habendum clause

What Are the Types of Federal Oil and Gas Leases?

An Introduction to Federal Oil and Gas Leasing

The federal government is responsible for oil and gas leasing under three different types of land: onshore public lands, offshore public lands, and tribal lands.  For purposes of this series, we will focus on onshore public lands and, more specifically, those under the jurisdiction of the Bureau of Land Management (“BLM”).  Below is a brief history of federal oil and gas leasing, a summary of the most common types of oil and gas leases administered by the BLM (renewal / exchange leases, public domain leases, and right-of-way leases), and a basic outline of the federal oil and gas leasing process today.

History of federal leasing.  Prior to the Mineral Leasing Act of 1920 (“MLA”), the development of oil and gas on public lands was done by making a placer location under the General Mining Act of 1872.  Since the MLA was passed, oil and gas on public lands has been developed by leasing.  Specifically, the MLA originally authorized the issuance of competitive leases for lands within a known geologic structure (“KGS”) of a producing oil or gas field and prospecting permits for lands not within a KGS, until the Act of August 21, 1935, which replaced prospecting permits with non-competitive leases.  Although the MLA was amended numerous times, the basic framework remained the same from 1935 to 1987, when the Federal Onshore Oil and Gas Leasing Reform Act (“FOOGLRA”) was passed.  In addition to the numerous amendments to the MLA and FOOGLRA, Congress also passed additional laws affecting oil and gas development, including the Multiple Mineral Development Act of 1954, the National Environmental Policy Act of 1969, the Federal Land Policy and Management Act of 1976, the Federal Oil and Gas Royalty Management Act of 1982, and the Energy Policy Act of 1992.

Renewal and exchange leases.  Renewal and exchange leases are generally found only in very old oil and gas fields.  As discussed above, under the original MLA, the BLM issued oil and gas prospecting permits for lands not within a KGS.  Upon a valuable discovery of oil or gas, the permittee became entitled to obtain a lease on the greater of 160 acres or 1/4th of the permit area and a preferential right to lease the remainder of the permit area.  Under the MLA, such earned leases, as well as competitive leases issued before 1935, had 20-year fixed terms with no Habendum clause (i.e., no “and so long thereafter” language), but the lessee had a preferential right to a “renewal lease” for a fixed successive period of 10 years.  Renewal leases were subject to certain requirements, such as a limitation on existing overriding royalty interests of 5%.  There is no limit on the amount of times a renewal lease could be renewed, although a 1990 amendment to the MLA now provides that a renewal lease renewed after November 15, 1990 will continue for 20 years and so long thereafter.  Due to the uncertainty of operating under a fixed term lease, subsequent amendments to the MLA also authorized the lessee of any 20-year lease (including renewals of such leases) or any lease issued before August 8, 1946 to exchange the lease for an “exchange lease” with the customary Habendum clause.  Because they involve oil and gas leases issued prior to 1946, there are few active renewal and exchange leases today.

Public domain leases.  Public domain leases are the most common federal oil and gas leases.  They cover lands or mineral deposits owned by the United States that were never granted to the state, patented into fee ownership, or disposed of under any public land law (there are certain exceptions, such as lands incorporated by cities, towns, or villages, lands in national parks, monuments, or reserves, or lands in wilderness areas or wilderness study areas).  They can also cover acquired lands – lands patented into fee ownership and subsequently reacquired by the federal government – if consented to by the surface managing agency.  Public domain leases are authorized under the MLA.  However, because of the numerous amendments to the MLA, the history and terms of such leases vary significantly.  For example, the primary term, rentals, and royalties depend on several factors, including: whether the lease was issued competitively or non-competitively, the period of time in which the lease was issued, and the period in time in which the rental or royalty was required.  As a result, it is important to review the lease to confirm the terms of a public domain lease.  Where the original grant of the lease has been lost or destroyed, a review and understanding of the history of the MLA and applicable regulations becomes necessary.  Because most oil and gas leases issued today are public domain leases, we discuss current leasing of public domain lands in the final section of this article below.

Right-of-way leases.  The lands under federal rights-of-way, not subject to an oil and gas lease at the time the right-of-way was issued, may only be leased under the Right-of-Way Leasing Act of 1930 (the ROW Act).  Although the ROW Act appears to include all rights-of-way, the BLM typically only issues right-of-way leases under railroads and reservoirs.  Under the ROW Act, the right-of-way owner is the only party that may lease the lands, but an owner or lessee of the oil and gas rights in the adjoining lands may submit a compensatory royalty bid and the BLM will issue either a right-of-way lease to the right-of-way owner or a compensatory royalty agreement to the adjoining owner or lessee, whichever is the most advantageous to the United States.  Because of the limited instances where lands fall under this category, right-of-way leases are less common than public domain leases.

Oil and gas leasing today.  The MLA, as amended, and FOOGLRA still govern the leasing of public domain lands for oil and gas today.  Such leasing is accomplished as follows:

  • Lands available for oil and gas leasing are nominated
  • The BLM selects tracts to be included in an upcoming lease sale
  • Notice of the lease sale is made
  • The BLM considers any protests filed and makes a final list of included tracts
  • The lease sale is held and the tracts are offered for oral bidding
  • The BLM issues a lease on each tract to the highest qualified bidder

In the event any tract does not receive any bids or the minimum acceptable bid, the tract becomes available to be leased non-competitively for a period of two years following the lease sale to the first qualified applicant.  The current lease terms for both newly issued competitive and non-competitive oil and gas leases are a primary term of 10 years, a royalty interest of 12.5%, and rentals of $1.50 per acre for the first five years, then $2 per acre thereafter.  After a discovery on the leased lands, a minimum royalty of not less than the annual rental is due in lieu of the annual rental.

The Habendum Clause – ‘Til Production Ceases Do Us Part

The habendum clause is a fundamental provision of oil and gas leases. This clause (also called the term clause) sets forth the time period that the rights granted to the lessee under the lease are extended—i.e. how long the lease will be active.1

Basics

An habendum clause in an oil and gas lease typically contains two separate terms, the primary term and the secondary term. The primary term is a fixed period of time during which the lessee has the option, but not the obligation, to pay delay rentals and/or explore for and produce oil and gas. No actual production is necessary to keep the lease active during the primary term. Ten years used to be a common primary term; however, shorter primary terms (e.g. 1 to 5 years) are often seen in areas with proven fields or anticipated drilling.2 As with other lease terms, its length can be negotiated by the lessor and lessee; the relative bargaining power between the parties and the amount of bonus a lessee is willing to pay are important in determining term length.3

At the expiration of the primary term, the lease terminates as a matter of law unless production4 is achieved during the primary term. The time period under the secondary term is indefinite—so long as lease substances are produced, the lease remains in effect. While many leases expire at the end of the primary term without production, if production is achieved, it is not uncommon for oil and gas leases to be held by production for many years.

In having both a primary and secondary term, the interests of both lessors and lessees are represented. The fixed primary term protects lessors from having their mineral interests endlessly tied up without production and encourages development on the land. If production is not achieved by the lessee within the primary term, the lease terminates (unless otherwise extended, such as by other lease terms) and the lessor is free to re-lease his or her mineral interests. Conversely, if production is achieved, the lessee’s risk in expending substantial sums to develop the land is rewarded by extending the lease so long as production continues.5

Formulation

Although there are numerous variations of habendum clauses, a typical habendum clause will read substantially as follows:

[T]his lease shall remain in force for a term of ___ years from this date, and as long thereafter as oil or gas or either of them is produced from said lands.6

Additionally, the phrase “produced in paying quantities” or “produced in commercial quantities” is commonly included in the clause, along with phrases allowing for production to come from lands pooled or unitized with the leased lands.7

Meaning of “Produced”

As noted above, the typical habendum clause requires that oil or gas be “produced” from the leased land to extend the lease beyond its primary term. In most states, “produced” means exactly that—oil or gas must actually be produced from the leased land. A minority of states, including Oklahoma and West Virginia, hold that discovery of oil or gas is sufficient—no production is actually necessary—to extend the lease beyond its primary term, although the well must be completed and capable of production, and the lessee must make diligent efforts to market.8 Another minority of states, including Montana and Wyoming, appear to differentiate between oil and gas, with the discovery of gas being sufficient to extend the lease beyond the primary term, while actual production for oil is necessary to extend.9 The distinction arises because oil can be produced and stored economically while gas generally cannot be stored economically above the ground.10

Some habendum clauses include language that the lease will be extended “so long as oil or gas is capable of being produced in paying quantities.” In such instances, actual production is not necessary to extend the lease beyond its primary term, but may require a well that can be turned “on” to produce in paying quantities without the addition of extra equipment or repair.11

Once the lease is extended into the secondary term, if production ceases the lease automatically terminates (unless otherwise extended by a different provision in the lease).12 However, courts have held that it is not required that production be entirely continuous throughout the extended term to hold the lease. Courts recognize that production may temporarily cease due to repairs, breakdowns, and reworking operations.13 Where the lease is silent, and cessation in production is litigated, the burden of proof rests on the lessee to show that the cessation was for a reasonable reason and for a reasonable amount of time. Courts vary in what constitutes a reasonable amount of time.14 For example, one court held that a four-year cessation in production was “temporary,” while another court held that a six-month cessation was “permanent.” To provide more certainty in the face of inconsistent court rulings, modern oil and gas leases often include a “cessation of production” clause that specifies when production must be continued after cessation for the lease to not terminate.15

Meaning of “Produced in Paying Quantities”

A question that frequently arises when construing an habendum clause is how much production is necessary—i.e. is any amount of production sufficient to hold the lease, or must the production reach a certain level? As noted above, modern oil and gas leases commonly include the qualification that production be in “paying” or “commercial” quantities. For leases that only state “production” is required, courts generally have construed the clause to include this qualification. Thus, regardless of whether the lease includes the qualification “in paying quantities,” the term “produced” typically means “produced in paying quantities.”16

The question then becomes what constitutes “produced in paying quantities.” The Kansas Court of Appeals stated the general rule:

[T]he phrase “in paying quantities” as used in an oil and gas lease habendum clause means production of quantities of oil or gas sufficient to yield a profit to the lessee over operating expenses, even though the drilling costs or equipping costs are never recovered, and even though the undertaking as a whole may thus result in a loss to the lessee.17

Put simply, a lease is considered “producing in paying quantities” if production revenue is greater than operating expenses.

In determining production revenue, any royalty paid to the lessor is excluded, although any payment to overriding royalty owners generally are included as revenue.18 For operating expenses, any direct costs to operate, such as labor costs, electricity for pumping units, taxes (but not income taxes) payable by the working interest owner(s), and day-to-day maintenance cost are included.19 There is some dispute among courts whether depreciation and overhead costs should be included as operating expenses.20 Initial expenditures, such as the costs of drilling, equipping, and completing are not included as operating expenses.21 Such analysis makes economic sense—after these initial expenditures, an operator will continue to operate so long as the production on a lease is marginally profitable in order to recover as much of these costs as possible.22

It is important to have a reasonable time period when evaluating production revenues against operating expenses. Leases may operate negatively in the short-term, but profitably in the long-term. One source notes that in almost every instance, a time period of at least a year was used by the courts to evaluate profitability, and frequently a time period of eighteen months to three years was used.23 In times of distressed market conditions, courts have used longer time periods or have assessed whether the lease would have been profitable under normal market conditions.24

Conclusion

An understanding of the habendum clause is crucial when negotiating a lease or when evaluating whether a lease has been held by production past its primary term. As you do so, keep in mind that other lease provisions not discussed in this article may also affect lease duration, such as shut-in royalty, pooling, unitization, Pugh, continuous operations, delay rental, and cessation of production clauses, among others. Additionally, be aware that the law varies from jurisdiction to jurisdiction, and may be different from the general principles discussed in this article.


1See PEC Minerals LP v. Chevron U.S.A., Inc., 439 F. App’x 413, 416 (5th Cir. 2011).
2John S. Lowe, Oil and Gas Law in a Nutshell (6th ed. 2014).
3Id.
4Or a lease provision that serves as a substitution for actual production such as continuous drilling operations or payment of shut-in royalty.
5Lowe, supra note 2.
63 Patrick H. Martin & Bruce M. Kramer, Williams & Meyers, Oil and Gas Law § 603.3 (2014).
7Id.
8See McVicker v. Horn, 322 P.2d 410 (Okla. 1958); Eastern Oil Co. v. Coulehan, 64 S.E. 836 ( W. Va. 1909).
9See Severson v. Barstow, 63 P.2d 1022 (Mont. 1936); Pryor Mt. Oil & Gas Co. v. Cross, 222 P. 570 (1924).
10See 2 Eugene Kuntz, A Treatise on the Law of Oil and Gas § 26.6 (rev. ed. 2014). See also Lowe, supra note 2.
11Martin & Kramer, supra note 6.
12See Anadarko Petroleum Corp. v. Thompson, 94 S.W.3d 550, 554 (Tex. 2002).
13Martin & Kramer, supra note 6, at § 604.4.
14Id.
15Id. See also Dave Hatch, Potential Pitfalls of Continuous Drilling Provisions in HBP Fee Leases (Apr. 10, 2014), available at: http://www.hollandhart.com/pitfalls-of-continuous-drilling-provisions-in-hbp-fee-leases/.
161 Earl A. Brown, Earl A. Brown, Jr., & Lawrence T. Gillaspia, The Law of Oil and Gas Leases § 5.03 (2d ed. 2014).
17Avien Corp. v. First National Oil, Inc., 79 P.3d 223, 230 (Kan. Ct. App. 2003); see also Maralex Res., Inc. v. Gilbreath, 76 P.3d 626, 630 (N.M. 2003) (“To satisfy the habendum clause production must be in ‘paying quantities,’ such that the income generated from oil and gas production exceeds the operating costs.”).
18Lowe, supra note 2.
19Id. See also Martin & Kramer, supra note 6, at § 604.6(b).
20Martin & Kramer, supra note 6, at § 604.6(b).
21Kuntz, supra note 10, at § 26.7.
22Martin & Kramer, supra note 6, at § 604.6(b).
23Lowe, supra note 2.
24Id. See also Kuntz, supra note 10, at § 26.7.