Oil and Gas Lease Provisions Explained
Historically, mineral owners (“lessors”) and landmen/oil companies (“lessees”) spend most of their time focusing and negotiating the bonus payment, primary term and royalty provisions of an oil and gas lease. These provisions are important, but they represent only a small number of the important elements of the lease. The following is a list and general description of provisions commonly included in an oil and gas lease.
Consideration
In many jurisdictions, consideration must be paid to validate the contract. However, historically, the actual consideration paid to the lessor remains confidential, as the lease usually describes it as “$10 and other valuable consideration”. This consideration is also called the bonus payment. A bonus payment is calculated on a $/acre basis and paid to the lessor at the time the lease is signed.
Granting
This provision defines exactly what rights are being transferred in the described properties from the lessor to the lessee and outlines the activities allowed, such as exploring, drilling, conduction geologic and geophysical surveys, laying pipelines and building roads, just to name a few.
Description
It is critically important that anyone reading a lease be able to locate the leased lands. Therefore, the leased lands must be accurately described. Lands in different parts of the US are described differently. As a result of the history of the lands (the Original 13 colonies established by Great Britain, the Louisiana Purchase from France, Mexican or Spanish Cession, etc.), they can be described using the English Units of Measure, Metes and Bounds or Section, Township and Range and others.
Mother Hubbard
In the event there was a mistake made in the description, this provision provides that the lease will also cover lands owned or claimed to be owned by lessor if the lands are adjacent or contiguous to the described lands. Important to note that this includes only minor defects in the property description.
Habendum
This provision sets out the time period that the rights granted to the lessee will either terminate or be extended. This is called the Primary Term and usually describes the number of years in which the lessee must either establish production or begin drilling operations before the lease expires. The lease will provide for a secondary term which should extend the lease for as long thereafter as there is production on the leased lands or the operator is conducting operations. After a lease expires, the lessee will file a Release of Oil and Gas Lease in the county records.
Royalty
A portion of the proceeds from the sale of production which is paid monthly to the lessor. The mineral royalty is usually described as a fraction such as 1/8th, 1/6th.
Shut-in Royalty
A gas well can be shut-in for many reasons. Shut-in commonly means the well is manually turned off due to reasons such as a pipeline needed to move the gas to market has not been completed or the price of gas has dropped to a point where it is temporarily uneconomic to produce. The shut-in royalty clause allows for the lessee to make a shut-in payment to the lessor in lieu of making a royalty payment.
Pooling
This allows the lessee to combine 2 or more leases together in order to meet the minimum number of acres required by the state regulatory authorities to drill and produce a well. For example, if the state requires 640 acres be allocated to the drilling of a gas well, but lessor only owned and leased 320 acres, the lessee can lease an adjacent 320 acres and pool both leases together to make a 640 acre pooled unit. Production from a well drilled anywhere within the 640 acres would be allocated equally to each of the 320-acre leases.
Delay Rental
Lessee has the option to either begin drilling operations during the first year of the primary term or pay a delay rental which would extend the oil and gas lease into the following year. Lessee has the continued option to pay an annual delay rental each year during the primary term in the lieu of drilling a well. If the delay rental is not paid, the lease will expire. The delay rental will not extend the lease beyond the end of the primary term. Lessee may also ask for the option to combine the delay rental with the initial lease bonus, which would effectively result in the lease being described as a Paid Up Lease.
Cessation of Production
If production from a well that has perpetuated the lease beyond the expiration of the primary should cease to produce, lessee shall have (usually) 120 days to commence operations for the drilling of a substitute well. And if the substitute well is completed as a well capable of producing in paying quantities, the term of the lease shall be extended for as long as the substitute well continues to produce in paying quantities.
Pugh Clause and Continuous Development
Many leases cover large properties. At the end of the primary term, lessors want the lease to terminate as leased lands that were un-drilled and/or non-producing. Thus, a Pugh Clause can be added to the lease which provides for the lease to terminate as to certain portions of the leased lands after the end of the primary term. For example, if the lease covers 1,000 acres and the state regulations call for 640 acres to be allocated to a producing well, what happens at the end of the primary term if there is only one well producing on the leased lands?
The lessor would not want the primary term of the lease covering 1,000 acres to be perpetuated by 1 producing well. Therefore, a Pugh Clause can be added which will allow the primary term of the 1,000 acre lease to be perpetuated as long as there are continuous drilling operations anywhere on the leased lands. Once drilling operations have ceased with no more than 120 days elapsing between the completion of one well and the drilling of another well, the lease will terminate as to the leased lands which lie outside of a state regulated drilling and spacing units containing a producing well. This will allow the lessor to lease these lands again.
Proportionate Reduction
In the event it is later determined that lessor owns a smaller interest in the minerals than originally thought, lessee may proportionately reduce rental and royalty payments paid to lessor. Although there is a warranty clause in the lease that seems to guarantee clear title, the lessee needs this provision in order to make payment adjustments.
Whether you are currently negotiating an oil and gas lease with a landman or just want to better understand lease provisions, give us a call. At LandGate, one of our goals is to make certain that oil and gas mineral owners “informed”. Many times, an uninformed mineral owner will accept a smaller oil and gas lease bonus or oil and gas mineral royalty than the oil company would have been willing to pay. They may not even tell you that they are planning to drill an oil or gas well on your property. But on LandGate.com, you can locate your property to get a LandEstimate and find the exact location of all permitted wells they plan to drill. Give us a call. We are here to help.
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