An oil and gas lease is a conveyance and a contract designed to secure production of oil, gas, or both in paying quantities quickly[i]. An oil and gas lease is a transfer of an interest in oil and gas. The aim of an oil and gas lease is to make the mineral estate profitable to both parties through exploration, development, and production of resources located in the leased premises.
Oil, gas, and a mineral lease are ordinary leases of property. The consideration received from a mineral lease is considered rent. The main objective of the parties to an oil and gas lease is the extraction of the subsurface gas and oil for the mutual benefit of the parties in the form of profits. A mineral lease conveys an interest in real property and it does not create the ordinary relation of landlord and tenant[ii]. An oil and gas lease is a ‘grant in praesenti’ of oil and gas to be captured from underneath the land during the term of the lease and for the period until the substances are not found. Generally, mineral leases do not create a fiduciary relationship between the lessor and lessee. Mineral leases are purely contractual in nature.
The right to execute a gas and oil lease on particular lands is designated as the executive power or executive right. It remains as an interest in property even when it is severed from the other rights or attributes incident to the mineral estate. A top lease is an oil and gas lease that operates only if the preexisting lease is expired or terminated.
Courts determine the validity and effect of gas and oil lease by the law of the place of the leased property. There is no single form of reliable lease form. Therefore, parties to a lease often insert whatever provisions they deem proper.
Gas and oil leases can be divided into commence leases and completion leases that require commencement or completion of a well during the first term. Oil and gas lease deeds can be of different types. In some leases, the lessee is obligated to drill a well or pay rental. Such leases are ‘drill or pay’ leases. Normally, the lease is not forfeited or terminated by the failure to comply with its terms. However, on the failure to drill or commence drilling as required, the obligation to pay rental becomes absolute as an alternative requirement. In some types of leases, if no well is commenced on the leased land on or before a specified date, the lease is to terminate as to both parties “unless” the lessee on or before that date pays or tenders to the lessor a specified sum of money. This is described as an ‘unless’ lease or a ‘wildcat’ lease.
When a landowner accepts a share of the delay rentals, the person ratifies the oil and gas lease that includes his/her land but was executed by someone else[iii]. Where delay rental payments are accepted by an agent of the lessor, the oil and gas lease will be valid, even if a lease agreement has never been properly delivered to the lessor.
An oil and gas lease is a hybrid property interest. For some purposes it can be considered a personal property and for other purposes it can be treated as real property. Under an oil and gas lease, the lessee holds the dominant property and the lessor holds the servient property.
When an oil and gas lease is executed, the lessor does not convey title to the oil under his/her land. This is because it is an interest in real estate. The lease provides an exclusive right to the lessee to explore and reduce the oil to the lessee’s possession when it becomes the lessee’s personal property. An interest in an oil and gas lease grants the lessee the right to remove minerals from the land. A mineral lease grants the lessee the right to explore for and produce oil and gas. It gives the lessee the right to conduct seismic exploration to determine the presence of subsurface trapping mechanisms favorable to oil and gas production.
An oil and gas lease is deemed to be real property. However, a lease to explore for oil and gas creates an interest or estate in realty which is not deemed a real estate. The lessee’s interest in an oil and gas lease can be personal property. Such interest will amount to an estate for years when limited to a fixed term.
A person owning title to an oil and gas property can perform all acts necessary to discover and produce such minerals. The person will also have the right to lease and dispose of such oil and gas and to receive bonuses and delay rentals. A fee holder has an interest to give a valid oil and gas lease. An easement holder does not possess the interest to confer the rights comprised within an oil and gas lease.
In an oil and gas lease, the lessor or landowner retains the right to the surface, a reversionary interest in any oil remaining after the termination of the lease, and a right to royalties on oil produced by the lessee during the term of the lease. These interests can be independently conveyed or assigned by the lessor.
Lease deeds can have a clause called an acreage selection clause. This clause permits the lessee to extend the lease on certain acreage selected by him/her after the completion of a survey. There can also be a clause called a notice and demand clause. Generally, this clause requires the giving of a notice of breach of a lease provision and the making of a demand for the performance of the provision as prerequisites to a legal action based on the breach. A gas and oil lease can have provisions for termination of the lease upon cessation of operations for a particular period of time. An express covenant to protect against drainage can be provided in a lease deed. The parties to an oil and gas lease may provide that performance under the lease is excused where the lessee has made timely rental payments. Some leases include a clause called a judicial ascertainment clause. This clause declares that the lease is not to be terminated or cancelled or forfeited for failure of the lessee to perform implied obligations until the existence of such failure is judicially ascertained.
Entirety clauses in oil and gas leases are an agreement that if the mineral interest under the leased premises is owned by a number of different persons, the royalty will be treated as an entirety, with the separate owners participating. Such a clause binds the lessor, the lessee, and all persons holding under them so that the acceptance of a conveyance subject to an oil and gas lease implies an agreement by the grantee to the application of an entirety clause in the lease. Generally, oil and gas leases provide for free gas for a dwelling on the leased premises. This right is transferable and assignable as any other property interest. Free use of water is a provision in a gas and oil lease. This clause entitles the lessee to the free use of water produced on the land. Such a lease deed gives the lessee free use of water from the land, except water from the lessor’s wells, for all operations under the lease. However, it does not entitle the lessee to use water from the private pond or tank of the lessor but entitles him/her to use only water produced by the lessee.
Generally, a dry hole clause provides that when the first well drilled is a dry hole and a second well is not commenced within a specified period from the expiration of the last rental period for which rent has been paid, the lease is to terminate. However, if the lessee pays the rent on or before expiration of a specified period the lease will not terminate.
Implied obligations are part of an oil, gas, and a mineral lease. Implied obligations are as binding as expressed obligations[iv]. Implied covenants are justified on the ground of necessity and fair dealing. In the absence of express provisions in oil leases, covenants will be implied such as using reasonable diligence in the exploration and discovery of oil. Four implied covenants can apply to oil and gas leases[v]:
- to conduct exploratory drilling,
- to develop after discovering resources that can be profitably developed,
- to operate diligently and prudently, and
- to protect leased premises against drainage.
[i] McCullough Oil v. Rezek, 176 W. Va. 638 (W. Va. 1986).
[ii] Hafeman v. Gem Oil Co., 163 Neb. 438 (Neb. 1956).
[iii] Roberson v. Pioneer Gas Co., 173 La. 313 (La. 1931).
[iv] U. V. Industries v. Danielson, 184 Mont. 203 (Mont. 1979).
[v] Gillette v. Pepper Tank Co., 694 P.2d 369 (Colo. Ct. App. 1984).