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If an oil or gas well consistently pays a profit, however small, over operating expenses, it will be deemed to have produced "in paying quantities." Where, however, production on a well has been marginal or sporadic, such that, over some period, the well's profits do not exceed its operating expenses, a determination of whether the well has produced in paying quantities requires consideration of the operator's good faith judgment in maintaining operation of the well. In assessing whether an operator has exercised his judgment in good faith in this regard, a court must consider the reasonableness of the time period during which the operator has continued his operation of the well in an effort to reestablish the well's profitability.
Appellant Ann Jedlicka was the owner of a parcel of land consisting of approximately 70 acres located in North Mahoning Township (the "Jedlicka tract"). Samuel Findley and David Findley conveyed to T.W. Phillips Gas and Oil Co. ("T.W. Phillips") an oil and gas lease covering all 163 acres of the Findley property (the "Findley lease"), which included the Jedlicka tract. The Findley lease contained a habendum clause, which provided that the property should only be utilized for the sole purpose of drilling and operating for oil and gas with the exclusive right to operate for same for the term of two years, and as long thereafter as oil or gas was produced in paying quantities, or operations for oil or gas were being conducted thereon, including the right to drill other wells. In 1929, pursuant to the Findley lease, T.W. Phillips drilled four gas wells, identified as Well Nos. 1 through 4. Well No. 4 was situated on what was now the Jedlicka tract. Thereafter, PC Exploration drilled four additional wells. Subsequently, PC Exploration made plans to drill four more wells – Well Nos. 10 through 13 – on the Jedlicka tract. Jedlicka objected to the construction of these new wells, claiming that T.W. Phillips failed to maintain production "in paying quantities" under the habendum clause of the Findley lease, and, as a result, that the lease lapsed and terminated. Specifically, Jedlicka argued that there has not been continuous production in paying quantities on the wells because, in 1959, T.W. Phillips suffered a loss of approximately $40 as a result of operations under the Findley lease. In 2005, appellees filed a declaratory judgment action against Jedlicka to determine their rights with regard to the Jedlicka tract under the Findley lease. Appellees maintained that the Findley lease remained valid; that the wells on the original Findley property have produced gas in paying quantities because they have continued to pay a profit over operating expenses; and that they have operated the wells in good faith to make a profit. The trial court found that appellees were operating the wells in good faith and that there was no evidence they were holding the land for purely speculative purposes. Appellant sought review. The intermediate appellate court held that as to the issue of "paying quantities," under Young v. Forest Oil Co., the good faith of the lessee was a necessary determination, and that appellant failed to carry her burden of establishing that appellees acted in bad faith. Appellant challenged the decisions of the lower courts.
Were the appellees operating the wells in good faith?
The high court agreed with the decisions of the lower courts. Where, as here, production on a well had been marginal or sporadic, such that for some period profits did not exceed operating costs, the phrase "in paying quantities" had to be construed with reference to an operator's good faith judgment. The lower courts properly considered appellees' good faith judgment in concluding the oil and gas lease had produced in paying quantities.