CHAPTER 5 CONTINUING THE LEASE: SUBSTITUTES FOR PRODUCTION AND THE MEANING OF CONTINUOUS OPERATIONS

• Jurisdiction: United States

Drafting and Negotiating the Modern Oil and Gas Lease
(May 2018)
CHAPTER 5
CONTINUING THE LEASE: SUBSTITUTES FOR PRODUCTION AND THE MEANING OF CONTINUOUS OPERATIONS
Allen D. Cummings
Law Offices of Allen D. Cummings
Austin, TX

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ALLEN D. CUMMINGS is a solo practitioner with offices in Austin, Texas. He received his J.D. from the Dedman School of Law, Southern Methodist University in Dallas, Texas (1974) and is a member of the Order of the Coif. He concentrates his practice in oil and gas title examination, oil and gas transactions, and oil and gas arbitration and mediation. He has practiced law in the energy area, in both corporate legal departments and in private practice, since 1975, and has been Board Certified in Oil Gas & Mineral Law by the Texas Board of Legal Specialization since 1986. Mr. Cummings has presented numerous papers on oil and gas matters at annual and special institutes and continuing education seminars sponsored by the Rocky Mountain Mineral Law Foundation, the Oil, Gas and Energy Resources Law Section of the State Bar of Texas, the University of Texas, the American and Houston Associations of Professional Landmen, and similar organizations. He is a member of the State Bar of Texas Pattern Jury Charge Oil and Gas Committee and the Texas Board of Legal Specialization Oil, Gas and Mineral Law Exam Commission. He is a past Chair of the Oil, Gas and Energy Resources Law Section of the State Bar of Texas.

An oil and gas lease will most often terminate, according to its habendum clause, unless oil or gas is being produced on or before the expiration of the primary term to perpetuate the lease into its secondary term and oil or gas is continuously produced during the secondary term. There are of course habendum clauses favored by lessees in which the lease is perpetuated beyond the primary term by "operations as defined herein"¹ However, there are often circumstances where, notwithstanding the good faith efforts of the lessee, oil or gas is not being produced at or before the end of the primary term or oil or gas is not continuously produced during the secondary term. For example:

(1) lessee completes a well as capable of producing oil and substantial casinghead gas or only gas, the day before expiration of the primary term, but there are not any pipeline connections in the vicinity of the well to take the gas;

(2) the drilling rig suffers a casualty during the drilling of a well at or near the expiration of the primary term and ten days are required before normal drilling operations can be resumed;

(3) a horizontal shale well is drilled to the terminus, but no fracing services are immediately available;

(4) a well producing oil or gas during the secondary term suddenly stops producing due to a downhole failure;

(5) a well is completed as a dry hole 30 days prior to the expiration of the primary term and it will take several weeks to obtain another drilling rig and build location; or

(6) fracing operations on a well are in progress, but have to be temporarily abandoned because of Category 4 Hurricane Harvey;

There are any number of other conditions which could cause an oil and gas lease to terminate, or be subject to termination, because oil and/or gas is not being produced, unless the lease contains provisions which will perpetuate the lease into and during the secondary term even if oil and/or gas are not being produced - in other words what are commonly called "savings clauses." Savings clauses are provisions of an oil and gas lease that act as substitutes for production to perpetuate the oil and gas lease if complied with by the lessee.

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This paper will discuss the elements to consider in drafting and negotiating the following Savings Clauses:

(a) Dry Hole, Cessation of Production and Drilling Operations Clause

(b) Shut-in Royalty Clause

(c) Force Majeure Clause

This paper includes several examples for each of these clauses without recommending any of them, in order show how different scriveners have approached the issues and to illustrate the elements to consider in drafting and negotiating these Savings Clauses. It is clear from the examples there is not any uniform way to draft the Savings Clauses. The goal of this paper is to provide the scrivener with tools to be able to draft savings clauses that will not require reliance on case law or construction by the court to determine the result on competing claims for preservation or not of the lease, but rather that the facts as determined by the court or the jury will determine the result.

Dry Hole, Cessation of Production and Drilling Operations Clauses

Before dry hole, cessation of production and drilling operations clauses were routinely included in oil and gas leases, lessees relied to the temporary cessation doctrine to perpetuate an oil and gas lease in the absence of production after the expiration of the primary term.

Unlike the shut-in royalty clause and the force majeure clause, the dry hole, cessation of production and drilling operations clause requires the lessee to undertake operations to perpetuate the lease in the absence of production. Initially the dry hole, cessation of production and drilling operations provisions were included in single lease paragraph. For the sake of brevity, we refer to the dry hole, cessation of production and drilling operations provisions as the "operations clause." The operations clause is focused only on actions required of the lessee at or after the expiration of the primary term, because normally no action is required of lessee during the primary, except perhaps the payment of delay rentals. However, with the advent of 3-year term leases, often with an option to extend the primary term to 5 years by payment of additional bonus, most leases are now "paid up" leases without any delay rental provision.

An operations clause allows the lessee to continue the lease in effect past the expiration of the primary term in the absence of production by timely commencing and continuing the operations specified without interruption for more than a specified interval until production is obtained. However, if the lessee had drilled a dry hole within some stipulated time before the expiration of the primary term, then the operations clause allows the lessee additional time to commence operations to restore or obtain production. In addition, if production ceases during the secondary term, the operations clause continues the lease in effect without production so long as the lessee commences the specified operations on or before the expiration of the time provided in the lease. The cessation of production portion of the operations clause relieves the lessee of the need to rely upon the temporary cessation doctrine to perpetuate the lease.

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The following is an example of an operations clause contained in a Pound Printing printed form lease.

Example No. 1:

If at the expiration of the primary term, oil, gas, or other mineral is not being produced on said land or on land pooled therewith, but Lessee is then engaged in drilling or reworking operations thereon, or shall have completed a dry hole thereon within 60 days prior to the end of the primary term, then lease shall remain in force so long as operations on said well or for drilling or reworking of any additional well are prosecuted with no cessation of more than 60 consecutive days, and if they result in the production of oil, gas, or other mineral, so long thereafter as oil, gas, or other mineral is produced from said land or from land pooled therewith. If, after the expiration of the primary term of this lease and after oil, gas, or other mineral is produced from said land, or from land pooled therewith, the production should cease from any cause, this lease shall not terminate if Lessee commences operations for drilling or reworking within 60 days after the cessation of production, but shall remain in force and effect so long as such operations are prosecuted with no cessation of more than 60 consecutive days, and if they result in production of oil, gas, or other mineral, so long thereafter as oil, gas, or other mineral is produced from said land or land pooled therewith.

Example No. 1A: Compare Example No1 with a very brief operations clause found in a North Dakota lease:

Notwithstanding anything in this lease contained to the contrary, it is expressly agreed that if Lessee shall commence operations for drilling at any time while this lease is in force, this lease shall remain in force and its terms shall continue so long as operations are continuously prosecuted and, if production results therefrom, then as long as production continues. As used in this lease continuously prosecuted shall mean that not more than 30 days shall elapse without operations on any well or that not more than (90) days shall elapse between the completion or abandonment of one well and the beginning of operations for the drilling of a subsequent well ²

While not as detailed as Example #1 and there is no mention of a dry hole, the court in Tank noted that but for the Pugh clause in the Lease, this clause would be sufficient to perpetuate the lease as to all lands so long as there was drilling or production.

Under the simple operations clauses set forth above, the lease is preserved as to all of the leased premises so long as the lessee complies with the drilling or reworking requirements of the clause and those operation result in production in paying quantities. These simple operations clauses were intended to benefit the lessee. What has developed is an operations clause that addresses not only the lack of production at the expiration of the primary term and the cessation of production during the secondary term, but may also include a continuous drilling obligation to extend the lease as to all lands only so long as the lessee conducts continuous drilling operations. It is now common for leases to...