The Pennsylvania Supreme Court recently reaffirmed that whether a well is producing "in paying quantities" must be determined with reference to the operator's good faith judgment. See T.W. Phillips Gas and Oil Co. v. Jedlicka, Case No. 19 WAP 2009 (Mar. 26, 2012). The decision has a good discussion of the nature of an oil and gas lease under Pennsylvania law (i.e., if there is production in the primary term, it creates a fee simple determinable in the operator), and of the nature of the typical habendum clause in a lease. Interestingly, the Court notes that the plaintiff's argument "overlooks the fact that profits must be measured over some time period, and, as we discuss below, setting a reasonable time period necessarily implicates the operator's good faith judgment. Thus, in assessing whether a lease is producing in paying quantities, Young places the principal focus on the good faith judgment of the operator." It is therefore not simply "profit over operating expense."
Accordingly, the court held:
[That], if a 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.
Read the whole thing.