An operator and working interest owner (“Operator”) operates a marginally producing oil well on land subject to an oil and gas lease (the “Lease”) that is well beyond its primary term. A decline in oil prices together with the low volume of production has caused the Operator’s income from the well to be equal to or less than the actual cost of operating the well on the Lease. The Operator recognizes that if the price of oil does not increase, or continues to decline below present levels, the cost to operate the well on the Lease will exceed income and the well will no longer be considered to be producing in “paying quantities.”
The well is producing in a field (or from a formation) that is very mature. If the well is plugged, there is little likelihood another well will be drilled into and produce from the same formation. The remaining reserves that could be produced from the existing well will probably never be recovered.
Payments received by the royalty owners under the Lease have dwindled as oil prices decline. However, if the well on the Lease is plugged, the royalty owners will cease to receive any income from the well.
The Operator has determined that if the oil well could be “shut-in,” saving on electrical costs to pump the well, maintenance costs, and wear and tear on equipment, when oil prices increase, the well could be put back on production at a later date, when oil prices increase, and continue to produce for an indefinite period. However, there is no provision in the Operator’s Lease for “shutting-in” an oil well. To do so would be the equivalent of the well “ceasing to produce,” which if continued, would cause the Lease to expire by its own terms. While the mineral owners may not presently object to a cessation of production, if and when oil prices improve there may be renewed interest in the area where the Lease is located for exploration. At that time the mineral owners may contend the Lease expired for lack of production, or lack of production in paying quantities.
In response to this situation, consider obtaining an amendment to the existing lease.
An Amendment to Oil and Gas Lease can add a shut-in royalty provision to allow the Operator to shut-in an oil well. A shut-in provision, patterned after the fairly common shut-in gas provision found in many oil and gas leases may be included. It can provide that the shut-in royalty payment amount on oil is to be distributed to royalty owners in the same manner as shut-in royalty payments for gas.
Another solution is an Amendment to Oil and Gas Lease that provides for an extension of the primary term of the Lease.