The oil and Gas Lease

Question 1

What is a Oil & Gas Lease Transaction?

Answer 1

Mineral Owner (Lessor) transfers his rights to explore, develop and produce oil and gas to Company(Lessee) for a defined period of time

Question 2

Is Oil and Gas Lease Business Transaction

Answer 2

Yes, Lessor owns minerals with right to explore but insufficient capital to finance risk. Lessee has capital to risk with no right to explore.

Question 3

Is there a standard oil and Gas lease contract?

Answer 3

No, could use Producer 88 form, and negotiate lessor and lessee objectives

Question 4

What are the characteristics of and oil and gas lease?

Answer 4

1. Conveyance

2. Contract

Question 5

What are the type of ownership interest are in the O&G lease?

Answer 5

1. Royalty Interest
2. Leasehold interest, Working Interest, Operating Interest
3. Overriding Royalty Interest
4. Other

Question 6

What are the Oil and Gas Lease Clauses?

Answer 6

1. Date and Effective Date
2. Identification of Lessor and Lessee
3. Consideration
4. Other interest

Question 7

What is the Granting Clause?

What rights and uses?

What lands are described by the grant?

Answer 7

1. Lessor hereby grant, demise, lease and let unto said lessee
2. Rights and uses conveyed
   - Right to explore and produce and sell
   - Right to ingress and egress
   - Necessary and reasonable use of the surface
   - Limitations on the type and qty of lessors interest.

Question 8

What substances are covered by the granting clause?

Answer 8

• Oil and gas
• Other minerals
• Water for operations

Question 9

What are the Lands Descriptions in Granting Clause?

Answer 9

1. Legal Description
2. Encroachments or complicated
   - Mother Hubbard Clause - Intention of the lessor to include within his lease not only the land described but also any other land owned by the lessor in adjacent or contiguous to the lands specifically described.
3. Lessor acquires additional interest in the leased premises after execution of the oil&gas Lease
   - After the acquired title clause “The lease covers not only such interest in the leased premises as the lessor presently owns their but also such additional interest as he may acquire in the future by operation of the law or otherwise, and there shall be no increase in the rental in order to maintain this lease in force without drilling during its primary term in the event of the acquisition by said party of such additional interests.

Question 10

What is the Habendum Clause or Term Clause?

Answer 10

1. Period in which the lessee has the right but not the obligation to drill. The period in which the lessee may produce oil & gas.
2. Primary Term- This lease shall remain in force for a period of X fixed number of years from the date hereof
3. Secondary Term - so long thereafter as oil & gas is produced from said land by the lessee

Question 11

What does produced or production means in Secondary Term?

Answer 11

1. Actual Production Rule- The actual physical extraction and marketing of oil and gas in paying quantities is necessary to maintain the oil and gas lease in the second term.
2. Discovery Rule- The discovery of oil and gas in paying quantities is sufficient to maintain the oil and gas lease in the second term
3. Oil Production and Gas Discovery Rule- The discovery of gas in paying quantities and marketing of oil in paying quantities to maintain a lease in the secondary term
4. Effect of express language in the Oil & gas Lease

Question 12

How much production is necessary for the secondary term?

Answer 12

1. Production must be in paying quantities (commercial quantities) to the lessee
2. two-part test to determine production quantities
   - First test (objective) whether operating revenues exceed expenses over a reasonable period of time resulting in a profit to the lease.
   Operating Revenues- The gross amount of sales minus the gross production taxes and the lessor’s royalty (Majority position)- No deduction for overridding royalty
   Operating Expenses- Excludes all lease aquisition drilling, completion, lifting equipments and other capital expenses. Includes expenses related to the lifting of the product such as: Operating pumps, pumper salaries, supervision, electricity, fuel, telephone service, well repairs, saltwater disposal, trucking and transportation.
   Split of authority on admin expenses and depreciation of well equipment

Question 13

How much production is required for the Secondary Term?

Answer 13

1.First Test is required
- Reasonable Period of Time usually 3 years
- If operating revenues exceed operating expenses for a reasonable period of time, the production is deemed to be paying quantities and the second test is not necessary.
2. Second Test
if there is a failure to produce in paying quantities is justified
- Accidents, maintenance and repair or temporary loss of market for the product
-Reasonable prudent operator would expect to make a profit
- Cannot maintain the lease for speculative purposes
3. Lease cancelation lawsuit or automatic termination of lease.

Question 14

What is the Drilling Delay Rentals Clause

Answer 14

A payment by the lessee to the lessee to the lessor for the purpose of maintaining the oil and gas lease for a period of time (usually one year) during the primary term of the lease. Payment of the delay rental temporarily excuses the lessee need to conduct drilling operations

Question 15

What are the types of delay rentals

Answer 15

1. “OR” type - Begining with the first day of the second year of the primary term of this lease, if the lease has not commenced driling operations on lease premises, the lesse shall pay or tender to the lessor the sum of X dollars/acre each year until drilling operations are commenced or this lease terminates.
2. UNLESS type- If operations for drilling are not commenced on acreage on or before one year from the date of this lease the lease shall terminate unless before the aniversary date the lessee shall pay to lessor in the Banks for the sum of X $ which covers the provilesge of deferring commencement of drilling operations.
   - Consequence of non payment - termination

Question 16

What constitutes commencement of drilling operations?

Answer 16

1. General Rule- A well has been commenced if operations are conducted on the lease in good faith preparation for the drilling of a well for oil or gas and the operations have been continued in good faith with the intention of completing the well.

Question 17

What is continuous drilling clause?

Answer 17

1. If lesee shall commence to drill a well or commence reworking operations on an existing well within the primary term of this lease or any extension thereof, or on acreage pooled therewith, the lessee shall have the right to drill or rework with reasonable diligence and if oil or gas or either are found in paying quantities, the lease shall continue to be in force with like effect is the well had been completed with the terms of years first mentioned.
2. If lessee shall commence operations for drilling at any time of this lease shall remain in force and its terms shall continue so long as such operations are prosecuted wheather on the same or different wells with no cessation in said operations of more than 90 days and if production results therefore the as long as production continues.

Question 18

What is Dry hole clause?

Answer 18

Should the first well is a dry hole, then and in that event if a second well is not conmenced within 12 months of expiration of the last rental period for with the rental has been paid, this lease shall terminate unless lessee on or before the expiration of 12 months shall resume the payment of rentals in the same manner as herein above provided

Question 19

What is Pooling/Unitization?

Answer 19

Pooling - Bringing together, either by voluntary agreement or by order of an administrative agency, leased and or unleased tract or interests for the purpose of drilling a well for the jointg benefit of all owners in the pooled tracts
Unitization- Bringing together either by voluntary agreement or by order of a administrative agency some or all of the well spacing units over the producting units over a producing reservoir for the purpose of conducting joint operations for secondary or tertiary recovery of oil & gas
Comunitization Agreement- Requirement for pooling or unitization of federal and tribal indian lands.

Question 20

What are the types of pooling

Answer 20

1. Voluntary Pooling- Community oil and gas leasse, oil and gas lease with a pooling clause, Voluntary agreement
2. Compulsory or Forced Pooling- Forced Pooling is not applicable to owners which have entered into and Oil and Gas lease which have entered into a Farmout agreement or other agreement for the drilling of the proposed well
   - Forced Pooling order entered by administrative agency (OCC) which sets forth the pooled lands and common source of supply and the terms and conditions under which the polled owners can elect to participate or not participate in the drilling of the proposed well

Question 21

What are the prerequisites for Forced pooling?

Answer 21

• Spacing Order
• Notice (due Process)
• Forced Pooling Hearing

Question 22

What are the effects of the pooling the oil and gas leases?

Answer 22

• One well satisfies the driling clause
• One well satisfies the Habendum Clause
• One well satisfies the other applicable “savings” clauses in each of the polled oil and gas leases
• Royalty is shared proportionally

Question 23

What is the pugh clause (termination clause)?

Answer 23

1. Vertical- Notwithstanding any wording herein contained to the contrary, it is understood and agreed if any portion of the leased premises is pooled with other lands or included in a governmental unit or unit formed under this lease, production will maintain only the lands so pooled or included in a unit, and this lease shall automatically terminate as to the remainder of the leased premises not pooled or included in the unit.
2. Horizontal-Notwithstanding any wording herein contained to the contrary, it is understood and agreed that this lease shall automatically terminate at the expiration of the primary term as to all formations below the deepest producing formation.

Question 24

What is shutin Gas well royalty clause?

Answer 24

During any period (whether before or after expiration of the Primary Term) when gas is not being sold, used, or taken in kind, and the well (or wells) capable of producing gas in paying quantities is shut in and there is not current production of oil on the leased premises sufficient to keep this lease in force, lessee may pay or tender to lessor a royalty of Two Dollars ($2.00) per year per net mineral acre retained hereunder, such payment or tender to be made, on or before the anniversary date of this lease next ensuing after the expiration of ninety (90) days from the date such well is shut in. When such payment or tender is made it will be considered that gas is being produced within the meaning of this lease.”

Question 25

What is Cessation of Production Clause?

Answer 25

1. “Doctrine of Temporary Cessation” – In the absence of a clause dealing with a temporary cessation of production [i.e., temporary cessation clause], lessee will have a reasonable time within which to restore production in paying quantities.
   -Mechanical difficulties
   -Accidents
   -Loss of market
2. “If production from the above described land or acreage pooled therewith, ceases from any cause after the expiration of the primary term, this lease shall not terminate provided lessee succeeds in bringing back such production within 90 days from such cessation, or within such 90 day period commences drilling thereof with due diligence to completion, and if such production is restored through any such operations, this lease shall continue…”
   If the well is capable of producing in payment quantities, clause will not result in termination of the Lease. [Majority position]

Question 26

What is the Royalty Clause?

Answer 26

“Royalty” – A non-cost bearing share of production.
General Rule –

1. Lessee bears all production costs. Production costs include geophysical and seismograph surveys, drilling, testing, completing or reworking a well, surface equipment consisting of well-heads, pumping units, tank batteries, and separators at or near the wellhead and secondary recovery costs.
2. Lessor may be responsible for his/her share of certain post-production costs depending on the language of the Oil and Gas Lease and the application of State law. Post-production costs include dehydration, processing and treatment, compression , transportation, and marketing.
3. “Lessee shall deliver to the credit of lessor free of cost, in the pipe line to which it may connect its well or wells, a one-fourth (1/4th) share of all oil (including but not limited to condensate and distillate) produced and saved from the leased premises. Alternatively, lessor shall have the right to take, market and sell its one-fourth (1/4th) share of all oil in kind free of cost. If lessor elects to take its share of oil in kind at any time or from time to time, lessor shall provide to lessee written notice at least 30 days prior to lessor’s taking in kind.”
4. Gross Proceeds- To pay lessor for gas of whatsoever nature or kind (with all of its constituents) produced and sold or used off the leased premises, or used in the manufacture of production therefrom, one-eighth (1/8th) of the gross proceeds received for the gas sold, used off the premises or in the manufacture of products therefrom, but in no event more than one-eighth (1/8th) of the actual amount received by the lessee, said payments to be made monthly.”
5. Market Value- “On gas, including casing head gas, condensate or other gaseous substances, produced from said land and sold or used off the premises or for the extraction of gasoline or other products therefrom, the market value at the well of one-eighth (1/8th) of the gas sold or used, provided that on gas sold at the well, the royalty shall be one-eighth (1/8th) of the amount realized from such sale
6. Market Price-“To pay lessor for gas of whatsoever nature and kind produced and sold or used off the premises, or used in the manufacture of any products therefrom, one-eighth (1/8th) at the market price at the well for the gas sold, used off the premises, or in the manufacture of products therefrom, said payments to be made monthly…

Question 27

What happens with delayed payments?

Answer 27

Non-payment or delay in payment of royalty
Oil and Gas Lease does not terminate because of Lessee’s failure to pay or Lessee’s late payment of royalty. Lessor has action to collect amount due and owing, together with interest and attorney fees. [Majority position]

Question 28

What is free gas clause?

Answer 28

Free gas clause
“Lesser shall have the privilege at his risk and expense of using gas from any well, producing gas only, on the leased premises for stoves and inside lights in the principal dwelling thereon out of any surplus gas not needed for operations hereunder.”

Question 29

What about surface damages?

Answer 29

Surface damages
“Lessee shall pay lessor for all damage to the lease premises caused by lessee’s operations thereon and lessee shall remediate and restore the surface of the leased premises to its condition existing prior to this lease.”
Lessee has right to necessary and reasonable use of the surface.
State may have statute governing surface damage (e.g., Oklahoma’s Surface Damage Act

Question 30

What about Removal of Fixtures/Equipment

Answer 30

“Lessee shall have the right at any time to remove all pipelines, tanks, equipment, facilities, or structures on the leased premises, including the right to draw and remove casing from any well. Upon expiration of the lease, lessee shall be required to remove all pipelines, tanks, equipment, facilities, or structures and any other debris on the leased premises within 90 days and plug all wells in accordance with the rules and regulations of the Oklahoma Corporation Commission.”

Question 31

Lesser Interest Clause

Answer 31

“If lessor own a les interest in the leased premises than the entire and undivided fee simple estate therein, then the royalties and rentals herein provided shall be paid to the lessor only in the proportion which his interest bears to the whole and undivided fee.”

Question 32

Surrender Clause

Answer 32

Lessee may at any time and from time to time surrender this lease as to any part or parts of the leased premises by delivering or mailing a release thereof to lessor, or by placing a release of record in the proper county. After a partial surrender, delay rentals shall be proportionately reduced on an acreage basis

Question 33

Assignment and Change of Ownership

Answer 33

“If the estate of either party hereto is assigned, and in the privilege of assigning in whole or in part is expressly allowed, the covenants hereof shall extend to their heirs, executors, administrators, successors or assigns. However, no change or division in ownership of the lands, rentals or royalties shall enlarge the obligations or diminish the rights of lessee. No change in the ownership of the land or assignment or rentals shall be binding on the lessee until after the lessee has been furnished with a written transfer or assignment or a true copy thereof,… In case lessee assigns this lease, in whole or in part, lessee shall be relieved of all obligations with respect to the assigned portion or portions arising subsequent to the date of assignment.”

Question 34

Warranty Clause

Answer 34

“Lessor hereby warrants and agrees to defend the title to the lands herein described, and agrees that the lessee shall have the right at any time to redeem for lessor by payment any mortgages, taxes or other liens on the above described lands, in the event of default of payment by lessor, and to be subrogated to the rights of the holder thereof”.

Question 35

Implied Covenants

Answer 35

Unwritten promises made a part of the Oil and Gas Lease which impose additional burdens on the Lessee for the protection of the Lessor.

1. The law implies fairness and reasonableness in all contracts.
2. General Rule – An express covenant (or promise) will override an implied covenant on the same issue.

Question 36

Covenants implied

Answer 36

1. Covenant to drill an initial exploratory well (or to test for oil or gas)
   Modern Oil and Gas Leases have Drilling – Delay Rental Clause
2. Covenant to reasonably develop the leased premises
   Lessee has discovered a knows, producing formation on the leased premises.
   -Lessee has an obligation to continue development to assure reasonable rate of production over time from then same formation.
   -Elements, defenses, and remedies
3. Covenant to explore further
   Similar to covenant to reasonably develop, except that it requires drilling of an additional exploratory well to test unknown formations under the leased premises.
   Elements, defenses and remedies
4. Covenant to protect the lease premises from drainage
   -Alleged drainage from adjacent tract
   -Elements, defenses and remedies
   5.Covenant to conduct operations with reasonable care and due diligence -“Catch-all” covenant
   -Elements, defenses and remedies

Question 37

What is top lease

Answer 37

An Oil and Gas Lease granted on property which is already subject to an Oil and Gas Lease.

Question 38

When top lease starts?

Answer 38

Upon expiration of the existing Oil and Gas Lease (as opposed to a date certain)

“The primary term of this lease shall be _____ years commencing upon the expiration of the primary term of the presently existing lease or upon the termination of the presently effective lease, whichever date is later. However, in order to avoid any problems caused by the rule against perpetuities (60 O.S. 1977, §31), under no circumstances shall the primary term of this lease commence subsequent to…. [not more than 21 years from present date].”

Question 39

What is the protection of the top lease?

Answer 39

“Lessor agrees not to execute any instrument extending or renewing any presently effective oil and gas lease. This lease is subject to presently effective oil and gas leases of which lessee has actual or constructive notice.”