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Oil and gas lease clauses are very important in negotiating a lease. Negotiations can be tricky and have long-lasting consequences for your land and how much you receive in royalties. What gets negotiated in an oil and gas lease? Everything. However, “everything” is the stuff of legal treatises, not blog posts. Rather than try to cover everything in a short article, here are ten clauses you should try to negotiate into your next lease.
If you are leasing acreage that has spacing for more than one well, you should have a continuous development clause in your lease. These clauses require the oil company to continue to drill on your acreage in order to hold the entire acreage under the lease. In conjunction with a retained acreage clause, these can help in keeping the company from developing your property too slowly.
A continuous development clause requires the company to start the next well within a reasonable period of time after the prior well is finished. It has the effect of extending the entire lease as long as the property is being continuously developed. The typical timeframe negotiated from the completion of the prior well to the beginning of the next well is usually 30-180 days. If the company does not start the next well within this time frame, then the lease terminates for the acreage that is not being held by existing production.
In conjunction with the continuous development clause, you should also define how much acreage a single well can hold if the company stops drilling new wells. Retained acreage clauses have two components:
1. Limiting the amount of surface acres that can be held by a well; and,
2. Limiting the production depths that can be held by a well.
A well-drafted retained acreage clause should limit the acreage being retained by the existing well to a set number of acres, or the minimum size required by the Texas Railroad Commission, whichever is less. The clause should also take into consideration this usually differs between vertical wells and horizontal wells.
The second part of the retained acreage clause should limit the lease to one hundred feet below the deepest producing formation in a well. With advances in technology, especially in the shale plays, mineral owners are seeing a number of wells being re-drilled at greater depths to tap into previously unproducible formations. Having this retained acreage clause will allow the mineral owner to put up the “deep rights” for bid when these new formations are discovered or become feasible to drill.
Finally, your retained acreage clause should be drafted so that the lease terminates automatically for the undrilled acreage. If the company merely promises to give you a release of the unused acreage, you may have to sue to get a court ruling the lease is terminated, unless the lease specifically says it terminates.
It is surprising the number of companies that take an adversarial view of mineral owners, treating them as a pest to be dealt with. When it comes to getting information about the production on your minerals, a cooperation and information clause can be very helpful.
Generally, a cooperation and information clause should require the company to let you know when they plan to drill, send drilling reports while the well is being drilled, provide log and seismic data, production data as the well is being completed, and require the company to respond to reasonable requests for information. Even if you trust the company you are leasing to, leases get sold so frequently that these clauses should be included in the lease to protect the mineral owner.
Along with the bonus rate, the royalty fraction is the most negotiated portion of the lease. However, just negotiating the highest percentage royalty is not the end of the issue. Variable royalties can be negotiated, tied to well performance or a drilling timeline, or if the mineral owner is providing an existing well bore for the new company to use. For example, an escalating royalty clause based on drilling time can give the company a strong incentive to develop the property quickly.
Under Texas law, the first payment from a new well does not have to be made until 120 days after the end of the month of the first sale of production, and 60 days thereafter for oil, and 90 days thereafter for gas. As a lessor, you should try to negotiate shorter time frames, particularly for the first payment. In addition, penalty clauses for late payments should be negotiated into the lease.
Companies typically try to define what volumes they have to pay royalties on by adding a clause such as “produced and sold”. This limitation should be stricken, if possible, because there can be substantial differences in what is produced and what eventually gets sold due to compression of natural gas. A proper volume definition may differentiate between oil and gas production because gas losses are more common due to compression and evaporation issues.
To limit a company from possibly colluding to pay a low price with a subsidiary, sister company, or as a trade-out with another company, limitations should be placed on the price to be obtained so the price does not get determined solely at the whim of the company. Generally, mineral owners want a “market value” or “best available” definition of price inserted.
A mineral owner should also define what deductions are allowable from the volume produced. It is also important to provide safeguards, if deductions are allowed, to allow requests for information or audit rights. If left unchecked, the company will list a large number of allowable deductions which can greatly dilute the royalty received.
One of the most valuable parts of production can be natural gas liquids. These liquids usually bring a substantially higher price than natural gas or “dry” gas. The royalty clause should differentiate so you get a royalty based on the price for natural gas liquids.
If you also own the surface of the property, it is important to negotiate surface damage clauses to protect from unwarranted development. Surface damage clauses should cover:
1. Spacing requirements and prohibited areas around houses, pens, high-fenced wildlife areas, and other areas where the surface owner does not want oil and gas development activities;
2. Defining the quality of roads and maintenance responsibilities;
3. Defining the how, when, and where of access issues, especially after the initial drilling is completed;
4. Defining what water can be used, and how much is to be paid for it; and,
5. Defining clean-up obligations after well production is stopped.
These ten points are only a starting point and do not begin to encompass all of the potential points of negotiation of an oil and gas lease. However, they should be covered as part of the “deal points” when negotiating a lease.
G. Wade Caldwell
A managing member of Barton, East & Caldwell, P.L.L.C., a San Antonio-based firm which represents mineral owners and provides a wide variety of legal services.