The Effect of Low Oil and Gas Prices on Freehold Oil and Gas Leases: A Problem of Interpretation

Abstract

Freehold oil and gas leases seek to reconcile the interests of the lessor and the lessee by providing in the habendum a clause for an initial primary term and "so long thereafter as there is production''. Both Canadian and United States jurisprudence indicate that leases will terminate if production is not' 'in paying quantities''. A test as to whether or not oil or gas is being produced in paying quantities is whether the value of the oil or gas produced exceeds the operating costs. If production fails this test then it must be considered whether a reasonably prudent operator would have continued to produce the well. It is suggested that a slight loss due to a temporary fall in price will not necessarily terminate a lease. But if the well was marginal before the fall in price, or if it extends over a substantial period of time, the holding of the lease by the lessee will most likely be construed as mere speculation. Further, most shut-in clauses do not assist the lessee. Vie clauses generally assume the existence of a well capable of production ' 'in paying quantities''. However, the actual wording must govern and some clauses provide for ' 'economical "or" 'unprofitable'' markets and thereby specifically address the lessee's dilemma.