There are so many lease provisions that can be thrown into an agreement that often times the meanings can become skewed. More often than not, they can even mean different things to different people. It’s important to communicate with the other party to determine the intent, and ensure that the language conveys the intent of both parties. So, as the start of my series exploring various lease provisions I’m going to discuss continuous drilling, continuous operations, and continuous development.
The truth is that all three of these clauses are savings clauses, and are therefore very similar in application. Generally speaking, the secondary term of a lease requires “production in paying quantities” or the lease expires. A savings clause, however, can give a lessee an exception to this rule, extending the duration of the lease in the secondary term, even though there is not technically “production in paying quantities.” However, each clause goes about this in a different way.
All of these clauses involve the word ‘continuous’ so I think it would be prudent to first explore that word. Black’s Law Dictionary defines it as:
Continuous: Uninterrupted; unbroken; not intermittent or occasional, so persistently repeated at short intervals as to constitute virtually an unbroken series.
In typical legalese, the definition begins fairly simple, and then gets more complex as it meanders. It’s interesting to note the final portion of the definition. “Short interval,” as a relative term, could easily be subject to multiple reasonable interpretations. In other words, parties are likely to disagree as to the definition of a “short interval.” As such, most lease forms offer clarity by defining the length of delay that will be considered ‘continuous.’
Most leases have an operations clause that read similar to the following, as shown in Oil & Gas Law in a Nutshell:
“if at the expiration of the primary term, oil, gas or other mineral is not being produced on said land, but lessee is then engaged in drilling or reworking operations thereon, this lease shall remain in force so long as operations are prosecuted with no cessation of more than thirty (30) consecutive days, and if they result in the production of oil, gas, or other mineral so long thereafter as oil, gas or other mineral is produced from said land….”
Under this clause, called a “well-completion clause,” if the primary term expires, there isn’t production in paying quantities yet, but the operator is in the process of drilling a well, then they will have the ability to complete the drilling past the primary term, and continue to hold the lease thereafter if there is sufficient production. Under the above clause, Texas courts have routinely held that, in “saving” the lease, this clause allows a lessee to attempt to achieve production by completing the well begun prior to the end of the primary term, but no additional wells, even if the original well turns out to be a dry hole.
As is typical with lease forms, parties will attempt to slightly modify the language. A lessee will desire the more broadly definition of “operations,” and a lessor will want a more narrowly defined definition. The above clause infers that “operations” is limited to drilling and reworking, but more sophisticated lessors may elaborate on the definition of “operations.” A lessor may specify that the rig has to be capable of reaching the specified total depth (TD), or a ‘capable’ rig has to be turning to the right. I’ve heard very old stories about oil men trying to hold leases by ‘operations’ by sending out a group of guys with post hole diggers. The point is that ‘operations’ can be a tricky term, but it is generally held that the term ‘operations’ refers back to the “drilling or reworking operations thereon’ which triggered the clause.
One modification frequently placed in leases by lessees, is to include language allowing for ‘continuous operations’ by modifying the operations clause in the following manner (also referenced in Oil and Gas Law In a Nutshell) – emphasis added:
“if at the expiration of the primary term, oil, gas or other mineral is not being produced on said land, but lessee is then engaged in drilling or reworking operations thereon, this lease shall remain in force so long as operations are continuously prosecuted with no cessation of more than thirty (30) consecutive days, and if they result in the production of oil, gas, or other mineral so long thereafter as oil, gas or other mineral is produced from said land… and drilling or reworking operations shall be considered to be continuously prosecuted if not more than sixty (60) days shall elapse between completion or abandonment of one well and the beginning of operations for the drilling or reworking of another well“
Under this modification, termed a “continuous-operations clause,” if the primary term expires, and there is no production, but a lessee is drilling a well, then the lease will be saved if either (1) the well is completed and turns out to produce in paying quantities, (2) the well is abandoned or is completed as dry hole, but the lessee begins other wells within (60) days, one of which produces in paying quantities, or (3) continues to drill dry holes or abandon wells one after another with no more than (60) days elapsing between working on each well. Needless to say, this modification offers the lessee much more protection in maintaining a lease.
Lessors have introduced various modifications as well. John McFarland, on his blog Oil and Gas Lawyer Blog, discussed several modifications he suggests that lessors attempt to negotiate with their lease, in protecting the lessor’s interests, being the following:
1. The clause should contain a partial termination date (which is the end of the primary term generally). At that time the lands held by the lease should shrink down to a prescribed spacing around each producing well. It may also include a depth severance below the deepest producing zone.
2. The clause should specify that after the partial termination date, each production unit should operate independently as it’s own lease. So the production in each spacing unit will hold only the acreage in that unit. If any production ceases it will cause the lands held by that unit to expire.
3. The partial termination date should be the primary term, and it should only be extended if the lessee is drilling a well at the end of the primary term. The lessor should insist that the lease specify what operations can hold the lease, and specify the number of days between the abandonment or completion of one well and commencement of a new well.
As an additional protective measure for lessors, ‘continuous operations’ clauses are often coupled with a vertical and horizontal Pugh clause. This is because the lessor intends for the lessee to release lands outside of prescribed units unless they are actively working to develop the entire acreage.
Obviously, the landman negotiating these terms can look to the inverse of these assumptions to get the best deal for his client, protecting the lessee’s interests as follows:
1. It’s fairly typical for the Pugh clause to be operative at the end of the primary term, so this is not something that is likely to be negotiated.
However, as far as maintaining acreage, the landman should attempt to get the largest maximum spacing unit allowable in the lease. Typical is 80 acres for an oil unit and 640 acres for a gas well, but many leases also specify “largest unit allowable by the state regulatory agency”.
As far as maintaining depth, it is important to note that, while you should try to avoid depth severance clauses, you should definitely avoid clauses which sever depths “up the hole”. As an example, this type of language will look something like “at the end of the primary term lessee shall release all depths 100′ above the shallowest producing zone”. This is important because it prevents the operator from later completing productive zones further up the wellbore. Another negotiable item is how the depth is calculated, is it Total Vertical Depth or Total Measured Depth?
2. This is also a fairly standard item without much room for negotiation. However, consider your ability to get a longer cessation clause, reworking clause, or an indefinite ability to shut-in the well.
3. A landman should attempt to modify the operations clause as defined above, creating a “continuous-operations clause.” If possible, attempt to obtain a longer duration between abandonment of one operation and the drilling of an additional well.
One difference that should be noted between the continuous operations/drilling/development is that different clauses may allow different calculations of dates. Does your ‘continuous’ clause refer to the time from completion of one well until completion of the next well? Maybe it is from completion of one well until the spud of a another well? Is the spudded well required to have a rig on site that can reach the intended depth?
Have you encountered other types of continuous drilling provisions? Share your stores in the comments below!