DESIRABLE AMENDMENTS TO PETROLEUM AND NATURAL GAS LEASES

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3 DESIRABLE AMENDMENTS TO PETROLEUM AND NATURAL GAS LEASES The oil patch is expanding into new areas of our province and you may be asked to advise a client regarding the granting of a petroleum and natural gas lease. A petroleum and natural gas lease is like any other contract and you should feel free to question the terms that are being offered to your client. Most oil and gas companies now prefer to use one of the "standard form" leases put out by the Canadian Association of Petroleum Landman with the favourite being the CAPL 88(1) form. These standard form leases created by the oil and gas industry are, as you would suspect, worded in favour ofthe industry and to the disadvantage of the mineral owner. Accordingly, a number of wording amendments are necessary, not to tip the scales in favour of the mineral owner, but simply to level the playing field. The following comments are based on the CAPL 88(1) form oflease, but they apply generally to all forms ofpetroleum and natural gas leases: A. NUMBER OF PARCELS ON ONE LEASE Do not put more than one quarter section of minerals on one lease. If your client has more quarters of minerals to lease out, there should be a separate lease for each quarter section. The reason for this is that the term of the lease will be continued for as long as there is production of leased substances from any portion of the lands. If several quarter sections of minerals are included in one lease, then one well will keep all of those quarter sections tied up for as long as that one well produces, rather than the oil and gas company having to drill at least one well on each quarter section. Your client wants to get as many producing wells as possible. B. COMMENTS ON CAPL 88(1) FORM OF LEASE 1. A provision should be added to the lease prohibiting the lessee from using a well on the said lands for a disposal well or an injection well without entering into a separate agreement that ) MINING, OIL AND GAS October 2008

4 2 provides compensation to your client for the disposal or injection of substances into your client's minerals. 2. It is becoming more common to have a "reversionary clause" added to the lease whereby the lease expires with respect to all spacing units, zones and formations from which production is not being obtained. The purpose of this is to prevent the oil and gas company tying up portions ofthe lands or different zones or formations at different depths on which or from which new oil or gas wells could be producing. 3. Arguably road bans should not be included in the definition of "force majeure". There have been court decisions that stated that oil and gas companies should be aware that road bans happen annually and that the oil and gas companies need to plan around those road bans. Road bans should not be an event that extends the term ofa petroleum and natural gas lease. 4. The definition of "offset well" should be amended to state that it means "... any well drilled on any spacmg unit laterally or diagonally adjoining the said lands...". 5. The definition of"operations" is very important in that it has a direct bearing on when the petroleum and natural gas lease will terminate or expire. The term ofthe lease is for the primary term and "... so long thereafter as operations (as hereinafter defined) are conducted upon the said lands... with no cessation, in the case of each cessation of operations, of more than 90 consecutive days." The definition of "operations" in the CAPL forms of leases is far too broad and, over the years, this type of wording has been the subject of much abuse. The definition of "operations" should be restricted to activities which are bona fide attempts to obtain production of leased substances and which will result in royalties being paid to the mineral owner. The lease allows the oil and gas company to cease production of all leased substances from the mineral owner's lands for up to 90 consecutive days. and this provision is put in the lease in order to allow the oil and gas company to perform repairs to the well or to the equipment. It is hard to imagine circumstances in which those repairs cannot be completed within that 90 day period of MINING, OIL AND GAS October 2008 ~ SK l E S!

5 3 time. Accordingly, there is no need to include references to "repairing a well or equipment" in the definition of operations and those words should be deleted. The reference to "injecting substances" should also be deleted because the injection of any substances into your client's minerals should be done under a separate agreement that provides compensation to your client. The words "the recovery of any injected substance" should be deleted from the lease because no royalties are payable on any injected substances that are recovered and, therefore, this activity should not prolong the term ofthe lease. Obviously the words "any acts for or incident to any of the foregoing" should be deleted as being too nebulous. 6. Clause 3 of the lease is the clause that deals with suspended wells, and in its present wording, it allows an oil and gas company to arbitrarily stop producing that well or simply not get around to repairing the well, and as long as there is any well on your client's minerals that is capable of producing leased substances (even though none of those wells are producing any royalty income for your client), the lease does not terminate. This is another clause that has been badly abused over the years, and the clause should be amended to specify that the term of the lease will only continue for so long as the reason for all such wells being shut in or suspended is a reason beyond the lessee's control. 7,8. Clause 4(a) of the lease should be amended to clearly state that no expenses may be deducted from the royalty payable to the mineral owner. Instead of referring to the current market value at the "wellhead", the royalty should be calculated on the current market value at the "point ofsale". The leased substances are worth less at the wellhead, because gas may have to be dehydrated, oil has to be separated from salt water and other impurities, and then the oil and gas has to be transported to the point ofsale. The sentence that says the lessor shall bear its reasonable proportion ofany expense should be deleted and replaced by a sentence that says the lessor shall not bear any portion of any expense. Wording should also be included in clause 4 requiring the oil and gas companies to provide royalty statements that are clear and concise and that can be understood by a typical lay person. MINING, OIL AND GAS October 2008 ~ SK'l'E'S,1

6 4 9. Clause 8 ofthe lease provides that the offset obligation does not arise and the oil and gas company will not have to drill a well on your client's minerals if a well ever has been drilled on your client's minerals in the past. The object of this is to avoid requiring the oil and gas company to drill a well into minerals that have been proven to not be economic. It is recommended that a time limit be put on this exception to the offset obligation, because with the great improvement in technology and the drastic increase in the prices of oil and gas, a well that was considered to be uneconomic 30, 40 or 50 years ago may very well be economic in today's market. 10. The wording of the CAPL form of lease only triggers the obligation to drill a well on your client's minerals if an offset well exists on a laterally adjacent spacing unit. Laterally adjacent means a spacing unit that is directly north, south, east or west and does not include a diagonally adjacent spacing unit. Since a diagonally adjacent spacing unit may drain your client's minerals just as well as a laterally adjacent spacing unit does, this clause should be amended to includeboth laterally adjacent and diagonally adjacent spacing units. 11. The oil and gas company should not be allowed to send a small rig out to "spud" the well and then take its time coming back to actually complete the drilling of the well. Therefore, clause 8(a) of the lease should be amended to provide that the oil and gas company must commence drilling the well and, thereafter, continuously and diligently finish drilling the well. 12, 13, 14. Pooling is when the oil and gas company wants to combine your client's minerals with the minerals next door for the purpose of drilling one well. An example would be a horizontal well that crosses both your client's minerals and the neighbour's minerals. Unitization is usually where a larger number of quarter sections of minerals are combined into one unit and each person owning minerals in that unit receives a share of the total production from all of the lands included in the unit. Unitization is usually done so that some form of secondary recovery or enhanced production (e.g. a water flood or a CO 2 flood) can be undertaken. The CAPL forms of leases do not give the mineral owner any say in what portion of the oil produced from the pooled lands or the unitized lands will be attributed to him for the purposes of calculating his MINING, OIL AND GAS October 2008

7 5 royalty. In the case ofa pooling, the lease says that the portion ofthe oil produced from the well that is to be allocated to your client's minerals will be determined based on the surface area ofthe minerals contributed by each mineral owner. This is an easy formula to implement, but it is not necessarily fair if more of the oil or gas comes from one party's minerals than comes from the other party's minerals. In the case ofunitization, the lease says that the allocation ofproduction amongst the various mineral owners will be in the sole discretion of the oil and gas company. This clause should be amended to allow the mineral owner some say into how his share ofthe oil and gas will be determined. 15. Clause 13 is the clause that allows the oil and gas company to surrender the petroleum and natural gas lease or any portion ofthe lease. Ifthe lessee does surrender all or any portion of the lease, the lessee should only be released from the obligations that would accrue thereafter. Accordingly, the reference to the lessee being released from "accrued" obligations should be deleted. 16. Roughly paraphrased, clause 15(a) provides that ifthe lessor believes that the lessee has breached any of the terms of the lease, the lessor may give the lessee written notice of such breach and the lessee shall have 30 days to remedy or commence to remedy the breach or to seek a judicial determination as to whether there has been a breach. Clause l5(b), roughly paraphrased, says that ifthe oil and gas company does not remedy, commence to remedy or seek a judicial determination with the 30 day time period, the lease will terminate. It is recommended that the additional 30 day time period following the date ofany judicial determination be deleted. 17. Clause 15(c) of the lease is a dangerous clause because it provides that, even though the oil and gas company may be in default, the mineral owner is not able to terminate the lease if there is on those minerals a well capable of producing leased substances. The mineral owner's remedy is limited to suing the lessee for damages, and most mineral owners do not want to be put in that position. We recommend deleting clause 15(c) entirely, but if that is not possible, we recommend at a minimum that clause l5(c) be amended to state that the lease may be terminated ifthe default is the non-payment ofroyalties. MINING, OIL AND GAS October 2008 ~ SK l E S"

8 6 c. COMMENTS ON CAPL 91 FORM OF LEASE The only real difference in the amendments between the CAPL 88(1) form of lease and the CAPL 91 form of lease is the amendment to clause 4(a) relating to royalties. The different wording used in the CAPL 91 form of lease requires a slightly different amendment to obtain the same result as what is obtained with the amendment to the CAPL 88(1) form. The foregoing are some ofthe more fundamental and important changes you should advise your client about. This article has not attempted to deal with the business aspects of negotiating a lease, such as the amount of money that should be paid s consideration for entering into the lease, the amount of the royalty, the length of the term, etc. These changes do not slant the petroleum and natural gas lease in favour of the mineral owner, they only try to make the lease more fair and even to both sides. MINING, OIL AND GAS October 2008

9 ~p.is is SCHEDULE "A" attached to and fonning part of the PETROLEUM AND NATURAL GAS LEASE made between *, as hsor, and *, as Lessee, and dated the * day of *, 200*, and it is agreed between the parties thereto that should the provisions set out on this Schedule "A" conflict with any other tenns ofthe within Petroleum and Natural Gas Lease, the provisions set out in this Schedule shall prevail. 1. The following sentence shall be added to the endof the first paragraph on the first page: "The Lessee shall not use a well on the said lands for a disposal well or injection well without agreeing on compensation thereforand entering into a separate agreementwith the Lessor to thateffect." 2. The following sentence shall be added, at the double asterisk, to the end ofthe habendum clause in which the tenn is filled in on the first page: "Notwithstanding any other provision of this Lease, at the expiration ofthe primary tenn ofthis Lease, this Lease shall expire with respect to all spacing units (or portions thereot) and all zones and fonnations thereof on which operations are not then being conducted with no cessation, in the case ofeach cessation ofoperations, ofmore than 90 consecutive days." 3. In clause number l(c), the words "including road bans" shall be deleted from the second and third lines. 4. In clause number l(t), the words "or diagonally" shall be added immediately following the word "laterally". 5. Clause number l(g), the definitionof"operations" shall be deleted in its entirety and the following substituted therefor: "(g) 'operations' means any ofthe following: (i) drilling, drill stem testing, completing, reworking, recompleting, or deepening a well on the said lands in search for or in an endeavour to obtain, maintain, or increase production of any leased substance from the said lands, the pooled lands or the unitized lands; (ii) the production ofany leased substance." 6. In clause number 3 which deals with Suspended Wells, the words "for a reason beyond the Lessee's control" shall be added immediately following the word "suspended" in eachof the second and third lines of this clause. 7. In clause number 4(a), the Royalties clause, the word "wellhead" in the first line shall be deleted and replaced with "point of sale" and the last sentence shall be deleted and replaced with the following: "The Lessor shall not bear any portion of any expense incurred by the Lessee for separating, treating, processing or transporting leased substances." 8. The following wording shall be added to the endofclause number 4(d): "The Lessee agrees that it shall provide the Lessor with written monthly production and royalty statements providing a clear and concise explanationof the manner in which the payment has been calculated. Royalty statements shall include the total quantity ofleased substances produced for each well for that month, the total quantity ofleased substances sold, the price for which such substances were sold, the royalty rate applied in calculating the royalty payable to the Lessor, and any other relevant infonnation." 9..'l. ) In clause number 8, the words "within the 10 years immediately preceding the date of this lease" shall be added immediately following the words "... unless (i) a well has" in the first line ofthis clause. In clause number 8, the words "or diagonally" shall be added immediately following the word "laterally" in each instance where the word "laterally" appears in the second and third lines, the second line of 8(a), the first line of 8(b), and second line of 8(c),

10 and the fourth line of8(d). 11. In clause number 8(a), the words "continuously and diligently" shall be added immediately following the word "thereafter" in the second line ofthis clause. 12. In clause number 9(a), the sentence in the fifth line beginning with "In the event..." and ending with "... in the spacing unit." in the seventh line shallbe deleted in its entirety and replacedwith the following clause: "In the event of pooling there shall be allocated to that portion of the said lands included in the spacing unit that proportion ofthe total production of the leased substances from the spacing unit, after deducting any leased substances used in operations on the pooled lands, which the Lessor and Lessee may agree upon and in the event the Lessor and Lessee fail to agree, the matter shall be determined by arbitration in accordance with the provisions of The Arbitration Act, 1992 ofsaskatchewan or any successor legislation." 13. In the last line ofclause number 9(d), the words "in the sole discretion and determination ofthe Lessee, exercised bona fide, and when so determined shall be binding upon the Lessor" shall be deleted and replaced with "subject to the Lessor's prior written approval". 14. In clause number 9(e), the words "Upon notice from the Lessor" shall be deleted from the fourth line and the last sentence beginning with "The Lessee shall also have the right" shall be deleted in its entirety. IS. In clause number 13(b), the words "accrued or" shall be deleted from the first line and the word "thereafter" shall be added immediately following the word "to" in the first line of this clause. 16. In clause number 15(b), the words "nor shall it terminate if the Lessee within the 30 days of such final determination has remedied or commenced to remedy the breach or breaches, and having so commenced to remedy the breach or breaches. thereafter diligently continues to remedy the same" shall be deleted. 17. In clause number 15(c), the words "and subject always to the payment of royalties" shall be added immediately following the words "Notwithstanding anything contained in this Lease" in the first line; and the words "(other than a default in the payment of royalties in accordance with paragraph 4)" shall be added immediately following the words "... the Lessor's remedy for any default" in the third line. 18. The following clauses shall be added to the Lease: "27. This agreement shall be construed according to the laws of the Province of Saskatchewan." Optional* "28. The Lessee agrees that this lease form is an exact replica of the C.A.P.L. 88(1) SASK model lease form except for additions printed in bold. In the event that there is any variance between this lease form and the C.A.P.L. 88(1) SASK lease form, then the C.A.P.L. 88(1) SASK form shall take precedence." (This clause 28 only needs to be added if the oil company is not using the actual CAPL printed form of Lease but rather is using a different printed form.) Page * of*

11 '{lis is SCHEDULE "A" attached to and fonning part of the PETROLEUM AND NATURAL GAS LEASE made between *, as,bssor, and *, as Lessee, and dated the * day of *, 20*. and it is agreed between the parties thereto that should the provisions set out on this Schedule "A" conflict with any other tenns of the within Petroleum and Natural Gas Lease, the provisions set out in this Schedule shall prevail. 1. The following sentence shall be added to the end ofthe first paragraph on the first page: "The Lessee shall not use a well on the said lands for a disposal well or injection well without agreeing on compensation therefor and entering into a separate agreement with the Lessor to that effect." 2. The following sentence shall be added, at the double asterisk, to the end ofthe habendum clause in which the tenn is filled in on the first page: "Notwithstanding any other provision of this Lease, at the expiration ofthe primary tenn of this Lease, this Lease shall expire with respect to all spacing units (or portions thereof) and all zones and fonnations thereof on which operations are not then being conducted with no cessation, in the case ofeach cessation ofoperations, ofmore than 90 consecutive days." 3. In clause number l(c), the words "including road bans" shall be deleted from the second and third lines. 4. In clause number l(f), the words "or diagonally" shall be added immediately following the word "laterally". 5. Clause number l(g), the definition of"operations" shall be deleted in its entirety and the following substituted therefor: "(g) 'operations' means any ofthe following: (i) drilling, drill stem testing, completing, reworking, recompleting, or deepening a well on the said lands in search for or in an endeavour to obtain, maintain, or increase production of any leased substance from the said lands, the pooled lands or the unitized lands; (ii) the production ofany leased substance." 6. In clause number 3 which deals with Suspended Wells, the words "for a reason beyond the Lessee's control" shall be added immediately following the word "suspended" in each ofthe second and third lines ofthis clause. 7. In clause number 4(a), the Royalties clause, the word "wellhead" in the first and third lines shall be deletedand replaced with the words "point of sale". After the words "subclause (b) hereof," in the fourth line, the remainder ofclause number 4(a) shall be deleted and replaced with the following: "... the Lessee may not deduct any expense incurred by the Lessee. The royalty as detennined under this clause shall be payable on or before the 15th day of the second month following the month in which the leased substances, with respect to which the royalty is payable, were produced, saved and sold, or used by the Lessee for a purpose other than that described in subclause (b). No royalty shall be payable to the Lessor with respect to any substance injected into and recovered from the said lands, other than leased substances originally produced from the said lands for which a royalty has not been paid or payable." 8. The following wording shall be added to the endofclause number 4(d): "The Lessee agrees that it shall provide the Lessor with written monthly production and royalty statements providing a clear and concise explanation of the manner in which the payment has been calculated. Royalty statements shall include the total quantity of leased substances produced for each well for that month, the total quantity ofleased substances sold, the price for which such substances were sold, the royalty rate applied in calculating the royalty payable to the Lessor, and any other relevant infonnation."

12 9. In clause number 8, the words "within the 10 years immediately preceding the date of this lease" shall be added immediate)' following the words "... unless (i) a well has" in the first line ofthis clause. 10. In clause number 8, the words "or diagonally" shall be added immediately following the word "laterally" in each instance where the word "laterally" appears in the second and third lines, the second line of 8(a), the first line of 8(b), and second line of 8(c), and the fourth line of 8(d). II. In clause number 8(a), the words "continuously and diligently" shall be added immediately following the word "thereafter" in the second line ofthis clause. 12. In clause number 9(a), the sentence in the fifth line beginning with "In the event..." and ending with "... in the spacing unit." in the seventhline shall be deleted in its entirety and replaced with the following clause: "In the event of pooling there shall be allocated to that portion of the said lands included in the spacing unit that proportion of the total production of the leased substances from the spacing unit, after deducting any leased substances used in operations on the pooled lands, which the Lessor and Lessee may agree upon and in the event the Lessor and Lessee fail to agree, the matter shall be determined by arbitration in accordance with the provisions of The Arbitration Act, 1992 ofsaskatchewan or any successor legislation." 13. In the last line ofclause number 9(d), the words "in the sole discretion and determination ofthe Lessee, exercised bona fide, and when so determined shall be binding upon the Lessor" shall be deleted and replaced with "subject to the Lessor's prior written approval". 14. In clause number 9(e), the words "Upon notice from the Lessor" shall be deleted from the fourth line and the last sentence beginning with "The Lessee shall also have the right" shall be deleted in its entirety. IS. In clause number 13(b), the words "accrued or" shall be deleted from the first line and the word "thereafter" shall be addf immediately following the word "to" in the first line ofthis clause. 16. In clause number 15(b), the words "nor shall it terminate if the Lessee within the 30 days of such final determination has remedied or commenced to remedy the breach or breaches, and having so commenced to remedy the breach or breaches, thereafter diligently continues to remedy the same" shall be deleted. 17. In clause number 15(c), the words "and subject always to the payment of royalties" shall be added immediately following the words "Notwithstanding anything contained in this Lease" in the first line; and the words "(other than a default in the payment of royalties in accordance with paragraph 4)" shall be added immediately following the words "... the Lessor's remedy for any default" in the third line. 18. The following clauses shall be added to the Lease: "27. This agreement shall be construed according to the laws ofthe Province ofsaskatchewan." Optional* "28. The Lessee agrees that this lease form is an exact replica of the C.A.P.L. 91 SASK model lease form except for additions printed in bold. In the event that there is any variance between this lease form and the C.A.P.L. 91 SASK lease form, then the C.A.P.L. 91 SASK form shall take precedence." (This clause 28 only needs to be added if the oil company is not using the actual CAPL printed form of Lease but rather is using a different printed form.) Page * of*