Last Updated on Oftentimes, oil gas and mineral leases (OGML) – which exist between the production company that holds the lease of the minerals (the lessee) and the mineral rights owners that leases the minerals (lessor) – are associated with certain standard clauses. In this comprehensive guide, we will define some common clauses. Lessors must acquaint themselves with what these clauses mean.
This will enable them to understand their rights, as well as those of the oil company under their lease. If you wish to enforce your right, then a thorough understanding of oil and gas lease clauses is important. We will explain this and more better.
What is an oil, gas, and mineral lease?
The oil and gas lease is a contractual agreement that exists between the owner of a mineral estate (the lessor) and an oil and gas company (the lessee). With this lease, an oil and gas company can enjoy the right to explore and develop the oil and gas deposits in the area, as described in the lease.
What Clauses are in an Oil, Gas, and Mineral Lease ( OGML) and What do they Mean?
Important clauses in an Oil, Gas, and Mineral Lease ( OGML) will be discussed in this section.
Effective Date
An oil and gas lease clause must state the date on which the OGML becomes effective. This date initiates the lease’s primary term.
Granting Clause
The granting clause specifies three things:
- The land that is leased
- The minerals that are being leased
- The kind of rights the production company has to make use of the land in order to produce the leased minerals.
Primary Term Clause
Most OGMLs are for a guaranteed term of three (3) years. During this Primary Term, the Lessee has no duty to produce any minerals and can still hold the lease for that period. The only payment that is guaranteed to the Lessor is the Bonus Payment.
Habendum Clause
As soon as the primary term expires, this clause controls the expiration term of the oil and gas lease, as well as how long it stays active. The secondary term is the lease term that follows the primary term. Usually, these clauses describe the secondary term. The habendum clause ensures that the lease stays in effect beyond the expiration of the primary term and into the secondary term. This remains true when the lessee produces minerals. They must also pay the lessor a form of royalty payment.
Bonus Clause
Oftentimes, OGMLs are a form of paid-up oil and gas leases. This implies that every oil and gas lease payment is prepaid via the primary term. This is also true during the execution of the lease. What the bonus indicates is the amount of cash that is paid per leased acre. This is paid as rent throughout the entirety of the primary term. Royalties are the only means through which a lessor can receive payments, besides the bonus payment.
Royalty Clause
As mentioned earlier, the royalty clause represents the only right a lessor has to receive payments, in addition to bonus payments. Royalties are estimated as a fraction of the value of all minerals produced, usually 25%. Royalties are often free of cost and expense free. This implies that the cost of production, as well as oil drilling costs, may not be deducted from the Royalty payment of the lessor.
Surrender Clause
A surrender clause represents an oil and gas lease clause that involves the lessee being granted the privilege of surrendering their rights. They can also terminate their liability based on the stipulated notice given. This is also the case when there is a payment of a certain sum of money without any of these formalities.
Continuous Development Clauses
This is a clause in an oil and gas lease that helps in keeping the gas leases active beyond the primary term. This is even so when there is no production in paying quantities if the lessee is continuing a program of drilling.
Retained Acreage Clause
This clause is often used to offer protection to the lessor’s interest. This is especially true when a lease is held in force when production is continued. They ensure that the oil and gas lease can get terminated as to any acreage not held by continuing production.
Retained acreage clauses should consists of two components:
- Limiting the amount of surface acres that can be held by a well; and
- Limiting the production depths that can be held by a well.
A good retained acreage clause must be able to restrict the acreage that is retained by an existing well. This should be limited to a determined number of acres, as determined by a formula. A difference in this formula exists between horizontal and vertical wells. It is imperative not to use regulatory field rules to establish the amount of acreage that is retained.
Another party of the retained acreage clause limits the oil and gas lease to about 100 feet before the deepest producing perforation. In addition, ensure that you obtain a shallow depth severance of 100 feet above the shallowest producing perforation.
As technology advances, mineral owners have a number of wells being re-drilled at greater depths to tap into previously unproducible formations. By obtaining this retained acreage clause, minerals owners are allowed to put up the deep rights for bid. This is true particularly anytime the new formations are detected.
Furthermore, your retained acreage clause should be drafted. This will ensure that the oil and gas lease terminates automatically for the undrilled acreage. If you are just promised by the company to get a release of the unused acreage, you should sue to get a court ruling the lease is terminated.
Cooperation and Information Clauses
There are many oil and gas companies that often treat mineral owners like a pest that needed to be handled. It is important to get information about the production of your minerals. To achieve this, a cooperation and information clause can be very helpful.
Usually, a cooperation and information clause ensures that an oil company can let you know when they want to drill. The oil and gas company also indicates when they send drilling reports as the well is being drilled. They provide log and seismic data, as well as production data before the completion of the well. These clauses also ensure that the company must respond to reasonable requests for information.
Production Minimums
To avoid a situation where an operator holds an oil and gas lease with a barely producing well, be specific that the well terminates if not producing in “paying quantities.” Better yet, if you can set production minimums, it avoids getting into an argument over whether a well is producing in paying quantities.
Volume definition clause
Typically, an oil company would define the volumes they must pay royalties on. This is done by including a clause like “produced and sold”. The substantial differences that may arise between what is produced and what gets sold – due to the compression of natural gas – make it imperative that limitation should be stricken.
Payment Time Clauses
The payment clause ensures that you can set your own payment terms. This is true as long as they follow all the principles of contract law. A payment terms clause provides clarity over what should happen if, for instance, one of the parties fails to settle their bill. Payment time clauses establish policies that concern some important points:
- Accepted payment methods
- When a party is expected to pay
- How disputes will be handled
- Cancellations and subscriptions
Price Clause
This clause will help restrict a company from colluding with a subsidiary company to pay a low price. These restrictions are placed on the price. This ensures that the price established is not determined solely by the sentiments of the company. Usually, mineral owners will want the best available market value as a form of a backstop. This is done in case the price that is actually paid is lower than the market value.
Entireties clause
An entireties clause is a crucial provision in oil and gas leases that keeps the lease intact, covering the entire leased premises even if ownership changes through sale or division. It safeguards both the lessee’s rights to continue operations and the lessor’s entitlement to royalty payments, making it essential for smooth leasing relations.
Limiting Deductions
Mineral owners must define the allowable deductions from the volume produced. They must also provide safeguards. This will enable requests for information rights. By leaving it unchecked, the company will list a great number of allowable deductions. This can significantly dilute the amount of royalty received. A cost-free royalty is the best option.
Natural Gas Liquids
This represents one of the most valuable parts of production. Their prices are often higher than those of natural gas or dry gas. In the royalty clause, a distinction should be made. This will help you obtain a royalty, which depends on the price of the natural gas liquids.
Surface Damage Clauses
If you also own the surface of the property, it is important to negotiate surface damage clauses to protect from unwarranted development.
- Defining the quality of roads and maintenance responsibilities;
- Defining the how, when, and where of access issues, especially after the initial drilling is completed;
- Defining what water can be used, and how much is to be paid for it.
- Defining clean-up obligations after well production is stopped.
Pugh Clause
A pugh clause prevents a lessee from declaring all pieces of land under an oil and gas lease. This is true even if production is only on a percentage of the property. A lessor might have a huge amount of acreage under a lease. This could eventually get tied up by an oil and gas lease contract, which is beyond the initial oil and gas lease dates. They might become unable to provide these lands for lease to another party.
Vertical Pugh Clause
This clause provides a lease to a specific depth. For this instance, 100 feet below the drilled well implies that the lessee is restricted to drilling to 100 feet. This should not go any further.
Horizontal Pugh Clause
This clause covers acreage horizontally across the property.
Dry-hole clause
A dry-hole clause is a provision commonly found in oil and gas leases. It addresses the situation where drilling for oil or gas does not yield any productive results. Here are some applications of a dry hole clause:
- Financial Protection: The clause allows the lessee to be released from further obligations if the drilling results in a non-productive well.
- Cost Allocation: It specifies how costs associated with drilling and exploration are distributed among the parties involved.
- Extension Options: It may grant the lessee the option to extend the lease term or relinquish the acreage after drilling a dry hole.
- Remedial Actions: It outlines potential remedies or additional exploration obligations in the event of a dry hole.
- Termination Rights: It provides termination rights for the lessor if the lessee fails to drill a productive well within a specified timeframe.
Pooling Clause
Pooling clause is generally present in all company lease forms. It enables the company to combine all or a part of the leased acreage with another land for development purposes.
Shut-in Clause
The shut-in clause ensures that the lease can stay in effect. This is especially true anytime oil or gas is not produced from a well that is physically able to produce in paying quantities. Oftentimes, gas wells get shut in after initial drilling is complete. This is also the case during their producing life, owing to seasonal demand for natural gas. Typically, the shut-in clause offers the payment of a “shut-in royalty”.
Force Majeure clause
This enables an oil and gas company to save a lease anytime it is unable to do so. This can be due to any reasons beyond the control of the company. These clauses must be reviewed carefully. This will assure that it will not operate just for the company’s convenience. This clause should only perpetuate an oil and gas lease when it is impossible to save the lease in another fashion. This force majeure event should not be due to the company’s negligence or failure to abide by lawful government regulations.
Surrender Clause
This is a clause that ensures that parties embrace acreage in the area of mutual interest. Any of the parties must not surrender this acreage in part or in whole unless there is consent from all parties to surrender.
Operations Clause
This clause extends the lease. This is true as long as the company participates in operations for drilling a well. Oftentimes, it is initiated when the company participates in such operations towards the end of the primary term. However, the clause may save a lease that ceases operation. Many modern leases provide that the lease is saved by continuous drilling – be it on a single well or a series of wells.
Confidentiality clause
This clause is a part of an agreement that ensures that the parties involved will not give away any information to other parties. In other words, the agreement bars any parties of an agreement from disclosing details to an external party.
Assignment clause
This clause ensures that all parties abide by common industry practices. For instance, in the oil and gas industry, independent landmen can lease a large area. They can sell this to an oil and gas company.
What other clauses should be considered?
Some clauses that can be considered include:
Audit clause
An audit clause allows the royalty owner to obtain information from the oil and gas company in order to check its royalty statements to confirm whether the royalties are being paid in accordance with the lease.
Depth Clauses
This clause will release specific formations or deep rights on lands covered by the lease back to you after the primary term of your oil and gas lease has expired.
Additional Compensation
In addition to the royalty and bonus, the landowner may also be able to obtain other compensation. For example, compensation for each well that is placed on a wellpad may be negotiated.
Access
Just as the location of operations can be negotiated and limited, access to the leased premises can also be negotiated and limited. If it is not, access can be from anywhere.
Facilities and Equipment on the Leased Premises
There may be facilities and equipment that the landowner may not want on the leased premises.
Water
There may be water or water sources on the leased premises that must be protected.
Reclamation
The landowner can rely on state reclamation requirements if enacted, in order to reclaim the site upon completion of operations or the landowner may wish to negotiate a reclamation clause.
Insurance
There should be a clause in the oil and gas lease that requires that the oil and gas company have insurance to cover its operations, activities, etc.
Other clauses worth mentioning include an extension of term clause and location of operations.
Why are clauses important?
A critical part of any lease is a clear understanding of each clause. With clauses, you can avoid misunderstandings and any legal problems that may occur.
Conclusion
The aforementioned points are the starting points when it comes to negotiating an oil and gas lease. By learning about these clauses, you can prevent any form of misunderstandings or legal issues from occuring.
[…] like many oil and gas clauses, a Pugh clause has no industry standard for it. The clauses are specifically written with respect […]
Absolutely informative article!