CHAPTER 4 EXTENDED OIL & GAS LEASES: AND SO LONG THEREAFTER... HAPPILY EVER AFTER?
| Jurisdiction | United States |
(Jan 2014)
EXTENDED OIL & GAS LEASES: AND SO LONG THEREAFTER... HAPPILY EVER AFTER?
Poulson, Odell & Peterson, LLC
Denver, Colorado
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ESTEE A. SANCHEZ is a partner at Poulson, Odell & Peterson, LLC in Denver, Colorado. Ms. Sanchez represents oil and gas companies in all phases of acquisition, development, and operation of oil and gas properties. Her oil and gas title examination practice focuses on the preparation of comprehensive acquisition, drilling, and division order title opinions for fee, state, federal, and Indian lands throughout the Rocky Mountain Region. Ms. Sanchez earned her B.A. degree in Psychology, with honors, with double minors in Philosophy and Business Administration, from the University of Denver in 1994 and her J.D. degree from the University of Denver College of Law in 2000. Ms. Sanchez is admitted to practice in Colorado, Kansas, Nebraska, North Dakota, and Wyoming, and before the United States Court of Appeals for the Tenth Circuit. Ms. Sanchez is the updating author for the Chapter on Royalties in the Law of Federal Oil and Gas Leasing, the updating author for the chapter on Oil & Gas in the Colorado Bar Association's Annual Survey of Colorado Law, and has written articles for the Rocky Mountain Landman. Ms. Sanchez is a member of the American, Colorado, Kansas, Nebraska, North Dakota, Wyoming, and Denver Bar Associations; the Natural Resources & Energy Law Section of the Colorado Bar Association; the Rocky Mountain Mineral Law Foundation; the Denver Association of Petroleum Landmen; and the Denver Association of Oil and Gas Title Lawyers.
Introduction
One of the essential elements of title examination is reviewing the provisions of the oil and gas lease covering the subject lands and determining the status of the lease. Is the lease still within its primary term? Have the terms of the lease been satisfied for a valid extension into the secondary term? Is there any curative necessary relating to the lease and the aforementioned questions? This paper will examine the typical lease clauses providing for extension of the oil and gas lease, the case law interpreting such clauses in the Rocky Mountain region and the implied covenants and statutes pertaining to lease extension. Although the primary focus is on fee leases, the means by which federal oil and gas leases can be extended also will be addressed.
The Oil and Gas Lease
At the core of the exploration and production side of the oil and gas industry is the oil and gas lease. The oil and gas lease has a long, colorful history. The first commercial well was drilled in the United States under the terms of a lease dated December 30, 1857.1 Since that time, mineral owners and lessees alike have been modifying, rewriting and amending oil and gas leases to address their rights and obligations and to attempt to encompass drilling and exploration operations. The primary objective of the lessor is to be compensated for the oil and gas produced from the lands covered by the lease, or, when oil and gas is not being produced, to be compensated for the privilege of deferring the operations that would lead to production, and to receive such compensation within a relatively short period of time after execution of the lease. On the other hand, the objective of the lessee is to secure leasehold coverage for a small capital investment and hold the lease for exploration operations as long as possible. The oil and gas lease is comprised of express and implied covenants that endeavor to address both sets of goals while protecting the interests of the lessor and lessee and defining the means by which operations will be conducted. However, the often divergent goals of the lessor and lessee have led to litigation, legislation and the hundreds of lease forms in use today. Any discussion about the evolution of oil and gas leases would be incomplete without mention of the infamous, standard "Producers 88" lease. While there was, at one time, a "Producers Special" form run off by an Oklahoma printing company, which indicated
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"88" as the number of the form it was printing, there is neither any significance to the "88" nor is there any standard oil and gas lease form. This latter statement is very important to title examiners: it is imperative always to read every lease clause in its entirety. Even though it may appear to be "standardized" language, there may have been modification to the clause, or when read with other clauses in the lease, may have a different meaning or result.
Although there is not a standard oil and gas lease, most leases contain the following eight clauses that pertain to and affect lease extension:
1. Habendum clause.
2. Drilling/delay rental clause.
3. Dry hole clause.
4. Cessation of production clause.
5. Drilling operations clause or continuous drilling operations clause.
6. Shut-in royalty clause.
7. Pooling clause.
8. Force majeure clause.
Each of the aforementioned clauses will be discussed in terms of extending the oil and gas lease. Again, it is important to remember that while each clause is a separate part of the oil and gas lease, each clause can affect other clauses, and in some instances, may modify the terms of another clause.
Habendum Clause
Most current oil and gas leases contain an habendum clause, which is the clause that specifies the term of the lease and is typically comprised of a primary term for a short number of years (three to ten years), and a secondary term for so long thereafter as substances covered by the lease are produced or other qualifying operations are performed. The following are examples of habendum clauses:
It is agreed that this lease shall remain in force for a term of ten years from the date hereof and as long thereafter as oil, or gas of whatsoever nature or kind, or either of them is produced from said land or premises pooled therewith or drilling operations are continued as hereinafter provided.
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Subject to the other provisions herein contained, this lease shall remain in force for a period of five years from the date hereof herein called "primary term," and so long thereafter as leased substances or any one or more of them is being produced from said lands or any operation permitted hereunder is being conducted on said land or this lease is continued in force by reason of any of the other provisions hereof
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Subject to the other provisions herein contained, this lease shall remain in force for a term of ten years from this date (herein called "primary term") and as long thereafter as oil and gas, or either of them, is produced from the above-described lands or drilling operations are continuously prosecuted as hereinafter provided.
The primary term allows a lessee to spend a reasonable amount of time exploring, testing and drilling on the leased lands in an effort to obtain production. The secondary term then permits the lessee to realize the benefits and profits of exploration by continuing the right to produce oil and gas as long as it is profitable. However, the habendum clause is often a source of dispute between lessors and lessees as to what requirements must be fulfilled by the lessee during the primary term and what is necessary to extend a lease into the secondary term.
Historically, leases provided longer primary terms, such as ten, twenty or more years. Modern leases tend to contain much shorter primary terms, such as three or five years, so that the lessor has the opportunity to achieve quick production and the accompanying royalty payments. To prevent the lessee from merely holding the lands during the primary term, drilling and delay rental clauses require the lessee to commence operations within the first year of the lease or pay a "delay rental" for the privilege of deferring commencement of operations for one year. Failure to commence drilling operations or pay the rentals within the first year will result in termination of the lease absent extenuating circumstances. However, today many lessees negotiate "paid-up" leases that allow them to forego operations until the end of the primary term. Paid-up leases include all delay rental fees in the original lease negotiation.
Traditional oil and gas leases require the lessee to obtain production to continue a lease at the end of a primary term. However, many modern leases contain language that provides for extension of the primary term if the lessee has commenced, but not
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completed, operations by the end of the term. Example language may define a primary term for a number of years and a secondary term for "so long thereafter as oil and gas are produced from said land, or said land is developed or operated." Drilling and delay rental clauses may also be interpreted to extend a lease beyond the primary term in certain jurisdictions if operations have commenced. Additionally, parties often include continuous drilling or continuous operations clauses in leases to clear up this confusion. Absent such provisions or interpretations, a lease will automatically terminate at the end of the primary term if production is not obtained or will terminate in the secondary term if the well stops producing in paying quantities. Lessees have a strong interest in holding lands capable of production, and lessors have a strong interest in obtaining production from their mineral rights. These opposing interests often lead to disputes relating to the meaning of "production" and the meaning of "in paying quantities."
Variations of "thereafter"
The "thereafter" portion of the habendum clause provides that the lease shall be extended beyond its primary term and so long thereafter as oil or gas or either of them is produced from the lands covered by the lease. This provision can be varied as to the substances produced:
...oil, gas or other minerals
...oil, gas or other hydrocarbons...
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