Training - Operational Provisions

OPERATIONAL PROVISIONSDifferentiating Continuous Operations, Cessation of

Operations, Continuous Development, and Cessation of Production Clauses in Oil & Gas Leases

March 12, 2014

Jared ThomasConsulting Landman

Crew Land Research, Ltd.

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PURPOSE

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• It’s not always easy to tell the difference between the various Operational Provisions. Even “text book” examples can have similar wording and overlap

• Further yet, rather than following the text book examples, some attorneys attempt to cover various scenarios in a single provision

• The purpose of this presentation is to teach lease analysts how to identify the different Operational Provisions

PUGH & RETAINED ACREAGE CLAUSES

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• A basic, paid-up lease does not require any operations to hold the lease within the primary term

• However, if production is not established before Expiration of the Primary Term (EPT), the lease terminates

PRIMARY TERM

EFFECTIVEDATE

EXPIRATIONPRIMARY

TERM


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• Some leases have clauses which seek, at or after EPT, to partition the lease into producing and non-producing acreage, terminating any portion of the lease not assigned to a producing well

• Geographic Pugh Clause: Terminates the lease as to all leased acreage not assigned to a producing pooled unit

• Stratigraphic Pugh Clause: Terminates the lease as to all leased depths not assigned to a producing pooled unit

• Retained Acreage Clause: Terminates the lease as to all leased acreage not assigned to a producing non-pooled lease well

• Pugh and Retained Acreage clauses only come into effect at or after EPT


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• The date upon which this partial lease termination occurs is called the “Partial Release Date”.

• Partial Release Date: The date upon which the lease expires as to any non-developed acreage

• The first Partial Release Date typically occurs at EPT

Partial Release Date 1

PRIMARY TERM

EFFECTIVEDATE

EXPIRATIONPRIMARY

TERM

SAVINGS CLAUSES

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• When a lease has a Pugh clause or a Retained Acreage clause (or both), Lessees often seek to delay the Partial Release Date by inserting “Savings Clauses” into the lease

• Savings Clause: A clause that prevents lease termination so long as certain conditions are met

• Continuous Operations, Continuous Development, Cessation of Production, and Cessation of Operations are examples of Savings Clauses commonly found in oil and gas leases



CONTINUOUS OPERATIONS

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EFFECTIVEDATE

PRIMARY TERM SECONDARY TERM

EXPIRATIONPRIMARY

TERM

• A Continuous Operations clause allows Lessee to extend the lease beyond primary term if Lessee begins operating , e.g. drilling a well, on the leased lands or lands pooled therewith before EPT. It delays the Partial Release Date so long as Lessee performs successive qualifying operations without cessation of more than a specified amount of time, e.g. 90 days

• If the lease does not contain a Pugh or Retained Acreage clause, Continuous Operations may be used to hold the lease for the drilling of any number of dry holes until production is established—as long as the interval between wells does not exceed the time limit. Once production is established, the entire lease becomes HBP

• If the lease does contain a Pugh or Retained acreage clause, typically Continuous Operations only applies to a well drilled across EPT, i.e. the first well drilled

Well 1

Drilling across EPTwill hold lease

CONTINUOUS OPERATIONS

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• Example 1

• Common provision found in the Habendum Clause of many leases• Could also apply to the drilling of subsequent wells (talk about later)

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CONTINUOUS OPERATIONS• Example 2

• Possibly problematic because the clause begins with “after the primary term” rather than “at or after expiration of” or “upon or after expiration of” the primary term. This could require Lessee to produce across rather than drill across EPT



Partial Release Date d

CONTINUOUS DEVELOPMENT

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EFFECTIVEDATE

PRIMARY TERM SECONDARY TERMWell 1

(Drilling across EPTwill hold lease)

Well 2 Well w

EXPIRATIONPRIMARY

TERM

• Once the lease has entered its Secondary Term, the lease may yet terminate as to all non-producing acreage if it has a Pugh clause or Retained Acreage clause

• A Continuous Development clause, however, allows the entire lease to survive past EPT as long as Lessee continues to drill additional wells on the leased lands, or upon lands pooled therewith, without cessation of a specified amount of time, e.g. 120 days

• A Continuous Development clause does not exist without a Pugh and/or Retained Acreage Clause, since it is those clauses which seek to partially terminate the lease after EPT

Time between wells cannot exceed X days


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• Example 1

• Common Pugh clause with a 120 day Continuous Development clause (CDC)• There is never a need for a CDC without a Pugh clause or a Retained Acreage clause• Note that a prior condition of Continuous Development is that Lessee must have done

something, such as drill a well across EPT, in order to enter a Secondary Term, viz. production, a dry hole, or Continuous Operations is a prerequisite of Continuous Development


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• Example 2

• Key language that differentiates Continuous Development from Continuous Operations is that a CDC applies to the Secondary Term and covers the drilling of “additional wells”


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• Example 3

• Earlier I mentioned that a Continuous Operations clause could, depending on the Pugh clause, be used for Continuous Development. This is such an example

• This Pugh clause (Prov. 17) does not contain a CDC, but it does allow for drilling and/or reworking operations after EPT. Therefore, the time allowed between such operations is governed by the Continuous Operations clause (Prov. 2)


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• Example 4

• Some Continuous Development provisions allow Lessees to accumulate, or “bank”, unused days and use them to extend future intervals

11. Continuous Development. After the expiration of the primary term hereof, this lease shall remain in force and effect as to all of the lands covered thereby so long and only so long as Lessee shall conduct continuous drilling operations on the leased premises as hereinafter provided. Continuous drilling operations shall mean that not more than one hundred eighty (180) days shall expire between the completion as a producer or the abandonment as a dry hole of a preceding well and the commencement of operations for the drilling of the next succeeding well to the development of the leased premises to the density of maximum allowable production. In the conduct of the continuous drilling program described herein, if Lessee commences a well prior to the time that it is otherwise required to do so, Lessee shall be entitled to accumulate and later use any time so saved in the early commencement of such well, so that all or any part of said accumulated time may be used to extend the one hundred eighty (180) day interval between the completion of any well required herein and the commencement of the next succeeding well so required.



CESSATION OF OPERATIONS

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EFFECTIVEDATE


(Drilling across EPTwill hold lease)

Well 2

EXPIRATIONPRIMARY

TERM

• Some Operational Provisions state that any single operation, such as drilling a well, must be prosecuted continuously without delay of more than a specified amount of time, e.g. 30 days

• After EPT, failure to continuously prosecute an operation could cause the lease to terminate• This does not limit the gap between different operations, but rather the length of inactivity

allowed while conducting any single operation

Operation must not cease for more than Y days



• 90 days are allowed between wells, but the drilling of any single well must not stop for more than 30 days

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• Example 1

7. Continuous Drilling Operations.At the expiration of the Primary Term hereof, Lessee shall have the right, but not the obligation, to conduct a continuous drilling operation. The continuous drilling operation is defined as the commencement of a well (Initial Well), on or before the expiration date of the Primary Term and thereafter, to continue the drilling operations across the expiration date, with drilling equipment customary in the industry for such operations and in a manner and in a good faith effort to obtain production of oil or gas in paying quantities. Upon completion of the Initial Well, either as a producing well in paying quantities, or dry hole, Lessee is to commence drilling operations on the next well within ninety (90) consecutive days from the completion or abandonment of the Initial Well, and thereafter to continue the drilling operation with no more than ninety (90) consecutive days between the completion or abandonment of one well, and the commencement of operations for the drilling of a subsequent well to fully develop the Leased Premises, with the cessation of operations on each well is to be no more than thirty (30) consecutive days. If at any time after the Primary Term and during the continuous drilling operation the ninety (90) consecutive day requirement is not fulfilled, then this Lease shall terminate as to all lands of the Leased Premises, as provided in Section 8.


• Specifically applies to completion operations

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• Example 2


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• Example 3

• The same provision used as an example of Continuous Operations earlier also covers Cessation of Operations because it applies to “any one or more of such Operations”

Partial Release

Date

CESSATION OF PRODUCTION

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Well 3Last Producing Well Well 4

• The final question then becomes, if all wells cease to produce, is there anything Lessee can do to revive the lease?

• If there has been production from the lease, or if it’s been pooled into a producing unit, and all production should cease, a Cessation of Production clause allows Lessee a specified amount of time to begin drilling an additional well or re-work an existing well in order to restore production and revive the lease

Time between wells cannot exceed Z days

CESSATION OF PRODUCTION

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• Example 1

• Many Cessation of Production provisions, such as this one, contain a Dry Hole clause. The idea is to allow Lessee to establish or restore production if Lessee has demonstrated a willingness to drill

LITMUS TEST

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• It can be helpful to use a litmus test to correctly identify the different Operational Provisions:

1. Q: Can Lessee hold the lease by drilling or reworking across Expiration of the Primary Term, even if production has not been established yet? A: If you find a clause that allows Lessee to hold the lease by drilling across EPT, you have found a Continuous Operations clause

2. Q: Does the lease contain a Pugh clause? If so, how can Lessee delay the Partial Release Date? A: If you find a clause that allows the continuous drilling of additional wells after EPT, you have found a Continuous Development clause

3. Q: If Lessee begins an operation, must he continue that operation without taking a break? A: If you find a clause limiting the break Lessee can take during a single operation, you have found a Cessation of Operations clause

4. Q: If after EPT all production should cease, can Lessee do something to restore production and revive the lease? A: If you find a clause that allows Lessee to drill a new well or rework and existing well after EPT in an attempt to restore production , you have found a Cessation of Production clause

TIMELINE

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• When analyzing a lease, it can be helpful to sketch a timeline depicting the different expiration dates and savings clauses which can be used to hold that particular lease


Partial Release Date d

EFFECTIVEDATE


Well w

EXPIRATIONPRIMARY

TERM

Operation must not cease for more than Y days

Partial Release Date p

Drilling across EPTwill hold lease


Time between wells cannot exceed X days

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QUESTIONS?

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Training - Operational Provisions