The El Paso Court of Appeals' ruling in this case makes it increasingly difficult for a lessee with a small interest in the leasehold estate to be able to perpetuate a lease into the secondary term. Despite Cromwell's significant participation in oil and gas operations on the property covered by his lease, without a JOA, actual production, or some form of constructive production, he was unable to satisfy required production to perpetuate his leases through the secondary term.
Oil and gas leases include fee simple determinable language to the effect that the lease lasts for a set number of years and then for so long as oil and gas is produced, whether that be actual or constructive production. In Cimarex Energy Co. v. Anadarko Petroleum Corp., the El Paso Court of appeals clarified that when a lessee is relying on actual production to extend the life of the lease during the secondary term of the lease, actual production must be brought about through the lessee’s own efforts, actively or constructively such as through the activity of an operator under an operating agreement that the lessee had joined. 574 S.W.3d 73 (Tex. App. — El Paso 2019, pet denied).
In Cromwell v. Anadarko E&P Onshore, LLC, the El Paso Court of Appeals was confronted with the issue of whether a cotenant lessee who had not entered into an operating agreement could nonetheless establish a level of participation necessary to extend the lessee’s leases. In Cromwell, a lessee, David Cromwell, acquired two oil and gas leases covering six sections of land. Thereafter, on several occasions, Cromwell asked Anadarko for an operating agreement that would enable him to participate in the wells covered by his leases and an existing operating agreement covering the same property. Anadarko never responded. Eventually, the wells reached payout under the operating agreement and Cromwell began paying joint interest billings. Cromwell also elected to participate in an AFE for the installation of a compressor. After the expiration of the primary term of his lease, Cromwell continued participating in the costs of the wells covered by the leases and JOA until Anadarko realized that the primary term of Cromwell’s leases had expired. Anadarko then took leases from Cromwell’s lessors.
Anadarko maintained that Cromwell’s leases had expired, and it was free to take leases from Cromwell’s former lessors. Cromwell sued Anadarko, arguing that he had constructively participated in production under the JOA, which perpetrated his leases during their secondary terms. The trial court and El Paso Court of Appeals ruled for Anadarko. The court of appeals noted that Cromwell had merely paid his share of the wells operating expenses, which are ordinarily owned by nonparticipating cotenants. Cromwell did not shoulder risk or liabilities of exploration or development. Further, the court noted that Cromwell’s payments were not indicative of the parties’ intent that Cromwell participate in operations.
Mere payment for a well’s repair costs and equipment replacement did not rise to the level of constructive production sufficient to establish constructive production to maintain the leases. Further, even though Anadarko referred to Cromwell as an “owner” the partis conduct did not suggest an “operating relationship.” Ultimately the court determined that Cromwell, as a lessee, did not cause production of oil and gas on the lands at issue so his leases terminated and Anadarko was free to take leases from his former lessors.
The outcome of Cromwell creates a roadmap for oil and gas operators who want to expand their rights and interest in certain property. Oil and gas operators can essentially wash out other cotenant oil and gas lessee’s with an interest in the same land by refusing to include them in an operating agreement. In most cases, an operator under an operating agreement is under no obligation to extend the terms of an operating agreement to lessee with a lease covering the same land as an operating agreement. Operators might find it advantageous to refuse to enter into an operating agreement with the lessee in order to eventually gain control of the mineral rights at issue.
On the other hand, a lessee in Cromwell’s situation needs to be very careful to ensure that it: (1) gets a joint operating agreement; (2) establishes constructive production (i.e. shut in royalties if permitted by the lease); or (3) goes out on the property and establishes its own production. Cimarex requires a lessee to cause production (actual or contrastive) of oil and/or gas through the lessee’s own efforts.
