CHAPTER 2 THE GRANTING CLAUSE IN THE MODERN OIL AND GAS LEASE

• Jurisdiction: United States

Drafting and Negotiating the Modern Oil and Gas Lease
(May 2018)
CHAPTER 2
THE GRANTING CLAUSE IN THE MODERN OIL AND GAS LEASE
Monika U. Ehrman ^*
University of Oklahoma College of Law
Norman, OK

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MONIKA U. EHRMAN is Associate Professor of Law and Faculty Director of the Oil & Gas, Natural Resources, and Energy Center (ONE C) at the University of Oklahoma College of Law. Her scholarly interests are in the area of oil and gas real property issues, the intersection between law and petroleum technology, and energy policy. Her courses include Oil & Gas Law, International Petroleum Transactions, Energy Negotiations, Property, and Oil & Gas Contracts. She currently teaches in the J.D. and graduate programs at OU Law and in the Executive Energy Management Program at the OU Price College of Business. Prior to teaching, she served as general counsel of a privately held oil and gas company in Dallas; senior counsel with Pioneer Natural Resources; and associate attorney at Locke Lord LLP. Her practice experience includes oil and gas litigation and energy transactional work. Before law school, Professor Ehrman worked as a petroleum engineer in the upstream, midstream, and pipeline sectors of the energy industry. In addition to her experience with the technical aspects of the industry, she also worked as an analyst in the areas of commodity risk management and energy trading. She is a Trustee for the Rocky Mountain Mineral Law Foundation and Energy & Mineral Law Foundation. She is a delegate on the Educational Advisory Board for the Association of International Petroleum Negotiators, where she is the 2018 Professor in Residence. Professor Ehrman is the faculty advisor to the Oil and Gas, Natural Resources, and Energy Journal (ONE J), published by OU Law. She received her B.Sc. in Petroleum Engineering from the University of Alberta; J.D. from SMU Dedman School of Law; and Master's in Law from Yale Law School. During law school, she was Research Assistant to Professor John Lowe at SMU and to the Yale Center for Environmental Law & Policy.

Introduction

Of all the contracts used in the oil and gas industry, none is as important as the oil and gas lease. It is the foundational instrument in oil and gas and a required prerequisite to development for those who do not own the mineral estate. Its uniqueness arises in that unlike most other oil and gas contracts, it is both a contract and a conveyance of property. Part I of this article begins with an overview of the mineral estate, the predecessor to an oil and gas lease. Part II examines theories of oil and gas rights ownership and oil and gas lease ownership. Part III provides a general overview of the oil and gas lease. Part IV reviews the granting clause, examining its rights of use and the accommodation doctrine; substances granted by the lease; lands and interests granted by the lease, which includes in gross provisions, Mother Hubbard and coverall clauses, after acquired title language, proportionate reduction clauses, subrogation clauses, and warranty clauses. Following the conclusion, an Appendix provides useful granting clause drafting examples.

I. An Overview of the Mineral Estate¹

The proverbial "bundle of sticks" is an analogy familiar to real property scholars.² The analogy compares property ownership to a bundle of sticks--that is ownership is composed of separate and individual property rights--where each "stick" represents a right or stream of benefits available to the property owner. Under the centuries-old common law ad coelum doctrine, real property contained all lands from the core of the earth to the sky. Although this "heaven-to-hell" doctrine is now limited, oil and gas law still composes that part of subsurface real property, sometimes called the mineral estate. And in oil and gas law, the mineral property bundle is composed of five essential attributes: (1) the right to develop (the right of ingress and egress), (2) the right to make decisions affecting exploration and development of the mineral estate, (3) the right to receive bonus payments, (4) the right to receive delay rentals, and (5) the right to receive royalty payments.³ The right to make decisions affecting exploration and development of the mineral estate is also called the executive right.⁴ Commonly, the executive right refers to the right to execute an oil and gas lease,⁵ which is both a contract and conveyance of the subsurface mineral estate.

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The oil and gas lease not only governs the rights and obligations between the parties; it is also a fee simple determinable. Execution of an oil and gas lease gives the lessee--the party that takes the lease--the mineral property interest in fee simple subject to the condition of continued oil and gas production. If actual or constructive production ceases, the oil and gas lease automatically terminates and the mineral estate reverts to the lessor--the party that granted the lease.

II. Theories of Oil and Gas Ownership

Characterization of the mineral estate is a unique problem in property because of the fugacious nature of oil and gas. Unlike coal and other minerals that are mined, oil and gas hydrocarbons in gaseous and liquid form may migrate within the reservoir, ignoring any artificial delineations of property estates or tracts. The application of the rule of capture is another aspect of oil and gas law that creates challenges with respect to ownership. The rule of capture, also known as the "the law of capture," modifies the common law in Del Monte Mining & Milling Co. v. Last Chance Mining & Milling Co.,⁶ which applies a type of ad coelum doctrine. Although the Del Monte case involves hard rock mining, it is a good descriptor of the doctrine, which provides: Cujus est solum, ejus est usque ad coelum et ad infernos--"to whomsoever the soil belongs, he also owns also to the sky and to the depths."⁷ To promote the doctrine of property use and thereby prevent waste of natural resources, courts adopted the rule of capture as a qualification of the ad coelum doctrine.⁸

There are two major theories of oil and gas property ownership, applying to two incidents of oil and gas interests. Beginning with a description of interests, the first interest is the oil and gas mineral estate and the second is the oil and gas lease. But this section begins with a review of the theories of oil and gas property rights ownership.

A. Theories of Oil and Gas Property Rights Ownership

The major theories of oil and gas property ownership are (1) ownership in place and (2) exclusive right to take.⁹ One of the founders of American oil and gas law, Eugene Kuntz of the University of Oklahoma describes this ownership categorization:¹⁰

The peculiar characteristics of oil and gas which resulted in adoption of the law of capture also produced difficulties in the adoption of a theory of ownership. Because the rights in oil and gas were subject

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to being lost by drainage from operations on other land, it was difficult to describe, in conventional property terms, the nature of the rights to the oil and gas before capture. It is in the matter of description that theories differ. While courts and commentators have devoted considerable effort toward defining and justifying the various theories of ownership, the results of cases and the general course of the substantive law of oil and gas have been such that the distinction in theories is largely one of terminology. The acceptance of any one theory may result in subsequent difficulties for a court concerned with maintaining logical consistency; but, for the most part, logical consistency has not been exalted by the courts at the expense of sacrificing reasonable and realistic results. The adoption of a theory of ownership ultimately represents little more than the selection of an acceptable method of describing ownership in the light of the law of capture.

Although there have been various efforts to classify the theories of ownership into the categories of "ownership," "nonownership" and "qualified ownership," the theories may be reduced to two fundamental theories of "ownership in place" and "exclusive right to take." For purposes of convenience, such theories may also be referred to as the "ownership" as distinguished from the "nonownership" theory, although it must not be assumed that "nonownership" means the absence of property rights.

According to the ownership-in-place theory, the landowner owns all substances, including oil and gas, which underlie his land. Such ownership is qualified, however, in the case of oil and gas, by the operation of the law of capture. If the oil and gas depart from beneath the owned land, ownership in such substances is lost.

According to the exclusive-right-to-take theory, the landowner does not own the oil and gas which underlie his land. He merely has the exclusive right to capture such substances by operations on his land. Once reduced to dominion and control, such substances become the object of absolute ownership, but, until capture, the property right is described as an exclusive right to capture.

To the practitioner, this categorization is especially important with respect to the nature of litigation claims that may be brought and the remedies that may be pursued. In a state that follows the ownership theory, trespass claims may be brought where an opponent--the trespasser--disturbs the property right. However, in a state that follows the exclusive right to take theory, the same facts may bring an interference action--not trespass. Mostly, the difference is not substantial, but rather existential. The ownership in place states place great value upon the right of enjoyment. Legal drainage by another falls under the rule of capture and thus qualifies ownership, resulting in

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a qualified ownership in place modification.¹¹ Conversely, the exclusive right to take states place emphasis on the possibility of...