Colorado Supreme Court Clarifies the Law Applicable to Oil and Gas Leases

The Colorado Supreme Court on November 20, 2023, issued a long-awaited decision that reversed a 2021 panel of the Colorado Court of Appeals by rejecting the universal application of the “commercial discovery rule” to Colorado oil and gas leases. The announcement stems from Board of County Commissioners of Boulder County v. Crestone Peak Resources Operating LLC.

Rejecting the application of any universal definition of the word “production” (such as the commercial discovery rule), the Supreme Court held that “each oil and gas lease” in Colorado should be interpreted “on its own terms” and the goal of parties and the courts should be to “determine the parties’ meaning within the context of the lease.”

 As background, in 2021, a panel of the Colorado Court of Appeals held that an oil and gas lease in Colorado only terminates in its secondary term under a cessation-of-production clause if wells on leased or pooled lands are incapable of producing oil and gas in commercial quantities. The panel also rejected arguments that cessation-of-production clauses are triggered whenever production ceases from leased or pooled lands during the secondary term regardless of whether such cessation is temporary or permanent.

Among the many other important observations of the Supreme Court in reversing the decision are the following:

• Oil and gas leases are different from other Colorado contracts because they are both a conveyance and a contract.
• In Colorado, it is the intent of the original parties to an oil and gas lease that matters, and intent should ordinarily be gleaned from the language used in the lease as well as the expressed purpose of the lease and the terms and remedies chosen by the original parties.
• The nature of the primary term of an oil and gas lease differs in many respects from that of the secondary term, and the standard for determining whether sufficient production has been achieved during the secondary term may differ as well.
• To avoid unduly depriving lessees of their investment, courts should exercise greater caution when assessing and determining whether an oil and gas lease has terminated during its secondary term due to a cessation of production.
• Although the commercial discovery rule may aptly reflect the intentions of the parties to some oil and gas leases, it is unnecessary and unwise to universally impose its definition of production in every oil and gas lease regardless of the context and the other provisions chosen by the parties.
• Cessation-of-production clauses are savings clauses intended to extend, and not restrict, a lessee’s rights during the secondary term, and they may or may not eliminate or avoid the operation of the common law temporary cessation doctrine.
• Shut-in-royalty clauses are savings clauses that should be given meaning and not rendered superfluous through an interpretation of a cessation-of-production or other lease clauses.

For assistance or questions concerning the above, please contact the authors or any member of the Steptoe & Johnson Energy Team.