Production in
| Author | Patrick S. Ottinger |
| Position | Adjunct Professor of Law, Paul M. Hebert Law Center; Member, Louisiana and Texas bars |
| Pages | 635-676 |
Page 635
A. Preface
It is the purpose of this paper to review in some detail the requirement under Louisiana law that, in connection with the maintenance of mineral leases by production under the usual habendum clause, such production must be in "paying quantities."1Although this doctrine has not been presented at this institute for about forty years, it has been examined in several fine papers to which the reader is referred.2 While this paper attempts to capture all significant Louisiana decisions on this topic, reference will also be made to certain decisions in other oil producing states, particularly Oklahoma and Texas. As noted in the Comment to Article 124 of the Mineral Code,3 Louisiana's current law on this subject is fashioned in large part on the pronouncements of the Texas Supreme Court in Clifton v. Koontz.4
The notion that production must be of a certain quantity in order to maintain a mineral lease is as old as the industry itself. The earliest mineral lease in Louisiana jurisprudence contains an explicit requirement that production must be in "working quantity."5
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Although the requirement that production must be in "paying quantities" had been developed jurisprudentially, it is now codified in the Louisiana Mineral Code.6 As will be discussed,7 the Louisiana Mineral Code made significant changes to the scope of the inquiry as had been developed by the courts. Bringing Louisiana's test in line with other jurisdictions, the issue of production in "paying quantities" essentially concerns itself with the operator's motives in continuing production at the level being obtained.
B. Definition of Production in "Paying Quantities"
Before beginning the analysis, one should start with a few definitions. A "habendum" clause is that provision which dictates the duration of the mineral lease. The lease subsists during the "primary term"8 and "for so long thereafter as oil or gas is produced." The period of time after the "primary term" is sometimes called the "secondary term."9
It is initially observed that, even where the habendum clause does not utilize the phrase "in paying quantities," the courts of Louisiana will nevertheless imply such a requirement.10 In an early case, the habendum clause did not state that production had to be in "paying quantities," on the basis of which omission the lessee "argued . . . that the quantity of oil produced has nothing to do with the continued life of the lease; that just so long as any oil at all is produced from thePage 637 well the lease cannot be declared forfeited."11 The court rejected this contention, stating that it was "not prepared to give [their] approval to such a proposition."12 The court said:
A development that falls short of a reasonable production which would bring a net profit to the lessee and furnish an adequate consideration to the lessor for the continuance of the lease might well be said to be no development at all within the contemplation of the parties.
To hold that any production, however small, and in less than paying quantities, gives to the lessee the right to continue the lease indefinitely and with no obligation to further development, would be contrary to the established rule of jurisprudence, and would be writing for the parties a contract which they never intended to make.
It was never contemplated that the lease under consideration should be continued for all time to come upon the mere production of oil in quantities not sufficient to compensate the lessee and totally inadequate as a consideration to the lessor for continuing the lease.13The supreme court's succinct treatment in Caldwell of the lessee's argument suggests that this requirement is a judicial articulation of the policy of this State which seeks to prohibit the lessee from speculating with mineral interests, or otherwise acting in a selfish manner, without regard to the interest of the lessor. This guard against speculation was explicitly stated as a reason for the rule by the Texas Supreme Court in Garcia v. King.14 There, the court observed that the "lessors should not be required to suffer a continuation of the lease after the expiration of the primary period merely for speculation purposes on the part of the lessees."15
In Knight v. Blackwell Oil & Gas Co., the term "in paying quantities" was succinctly defined, as follows:
The words 'in paying quantities' can mean the production of oil or gas in such a quantity as will pay a small profit over operation costs of the well, although the expense of drilling and equipping the well may never be paid, and thus, thePage 638 operation as a whole might result in a loss to the lessee. Under such circumstances, the well might be operated by the lessee, in order to recoup some of the drilling and equipment costs.16
The Louisiana Supreme Court has articulated a strict reading of the habendum clause, saying that mere "[d]iscovery of a well capable of producing minerals in paying quantities does not satisfy the requirement that oil, gas or some other mineral be produced under the habendum clause in order to continue the lease in full force and effect beyond the primary term."17 Moreover, production under the habendum clause "should be understood to mean production in paying quantities in the absence of a stipulation that it should be production in paying quantities."18 A Texas court-faced with a lease wherein the words "whether or not in paying quantities" were stricken from the habendum clause-found that the lease nonetheless contemplated production in "paying quantities."19
The jurisprudence of Louisiana had developed the test in connection with inquiries into whether production is in "paying quantities," that production must be such as to the interest of the lessor as well as with respect to the interest of the lessee. The two "prongs" of this test-first, as to the lessor, and second, as to the lessee-have been called the "objective" standard and the "subjective" standard.20
The first prong of the test-an examination of the relative worth or sufficiency to the lessor of the production royalties as compared toPage 639 the other payments contemplated by the lease terms-is a necessary corollary to the fact that, in Louisiana, royalties are characterized as "rent."21 The courts feel that, in order to sustain the validity of the lease, it is necessary to determine that the lessor is receiving "rent."22
The initial inquiry is a comparison of the production royalties paid to the lessor under the lease to other lease payments received by the lessor, e.g., the bonus, delay rentals, or shut-in gas payments.23If the comparison is favorable to the lessor or, as the courts state it, if the royalties constitute a "serious consideration" to the lessor for the maintenance of the lease, the inquiry stops and any attack on the lease as not having been produced in "paying quantities" is foreclosed.24
If, on the other hand, the comparison of the royalty payments to the other monetary benefits inuring to the lessor under the lease is unfavorable, then the second prong in the test is reached. The essence of the inquiry at this point is whether the conduct of the lessee as manifested by the circumstances would indicate speculation on its part. That is to say, can the production secured, and being secured, be said to be in "paying quantities" with respect to the interest of the lessee?
If the lease is producing in quantities sufficient to meet current operating expenses and yield a small profit to the working interest owner, then the test is satisfied and, again, production is said to be commercial or in "paying quantities." It is appropriate to observe that, in the application of this phase of the jurisprudential test, one is not concerned with recovery of investment costs.25 As long as aPage 640 small profit (above and beyond current operating costs) is yielded, such profit is dedicated to recoupment of investment costs, and the well is deemed to be producing in "paying quantities."
As was hereinabove seen, the rule that production must be in "paying quantities" evolved so as to prevent speculation in mineral interests and, correspondingly, to deny a mineral lessee the right to effectively remove minerals from commerce. When, in applying the jurisprudential test to a...
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