SHUT-IN WELLS, BANKRUPTCY, ACTS OF GOD & COVID-19

April 30, 2020

Shut-in Wells, Bankruptcy, Acts of God & Covid 19

Over here at LandGate we are starting to get calls from mineral owners concerned about the drop in oil prices. Common questions are:

I hear that oil companies might start shutting-in wells and not producing them. If this happens, will I still receive royalty checks?
If they quit paying me royalty, can I terminate the lease?
If the company operating wells on my minerals files for bankruptcy, what happens to my lease?
Does my lease allow the operator to shut-in a well?

Before I address your questions and add a few myself, please understand that there are no easy answers and no easy solutions. Not all lease provisions are the same. And if they were the same, not every state/court has the same interpretation of the provisions.

Royalty Checks

Your royalty checks are calculated based on revenue the Operator receives from selling production. If the wells are not producing, you will not receive your royalty check. Under some lease forms, they may be required to pay you what is termed a shut-in royalty each month while a well is shut-in. But that could depend on whether the lease is in the primary term or the secondary term.

Lease Termination

You probably cannot terminate the lease just because they quit paying you royalties. But you must determine why they quit paying. Did the well quit producing? If so, then if the lease is in its secondary term, the Operator could have the right to commence additional drilling operations to perpetuate the lease.

Perhaps the Operator could no longer produce the well in paying quantities. Most lease forms will not allow an Operator to maintain a lease in force and effect if there is not production in paying quantities. Therefore, the lease could possibly terminate if not being held by a well producing in paying quantities or any other provision of the lease.

Is there a benefit to terminating the lease? What is the royalty rate in your lease? Is it 12.5%? What is the royalty rate in current leases? Good chance that new leases will have a higher royalty rate. Therefore, if your lease terminates, you can likely negotiate a higher royalty rate as well as receive another signing bonus. Operators do not want their lease to terminate. The higher your royalty, the lower the Operator’s net revenue interest.

My Operator Filed for Bankruptcy

You read that your Operator filed for bankruptcy. This does not mean that they will quit making royalty payments. If you continue to receive royalty payments, then you will notice how the drop in oil and gas prices impacts the amount you are receiving. Bankruptcy is an extremely complicated matter. If you are no longer receiving royalty checks, you need to talk to an expert to better understand any recourse you may have.

Royalties can be paid to you by the operator or by another company who is purchasing the production from the operator. For instance, if the purchaser goes into bankruptcy and quits paying you, you may have no recourse against the operator. And if the operator is paying you royalty and goes into bankruptcy, you may not be protected if the operator was organized in another state.

Does My Operator Have the Right to Shut-in a Well?

Yes. Most oil and gas leases allow the operator to shut-in a well for various reasons. Safety is an important reason. Or perhaps a winter storm damaged the pipeline used to move production to market. But the most common reason for shutting in a well is when it becomes uneconomic. Meaning the cost of producing the well exceeds the revenue from the sale of its production. Crude is currently selling for $10/barrel. At that price, most operators would claim the wells are uneconomic and want to shut the wells in. But shutting in a well with no other production on a lease can put the operator at risk of the lease terminating.

And as a mineral owner, you might prefer that a well be shut in while the price of oil is low, then turned back on when the price is high. But operators must be careful to read the lease to understand their rights. There are many other provisions in an oil and gas lease which could possibly perpetuate the lease if a well is shut-in. You need to read the shut-in royalty clause, the continuous operations clause, cessation of production clause and producing in paying quantities clause to name a few.

Did an Act of God Cause Oil Prices to Drop?

Another term you are hearing today is force majeure. Force majeure is a French term that means “greater force” and is related to the concept of “Act of God.” It is also defined as an unforeseeable circumstance that prevents someone from fulfilling a contractual obligation. Courts have ruled that for an event to qualify as force majeure, it must be unforeseeable, external and irresistible. The force majeure clause is added to contracts to remove liability for natural and unavoidable catastrophes, such as hurricanes, floods, etc. And variations of the force majeure clause are usually included in an oil and gas lease.

As a result of the COVID-19 pandemic, fuel demand has decreased as billions of people cancelled travel plans. The US has been left with so much oil there is nowhere to put it. State regulatory agencies are beginning to encourage oil companies to shut-in their producing wells. As a mineral owner, you understand what is happening to the oil industry and why. However, what exactly does your lease say? Is there a force majeure clause in your lease? Just a few months ago there may have been a well on your minerals that was producing in paying quantities. Is there no longer a producing well on your minerals?

This is not legal advice. At LandGate, we just want to inform you of some relevant issues of importance to all mineral owners. If you want to talk more specifically about your situation, we’re happy to get on the phone with you and take a look at what you’re experiencing. We’ve got a team of geologists, engineers and land experts over here working on your behalf. Call us at 855-867-3876, or shoot us a contact note here.