Question: When Does My Oil and Gas Lease Terminate and Should I Enter Into an Agreement or Top Lease to Extend my Expiring or Terminated Gas Lease?
Answer: It depends….. (Lawyer speak)
When does my Oil and Gas Lease end? It may seem like an easy question, but unfortunately it can be very complicated and every landowner and gas right owner must understand and know whether their gas lease has terminated at the end of the initial “primary term”.
In order to fully understand this issue, the landowner “Lessor” must understand a few terms of art that typically appear in natural gas leases. In general, Gas Leases provide for two “terms” (Primary and Secondary) that apply to the status of your lease. The initial term (in this example we will use the common example of a 5 year term) is called the “Primary Term”. The Primary term is typically the defined timeframe that is set forth in the lease. Most gas leases are 5 year primary term leases, but many leases offer the gas company an option to extend the 5 year term for an additional 5 years provided that the company pays the landowner the same per acre bonus payment at the end of the first 5 year term to extend the lease for an additional 5 years.
Of course there is no required set term for an Oil and Gas Lease and some leases have 3, 6 or even 10 year initial primary terms. When initial primary terms are negotiable, it is almost always in the landowner’s interest to negotiate the shortest primary term possible. A shorter gas lease will require the company to engage in activities designed to produce natural gas in a shorter period of time or the lease will terminate and the landowner is free to lease their oil and gas rights again in the future.
What Must a Drilling Company do to “hold” My Gas Lease Beyond 5 Years?
Unfortunately, in oil and gas law and gas lease interpretation, nothing seems easy. The second step in the process is to determine what has to occur within the initial 5 years in order to extend the gas lease indefinitely and typically many decades after the initial 5 year primary term. In order to evaluate and determine whether your gas lease has terminated a landowner must understand what “Operations” the gas company must perform in order to hold your lease and prevent your lease from terminating after 5 years.
“Operations” is another term of art that is generally defined in the body of most Oil and Gas Leases. Gas companies typically define “Operations” very broadly in order to prevent gas leases from terminating so the gas company does not lose the lease they have already paid for and that may contain company friendly lease terms. Many landowners who entered into 5 year gas leases believe that the company must have drilled at least one well or even believe that they must be receiving royalties within 5 years or else the gas lease will automatically terminate. Unfortunately this believe is significantly mistaken.
Gas leases drafted by energy company lawyers will often define “Operations” as activities that include,
(1) commencing the construction of a well pad,
(2) simply filing for a drilling permit with Pennsylvania Department of Environmental Protection (PA DEP), or
(3) even engaging in activities in search of gas or oil production.
However, even though most gas leases provided the drilling company great latitude when determining what “Operations” are necessary to hold a lease, it is clear that the gas company must do “something” in order to continue a lease beyond the primary term.
The question then arises:
“Has the gas company done enough by way of operations to hold my gas lease beyond its 5 year primary term?”
To get this answer the landowner and their attorney may have to do some further investigation into what activities or operations the gas company has performed and when did they perform these activities. This information must be carefully reviewed in the context of the Oil and Gas Lease entered into by that particular landowner as most leases do not define “operations” in the same fashion.
Over the past years many landowners have been very disappointed to find out that their gas lease they thought was expiring did not expire because the gas company drilled a well and included a portion of their property into a gas production unit for that well. Many landowners hoped their existing lease would expire so that they would get a second bite of the apple and have the opportunity to negotiate a new gas lease for additional per acre bonus money, possibly a higher royalty percentage and possibly eliminating or reducing post-production cost deductions for such items as pipeline gathering, transportation and gas compression fees. Landowners generally should welcome the opportunity to negotiate a new gas lease with much more experience and educational resources available to avoid repeating mistakes of the past.
The Impact of Low Natural Gas Prices on Drilling and Expiring Leases
One positive side effect of low natural gas prices is that hundreds upon hundreds of gas leases are expiring as gas companies have stop drilling and this down natural gas price market has created outstanding opportunities for landowners with expiring leases.
Although many landowners over the past several years have seen their leases held beyond the 5 year primary term, the current low natural gas price market has resulted in gas companies across Pennsylvania stopping completely or significantly curtailing drilling activities. As leases near expiration many gas companies cannot hold or extend the existing lease unless they begin expensive drilling activities prior to the expiration of the primary term of the lease and then reasonably continue these drilling activities with due diligence.
One common company tactic at the present time is to approach landowners and request that the landowner enter into a written agreement to extend or modify their existing gas lease to allow the company more time to drill or conduct operations. Landowners who are approached to sign gas lease extensions and modifications or top leases must carefully scrutinize these offers and understand that it very well may not be in their best interest to extend an inferior gas lease for what will ultimately be many decades or even a century into the future.
Beware of Companies Crying Poor and Offering Little Financial Incentive to enter into a Gas Lease Extension or Top Lease
One effective argument that gas companies present to landowners in a down gas market is that the company lacks the money to present better offers to the landowner. The company landman explains that low natural gas prices have resulted in the gas company having very limited financial resources and they request that the landowner agree to extend the lease or enter into a top lease for very little or no compensation. Anytime a landowner is asked to sign any agreement for little to no compensation, the offer must be highly scrutinized.
Should I Extend My Existing Lease or Enter into a Top Lease at this Time?
It is true that there are times that landowners will want to extend their existing gas lease and not want their lease to terminate. However, there are many important factors and considerations to weigh when deciding whether to extend an existing gas lease.
Certainly a fundamental factor will be how strong the existing lease is for the landowner. A landowner may be interested in extending their gas lease if they can preserve their strong landowner friendly gas lease with a high royalty percentage, a limited or no ability for the gas company to take post-production cost deductions from your royalty payments, and strong property protections. Under these circumstances, with consideration given to many other factors, a landowner may be interested in extended their existing lease into the future even though they will not be immediately rewarded with a nice per acre bonus payment to extend their lease.
However, in many areas landowner leases with very strong company terms are expiring and landowners in many cases should not want to extend company favored leases that lock in a low royalty percentage, allow for full post-production cost deductions and offer little to know substantial property protections. As I say on All Things Marcellus repeatedly, the key to landowners making the right decision for themselves is to be fully informed and educated and to identify and consider all relevant factors.
Lease Extensions and Top Leases as a Second Bite of the Leasing Apple
A request to extend an existing gas lease can present an outstanding opportunity for the landowner to have a second bite of the apple and negotiate a stronger lease that may last one hundred years or more. Remember, if gas prices are low at the present time and gas companies are operating with significantly reduced budgets perhaps this is not the right time for you to extend or modify an expiring lease.
I could write many more pages about factors that must be considered when weighing whether to extend or modify your expiring lease, or even whether to enter into a top lease, but the key for each landowner is to get specific advice for their specific situation and not rely on the company landman to represent the landowner’s interest.
Lease Extension and Modification Reviews and Consultations
As I say repeatedly and continue to say, if you are considering a gas lease extension, modification or top lease, feel free to contact my office anytime at 570-307-0702 for at least an initial review and consultation to zero in on your specific issues and what you should be thinking about and considering in this very important decision.
Initial reviews and consultations typically take only 1-2 hours and are often done over the telephone for landowners across the state and even across the country provided the property or gas rights are located in Pennsylvania. I have participated in countless initial reviews and consultations and I have seen time and time again the benefits for landowners and we consistently receive outstanding feedback on this service. Please know that I try not to get too commercial in the blogs, but this is yet another area where landowners must seek qualified legal assistance as an uninformed or bad decision can have extreme financial consequences and may impact the landowner and family for generations.
Remember, this blog and any information on our websites is not specific advice for any individual landowner and all landowners seriously considering an Oil and Gas Lease Extension, Modification, Amendment offer or any natural gas agreement should consult with an experienced oil and gas attorney before making any decisions or signing any contract.
Douglas A. Clark, Esq. – Protecting Pennsylvania Landowners
Some radio shows on topic include: