More Oil and Gas Lease Clauses

In this post, we’ll continue our overview of Oil and Gas Lease clauses. Not all of the clauses we’ll be discussing here are considered standard clauses, but may instead be negotiated and made part of an Oil and Gas Lease through an addendum. Generally speaking, if a clause found in an addendum conflicts with the terms of the lease, the additional clause will prevail. Remember that in an Oil and Gas Lease, the mineral owner is called the “Lessor” and the oil and gas company is called the “Lessee.”

For an introduction to Oil and Gas leases see our post HERE. To see more information and other Oil and Gas Lease Clauses click HERE.

Shut-In Royalty Clause

Once the lease has been perpetuated into its secondary term, the lease will expire once production ceases. But what if outside circumstances, like a market price drop, cause production to no longer be economically feasible? Enter the shut-in royalty clause: it allows an oil and gas company to shut in its well for a defined period of time in exchange for a royalty payment to the mineral interest owner, so long as the well itself is actually capable of production. Through this clause, the lease will not expire during this period of production cessation. An example of a shut-in royalty clause follows:

If a well capable of producing gas in paying quantities is complete on the above described land or acreage pooled herewith and is shut in, this lease shall continue in effect for a period of 1 year from the date such well is shut in. Lessee may thereafter pay or tender to Lessor as a royalty, on or before 1 year from the date such well is shut in, the sum of $1.00 per acre, and if such payment or tender is made, this lease shall continue in effect for a further period of 1 year.

Force Majeure Clause

A force majeure clause can also continue to hold a lease if production ceases during the secondary term. Similar to the shut-in royalty clause, a force majeure clause may be invoked when outside forces prevent the oil and gas company from producing the well. Unfavorable market conditions, however, would not trigger a force majeure clause. Events that would trigger this clause include natural disasters or “acts of God” such as floods, earthquakes, and tornados, as well as war, terrorism, or labor strikes. The following is an example of a force majeure clause:

This lease shall not be terminated nor Lessee held liable in damages if compliance with covenants in this lease is prevented or hindered by an act of God, of the public enemy, adverse field, weather or market conditions, labor disputes, inability to obtain materials in the open market or transportation thereof, inability to obtain governmental permits or approvals necessary to Lessee’s operations, such circumstances of events being hereafter referred to as “force majeure.”

No Deductions Clause

Mineral interest owners are owed a royalty payment on oil and gas production once a well has been successfully drilled. The costs associated with operating and maintaining the well are not included in the mineral interest owner’s royalty payment of production, but this payment is burdened by the costs associated with transforming the produced minerals into a marketable product ready for commercial sale. With a “no deductions” clause, however, the mineral interest owner can attempt to limit these marketability costs deduced from their royalty payment. An example of such clause may read as follows:

It is agreed between the Lessor and Lessee that, notwithstanding any language herein to the contrary, all oil, gas or other proceeds accruing to the Lessor under this lease or by state law shall be without deduction, for the cost of producing, gathering, storing, separation, treating, dehydrating, compressing, processing, transporting, and marketing the oil, gas and other products produced hereunder to transform the product into marketable form, however, Lessor’s share of any such costs which result in enhancing the value of the marketable oil, gas or other products to receive a better price may be deducted from Lessor’s share of production so long as they are based on Lessee’s actual cost of such enhancements. However, in no event shall Lessor receive a price that is less than or more than the price received by Lessee.

Extension Clause

An extension clause gives the oil and gas company the option (but not the obligation) to extend the primary term of the lease for an additional term of years. This clause can be especially useful to the oil and gas company if it was not able to drill a well during the initial primary term. In exchange for the extension of the primary term, the mineral interest owner is tendered an additional bonus payment. The following is an example of an extension clause:

Lessor and Lessee hereby agree that Lessee shall have the option to extend the primary term of this lease for an additional 2 years from the effective date of this lease, by tendering to Lessor a payment equal to the per acre price paid to Lessor under the original terms of this lease times the net acres actually owned by Lessors on the date the option is exercised. Payment shall be deemed made upon Lessee’s tendering of such payment by certified mail to Lessor at Lessor’s address shown on this lease on or before the expiration of the primary term hereon. Nothing contained herein nor any separate implied agreement between the parties shall serve to bind Lessee to exercise this option and it shall be at Lessee’s sole discretion to do so.

Depth Limitation Clause

When an oil and gas company drills a well, it will produce oil and gas from a targeted formation in the earth. Oklahoma has many different formations, which you can check out in this Stratigraphic Guide HERE. Historically, Oil and Gas Leases covered all mineral interest from the surface to the center of the earth, thereby covering all of these formations. With today’s advancements in drilling technology, multiple wells can be located on the same tract of land producing from different formations. As a result, depth limitation clauses have become a popular addition to the Oil and Gas Lease in recent years. A depth clause releases a lease that has been perpetuated into its secondary term as to all depth below a certain point, thereby allowing a second oil and gas company to execute another lease as to these released depths. An example of such clause reads as follows:

It is agreed and understood that upon the expiration of the primary term, this lease shall expire as to all rights below 100 feet below the base of the stratigraphic equivalent of the deepest producing formation contained in the drilling and spacing unit on the leased premises, or on lands pooled or unitized therewith.    

Top-Lease Clause

Historically, if an oil and gas company wanted to lease mineral interest that was already subject to an existing lease, it would wait until that existing lease had expired before executing its subsequent lease. In recent times, however, oil and gas companies have instead begun executing “top leases,” which are leases that cover a mineral interest where a current lease already exists. The top lease becomes effective once the current lease, also called the “bottom lease,” expires. Top leases will generally contain a provision referencing the current lease and stating when the top lease will become effective. An example of this provision is as follows:

This lease shall become effective August 28, 2013 at the moment in time the lease executed by and between the above named Lessor and Smooth Operator, LLC, and recorded in Book 4357 at Page 278 expires.

In an effort to prevent losing its leased mineral interest upon expiration to a top lease, some oil and gas companies will include a top lease clause in the original lease. You can think of a top lease clause as a right of first refusal provision. A top lease clause gives the oil and gas company the right to execute a top lease before any other third party does. A top lease clause may read as follows:

If at any time within the primary term of this lease and while the same remains in effect, Lessor receives any bona fide offer, acceptable to Lessor, to grant an additional lease (top lease) covering all or part of the aforedescribed lands, Lessee shall have the continuing option by meeting any such offer to acquire such top lease. Any offer must be in writing and must set forth the proposed Lessee’s name, bonus consideration, and royalty consideration to be paid for such lease, and include a copy of the lease form to be utilized which form should reflect all pertinent and relevant terms and conditions of the top lease. Lessee shall have 15 days after receipt from Lessor, of a complete copy of any such offer to advise Lessor in writing of its election to enter into an oil and gas lease with Lessor on equivalent terms and conditions. If Lessee fails to notify Lessor within the aforesaid 15 day period of its election to meet any such bona fide offer, Lessor shall have the right to accept said offer.