Legal Definitions - shut-in royalty

A shut-in royalty is a payment made by an oil and gas company (the lessee) to a landowner (the lessor) when a well on the landowner's property is capable of producing oil or gas but is temporarily not producing. This payment serves as a substitute for the regular production royalties that would be paid if the well were actively extracting resources.

The purpose of a shut-in royalty is to keep the lease agreement in effect, even without immediate production. This typically occurs due to reasons such as a lack of market demand, insufficient transportation infrastructure, or temporary operational or regulatory issues that prevent the sale of the extracted resources.

• Example 1: Lack of Transportation Infrastructure

  A drilling company successfully drills a natural gas well on Sarah's ranch. The well is tested and confirmed to be capable of producing a significant amount of gas. However, there isn't a pipeline connection to transport the gas to market yet, and building one will take several months. To maintain the lease agreement with Sarah and prevent it from expiring due to lack of production, the company begins paying her a monthly shut-in royalty until the pipeline is completed and gas production can commence.

• Example 2: Unfavorable Market Conditions

  An oil company has a productive oil well on Mark's property. Due to a sudden global oversupply, crude oil prices drop dramatically, making it uneconomical to produce oil from Mark's well at the current market rate. Rather than abandoning the well or letting the lease expire, the company decides to temporarily "shut in" the well, hoping prices will recover. During this period, they pay Mark a shut-in royalty each month to keep the lease active and retain their rights to the oil when market conditions improve.

• Example 3: Regulatory Delays

  A gas exploration company completes a new well on the property of the Miller family. Before they can begin commercial production, a new state environmental regulation requires an additional permit for a specific type of water treatment facility, which will take several months to obtain and install. The well is fully capable of producing, but cannot legally operate yet. To ensure the lease remains valid and the Miller family continues to receive some income, the company pays them a shut-in royalty during the permitting and construction delay.