Oil and Gas Lease Clauses and Provisions Part 1

In our last post, we discussed the basics of the Oil and Gas Lease. Today we will discuss some of the finer points, provisions, and clauses of the lease.

Granting Clause: Usually, the opening paragraph of the lease is the granting clause. It outlines the purposes of the lease and describes the substances that can be explored and produced.

Duration: Both the Primary and Secondary Terms were discussed in yesterday's post and will not be rehashed here. However, there are three important provisions that should be discussed.

• Shut-in Provision: Allows the lease to remain in effect whenever the production from a well capable of producing in paying quantities is not being sold. The lessee must pay shut-in royalties to the lessor to maintain the lease after the expiration of the primary term.
• Dry Hole Provision: Will extend both the primary and secondary terms of the lease if oil and gas is not discovered when a well is drilled and certain conditions are met.
• Cessation of Production: Will extend the secondary term of the lease if certain conditions are met.

Royalty Clause: Again, discussed yesterday.

Surface Damages: Unless stated otherwise, the granting of an oil and gas leases carries the implied right to use as much of the surface as in reasonable necessary for the development of the minerals. This is because the surface estate is subservient to the mineral estate.

Pooling Clause: A provision giving the lessee the right to consolidate the leased premises with adjoining leased tracts in order to meet the requirements for the state mandated size for drilling and spacing units. Pooling, both compulsory and voluntary, will be covered in a post at a later date.

Assignment Clause: A provision permitting the lessor and the lessee to assign their rights under the lease to other parties.

Warranty Clause: A clause requiring lessors to defend their interest in, or title to, the leased premises.

Force Majeure Clause: The clause that protects the lessor from liability and loss of the lease whenever an "Act of God" causes the lessor to suspend operations. These acts can range from a tornado to a terrorist attack to the unavailability of a drilling rig.

More to follow.

BR

The Basics of the Oil and Gas Lease

For the mineral owner, the Oil and Gas Lease is the most common, but also the most important legal instrument that he will have to negotiate. Many books have detailed the Oil and Gas Lease, however, we will limit our study today to the basics.

99.9% of mineral owners will lease their mineral rights to an oil company for the right to explore and drill for oil and gas. The Oil and Gas Lease is a legally binding agreement between two parties, the mineral owner, called the Lessor, and the oil company or his agent, call the Lessee.  In exchange for the opportunity to lease the mineral rights, the Lessee will tender consideration to the Lessor. 

There are two components to the consideration. First, the Lessee will pay a cash bonus payment to the Lessor. Bonus payments vary widely and are dependent on local market conditions. Second, the Lessee will pay a royalty to the Lessor if a well is drilled and it produces oil and gas. The royalty is a percentage of the production revenues. The most commonly negotiated royalties are 1/8th and 3/16th. This means that if a Lessor agrees to a 3/16th royalty, he will receive 3/16th of the revenues attributed to the minerals he leased in the well free of any charges.

When leasing, most oil companies will offer at least two options with differing cash bonuses and royalty percentages which are inversely related.

For Example:

Option 1: $200/net mineral acre and a 1/8th royalty

Option 2: $150/net mineral acre and a 3/16th royalty

As mineral owners have differing horizons, each may choose a different option based on his current financial situation.

The Lease will also have a Primary Term. The Primary Term is the amount of time, usually three years, the oil company has to drill an oil and gas well. If the company does not drill a well capable of producing oil and gas in paying quantities, then the lease will expire. If the oil company does drill a well, then the lease will enter its Secondary Term and will remain in force as long as the well is capable of producing in paying quantities.

The Lease will also describe the lands being leased using the legal description. These will usually include the section, township, and range along with a more specific description of the tract. Legal descriptions will be detailed more thoroughly in a later post.

Stay tuned for more information about the Oil and Gas Lease in future posts.

BR