writ).
• Remedying issues other than those affecting the well to flow may not be
sufficient (i.e. cleaning up the surface facilities).
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11. CONTINUOUS DEVELOPMENT PROVISIONS,
cont’d
• “Completion”
– This phase of the provision is generally within the lessee’s control and can
be extended for quite some time or at least difficult for a lessor to confirm
completion.
• Examples:
– The date of total or target depth
– The date the well is cemented and cased
– The date that the reservoir is perforated
– Courts have provided little guidance on this term.
– TX Sup Ct found that a “well need not be a producing well to be
completed within the meaning of the development clause of oil and gas
lease; it only needs to be capable of producing oil or gas.” Exxon Corp. v.
Emerald Oil & Gas Co., 348 S.W.3d 194, 212 (Tex. 2011).
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12. CONTINUOUS DEVELOPMENT PROVISIONS,
cont’d
• Timing issues
– Most CD provisions are triggered when lessee’s operations span the end of
the primary term.
– CD provisions may discourage drilling early during the primary term in
order to be in compliance with this provision.
• Problems arise when a dry hole is completed shortly before the expiration
of the primary term.
– Since no production or drilling or reworking operations span the primary
term, the CD provision is not triggered.
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13. SHUT-IN ROYALTY PROVISIONS
Example:
“While there is a well on this lease or on acreage pooled therewith, which well is capable of
producing only gas, gas condensate, or some combination of gas and gas condensate, but from
which well production is not being sold or used, this lease shall be extended for a period of 90
days from the date such well is shut-in, and Lessee may tender or pay annually as royalty a sum
equal to the amount of annual delay rentals which would be payable during the primary term to
defer drilling operations on the lands then subject to this lease, but in no event shall such
payment exceed $100.00 per well per year, payment or tender of such royalty may be made by
check or draft of Lessee mailed or delivered to Lessor or to Lessor’s credit…with the first
payment to be made on or before 90 days from and after the date on which such well is shut-in
and a similar payment to be made annually thereafter on or before the anniversary date on
which such well is shut-in, and if such payments are so made, it shall be considered that gas, gas
condensate, or a combination of gas and gas condensate is being produced in paying quantities
from the above described land under all the terms, conditions and limitations of this lease.”
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14. SHUT-IN ROYALTY PROVISIONS, cont’d
• Provision is considered as providing constructive production.
• Provision is generally strictly construed by courts against the lessee.
• Texas generally require 2 elements for a well to be shut-in:
1. The well is capable of flow (production).
2. The well is capable of producing in paying quantities.
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15. SHUT-IN ROYALTY PROVISIONS, cont’d
• Element #1 – Capable of flowing
– A well must be capable of production when it “is turned ‘on’ and it begins
flowing, without additional equipment or repair.” Anadarko v. Thompson,
94 S.W.3d 550, 557 (Tex. 2010); Hydrocarbon Mgt., Inc. v. Tracker Expl.,
Inc., 861 S.W.2d 427, 433-34 (Tex. App.—Amarillo 1993, no writ).
– “The lack of surface facilities, or the fact that surface facilities may need
repair, does by itself not render a well incapable of production.” EnerQuest
Oil & Gas, LLC v. Plains Exploration & Prod. Co., 981 F. Supp 2d 575, 590
(W.D. Tex. 2013).
– Courts focus solely on whether hydrocarbons can flow to the wellhead;
downstream capabilities are irrelevant.
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16. SHUT-IN ROYALTY PROVISIONS, cont’d
• Element #2 – Capable of producing in paying quantities
– There must be “facilities located near enough to the well that it would be
economically feasible to establish a connection so that production could
be marketed at a profit.” EnerQuest Oil & Gas, LLC v. Plains Exploration &
Prod. Co., 981 F. Supp 2d 587 (W.D. Tex. 2013).
– Production in paying quantities focuses on the quantity of hydrocarbons
produced, not whether the hydrocarbons are of marketable quality.
Blackmon v. XTO Energy, 276 S.W.3d 600, 604 (Tex. App.—Waco 2008, no
pet.).
• The ‘quantity’ factor focuses on the amount of production the well would
have produced if it had been turned ‘on’ the date it was actually shut in;
the quantity with additional equipment or repairs is not relevant.
EnerQuest Oil & Gas, LLC v. Plains Exploration & Prod. Co., 981 F. Supp 2d
595 (W.D. Tex. 2013).
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17. SHUT-IN ROYALTY PROVISIONS, cont’d
• Effect of non-payment – condition or covenant?
– Generally, SIR provision places a condition precedent in the lease.
– Non-payment of production royalties will not terminate the lease;
conversely, non-payment of shut-in royalties will terminate a lease unless
lease terms provide otherwise.
• “Any timely payment or tender of shut-in royalty which is made in a bona
fide attempt to make proper payment, but which is erroneous in whole or
in part as to parties or amounts, shall nevertheless be sufficient to
prevent termination of this lease in the same manner as though a proper
payment had been made…”
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18. SHUT-IN ROYALTY PROVISIONS, cont’d
• Common problems for lessees
– Problem #1 – Provision is limited to gas wells only.
• Since most oil wells also produce gas, a lessee may need to shut-in an oil
well to find a gas purchaser.
• Draft provision to cover “oil or gas wells” or all wells “capable of
producing gas.”
– Problem #2 – 90-day shut-in royalty provision and 60-day cessation-of
production clause are both included in a lease.
• The 60-day cessation-of-production clause trumps the 90-day shut-in
royalty provision
• The shut-in royalty MUST be paid within 60 days of shutting in or lease
terminates.
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19. San Antonio
Weston Centre
112 East Pecan
Suite 700
San Antonio, TX 78205
T: 210.820.2625
F: 210.820.2609
Pittsburgh
Southpointe Town Center
1900 Main Street
Suite 201
Canonsburg, PA 15317
T: 724.746.6644
F: 724.746.6645
Midland
Midland Tower
223 W. Wall Street
Suite 400
Midland, TX 79701
T: 432.253.8600
F: 432.253.8601
Houston
Pennzoil Place
700 Milam Street
Suite 1100
Houston, TX 77002
T: 713.358.1700
F: 713.358.1717
Denver
Wells Fargo Center
1700 Lincoln Street
Suite 1300
Denver, CO 80203
T: 303.801.3200
F: 303.801.3201
New Orleans
Poydras Center
650 Poydras
Suite 1400
New Orleans, LA 70130
T: 504.299.3427
F: 504.299.3411
Thank you for attending!