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Understanding an oil and gas lease: What does it really mean?

By Steven A. Walton

 
 

 

 

We have all heard the old adage ‘the devil is in the details.’  This holds particularly true in oil and gas leasing.

The story line has repeated itself time and time again since the Marcellus Shale land rush came to Pennsylvania.  A landman contracted by the gas exploration company knocks on a landowner’s door, puts a lease in front of them, and asks them to sign on the dotted line.  Stories have percolated up that some unscrupulous landmen use ‘scare tactics’ to entice landowners to sign quickly – suggesting that the company will drill under their land even if the landowner doesn’t sign a lease, or that if they don’t sign now the landman won’t be back…neither of which are true.

Many times a landowner signs a lease without a firm understanding of the implications either with respect to their rights or the rights of generation after generation of their family members who inherit the land.

Below are some of the provisions that may be included in oil and gas leases.  It is by no means a complete list, but it provides examples of what may be discussed and negotiated with the landman and the gas exploration company.

A lease provision might state that:

The Lease is granted for any or all of the following purposes: the right to stimulate all coal seams or other strata or formations using any and all methods and technology available at the time of stimulation; 

This means that the lease is not limited to exploration of the Marcellus Shale formation which sits 5,000 or more feet below the surface.  Coal seams are located much closer to the surface and the operations to extract natural gas from such coals seams is a markedly different process than extraction from the Marcellus Shale strata deep below the surface.  There are other natural gas bearing formations that lie below the Marcellus Shale strata, such as the Utica Shale, and those will be developed in time as well.

A lease might include this language:

...to transport by pipelines or otherwise across and through the Leased Premises Oil and Gas from the lands covered by the Lease, for so long as the transportation of such production may be desired by LESSEE; 

This provision allows the oil and gas exploration company (the “Lessee”) to lay natural gas pipelines across your land even if your land is not used for the well pad.  Many leases include a provision that the company’s right to keep these pipelines in place remains even after the lease you signed has terminated and you are no longer receiving royalties.  Often a lease will state that no additional money is paid to the landowner for use of their land for pipelines.

Most leases provide something like the following:

...the placing of tanks, equipment, electric power lines, telephone lines, water lines, impoundments and ponds, compression and collection facilities, roads, structures for the production of Oil and Gas, together with the right to enter into and upon the lands covered by the Lease at all times for the aforesaid purposes. 

Many landowners say that the landman assured them that there will be no ‘surface operations’ on their property – that their land will only be ‘drilled under.’  While that may be true, the lease will often still provide that the company can do much more than drill under the landowner’s property.  The sentence above is common in oil and gas leases and one can only imagine the impact of any of these structures on their land.  The last sentence permits the company to enter your land “at all times.”  Drilling operations run around the clock so this might mean at 5:00 in the morning, or after midnight, or whenever. 

All leases will describe the leased premises: 

The lands covered by the Lease are situated in [        ] Township, [       ]  County, Commonwealth of Pennsylvania, Tax Parcel Number(s)
[          ], being all the property owned by LESSOR or to which LESSOR may have any rights in said Township, and including all adjacent or contiguous lands owned or claimed by LESSOR, although not included within the boundaries of the land particularly described above.

This language can take a landowner by surprise.  Suppose that you own several parcels of real estate in a county or different counties – one parcel you live on, and the other parcels are farmland that you inherited years ago.  You intend to only lease the minerals rights to the farmland (which is identified specifically by Tax Parcel ID and a description of the deed) and you sign the lease with the language above included.  You have just leased the mineral rights to the land under your home.

Oil and gas companies may want to aggregate your land with adjacent lands:

LESSOR grants to LESSEE the right at any time to pool or consolidate the Leased Premises with other lands, whether owned by or leased to LESSEE or owned by or leased to others, to form an oil, gas, and/or coalbed methane gas pooled unit for the purpose of drilling a well or wells thereon. 

Oil and gas exploration operations have two footprints – one above ground and one below ground.  Above ground, operations include such things as the well pad, impoundment pit, the well head, etc.  A well pad can cover several acres.  Add to that the hundreds of other acres that are needed for a staging area for water trucks, access roads, metering or compression facilities, pipeline routing, etc. and one can see why the company needs to lease large swaths of acreage.  Even if you lease your mineral rights your surface land may never be touched.  The companies need the leases also to cover the subsurface area that will be drilled and fracked.  To accomplish all of this the companies combine the leased lands into a ‘pool’ or ‘unit.’  This is important to understand because whatever royalties are paid from a producing well will be split among the landowners in the ‘unit’ and will be based on their respective acreage.  It is also important because companies can rely on ‘commencing operations’ on lands other than yours, but you are still bound by the terms of the lease that you signed.

Many oil exploration companies buy and sell leases as part of their business model:

LESSEE shall have the right to assign and transfer this Lease in whole or in part at anytime, and LESSOR waives notice of any assignment or transfer of this Lease.

Signing an oil and gas lease is a business deal, but it has a personal side as well.  You hopefully have researched the company you intend to lease with, you have some idea how fiscally strong it is, how environmentally conscious it is, how long it has been around.  To the companies, these lease holdings are commodities that are sometimes bought and sold.  It is only fair that you get to decide who holds the lease to your mineral rights, Right? If you signed a lease that includes the language above, the answer is ‘Wrong.’

Every lease will have a primary term and circumstances for extending that term:

This Lease shall continue in force and the rights granted to LESSEE shall be quietly enjoyed by LESSEE for a term of Five (5) years (the “Primary Term”), and as long thereafter as operations are conducted on the Leased Premises, or as long as well(s) producing Oil and Gas in paying quantities or well(s) capable of producing Oil and Gas in paying quantities from the Leased Premises or from lands unitized or pooled therewith, in the sole judgment of LESSEE.

This is a short paragraph in the typical oil and gas lease, but it is arguably one of the most important.

Oil and gas exploration companies generally want to hold the leased mineral rights for a period of years until they actually begin drilling.  This could be because the price for natural gas is down, or their rigs are operating elsewhere, or for any number of business reasons.  So the company will pay you a ‘bonus’ (a set dollar amount per acre leased) as part of a ‘paid up lease’ and their obligations to you are fulfilled for the Primary Term, generally five (5) years.

What happens when the Primary Term expires?  What if the company has not yet started drilling, and may not be ready for some time beyond expiration of the five (5) year Primary Term, but it would like to still hold the lease to your mineral rights.  Often companies will attempt to extend the Primary Term, sometimes without additional money paid to you, by relying on “and as long thereafter as operations are conducted on the Leased Premises” or “well(s) capable of producing Oil and Gas in paying quantities from the Leased Premises or from lands unitized or pooled therewith” language in the lease.  “Operations” are sometimes defined in the lease, sometimes not, but in nearly every case the term “Operations” is more expansive than actually drilling a hole in the ground.  It may include seismic testing, or it may include putting up a fence or excavating an access road (on your lands or lands that you don’t own but that have been ‘pooled’ or ‘unitized’ with your land).  A “well capable of production in paying quantities” has been determined by Pennsylvania courts to be generally at the sole discretion of the oil and gas exploration company.  Whichever vice is used, the effect is the same – your mineral rights remained leased out to the company despite the fact you may not have received a dime in royalties.

As noted above, this article discusses some of the most common, and important, provisions you will find in an oil and gas lease, but each lease and each situation brings with it specific issues.

Remember that an oil and gas lease might affect your rights to your land for generations to come.  Do your homework and learn about the company you are dealing with and most importantly if you are not an oil and gas leasing expert it is in your best interest to get help from someone who is.

 

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