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Colorado Supreme Court Declines to Adopt Universal Definition of “Production” Under Oil and Gas Leases

November 21, 2023

On Monday, November 20, 2023, the Colorado Supreme Court issued a decision in which it declined to adopt a universal definition of “production” in Colorado oil and gas leases, instead holding that Colorado courts should interpret each oil and gas lease pursuant to its own terms.

In Bd. of County Comm’rs of Boulder County v. Crestone Peak Res. Operating LLC, 2023 Colo. LEXIS 1086 (Colo. Nov. 20, 2023), the Board of County Commissioners of Boulder County (“Boulder”) sought to invalidate two oil and gas leases with Crestone Peak Resources Operating LLC (“Crestone”). The leases contained a habendum clause that provided for a primary term of two years, and a secondary term for “as long thereafter as oil or gas, or either of them, is produced from said land . . . or the premises are being developed or operated.” Id. at 3-4, 6-7. In 2014, during the secondary term of the leases, a third party’s pipeline maintenance forced lessee to shut-in otherwise commercially viable wells for approximately four months. Boulder did not claim the leases had been terminated during the shut-in and continued to accept royalty payments, even throughout the course of the lawsuit. Id. at 10. In 2018, Boulder filed suit claiming that the 2014 shut-in constituted a cease in production which terminated the leases under the cessation-of-production clauses. Such clauses provide that if production “shall cease from any cause, [the] lease shall not terminate provided lessee resumes operations for reworking or drilling a well within [60 or 90] days from the cessation . . . .” Id. at 7.

Crestone moved for summary judgment, arguing that under the cessation-in-production clauses, Crestone merely ceased marketing – not production – during the shut-in, such that the leases were never terminated. The District Court granted summary judgment and Boulder appealed. Relying on Davis v. Cramer, 837 P.2d 218 (Colo. App. 1992), the Court of Appeals adopted the “commercial discovery rule” which provides that the term “production” means “capable of producing oil or gas in commercial quantities.” Id. at 11. The Appeals Court determined that the leases had not terminated because “at all times relevant to the dispute, there remained a commercially viable discovery of oil and gas at the wells.” Id. at 12.

The Colorado Supreme Court granted certiorari review of one issue: whether the Court of Appeals erred in adopting the “commercial discovery rule” in interpreting oil and gas leases. Id. at 12 n. 3. Boulder argued that the Court should instead apply an “actual production” rule and find that “production” requires “extraction.” Id. at 20 n. 5. The Supreme Court rejected that argument, reasoning that the term “must be given meaning that is consistent with reality in the light of the circumstances which are commonly incident to oil and gas operations and which the parties must have contemplated.” Id. at 18 (citing 2 Eugene Kuntz, A Treatise of Oil and Gas § 26.6 (2022)). While the “commercial discovery rule” set forth in Davis v. Cramer is most applicable in determining whether there was sufficient production within the primary term to extend to the secondary term, once in the secondary term, the lessee has fulfilled its obligation and achieved the primary objective of the lease. Id. Courts should then exercise greater caution in terminating a lease to avoid depriving the lessee of its investment. Id. at 19-20. In considering whether the shut-in triggered termination under the cessation-of-production clauses, the Court held that the leases make clear that these clauses are triggered only when a cessation of production occurs that would be permanent without reworking or drilling. Id. at 22. To require the lessee to engage in reworking or drilling operations under these circumstances would result in economic and environmental waste. Id. at 24. Accordingly, the 2014 shut-in did not trigger termination of the leases under the cessation of production clauses. Id. at 23-24. Thus, the Colorado Supreme Court upheld the judgment of the Court of Appeals under different reasoning.

Should you have questions about the content of this Legal Alert, please contact Stephanie Morr or Sam Niebrugge.