Best if printed in landscape.

4) SAVINGS CLAUSES (EXTENDING THE LEASE WITHOUT PRODUCTION)

Most companies will not promise to drill a well. Thus, the primary term essentially gives the company an option to drill and perhaps perpetuate the lease (possibly for decades) into the secondary term by actually producing oil and gas. Thus, mineral owners must understand that while a primary term may be short, the total lease duration may be very long—lasting well beyond the life of the leasing mineral owner. The lease will continue to govern the rights of the parties for its entire duration. Thus, as previously stated, getting the lease right the first time is essential, as there may be no second chance.

The basic primary and secondary term does not address all of the company’s concerns and needs. Thus, the typical lease contains various “savings” clauses that are favorable to the company. Some of these clauses are not objectionable but others are or at least may be, depending on their detail. In general, the duration of a lease may extended without production by the following savings clauses found in nearly all oil and gas leases: (1) drilling operations provisions, (2) shut-in provisions, (3) dry hole provisions, (4) cessation of production provisions, and (5) the force majeure clause.

Drilling Operations Clause

This clause perpetuates the lease so long as the company is engaged in operations for the drilling of well. It is often triggered when the company is engaged in such operations at the end of the primary term, but as explained below, the clause may also save a lease that ceases production. Most modern leases provide that the lease is saved by any continuous drilling, whether on one or a series of wells.

Satisfactory operations generally include surveying and staking the well site, building access roads, or other activity preparatory to actual drilling. For greater certainty, it is useful to provide that a well must be “spudded in” on or before the expiration of the primary term, but this is not nearly as important as negotiating a favorable royalty and limiting the acreage that can be held by a lease.

Shut-in Clause

A shut-in clause allows the lease to remain in effect whenever gas or perhaps even oil is not being produced from a well that is physically capable of production in paying quantities. Frequently, gas wells are shut in after initial drilling or perhaps periodically throughout their producing life due to seasonal demand for natural gas. Usually, the shut-in clause provides for the payment of “shut-in royalty”—generally a nominal sum. Under most modern leases, the royalty does not have to actually be paid for the lease to be saved.

Mineral owners may wish to consider the following matters regarding the shut-in clause, but these provisions are is not nearly as important as negotiating a favorable royalty and limiting the acreage that can be held by a lease.

1. Provide that if shut-in royalties are not timely and properly paid, then the lease will automatically terminate.
2. Place a maximum number of years on the shut-in clause—e.g., no more than three consecutive months and no more than 24 cumulative months.
3. Provide for more than nominal shut-in royalty.
4. Carefully review the circumstances when the shut-in clause may go into effect. For example, the lack of any market, the lack of an available pipeline connection, and government regulatory action that is not the fault of the company are generally acceptable reasons for shutting in a well. Other reasons are more dubious.
5. Provide for automatic suspension of the right to shut in a well whenever a well located on an adjacent spacing unit and completed within the same producing reservoir begins producing and selling gas or oil.

For example, see paragraph 10 of the State lease.

Dry-Hole Provisions

The “dry-hole” provision perpetuates a lease for a stated grace period (e.g., 60 days) if the company drills a dry hole in a circumstance where the lease would otherwise terminate (e.g., see paragraph 6 of the State lease). If the company does not otherwise save the lease during this grace period (such as by commencing an additional well and thereby triggering the drilling operations clause), the lease may terminate. However, if the lease is still within its primary term, most modern leases will perpetuate the lease at least until the end of the primary term.

Cessation of Production Clause

The “cessation of production” provision operates similarly to a dry-hole provision (e.g., see paragraph 7 of the State lease). The cessation of production clause perpetuates a lease for a stated grace period (e.g., 60 days) if a well ceases production in a circumstance where the lease would otherwise terminate. If the company does not otherwise save the lease during this grace period (such as by restoring production or commencing an additional well), the lease may terminate. However, if the lease is still within its primary term, most modern leases will perpetuate the lease at least until the end of the primary term. Modern leases also limit the triggering of a clause to complete cessation of production, not to a mere decline in production below paying quantities. The reason for this is that courts have generally given a company a reasonable time to increase production above the paying-quantities threshold.

“We agree with the general rule that temporary cessation of production will not, in and by itself, terminate the lease.”  Feland v. Placid Oil Company, 171 N.W.2d 829 (N.D. 1969)

Force Majeure Clause

The “force majeure” provision allows a company to save a lease when it is otherwise unable to do so because of an act of God, regulatory action or delay, or some other reason beyond the company’s control. Force majeure clauses should be carefully reviewed to assure that it will not operate for the company’s convenience (e.g., see paragraph 11 of the State lease).

The force majeure clause should perpetuate a lease only when saving the lease in some other fashion is impossible and when the reasons for the force majeure are beyond the company’s control. The force-majeure event should not be due to the company’s fault, negligence, or failure to comply with a lawful government regulation or order.

The force majeure clause should require the company to give notice of a force majeure event and full explanation as to why the event made it impossible for the company to otherwise save the lease. The clause also should require the company to work diligently to overcome the force-majeure event as soon as possible. Under no circumstances should force majeure relieve any obligation to pay money, such as royalty for oil and gas that has already been produced. Consider placing a maximum limit on the amount of time the clause can remain in effect.

Pooling Clause

The pooling clause, generally found in all company lease forms, allows the company to combine all or a portion of the leased acreage with other lands for purposes of development. This clause may allow the company to save several leases with one well. The clause also affects royalty because a mineral owner’s royalty will be reduced in proportion that the mineral owner’s net mineral interest bears to the whole unit.

This clause should be deleted. If the company balks at its omission, remind the company of the availability of compulsory pooling through the North Dakota Industrial Commission Oil and Gas Division. If the clause is retained, it should be expressly limited to the pooling of a normal spacing and drilling unit only. Be sure to delete any mention of pooling larger units and any mention of “unitization” should be deleted. Moreover, the pooling of any lands should be expressly limited to the duration of the lease. Pooling and unitization are further discussed under State Regulation.

Next Pages

Mineral Lease -- Introduction and Habendum clause

Mineral Lease -- Granting clause

Mineral Lease -- Royalty clause

Mineral Lease -- Saving clauses

Mineral Lease -- Other clauses and Closing Thoughts

Last updated July 26, 2010

E-Mail agecinf@ndsuext.nodak.edu
Published by Agribusiness and Applied Economics
Morrill Room 217, P.O. Box 5636
North Dakota State University, Fargo, ND 58105-5636
Phone: (701) 231-7441
Fax: (701) 231-7400