THE BLOG
01/24/2017 03:17 pm ET Updated Jan 25, 2018

A Legal Introduction to an Oil and Gas Production Lease

The document that allows a petroleum company to drill for petroleum is called an "Oil, Gas, and Mineral Lease" (OGL). This comment briefly introduces some of its features. Always consult an experienced attorney in all petroleum and mineral matters.

The classic form was called a "Producers 88." A widely circulated story is that the name came from an early printing shop cataloging system. While any form has numerous variations, investors and others liked the certainty of a "standard" form and for many years would insist that the transaction be documented on a Standard Producers 88.

In fact, the drilling rights secured are not, in spite of the vocabulary, a "lease" but a "fee simple determinable." English real estate vocabulary standardized in the 1600s and hence sounds archaic. A fee simple determinable is an ownership interest in land that may revert back to the grantor (seller) if specified events occur. State law controls the precise rights granted by the "lease" and the requirements to keep it in force.

The following is a brief overview of the likely provisions in a typical classical OGL:

Granting Clause

This provision identifies the parties and their U.S. mail addresses and contains a statement of some money paid (consideration, called "bonus") although this may not be the exact sum paid in a non-disclosure state. Bonus is negotiable. The words "grant," "lease," or "convey" typically appear followed by language granting an exclusive right to explore, drill, mine, or operate for oil and gas and related hydrocarbons together with a right to install necessary pipelines, roads, etc. A stated effective date is legally important in establishing priority and other obligations that occur on this anniversary date.

Note that a reference to "oil, gas, and other minerals" may result in potential litigation involving surface destruction as might occur with coal or limestone mining. Since mineral and surface ownership may be divided, best practice is to carefully review and specify the described minerals and multiple allowable activities. In general, a mineral owner is allowed to utilize a reasonable amount of the surface in order to extract the minerals. Drilling operators tend to like broad provisions.

A legal description of the property that a licensed surveyor may follow is essential. A number of acres may be specified that helps fix required payments and the sharing of proceeds from production pooling. A so-called "Mother Hubbard Clause" after the legal description includes adjacent, contiguous, or adjoining land in an attempt to prevent small strips of land not being included in the lease.

Habendum Clause

The phrase "as long as," or "for so long as," etc. appears and when the described event ceases, the interest granted to the petroleum company automatically reverts to the original owner (grantor). A "primary term" in months or years is specified and thereafter as long as "production" or pooling occurs with perhaps an allowable 90 days of cessation. The meaning of the word "production" has been litigated and is typically understood to mean "production in paying quantities," that is to say, profitable. Lack of a market, as might occur without gas pipelines, is not an excuse or exception to the production requirement, unless specified otherwise. Courts also distinguish "conditions" that automatically terminate the lease from "covenants" that allow a legal remedy for breach of contract but do not terminate the lease. Carefully review the language in the document and amend as appropriate.

Royalty Clause

This specifies the payment to the mineral owner as production occurs. The term "royalty" goes back to English history when payments were made to the King or Queen who owned all the land and minerals. There may be one payment specified for oil, another for gas, and a third for other minerals. A "minimum royalty" may be specified and payments specified for shut-in wells (a well not producing due to market, transportation or reservoir pressure considerations). The traditional oil royalty was 1/8 - the petroleum company receives seven barrels and the mineral owner receives one. All terms are negotiable unless some legislative restriction applies to publically owned lands. Suffice it to say, there are numerous forms of royalty and royalty language, as well as methods of calculating royalty (particularly considering allowable expense deductions). Royalty language must be reviewed by an experienced attorney before any document is signed. Millions of dollars may be at stake.

Pooling Clause

This provision typically broadly allows the petroleum company to unilaterally combine various leases into production units (pools) and maintain ownership without production actually occurring in a particular well as long as operations are occurring somewhere in the pool. A "Pugh Clause" (sometimes called a "Freestone Rider Clause") releases land either not included within a pool or otherwise produced upon or within specified depths or geological formations. The production monies from pooling is typically divided on an acreage allocation basis. Pooling typically allows more efficient production of a greater quantity of petroleum and maintains reservoir pressure.

Delay Rental

This provision provides for a payment after a specified period to delay the obligation to drill and produce. The time frames and dollar amounts are negotiable and the time tends to be shorter than was true historically. At one time a ten-year pre-payment period was commonplace and today periods of one year or less are not infrequent. The delay rental money today is often pre-paid in advance so as to create a "paid up" OGL since a failure to pay the correct persons on-time voids the lease under the "unless" model frequently encountered in Texas. However, an "or" model found in California only provides a right to sue and does not void the lease. The amount to be paid is typically on a per-acre basis.

Dry Hole and Operations Clause

Preparing to drill before the end of the primary term extends the lease; however, how much activity is necessary is litigated. A typical 60 or 90-day time frame for new drilling or reworking of a dry hole is stated in this clause. A "good faith" operational standard is often applied by courts.

Right to Remove Fixtures and Limit of Locations

This allows the petroleum company to remove equipment, pipe, etc. and often states that drilling locations must be more than 200 feet from a residence or barn. Well casing typically may not be removed when removal would damage the well or subsurface water, etc. Many OGLs expand this provision with attached additional provisions where roads, gates, cattle guards, etc. are addressed.

Assignment Clause

This prevents OGL termination if the petroleum company makes payments to those it believes to be the correct owners and requires that recorded documentation be furnished if ownership changes. A mineral owner could insert anti-assignment language to prevent transfers without her or his written consent. This might keep a promising area from being acquired surreptitiously by a major company without renegotiation.

Warranty and Subrogation Clause

The mineral owner asserts by warranty that he or she has good title: however, this language might be eliminated as the petroleum company likely knows more about the title than the owner. Furthermore, the petroleum company may pay taxes, mortgages, or other liens and deduct these amounts from monies due ("subrogation"). All outstanding royalty interest owners may be paid by the petroleum company out of the negotiated royalty.

Force Majeure

Force majeure literally means "superior force" - overriding events, such as storms, beyond the control of a party. These are described events that excuse or delay performance. In general, the events must be outside of the control of the petroleum company. Courts tend to strictly interpret the precise language utilized.

Supplemental Provisions

Many items may be included such as surface use and restoration, water usage, saltwater disposal, insurance, etc. Note that in the absence of an agreement, there is no duty to restore the surface. Carefully consider how restoration will be funded in the event of abandonment or bankruptcy. Perhaps a cash advance placed in an appropriate, and otherwise inaccessible, trust fund is desirable. Carefully crafted language about covered applicable production zones and depths must also be considered. The entire subsurface need not be leased in a single document. Be thoughtful and creative in including supplemental provisions.

This comment provides a brief and incomplete educational overview of a complex subject and is not intended to provide legal advice. Always consult an experienced attorney in specific petroleum and mineral situations.