Nature of the oil and gas lease
| Development Geology Reference Manual | |
| |
| Series | Methods in Exploration |
|---|---|
| Part | Land and leasing |
| Chapter | Nature of the oil and gas lease |
| Author | James C. Tinkler |
| Link | Web page |
| Store | AAPG Store |
General terms
An oil and gas lease is an instrument executed by the owner or holder, the lessor, of the rights of execution (executive rights) who conveys leasehold rights as to oil and gas and such other mineral interests as are to be included in the property described, to a lessee, for a fixed or determinable period of time. In some cases, top leases are obtained on lands already leased to others, with the top lease only becoming effective, at the option of the lessee, upon the termination of the preexisting lease.
Generally, the typical private oil and gas lease provides for the lessee to obtain the rights incidental to exploration, drilling, developing, producing, and disposing of the oil, gas, and associated hydrocarbons underlying the leased premises. In consideration for a lease, the lessee usually pays the lessor a negotiated or competitive signature bonus at the time the lease is executed. In some cases, the lessee, in lieu of or in addition to the bonus, may agree to perform certain services, such as drilling and seismic and/or geological surveys. Also, the lessee provides the lessor with a cost-free royalty interest that is at least 1/8 of the production.
The terms of an oil and gas lease spelling out the rights, duties, and obligations of the parties may vary substantially depending upon the marketplace, the negotiating abilities of the parties, and/or the statutory terms mandated on public lands by governmental agencies. Generally, most oil and gas leases contain the following provisions and topics.
Date and parties to the lease
The date shown on the lease is the commencement date of the lease term. Some states require that the addresses of parties be shown on the face of the lease.
Consideration
Nominal consideration is nearly always specified. A few states require the actual consideration to be shown.
Granting clause
This clause contains words of grant and sets out the rights the lessee is acquiring under the lease.
Description clause
The description clause describes the land covered by the lease.
Mother Hubbard clause
This clause is intended to include within the lease description small contiguous tracts of land owned by the lessee, which due to minor discrepancies, may have been omitted or not covered by the lease description.
Estimate of acreage clause
Because delay rental payments are based on the amount of acreage in a given tract and because at the time a lease is executed an exact amount is not always determinable, this clause allows the rentals to be based on the estimated amount.
Habendum (or Term) clause
This clause specifies the primary term of the lease and usually provides for an extension of the primary term in the event that production in paying quantities is had from the lease. The Habendum clause is usually affected by other clauses in the lease, such as the pooling, rental, dry hole and cessation of production, nonforfeiture, and force majeure clauses, as well as other special clauses (e.g., Pugh clause and continuous drilling clauses).
Royalty clause
The Royalty clause generally provides for several things. First, it provides for the lessor to receive from the lessee a cost-free payment for its fractional share of any oil and gas production obtained from the lease, valued at the wellhead. Second, it allows the lessor the right to take its share of production in-kind. Third, it provides for the lessee to maintain the lease in force during periods when gas wells must be shut-in for lack of a market, by making specified payments periodically to the royalty owners (called shut-in gas royalty). Fourth, it gives the lessee free use of the oil, gas, and water (except from the wells of others) in its operations on the lease. Finally, it allows the lessor to receive royalty for other minerals such as sulfur.
Pooling clause
This clause provides for pooling all or part of the leased acreage with other acreage for the purpose of drilling a well on the pooled or unitized area of a specified size (and in some cases, as limited in shape and horizons) in the interest of conservation and prevention of waste, as permitted by the appropriate governmental regulatory agency. The effect of this provision is to eliminate the drilling of unnecessary wells and to perpetuate the lease by allowing off-the-lease-premise unit well(s) to maintain the lease in force. Royalty is paid pro rata on an acreage basis (that is, the number of acres contributed by the lease divided by the number of acres in the pooled unit).
Delay rental clause
This clause sets out the following conditions: (1) an amount of money that may be paid periodically (usually annually) to the lessor by the lessee to defer drilling operations during the period; (2) a depository bank for delivery of the payments; (3) the methods and delivery of the payment; and (4) the methods for handling changes in ownership and designating a different depository bank. It also ensures that the shut-in gas royalty payment procedures conform to those provided for delay rental payment and that the lessee may release a portion of the lease and reduce its rentals and obligations accordingly. Unless operations or production of the type provided for in the lease occur to relieve the rental payment obligation, the nonpayment of rentals will cause the lease to terminate. Note that in some cases, usually where small tracts or interests are leased, the lessee purchases a paid-up lease, avoiding the administrative need for rental payments.
Dry hole clause and cessation of production clause
These clauses generally set out three conditions. First, in the absence of production or after drilling a dry hole, they establish what type of activity (drilling, reworking, or rental payment resumption) by the lessee must occur to maintain a lease in force during and after the end of the primary term of the lease. Second, they state when and how rental payments may be resumed during the primary term. Third, they set out the obligations of the lessee to protect the lease from drainage by offset wells.
Environmental and property obligation clause
This clause sets the obligations of the lessee to (1) remove its property from the leased lands in a timely manner; (2) restore the surface to its original condition, also in a timely manner; (3) bury its pipelines to a specified depth; (4) restrict the location of wells and use of the surface; (5) pay damages for destruction of crops, trees, animals, or structures; and finally, (6) take care of environmental obligations, if any.
Assignment, changes in ownership, and lease divisibility clause
This clause sets out the rights and obligations of the parries as to the assignability of their interests in the lease, and in the event of changes in ownership, it specifies the impact of the changes upon the obligations of the parties and how the changes are to be administered.
Nonforfeiture clause or breach of obligations and development clause
This clause usually provides (1) that the lessor, within a specified time period, must notify the lessee of any breaches by the lessee of lease obligations, allowing the lessee time to remedy the breach, and (2) that the lease must be developed in a reasonably prudent manner in accordance with that permitted by regulatory authority as to acreage spacing for oil and gas wells. Alternatively, the clause may provide for a specific spacing requirement.
Warranty of title clause
The warranty of title clause generally provides (1) that the lessor warrants and agrees to defend title to the leased interests; (2) that the lessee may pay taxes or the hens owed by the lessor to prevent foreclosure of the lessee's rights (and the lessee, if production is established, may recover such costs from the lessor's share); and (3) that in the event the lessor owns less than a full interest in the lease, rental and/or royalty payments may be reduced accordingly.
Force majeure clause
This clause protects the lessee from losing the lease or from incurring damages when natural catastrophes or other named significant events occur that are beyond the control of the lessee.
Other special or unusual clauses
One typical special clause limits the period of time and the amount of leased acreage the lessee may keep around producing wells or units after the end of the primary term, which in some jurisdictions are called Pugh or Freestone rider clauses. Another example of a special clause is one that defines the costs that can be charged and the calculations to be used in determining the royalty owner's share of revenue from plant processing production for value-enhanced products, called plant product clauses. Another special clause limits the lessee's access to the lease during periods of environmental sensitivity, and yet another specifies well or work obligations.
Private versus public sector leasing
Private sector oil and gas leasing usually requires intensive title searches on relatively small tracts and negotiation of sometimes complex terms with multiple owners of interests underlying the same tract of land.
Public sector leasing generally involves relatively large tracts of land leased from a single governmental agency whose lease terms are not negotiable since they are fixed by law. The consideration paid is usually determined by competitive bidding. Operationally, governmental oversight on public sector leases is considerably more involved than those on private leases.
Leasing of state lands
The statutory terms of state leases vary from state to state and with time as market conditions change. For specific information about each state's leasing terms and requirements, one should contact the state leasing agent. Table 1 lists the most active state leasing agents.
| State | Leasing Agent |
|---|---|
| Alaska | Commissioner of Public Lands |
| Arizona | State Land Commissioner |
| Arkansas | Department of Commerce |
| California | State Land Commissioner |
| Colorado | Board of Land Commissioner |
| Idaho | Board of Land Commissioner |
| Illinois | Department of Mines and Minerals |
| Indiana | Oil and Gas Division, Department of Conservation |
| Kansas | Department of Interior |
| Louisiana | State Mineral Board |
| Michigan | Department of Mineral Resources |
| Mississippi | Mineral Lease Commission |
| Montana | Board of Land Commissioner |
| Nebraska | Board of Education, Lands and Funds |
| New Mexico | Commissioner of Public Lands |
| New York | Bureau of Surplus Real Property |
| North Dakota | State Land Department |
| Ohio | Department of Natural Resources |
| Oklahoma | Commissioner of Land Office |
| Pennsylvania | Department of Forests (and others) |
| South Dakota | Commissioner of School and Public Lands |
| Texas | General Land Office |
| Utah | State Land Board |
| West Virginia | Department of Natural Resources |
| Wyoming | State Land Commissioner |
Leasing of federal onshore lands
The Oil and Gas Leasing Reform Act of 1987, and the regulations issued in 1988 to implement the Act, materially changed requirements for the leasing of federal onshore lands. The changes implemented require that any federal land offered for leasing by any federal agency must first be offered for competitive, oral bonus bidding at sales to be held at least quarterly by the Bureau of Land Management state office. The statutory minimum bid is cost::2.00 USD per acre, and the royalty must be no less than 12.5%. Rental rates must be no less than cost::1.50 USD per acre for the first 5 years and cost::2.00 USD thereafter, and the maximum term is 10 years. Lands that receive no bids at an offering for a period of two years may be leased to the first qualified applicant on the same terms specified for competitive leasing. This system is called the over-the-counter noncompetitive leasing method.
The Reform Act did away with the old noncompetitive simultaneous filing or lottery system and the competitive KGS (known geological structure) lease sales.
Leasing of federal offshore lands (Outer Continental Shelf)
The procedures for the leasing of federal offshore lands are the responsibility of the Mineral Management Service, Department of the Interior.[1] These procedures are generally the same for each of the MMS designated regional areas, including the Gulf of Mexico, Alaska, Pacific, and Atlantic regions.
Federal OCS leases are generally granted on the basis of sealed competitive bonus bids calling for at least 1/6 royalties, cost::3.00 USD per acre rentals, and a 5-year term (10 years for deep water tracts). Sales are offered periodically in accordance with the Secretary of Interior's Tentative Milestones for 5-Year Offshore Leasing Schedule, which are revised from time to time. It takes about three years from the time the MMS makes a “call for information” (that is, it seeks information on the desirability of a sale for a given area) until an actual lease sale occurs.[2]
Indian and Alaskan native claims lands
The procedures for the leasing of Indian lands are generally provided for in Title 25, Code of Federal Regulations, and involve either oral or sealed bidding and/or negotiation and approval of the lease terms by the affected Indian tribe (in the case of unallotted or tribal lands) or by the individual Indian (in the case of allotted lands). In both cases, the Bureau of Indian Affairs, Department of the Interior, supervises and must approve the lease terms.
As to the leasing of Alaskan Native lands, approximately 39.2 million acres may be leased from 12 different regional native corporations. An additional 4 million acres may be leased from the various village corporations. These subsurface rights were obtained by the Indian corporations (created under state laws) pursuant to the Alaskan Native Claims Settlement Act of 1971. As of 1989, only about 60% of the regional corporations lands have been conveyed to them by the United States. Approximately 80% of the village lands have been conveyed.
See also
- Functions of a petroleum landman
- Determining owners of oil and gas interests, and methods of conveyance
- Oil and gas contracts
- Land description and maps
References
External links
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