North and west of the Philadelphia region, about 40 Pennsylvania counties sit upon the “Marcellus Shale” — named after Marcellus, a New York town. By some estimates, the Marcellus Shale may produce more than 400 trillion cubic feet of natural gas, enough to supply U.S. natural gas needs for 20 years.
“The Marcellus Shale gas play has the potential to be one of the biggest economic drivers in the state’s economy over the next two decades,” according to environmental attorney Robert D. Fox, managing partner of Manko Gold Katcher & Fox in Bala Cynwyd.
Until the last two decades, little attention was paid to the Marcellus Shale as a viable natural gas source, because of its depth (more than two miles in some spots) and the difficulty and expense to extract the gas. Two technology changes altered that landscape: (1) horizontal (as opposed to merely vertical) drilling; and (2) “fracking,” or hydraulic fracturing of rocks to force the gas from cracks (often sizable vertical cracks).
With the advent of that technology, gas companies found it more feasible and cost-effective to extract the gas, which launched a flurry of land-leasing activity. Although there has been a recent lull, more sought-after land garners $5,000-$6,000 per acre, with production royalties negotiated at 15 percent or more (the statutory minimum is 12.5 percent).
Some refer to this as the “Marcellus Shale Gold Rush.” That remains to be seen. What we do know is that, more frequently, practitioners will start seeing these proverbial pre-printed “standard form leases.”
Here’s a list of typical oil/gas lease terms, concepts and issues — usually not found in retail or office leases. Some are covered by the lessee-company’s “preprinted form”; as expected, the lessee’s form is usually silent on many landowner-protective provisions.
• “Lease” versus “conveyance.” Typically called a “lease,” the oil or gas grant actually conveys more than a leasehold interest in real estate. Like a deed, only the grantor (lessor) needs to sign the lease, which is industry custom.
• Lessor and lessee. While we prefer using plain language terms like “Landlord” and “Tenant,” these leases are of a unique nature — sort of a hybrid of a lease, contract and deed. Therefore, it’s customary to still see and use the terms “Lessor” for landowners and “Lessee” for the oil or gas company.
• Addendum. Most changes are made via addendum, rather than on pre-printed forms. It is important to state that provisions of an addendum supersede. Practice pointer: In the preprinted lease form, incorporate by reference the addenda, schedules, exhibits, riders and other pertinent pages.
• Pipelines. Except for pipeline to transport oil or gas from the site to commercial transportation pipelines, resist giving blanket permission to erect “any pipelines,” without a separate — and compensated — agreement.
• Storage. Refrain from allowing the site to be used for oil or gas storage.
• Indemnity. Resist liquidated damages clauses; lessee should be responsible for all liabilities, to full extent, and to comply with federal and state law.
• Water quality. Have it tested as baseline, then monitored.
• Wastewater disposal. Remove and treat it off-site.
• Nuisance. Keep drilling a specified distance away from dwellings (e.g., 500 feet).
• Restore surface: Want minimal invasion, and repair and restore premises after operations — whether it’s test drilling, during well operation, or after production.
• “House Gas”: Form leases typically give the lessor annual “free gas” for household use (e.g., 300,000 cubic feet). Rather than deal with tapping in or installing utility lines, it’s easier to receive payment in lieu of “house gas.”
• Shut-in well. A well capable of production, but not then being used.
• Payments. “Bonus,” often paid up-front. Might range from $25 to $5,000 or more (per acre), depending on desirability. “Shut in,” usually a nominal amount (e.g., $5/acre), for well capable of production but not then being used. “Delay” and “Delay in Marketing,” interim time during which the premises are just being “held” before any significant drilling, production or marketing activity. Again, usually nominal amount (because the lease is paid up-front).
• Royalties. Based upon production “at the wellhead.” Statutory minimum is 12.5 percent. Can contractually negotiate whether the royalty is before or after production expenses; statute is silent. Currently a hot issue because of the ambiguity in statute; some lessors seek to void their leases, especially old ones, for more favorable terms.
• Primary and secondary terms. Just like with typical lease: main term and extension term.
• Held for production. The lease continues as long as well activities produce revenue.
• Pooling/unitization. Often used interchangeably, this aggregates the premises with other lands, for the most economically efficient manner of drilling and production. It is geologically driven.
• “Pugh” Clause: If all of the pooled premises are not being used for drilling/production operations, then at end of the primary term, the unused portion of the premises, which could be vertical or horizontal, is no longer subject to the lease.
• “Play.” The extent of a petroleum-bearing formation; the activities associated with petroleum development in an area.
• “Old Mother Hubbard” clause. To avoid overincluding lessor’s other lands, most form leases will include — with a “dragnet” clause — “other lands” of lessor, particularly adjacent/contiguous lands. Addendum makes clear only applies to land expressly described in the lease (by rough “metes and bounds” description); it ensures other lands aren’t inadvertently subsumed within this particular lease, if that’s not the intent.
• Location. Want lessor’s reasonable consent as to location of well, access roads, pipelines routes and tanks
• Landman. A land professional who primarily negotiates acquiring or divesting mineral rights and business agreements for exploring for and developing minerals.
• “Rollback” taxes: If the land received favorable tax treatment (e.g., a real estate tax abatement) because of some unique program (e.g., preserving farmland), the oil or gas exploration or production may nullify that favorable treatment, and impose taxes retroactively. Ask the oil or gas company to bear that increase.
• Arbitration. Helpful clause to have, instead of resorting to courts.
• Roads. Want some constraint on depth and width, to minimize inconvenience and disruption to the landowner.
• Commencement of operations. Unlike prototypical leases with defined expiration dates, if operations haven’t commenced then an oil or gas lease continues indefinitely, i.e., in that case it is NOT a “term for years.” “Commencing operations” alone is vague; it is helpful to define with some benchmark, for example, procuring a state-issued drilling permit, building of access roads, and bringing equipment on-site to begin drilling operations.
Why is this important? Because an oil or gas lease can hypothetically continue for a long unspecified (undetermined) period of time: from (a) commencing operations until (b) oil or gas is no longer produced in paying quantities. If operations haven’t commenced during the then-applicable term, then the lease will end at that term’s natural expiration date (unless there’s an extension term, like with a conventional lease).
• Gates and fences: Obviously desired to keep out trespassers and for safety; also important if landowner has livestock or crops.
• Well fee: A well costs approximately $3 million to install and construct; if ultimately the oil/gas company is going to install a vertical well on-site, it’s not unusual to request a well-siting fee (e.g., $10,000-$20,000).
• No “omnibus clause” for all minerals: Limit the lease to just the specific mineral, fuel or ore being extracted. If it’s limited to natural gas, then carve out coal, metallurgic ores, etc.
• Title: Unless landowner has current title search and knows with certainty there are no prior oil, gas or other mineral grants — which could go back 150 years! — easements or other matters that would adversely affect the oil or gas lessee’s rights and interests, it’s important to not give a blanket general, or even a special, warranty. Better to just say “to lessor’s best knowledge,” and use further limiting language.
• Memorandum of lease/lease release. The lessee will usually want to record a memorandum of lease. To avoid a cloud on title when the lease ends, it’s customary to ask for the lessee to deliver a “release of lease” in recordable form.
• Information and audit rights. May depend on the lessor’s leverage; would at least like access to lessee’s information — not just to track gas production for royalty purposes, but also to determine compliance with law and the lease.
• Reservation of rights. Makes it clear that except for what lessor expressly granted or promised (covenanted) in the lease, lessor retains (keeps) everything else. •
Frank N. Tobolsky focuses on commercial real estate, including sales, purchases, financing and leasing. He is a partner with the Philadelphia firm of Astor Weiss Kaplan & Mandel. Tobolsky practices in Pennsylvania, Florida and New Jersey. He can be reached at email@example.com.
Attorney Dale Tice provided addenda and comments, some of which served as reference tools for this article. Tice can be reached at firstname.lastname@example.org.