Intro: I have received a lot of questions by those new to the oil and gas business about how to break down a lease. For those of you who are veterans, please use this blog as a review, or forward it to any newbies who may benefit.
The Contracts: When a client comes to me with information about any part of their holdings in the oil business, the first thing I do is look at the land related contracts and how they are read together. I begin with the lease because it contains the basic contract between the parties. I coordinate that information with the clauses in the Joint Operating Agreement (JOA), because it defines the area of mutual interest; any available Title Opinions, because they shed light on the history and ownership of the land; the Unitization Agreement (if there is one); and the Purchase and Sale Agreement (if the review is in conjunction with an acquisition or divestiture).
I also may look at any other contracts and correspondence specific to the particular deal. At this point, I don’t concern myself with drilling company, service, pipeline, or sales contracts because those may be handled in house or by accounting, and/or can be layered onto the primary information later.
Checklist: If the review warrants the time, I will use an information sheet checklist with the items I glean from the lease. This prevents my forgetting any items, and also gives me a “cheat sheet” to refer to in the event the client calls or I later write up a property summary.
The Lease: When breaking down a lease, the first thing I look at is the state and county where the property is located, and view the terms of the lease through this lens. Each jurisdiction has specific rules of law, including common law, legislated statutes, and regulatory agency requirements.
Of particular note are the effective date, Lessor and Lessee, term of the lease (including any extension periods), the royalty and other consideration to be paid, conditions surrounding assignment (including consent), the surrender clause (including Pugh), and habendum or granting clause. I check to see whether the lease has expired, or is soon to expire. I also check for the warranty clause to make sure the Lessor has stated that he owns the land (the title opinion may also shed light on this issue), and whether the lease is assignable and under what conditions. These are the basic components to make the contract binding and transferable.
I spend the most time on the property description, and how it is phrased. The requirement is that the description is thorough enough for a surveyor to locate the land from the wording. If it is a lot and block or section, township, and range description, with no depth limitations, that’s an easy notation in the checklist. However, if the property description is in a metes and bounds form, divides the depths into various strata, or has conditions for including the land, more detailed notations are required.
Next, I review the clauses effecting drilling and combining the lease with other lands. These are the drilling/continuous drilling clause, delay rental, shut-in royalty, and pooling clause. These components give me a snapshot of how the property is going to be developed. In this section, there may also be notations about maintaining or repairing the property after drilling, and contract conditions in the event of a dry hole.
Next, I look for anything outside the ordinary. If it’s not a form lease, such as the Producers 88, I am particularly detailed in this step, as the client may not be aware of special provisions that have been added.
Bottom Line: Just read the lease. At first, it may seem like a foreign language with the legalese and historical phrasing; but if one keeps reading different lease forms and contracts over a period of time, the commonalities begin to emerge. After a while when a lease has a non-common element or unusual clause, it sticks out like a red flag. I suggest that one new to the industry refer to the Glossary of Oil and Gas Terminology (download for free from the newsletter or website) if any of the above terms seem foreign or confusing.