Face Challenges Confidently

183 AFE Oil & Gas, L.L.C. v. Armentrout

Wednesday, September 2nd, 2015

Richard F. Brown

The following is not a legal opinion. You should consult your attorney if the case may be of significance to you.
AFE Oil and Gas, L.L.C. v. Armentrout, No. 2-07-100-CV, 2008 WL 623980 (Tex. App.—Fort Worth March 6, 2008, pet. denied) (Memorandum opinion), holds that a Barnett Shale gas well that had not been fraced by the end of the primary term was not capable of producing gas at the time shut-in royalties were paid. Lessee began operations on the well on July 30, 2003. The primary term expired on August 1, 2003. The well was shut in on August 5, 2003. In August, the well was acid perforated, a technique used to stimulate production of a gas well, and apparently some gas did flow. The lease could be continued in force under the shut-in royalty clause if the well was capable of producing and shut in royalties were paid within ninety days. Lessee attempted to pay shut-in royalties to lessor in October 2003. Lessee fraced the well in November 2004. Lessor refused to accept the shut-in royalty payment and brought suit for lease termination.
The court stated:

To avoid forfeiture of the lease, most gas leases allow for the lease to be extended even if the well is not producing gas if shut-in royalties are paid and the well is actually capable of producing gas. In other words, if further work on the well is required before the well will be capable of producing gas, then even paying shut- in royalties will not prevent the termination of the lease. The term “capable of production” has been held to mean capable of producing gas in paying quantities where the lease does not define the term.

The parties contested the issue of and produced conflicting testimony on whether the well could produce natural gas at the time the shut-in royalties were paid. Lessee contended that “capable of production” means that gas will flow when the well’s switch is turned on. Lessee presented evidence that in August 2003, there was a quantity of gas in the well, and that the operator’s daily reports showed there was gas flowing during this period of time.
Lessor offered evidence from several sources that gas wells in the Barnett Shale will not produce without fracture stimulation. At the end of the primary term, lessee had only performed an acid perforation, which is an entirely different procedure, and the well had not been fraced. Lessor also supplied expert testimony indicating that a month after the lessee’s November 20, 2004, frac job the well was still not capable of production. In addition, lessor’s expert testified that the well could not be turned on and/or begin to flow on either August 5, 2003, the date the well was shut-in, or in October 2003 when the shut-in royalty payments were tendered to Lessor.
The issue was submitted as follows:

The trial court thus submitted this question to the jury: “Do you find that in October, 2003, the Armentrout No. 2 Well was not capable of producing gas?” The trial court instructed the jury that a well is not capable of producing gas if the well needs further work, repairs, or equipment in order to produce gas. The jury sent a note to the trial judge asking, “[M]ust the gas be able to flow in order to be considered ‘producible’?” The judge then submitted this supplemental instruction: “In response to your question, you are instructed that in order for a gas well to be ‘capable of producing gas’; the gas must be able to flow.” The jury found that the well was not capable of producing gas, and the trial court entered final judgment for [lessor].

The court of appeals found the evidence was sufficient to support the jury’s finding that the well was not capable of producing gas at the time the shut-in royalty payments were made.
The significance of this case is that lessee relied heavily on Anadarko Petroleum Corp. v. Thompson to argue that “capable of production” required only that “gas will flow when [the well’s] switch is turned on.” However, the jury’s finding was that gas would not flow, and at least in this case, the well had to be fraced before a shut-in royalty payment could hold the well.