Shut-In Provisions: Maintaining Leasehold in a Low-Price Environment

Shut-In Provisions: Maintaining Leasehold in a Low-Price Environment

The language of a shut-in royalty clause in an oil and gas lease is a “creature of contract” that determines when and how a lessee may shut-in a well during depressed market conditions. If a well on leased or pooled land is capable of producing in paying quantities (1), but is unable to do so due to lack of market, a typical shut-in royalty provision would allow payment of royalties to maintain the lease past the primary term (2) in lieu of such production. Most leases can be maintained as long as there is at least one well producing in paying quantities on the leased lands or lands pooled therewith, and some lease forms require a shut-in payment for each shut-in well. The applicability of any specific shut-in clause is dependent on the language of the clause and the other provisions included in the lease(3)  

In the first half of 2020, many lessees discovered that the language of the shut-in clause in their leases limited their ability to shut-in wells and maintain their leasehold. Shut-in clauses with language that limits a lessee’s ability to shut-in a well often require “lack of a pipeline connection”, “lack of market”, or “lack of satisfactory market” as conditions of shut-in. These limitations have been subject to litigation which can be avoided with thoughtful drafting.  A lessee should draft and negotiate for non-limiting, operator-friendly shut-in language. For example: 

“If Lessee drills a well on land covered by this lease or on land pooled therewith, which well is capable of producing oil or gas but such well is not being produced and this lease is not being maintained otherwise as provided herein, this lease shall not terminate, whether it be during or after the primary term, (unless released by Lessee) and it shall nevertheless be considered that oil and gas is being produced from the land covered by this lease. When the lease is continued in force in this manner, Lessee shall pay or tender as royalty.” 

Lessees should also make sure they are familiar with the provisions contained in presently owned leases.  

If you have questions concerning the shut-in or other provisions in your lease(s), and the effects they may have on maintaining your lease in a low-price market, contact Kuiper Law Firm to discuss your options.

[1] The Supreme Court of Texas has held that “production in paying quantities” is determined over a reasonable period of time up to and including the date specified in a shut-in clause, and it is not determined on the date the shut-in royalty is tendered. BP Amoco Prod. Co. v Red Deer LLC, 526 S.W.3d 389. 

[2] Some modern lease forms contain shut-in clauses that require payment for shut-in wells even during the primary term of the lease. 

[3] Pugh clauses and retained acreage clauses may entitle a lessor to additional shut-in payments for each subdivided lease or proration unit depending on the language of these clauses.