This fall the Colorado Supreme Court is expected to hear argument in Board of County Commissioners of Boulder County v. Crestone Peak Resources Operating LLC. The case presents the question of whether a commercial discovery is sufficient to maintain an oil and gas lease in the secondary term. After receiving several years’ worth of oil and gas royalties, Boulder County brought suit in 2019 against Crestone, claiming that two oil and gas leases had expired March of 2014 during a one hundred twenty-two-day period in which the wells were shut in for pipeline maintenance and repair. Boulder argued, in the district court and on its appeal to the Colorado Court of Appeals and in briefing before the Colorado Supreme Court, that production sufficient to maintain an oil and gas lease requires the extraction of the minerals.
The Court of Appeals decision affirmed the District Court, concluding that the leases remained in effect because the term “production” in the relevant leases required that the wells be capable of production, not that oil and gas must be extracted. Commissioners of Boulder County v. Crestone Peak Resources Operating LLC 493 P.3d 917 (Colo. Ct. App. 2021). The Court of Appeals relied on Davis v. Cramer, 837 P.2d 218 (Colo. Ct. App. 1992), to conclude that a “commercial discovery” of minerals is sufficient, without extraction or marketing, to satisfy the habendum clause and hold the lease.
The two leases at issue in this lawsuit, referred to as the Henderson lease and the Haley lease, both included cessation of production provisions and shut-in royalty clauses. The Court of Appeals stated that Boulder’s position would undermine the shut-in royalty clause: “Here, the lessee’s extraction interruption lasted only four months, if production included extraction, triggering lease termination under the cessation clause after sixty days, then the lessee would never be able to utilize the shut-in royalties clause.” Crestone Peak Resources, 493 P.3d at 922. The Court of Appeals concluded that by defining production as commercial discovery all the provisions of the leases could be given proper effect.
In briefing before the Colorado Supreme Court, Boulder makes multiple arguments against the commercial discovery rule. Boulder asserts that the commercial discovery rule is an ill-founded minority position, that the Davis decision was legally incorrect and that it fails to protect lessors and lessees. More broadly, Boulder argues that because “this court is considering the best approach for oil and gas leases generally” it was irrelevant to focus on the “outcome of applying the actual production rule to a specific provision in the [Haley and Henderson] leases.” Boulder Opening Brief at 25. The brief goes on to address the concerns raised in the Davis decision that adoption of a rule requiring extraction of minerals would render the shut-in royalty provisions on the Henderson and Haley Leases meaningless. Id. Boulder asserts that, as a general matter, the Lessee had the option of paying the shut-in royalty during the period of time allowed under the cessation of production provisions. Id. at 26.
The answer brief responds to these arguments by examining the provisions of the actual leases at issue, cautioning the court against adopting broad general rules. Crestone Peak Answer Brief at 21-28. The Answer Brief asserts that pauses are not the same as a cessation in production, because ordinary maintenance and other common events require temporary interruptions in extraction. Id. at 24. Moreover, the parties’ intentions regarding such interruptions are reflected in the cessation of production clauses. Those clauses clearly anticipate cessation of production that can be resolved by reworking existing wells or drilling new ones. Id. at 24. Where the wells are briefly shut in for pipeline repair, the cessation of production clause is not relevant. The answer brief refutes Boulder’s argument regarding shut-in royalty clauses, by noting that paying shut-in royalties during the cessation of production provision period (90 Days under the Henderson lease, 60 under the Haley lease) would require the operator to make payment before shut-in royalties were ever due under the lease, and therefore the terms of the shut-in clauses would be made irrelevant. Id. at 28-29.
The Colorado Supreme Court’s decision could have far-reaching consequences for oil and gas Lessors and Lessees. As discussed in the Answer Brief of Crestone Peak, Boulder County’s position requires a somewhat contorted reading of the duties under the oil and gas leases. For example, consider the law concerning the duty to market under an oil and gas lease. The Court of Appeals decision in Davis v. Cramer, 837 P.2d 218 (Colo. Ct. App. 1992) resulted from a remand by the Colorado Supreme Court in Davis v. Cramer, 808 P.2d 358 (Colo. 1991). In the Supreme Court review of the case, the Court considered whether the implied duty to market arose during the primary term of the oil and gas lease at issue there. Davis, 808 P.2d at 362. Case law from other jurisdictions guided the Supreme Court to conclude that lessees should have a “reasonable time, after the completion of the well, to comply with [the implied duty to market]” regardless of whether the lease was in the primary or secondary term. Id. (quoting Gazin v. Pan American Petroleum Corp., 367 P.2d 1010, 1012 (Okla. 1961)). Boulder county’s argument that a lease is only maintained by extraction creates the somewhat awkward possibility that a lessee would be required to extract minerals to maintain the lease, but would not be subject to the duty to market such minerals. Other jurisdictions, including those that treat the term “production” to mean actual physical production, avoid these contortions by relying on a common sense interpretation of provisions like the cessation of production clause and the shut in royalty clause to support operation of an oil and gas well without fear of cancellation for ordinary maintenance. When the Supreme Court decision is announced we will post a summary of the decision.