Oil & Gas Lease Clauses
In this post, we’ll be going over the main clauses of an Oil & Gas Lease.
For an introduction to Oil & Gas Leases see our last post HERE. In an Oil & Gas Lease, the mineral owner is called the “Lessor” and the oil and gas company is called the “Lessee”. Here is a list of several of the most important clauses found in an Oil & Gas Lease.
Granting Clause
The granting clause specifies which rights the mineral interest owner is conveying to the oil and gas company. In Oklahoma, the mineral interest owner conveys their right to develop the minerals to an oil and gas company through a lease. The granting clause will also specify which minerals are subject to development and will include a description of the land that is being leased. A standard granting clause may read as follows:
Lessor, in consideration of Ten and no/100 ($10.00) dollars, receipt of which is acknowledged, does hereby grant, bargain, lease and let unto the Lessee, for the purpose of exploring and drilling for and producing oil and gas, and their respective constituent products, and laying pipelines, building tanks, power stations and structures to produce, save, take care of, and manufacture all of such substances, said tract of land, situated in the County of Atoka, State of Oklahoma, described as the NW/4 SE/4 of Section 24-12E-3S, containing 80.00 acres, more or less.
Habendum Clause
The habendum clause sets forth the duration of the Oil & Gas Lease and is broken down into two parts: the “primary term” and the “secondary term.” The primary term will be for a set number of years, during which the oil and gas company can begin oil and gas production. If production is begun and continues beyond the primary term, then the secondary term is triggered. The secondary term allows the oil and gas company to continue producing oil and gas beyond the term of years specified in the primary term, so long as such production is in commercial paying quantities. The following is an example of a habendum clause:
It is agreed that this lease shall remain in full force and effect for a term of 3 years and as long thereafter as oil or gas, or either of them, is produced from said land by the Lessee.
Royalty Clause
The royalty clause specifies the amount that the mineral interest owner will share in the profits from production of oil and gas. Generally, the mineral interest owner’s share of production is not burdened by the costs of production, being the costs associated with operating and maintaining the producing well. The mineral interest owner’ share of production, however, does bear the costs associated with transforming the produced minerals into a marketable product ready for commercial sale. A royalty clause may read as follows:
The royalties to be paid by Lessee are: (a) on oil and other liquid hydrocarbons, 3/16 of that produced and saved from said land, the same to be delivered at the wells, or to the credit of Lessor into the pipeline to which the wells may be connected; Lessee may from time to time purchase any royalty oil in its possession, paying the market price therefore prevailing for the filed where produced on the date of purchase; (b) on gas and the constituents thereof produced from said land and sold or used off the premises or in the manufacture of products therefrom, the market value at the well of 3/16 of the products sold or used. On product sold at the well, the royalty shall be 3/16 of the net proceeds realized form such sale. All royalties paid on gas sold or used off the premises or in the manufacture of products therefrom will be calculated after deducting from such royalty Lessor’s proportionate amount of all post-production costs, which shall include, but shall not be limited to gross production and severance taxes, gathering and transportation costs from the wellhead to the point of sale, treating, compressing, and processing, line loss/fuel, separating, and dehydration. On product sold at the well, the royalty shall be 3/16 of the net proceeds realized from such sale, after deducting from such royalty Lessor’s proportionate amount of all of the above post-production costs and expenses, if any.
Delay Rental Clause
Historically, oil and gas companies were bound by an implied covenant to drill a well during the primary term of the lease. If no well was drilled, oil and gas companies could instead make payments throughout the primary term to the mineral interest owner called “delay rental payments.” These clauses were strictly enforced, and if an oil and gas company failed to drill and make delay rental payments at the proper time to the proper party, then the lease terminated. The following is an example of a delay rental clause:
If drilling operations or mining operations are not commenced on the leased premises on or before one year from the date of lease execution, this lease shall terminate as to both parties unless Lessee on or before the expiration of said period shall pay or tender to Lessor, or to the credit of Lessor in the Lessor’s bank or any successor bank, the sum of $100.00, hereinafter called a “rental” which shall extent for 12 months the time within which drilling operations or mining operations may be commenced.
Most leases today, however, are “paid-up leases.” When a lease is paid-up, the oil and gas company pays the mineral interest owner all delay rentals upfront, and both parties agree that there is no obligation for the oil and gas company to drill a well during the primary term. A paid-up lease will typically note that the lease is paid-up at the top of the document or may contain a variation of the following provision:
This is a Paid-Up Lease. In consideration of the down payment, Lessor agrees that Lessee shall not be obligated, except as otherwise provided herein, to commence or continue any operations during the primary term or make any rental payments during the primary term.