Energy & Natural Resources Alert: Ohio Fourth District Court of Appeals Further Defines the Terms “Paying Quantities” and “Operations” in Oil and Gas Leases

In Pottmeyer v. E. Ohio Gas Co., 4th Dist. Washington, 2016-Ohio-1294 (March 18, 2016), the landowners brought actions against the successors to the deep-rights-lessee, requesting that the court declare the oil and gas leases void because the secondary terms of the habendum clauses of the leases had expired. The successors to the deep-rights-lessee counterclaimed. The Fourth Appellate District of Ohio held:

  1. the landowners’ personal use of gas produced from the wells does not count towards the calculation of gas produced in paying quantities as required to maintain the leases;
  2. the sporadic and de minimus production of oil and gas from the wells does not constitute production in paying quantities as required to maintain the leases; and
  3. the landowners’ incidental and domestic use of gas from the wells is insufficient to constitute operations (as defined in an oil and gas lease) for purposes of maintaining the leases.

Facts

This case was the consolidation of two separate actions with very similar fact patterns. Each case featured an oil and gas lease that was executed in 1974 for the term of five years and as much longer as “oil or gas or their constituents shall be found on the premises in paying quantities in the judgment of the Lessee or as the premises shall be operated by the Lessee in the search for oil and gas…” The leases were then included in a 1976 farmout agreement in which the lessee agreed to assign the shallow rights under the leases unto the operator, provided that the operator drilled four wells on each respective property. This farmout agreement also contained protections for the lessee by including a provision prohibiting the operator from allowing the leases to lapse. In 1989 and 2008, the successors to the deep-rights-lessee then acquired all the deep rights in and to the leases, but did not drill any wells or conduct any other operations.

Only one well was completed on each of the landowners’ respective properties in 1977, and the wells and corresponding shallow rights in the leases, were subsequently assigned to the landowners in 1991. Each well produced gas for household and personal use for the respective landowners, but the landowners asserted that it was no longer economically reasonable to commercially sell the gas from the well and oil from the well had been sold only on rare occasions.

The trial court in each case declared the oil and gas leases void because the secondary terms of the habendum clauses of the leases had expired and the successors to the deep-rights-lessee appealed the decisions.

Holding

The first argument made by the successors to the deep-rights-lessee was that the leases remained in full force and effect because the landowners’ use of the wells to provide gas to multiple dwellings on their respective properties is equivalent to production in paying quantities. The court disagreed, holding that the landowners’ personal use of the gas produced from the wells does not count towards the calculation of gas produced in paying quantities because their personal use of the gas is incidental to the real purpose of the leases, which of course were originally acquired to produce oil and gas for commercial sale.

The successors to the deep-rights-lessee also argued that there was evidence of the infrequent commercial sale of oil produced by the wells in limited quantities since 1991 and these sales should constitute production in paying quantities. But the court found that the sporadic and de minimus production of oil from the wells cannot maintain the leases.

The second argument made by the successors to the deep-rights-lessee was that the leases were maintained by the landowners’ domestic use of the gas produced from the wells, which constituted operations under the terms of the oil and gas lease. However, the court found that operations, like production in paying quantities, are assessed from the perspective of the lessee because they are the party with the right and duty to drill for oil and gas. As stated above, the successors to the deep-rights-lessee did not conduct any operations under the leases.  Thus, the court held that the landowners’ use of domestic gas does not constitute operations under the leases.

Finally, the successors to the deep-rights-lessee argued that the landowners breached the provisions of the farmout agreement mentioned above. The court, however, held that based on the specific language of the agreement, the successors to the deep-rights-lessee were not entitled to the protections of the farmout agreement because they were neither parties to the agreement nor intended third-party beneficiaries. Therefore, the successors to the deep-rights-lessee were not entitled to any of the agreement’s protections.

The Fourth Appellate District covers Adams, Athens, Gallia, Highland, Hocking, Jackson, Lawrence, Meigs, Pickaway, Pike, Ross, Scioto, Vinton, and Washington counties.

For Additional Information

A complete copy of the Fourth District Opinion can be found here.

If you have any questions about this Alert, please contact Brian Boyer, David Hall or any of the attorneys in our Energy and Natural Resources Services Group.

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