Surviving COVID-19: 3 Lease Provisions to Consider Before Shutting-In a Well

The oil and gas industry continues to navigate the effects of the Russia-Saudi oil war and Covid-19. Throughout recent months, US oil prices continually hit new record lows, reaching numbers unseen since the Persian Gulf War. Consequently, US producers have scrambled to shield themselves from permanent damage during the downturn, with six significant players expected to shut some 300,000 barrels per day (bpd) of crude for May and June. For other producers, the process of shutting in wells to downsize risk is paramount. Below, we will dig deeper into what led to the current climate and three important lease provisions to review before shutting-in your wells.

What Led US Producers Here

On March 8, 2020, Russia and the Kingdom of Saudi Arabia launched a price war against US shale producers that dropped US West Texas Intermediate (WTI) by a record 30%. Shortly after that, the effects of Covid-19 rapidly decreased the demand for oil sending WTI to less than $20/bbl. At these prices, the cost to produce oil was more than the price for selling it. As a result, US producers attempted to acquire storage until prices recovered but discovered that capacity was almost maxed out. Faced with this scenario, companies quickly needed to ascertain if they could shut-in production under the terms of their leases and seek relief from state and federal government agencies.

Read More: How to Protect Your Non-Operated Assets

Three Lease Clauses to Evaluate Before Shutting-in Wells

As mentioned, major US shale producers have already begun shutting-in their wells. Any operator looking to follow suit should look closely at three clauses of their lease agreements to avoid violating the terms of their leases:

1. Habendum clause. The Habendum clause establishes the term of a lease, so it’s integral to examine it. Start by noting if there’s anything within the lease that could narrow or broaden the Habendum clause as this could affect opportunities to shut-in.  Also, look to see if the lease establishes any specific guidance for determining “Production in Paying Quantities” (PPQ). 
   
   
2. Cessation of Production clause. Relying solely on the Habendum clause can limit your ability to shut-in a well, so you should also look at the lease savings provisions, like the Cessation of Production clause. This clause perpetuates the lease for a certain grace period (e.g. 60 or 90 days) if production ceases and is helpful in a situations in which the lease would otherwise terminate. 
   
   
3. Force Majeure clause. A final clause to consider is the Force Majeure clause, which may allow the lessee to perpetuate a lease when saving the lease is impossible for reasons beyond the lessee's control.  However, Force Majeure clauses are narrowly interpreted by the courts to encompass only certain events - low commodity prices or lack of storage do not typically qualify to invoke Force Majeure. If your fee lease has this clause, in almost every case, it will not provide relief to shut-in the well. 

Conclusion

Deciding to shut-in your wells - and doing so in accordance with each one of your leases - is a complex undertaking. Considering these issues above, along with other dimensions of your leases and agreements, we can help you develop a comprehensive risk management plan. Contact us to discuss your concerns.