Surely, the Pennsylvania Supreme Court has been busy since century before last, but apparently not on a lot of oil and gas cases. The court revisited the standard, first established in 1899, for determining whether an oil and gas lease has produced in paying quantities. In T.W. Phillips Gas & Oil Co. v. Jedlicka, the court said that where production has been marginal or sporadic such that for some period profits did not exceed operating costs “paying quantities” must be construed with reference to the operator’s “good faith judgment”.
The Texas Standard
The court reviewed paying quantities cases, in particular the seminal Texas case, Clifton v. Koontz, in which the Texas Supreme Court said the question is, “ … whether or not under all the relevant circumstances a reasonably prudent operator would, for the purpose of making a profit and not merely for speculation, continue to operato a well in the manner in which the well in question was operated.”
The lease was granted in 1928. (If you are wondering how times have changed, Burleigh Grimes of the Pittsburgh Pirates pitched 330 innings that year with a 2.99 ERA). First production was in 1929. In 1959 the operator lost approximately $40.00 from operations. It appears that at all other times during the life of the lease the well was profitable. Think about what the plaintiff was trying to terminate: A venture that had been profitable to the operator for 79 of the 80 years it had produced, not to mention the royalties paid to the lessor over that time.
According to the court, Jedlicka was the first time the issue of paying quantities has been addressed since the 1899 case of Young v. Forrest Oil Co., and the court said it was reaffirming its opinion in that case.
Good Faith vs. Reasonable Prudent Operator
The court found that the Texas inquiry implicates the issue of whether a lessee is exercising his judgment in good faith. However, I’m not aware that the Texas court has ever held that the operator’s subjective good faith is, in and of itself, a factor. The dissent in Jedlicka focused on this question, and observed that when looking at the lessee’s operations, the good faith judgment test and the reasonable prudent operator standard are two distinct concepts. One is subjective and the other is objective, said the dissent.
The court also looked at cases from Oklahoma and Kentucky, which apply a variation of the good-faith test.
It could be said that the “good faith” standard is similar to the Texas approach when the question is whether the operator is maintaining production for “speculative purposes”. Other than that, the tests do not appear to be the same. Surely the proof at trial and the questions to be answered by the jury would be different.