CHAPTER 13 NEGOTIATING THE OIL AND GAS LEASE
| Jurisdiction | United States |
(May 2018)
NEGOTIATING THE OIL AND GAS LEASE
McClure & Cross LLP
Dallas, TX
John B. McFarland
Graves, Dougherty, Hearon & Moody, P.C.
Austin, TX 1
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TERRY CROSS is a founding partner of McClure & Cross LLP, established in 2008, and practices in the Dallas office of that firm. He has 40 years' experience in providing legal counsel to the oil and gas industry as in-house counsel in a major oil company, partner in a large law firm energy practice and now in the boutique oil and gas firm of McClure & Cross. He is licensed in North Dakota and Texas and board certified in Oil, Gas and Mineral Law by the Board of Specialization of the State Bar of Texas. He regularly teaches Texas Land Titles as Adjunct Professor at SMU Dedman School of Law and is a frequent speaker and author on energy finance, oil and gas law and industry contracts. He is a member of the joint editorial board for the development of title examination standards established by the Real Property, Probate and Trust Law and Oil, Gas and Energy Resources Sections of the State Bar of Texas. Cross was selected for the 24th Edition of The Best Lawyers in America in Energy and Natural Resources Law and named the Best Lawyers® "Lawyer of the Year" in Natural Resources Law for Dallas/ Fort Worth for 2018. His recent papers and presentations include:
JOHN B. MCFARLAND, is a Shareholder with the firm of Graves, Dougherty, Hearon & Moody, P.C., in Austin, TX. Mr. McFarland represents land and mineral owners in oil, gas and mineral law, water law, and environmental law issues, in both transactional and litigation matters. He obtained Board Certification as a Specialist in Oil, Gas and Mineral Law in December 1986. Mr. McFarland is the author of the Oil and Gas Lawyer Blog. Professional Qualifications: Admitted to bar, 1975, Texas. Board Certified, Oil, Gas and Mineral Law, Texas Board of Legal Specialization. Briefing Attorney to the Honorable Ruel C. Walker and to the Honorable Ross E. Doughty, Supreme Court of Texas, 1975-1976. Education: Yale University (B.A., cum laude, 1972); University of Texas (J.D., 1975).
I. Introduction
A. Lessee Perspective 2
Oil and gas leases are negotiable. They are and always have been, but the scope of those negotiations has changed dramatically from when mineral owners assumed that the Producers 88 form,3 with its 1/8 royalty fraction, presented by the lessee was "standard" and the only negotiations were likely over the bonus. A lessor who held out until the neighbors were all signed up might have gotten a few extra dollars as bonus in the leasing transaction but rarely would have aspired to rewrite or add to the basic provisions of the standard form. Today, negotiations are the norm for not only the financial terms (bonus, royalty fraction, shut-in payments, surface damages, etc.) but also for the operative language used throughout the lease. Sophisticated lessors have their own lease forms and even the owners of small tracts develop detailed requests, often in the form of an addendum to the lessee's form, for new provisions and modifications of the boilerplate provisions.
What Issues Drive Lessees?
Operating Profit-There are overt negotiations on money issues when the deal is struck on the bonus amount and in filling in the blanks on delay rental amounts (if any), shut-in payments and surface damages. In the current climate, the dollars and cents issues imbedded in the royalty computation provisions are only slightly less conspicuous than those associated with filling in those blanks with dollar signs beside them. All of these issues are transparently "zero sum" negotiations. Whatever is "won" by one of the parties is "lost" by the other.
Holding Reserves - The Producers 88 form allowed a single producing well to hold all land and depths covered by that lease indefinitely, subject only to the implied covenant to reasonably develop the known reserves under the land. The ability of the lessee to control "proved undeveloped" and even less certain reserves for long periods of time is often limited in modern leases by "retained acreage" provisions that require earlier development than would any implied covenant. The details of the lease language that control how fast the lessee must develop and how much acreage and depths are held by each well directly affect the value of each lease. The lessee will guard against lease provisions that allow a lease termination for any reason other than the lack of actual or constructive production. Thus, predictable and reliable "savings provisions" that prevent a precipitous termination of the lease are important in preserving control
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of the reserves. Likewise, the lessee will resist provisions that allow lease termination as a result of what have been historically treated as breaches of covenants, eg., late or short paid royalty.
Liquidity of Assets - While the lease form has been mutating, so have the business plans of producers. The companies that developed the Producers 88 were generally of the "drill, hold and deplete" mentality, but nevertheless the rights of the lessee were freely transferable. Today, producers are more likely to be funded by stakeholders who expect a payday within 3 to 5 years, which can only be accomplished with a sale.4 Restraints on alienation will frustrate these scheduled exit plans.
Uniformity in Lease Provisions - There are commercial, profit and loss, issues in every lease provision, but there is also commercial value to the lessee in having uniformity of lease forms throughout its lease inventory. Uniformity in lease provisions facilitates compliance with and proper administration of the leases. In particular, "one off" royalty calculations, shut-in royalty provisions and pooling authorizations are anathema to claims free lease administration. Absolute uniformity is unattainable, but increments matter. There is a big difference between allowing negotiated changes to the lessee's form (with the variations that result) and negotiating from a form tendered by the lessor. The lessor generated form will most likely be unique, not in concept but in key language components, with respect to many of the provisions that determine lease termination and exposure for damages.
Obviously, lessees take leases without negotiations on the forms promulgated by governmental entities, and that fact alone means that there will not be uniformity in the lease forms covering any significant block of acreage. The provisions of these "government forms" are generally well known and tested so that the "gotcha" threat is minimal. The typewritten forms from lessors may also be comprehensive and well written, but not all are.
An additional historical benefit, arguably to both lessors and lessees, of industry-wide use of standard forms is the case law construing the form that brought certainty to the meaning and effect of its component provisions. Finally, uniformity among the various leases that comprise sales packages adds value when it is time to market those assets. The inability to assume homogeneity among the lease forms that comprise a sales package requires due diligence, often line by line within the leases, by the buyer to confirm the most fundamental components of those leases.
B. Lessor Perspective
The movement away from the "standard" Producer's 88 lease form is not new, and it has many causes. First, there has never been a standard Producer's 88 lease form. For many years the most common forms were those published by Pound Printing & Stationery Company. There were several Pound forms, and those forms changed over time. The forms were written by exploration companies and the lawyers representing them. As landowners learned of the shortcomings of those forms from a landowner's perspective, they and their counsel developed "riders" used to ameliorate the most lessee-friendly provisions of the printed form, such as the Pugh clause and restrictions on pooling. Riders also addressed issues relating to surface operations, not addressed at all in the Pound form.
Landowners with large holdings have negotiated non-standard lease agreements since the beginning of oil and gas exploration. Far more detailed than a "standard" oil company form, these leases
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contain detailed provisions for exploration and development, measurement of production, accounting for royalties, use of the surface, compliance with laws and regulations, indemnities, insurance, etc.
Over the last 25 years, oil companies have developed their own "standard" lease forms. Bank trust departments have their "standard" lease forms. With the recent acquisitions of minerals by large well-funded mineral buyers, mineral acquisition companies now have their "standard" form.
It is true that "standard" lease forms make administration of large lease blocks easier. Such leases can be treated as a commodity asset and traded among producers as such. But I disagree that these advantages outweigh gains to the lessor from using non-standard lease forms. A lease is a contract. A well-constructed lease, negotiated between parties who understand the industry and their relative bargaining power, allocates the risks and benefits between the parties. Each party then receives what it bargained for. While landowners must understand the lessee's need for some uniformity in lease terms, a well-crafted lease balances that need against the individual landowner's goal of maximizing the benefit of its mineral estate. Because Texas has only very limited forced pooling, landowners in Texas have the greatest freedom of any state to negotiate lease terms to their liking. Texas nevertheless is and has been the most successful of any state in developing its privately owned oil and gas resources. And, although I don't have statistics to prove it, I believe that Texas landowners receive a larger share of...
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