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The Crestone Case: Motivations and Implications

February 7, 2024 by Sarah Berman
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Commercial Discovery Rule vs. Actual Production Rule

Oil and gas leases generally include two terms.[1] The first is a fixed primary term within which the lessee holds the mineral rights but is not obligated to produce.[2] Should the primary term of a lease end without any production, the lease will expire. The secondary term of an oil and gas lease begins upon production and continues so long as the production continues.[3] In essence, production is essential to the extension of an oil and gas lease beyond the primary term. The meaning of “production,” especially when oil and gas leases do not contain express provisions defining production, elicits much debate and litigation.[4] Does production mean the constant flow of oil and gas resources to market with no exceptions? Does production allow pauses for maintenance and other reasons? Does production mean only the discovery of resources and that a well is capable of producing regardless of whether resources are actually extracted?

Many oil and gas lease drafters will include a cessation-of-production clause as a substitute for the strict requirement of production. A cessation-of-production clause specifies what a lessee must do to maintain their lease if production pauses or stops.[5] Additionally, shut-in royalty clauses allow lessees to pay lessors a “shut-in royalty” in lieu of production to maintain a lease during a period without actual production.[6] Other drafters will define production as including (or not including) marketing of the oil and gas.[7] In cases in which a lease does not define production explicitly, the majority of jurisdictions define production as including both the discovery and the actual marketing of an oil and gas product.[8] This is known as the actual production rule. Compare that to the rule of the minority of jurisdictions: the commercial discovery rule. Under the commercial discovery rule, a lessee need only show that a well is capable of production in paying quantities and that the lessee has diligently sought a market for oil and gas resources, however, the actual marketing of the resource is not required.[9]

Board of County Commissioners of Boulder County, Colorado v. Crestone Peak Resources Operating, LLC presented the Colorado Supreme Court with the opportunity to adopt either the actual discovery rule or the commercial discovery rule.[10] Somewhat surprisingly, the Colorado Supreme Court avoided choosing either rule.

The Crestone Case

Eastern Boulder County is home to many oil and gas wells at various stages of their production life cycles. The Crestone case concerns two oil and gas leases negotiated between Boulder County, the lessor, and Crestone Peak Resources, an oil and gas operator and the lessee, in the 1980s.[11] The two leases provided for 60 and 90 day pauses in production without lease termination.[12] However, in 2014, Crestone ceased production for 122 days while the well was shut-in for repairs by a third party.[13]

The District Court held that the leases at issue never terminated and the Colorado Court of Appeals agreed and issued what many regarded as a sweeping decision in Crestone’s favor.[14] The Court of Appeals held that “production” in an oil and gas lease in Colorado “means capable of producing oil or gas in commercial quantities.”[15] This decision went beyond deciding the meaning of the two leases at issue and adopted the commercial discovery rule to define “production” in Colorado as meaning “capable of production.”[16]

Boulder County appealed and the Colorado Supreme Court granted certiorari and heard oral arguments in September, 2022. Boulder County argued this stoppage in production caused the leases to expire and that Colorado should adopt the actual production rule.[17] Crestone argued that the shut-in royalty and cessation-of-production clauses in their leases accommodated such pauses without forcing the leases to terminate and that the commercial discovery rule is preferable.[18]

Motivations and Implications

This case is, at its core, a contest between a county that prioritizes the reduction of greenhouse gas producing industries and a private operator that prioritizes the extraction of oil and gas resources. Since Colorado does not have a statewide rule defining production in oil and gas contracts, this case presented the opportunity for the Colorado Supreme Court to move the state toward the industry-friendly commercial discovery rule or toward the strict actual production rule.

The Colorado Supreme Court recognized the motivations of both parties. The justices sharply questioned Boulder County’s analysis of the leases and motivations for pursuing lease termination. During oral arguments, Justice Márquez asked if Boulder County’s lease termination argument was a “gotcha” to stop oil and gas operations.[19] After oral arguments, a decision favoring Crestone was generally anticipated. The main question lingering was whether it would be a narrow decision applicable to just the two leases at issue or a broad statewide rule.

In November of 2023, the Colorado Supreme Court interpreted the terms of each lease and found that both leases avoided termination.[20] However, the Colorado Supreme Court also held that the Colorado Court of Appeals went too far in their broad adoption of the commercial discovery rule and that such a rule was not appropriate.[21] The Colorado Supreme Court spent most of its opinion examining the language in and intent behind the two leases at issue and interpreting the agreement accordingly: “[o]ur job when interpreting a contract is to determine and effectuate the parties’ intent and reasonable expectations at the time the contract was made.”[22] This decision gave effects to the cessation-of-production clauses of the lease, holding the leases did not terminate despite the pause.[23] It went no further. In sum, the Crestone decision is an exercise of contract interpretation principles rather than an adoption of any sweeping rule change to oil and gas law in Colorado.

Boulder County considered the rejection of the commercial discovery rule to be a win.[24] And Crestone and the oil and gas industry more broadly considered the continuation of the leases to be a win.[25] While this case was arguably more of a win for Crestone than for Boulder, the court’s decision not to adopt a statewide rule leaves open the opportunity for a different arrangement of facts to convince the court to reconsider in the future.

In Boulder County, there are 134 oil and gas wells that are capable of production but are currently shut-in.[26] Depending on the length of time of those various shut-ins, the Colorado Supreme Court’s decision could have caused many of those wells, as well as others across the state, to immediately terminate, an effect highlighted by Crestone’s arguments.[27] Should Colorado adopt the actual production rule in the future, oil and gas operators will not necessarily face immediate lease terminations, however. As long as a lease speaks to the consequences of temporary cessations of production, leases will stand. Only leases that do not explicitly address the consequences and specifics of pauses in production for various lengths of time would likely be affected. In fact, the majority of states, including states with massive oil and gas production such as Texas, Louisiana, and New Mexico, all follow the actual production rule. The actual production rule would not be as dire as oil and gas operators predict, especially if operators explicitly contract around concerns.

Despite the supposedly drastic change to the oil and gas industry that this case proffered, its effects were tapered to the leases at issue in the case, and even if Colorado does adopt a statewide rule in the future, the ripple effects can be carefully controlled by both lessors and lessees with explicit drafting.

  1. Habendum clause, Black’s Law Dictionary (11th ed. 2019). ↑
  2. Id. ↑
  3. Id. ↑
  4. Emily Richard, Recent Developments in Oil and Gas Habendum Clause and Savings Clause Interpretation, 8 Oil & Gas, Nat. Res. & Energy J. 51, 55 (2022) https://digitalcommons.law.ou.edu/cgi/viewcontent.cgi?article=1366&context=onej. ↑
  5. Cessation-of-production clause, Black’s Law Dictionary (11th ed. 2019). ↑
  6. Shut-in royalty clause, Black’s Law Dictionary (11th ed. 2019). ↑
  7. McVicker v. Horn, Robinson & Nathan, 322 P.2d 410 (Okla. 1958). ↑
  8. Baldwin v. Blue Stem Oil Co., 189 P. 920 (Kan. 1920) (holding leases terminated for lack of production). ↑
  9. McVicker v. Horn, Robinson & Nathan, 322 P.2d at 410 (holding lack of actual production did not terminate lease). ↑
  10. Bd. of Cnty. Comm’rs v. Crestone Peak Res. Operating LLC., 538 P.3d 745 (Colo. 2023). ↑
  11. Id. at 747. ↑
  12. Id. at 748. ↑
  13. Id. at 749. ↑
  14. Colorado Supreme Court Rules on Boulder County Oil and Gas Case, Boulder Cnty. (Nov. 20, 2023) https://bouldercounty.gov/news/colorado-supreme-court-rules-on-boulder-county-oil-and-gas-case/#:~:text=In%202019%2C%20the%20county%20sued,to%20termination%20of%20the%20leases. ↑
  15. Bd. of Cnty. Comm’rs v. Crestone Peak Res. Operating LLC, 493 P.3d 917, 919 (Colo. App. 2021). ↑
  16. Id. ↑
  17. Petition for Writ of Certiorari at 3-4, Bd. of Cnty. Comm’rs v. Crestone Peak Res. Operating LLC., 538 P.3d 745 (Colo. 2023) (No. 21SC477). ↑
  18. Answer Brief for Respondent at 15-18, Bd. of Cnty. Comm’rs v. Crestone Peak Res. Operating LLC., 538 P.3d 745 (Colo. 2023) (No. 21SC477). ↑
  19. Oral Argument at 2:10:42, Bd. of Cnty. Comm’rs v. Crestone Peak Res. Operating LLC., 538 P.3d 745 (Colo. 2023) (No. 21SC477) https://cojudicial.ompnetwork.org/embed/sessions/252682/21sc334-21sc477. ↑
  20. Bd. of Cnty. Comm’rs v. Crestone Peak Res. Operating LLC., 538 P.3d 745, 756 (Colo. 2023). ↑
  21. Id. at 747. ↑
  22. Id. at 750. ↑
  23. Id. at 756. ↑
  24. Colorado Supreme Court Rules on Boulder County Oil and Gas Case, Boulder Cnty. (Nov. 20, 2023) https://bouldercounty.gov/news/colorado-supreme-court-rules-on-boulder-county-oil-and-gas-case/#:~:text=In%202019%2C%20the%20county%20sued,to%20termination%20of%20the%20leases; Nicole Dorfman, Colorado Supreme Court rules county’s oil and gas leases remain valid, The Daily Camera, (Nov. 20, 2023) https://www.dailycamera.com/2023/11/20/colorado-supreme-court-rules-countys-oil-and-gas-leases-remain-valid/. ↑
  25. Wheeler Trigg O’Donnell LLP, Won precedent-setting Colo. Supreme Court victory for Crestone Peak Resources (Nov. 20, 2023) https://wtotrial.com/won-a-colorado-supreme-court-opinion-for-crestone-peak-resources-in-a-lease-dispute-with-significant-implications-for-colorados-oil-and-gas-industry; See Press Release, Colorado Oil & Gas Association, Dan Haley, President & CEO, responds to Colorado Supreme Court Ruling (Nov. 21, 2023) https://web.coga.org/news/NewsArticleDisplay.aspx?articleid=3054. ↑
  26. Tim Drigen, Boulder County dealt setback in Supreme Court ruling on oil and gas leases, but finds silver lining for climate goals, Boulder Reporting Lab (Nov. 29, 2023) https://boulderreportinglab.org/2023/11/29/boulder-county-dealt-setback-in-supreme-court-ruling-on-oil-and-gas-leases-but-finds-silver-lining-for-climate-goals/. ↑
  27. Oral Argument at 2:19:10, Bd. of Cnty. Comm’rs v. Crestone Peak Res. Operating LLC., 538 P.3d 745 (Colo. 2023) (No. 21SC477) https://cojudicial.ompnetwork.org/embed/sessions/252682/21sc334-21sc477. ↑