TWENTY-FIVE PROVISIONS OF AN OIL AND GAS LEASE IN FIFTY MINUTES

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1 TWENTY-FIVE PROVISIONS OF AN OIL AND GAS LEASE IN FIFTY MINUTES Timothy C. Dowd Elias, Books, Brown & Nelson Oklahoma City, OK NALTA September 2017

2 1. TITLE OF DOCUMENT Oil and Gas Lease (Paid Up) Typically, an oil and gas lease is entitled oil and gas lease. However, the title to the document is not definitive. There are some documents that have been filed in the past which recite that they are oil and gas leases but, in fact, they are term mineral deeds.

3 2. EFFECTIVE DATE OF LEASE AGREEMENT, Made and entered into this day of, 20, by and between, Party of the first part, hereinafter called lessor (whether one or more) and, party of the second part, hereinafter called lessee. IN TESTIMONY WHEREOF, we sign this the 20. day of, LESSOR: BY: The first line of an oil and gas lease typically recites the date of the agreement. The date of the agreement is important because this date is the date from which the primary term extends, regardless of when the lease was actually executed. As an example, if the lease is made and entered into on January 1, 2010, then the primary term runs from that date even if the lessor did not execute the deed until February 1, 2010 or later.

4 3. PARTIES TO THE AGREEMENT WITNESSETH, That the said lessor, for and in consideration of Ten and no/100 ($10.00) DOLLARS, cash in hand paid, receipt of which is hereby acknowledged and of the covenants and agreements hereinafter contained on the part of lessee to be paid, kept and performed, has granted, demised, leased and let and by these presents does grant, demise, lease and let exclusively unto the said lessee, for the sole and only purpose of exploring by geophysical and other methods, mining and operating for oil (including but not limited to distillate and condensate), gas (including casinghead gas and helium and all other constituents), and for laying pipe lines, and building tanks, power stations and structures thereon, to produce, save and take care of said products, all that certain tract of land, together with any reversionary rights, riparian rights and after- acquired interest,

5 3. PARTIES TO THE AGREEMENT The parties are listed in the oil and gas lease. They give the name of the lessor, (the mineral owner), who leases and grants his rights to explore for hydrocarbons to the lessee (oil company). Case law has held that an oil and gas lease is valid between the parties even if consideration is inadequate. Rich v. Doneghey, 1918 OK 689, 177 P.86. A typical oil and gas lease grants the right to explore for oil, gas and other hydrocarbons. A well-written oil and gas lease will include all elements of petroleum products. It will also grant the exclusive right for geophysical exploration to the lessee.

6 4. CONSIDERATION The oil and gas lease typically recites that the consideration is $10.00 or more dollars, cash in hand paid. The consideration clause is not important in many states. Case law has held that an oil and gas lease is valid between the parties even if consideration is inadequate. Rich v. Doneghey, 1918 OK 689, 177 P.86.

7 5. SUBSTANCES TO BE PRODUCED A typical oil and gas lease grants the right to explore for oil, gas and other hydrocarbons. A well-written oil and gas lease will include all elements of petroleum products. It will also grant the exclusive right for geophysical exploration to the lessee. Typically, the clause will also recite that it grants certain surface obligations such as laying pipelines, building tanks, power stations, etc. However, while these may be helpful, it is not important under most state laws. For example, under Oklahoma law, as the mineral estate is the dominant estate, the mineral owner, or his lessee, has the right to use as much surface as in necessary in order to perform the functions of an oil and gas lease. In other words, subject to the Oklahoma Surface Damage Act, the oil company has the right to use the surface in order to explore for oil and gas hydrocarbons.

8 6. LEGAL DESCRIPTION Therein situated in the County of Washington State of Oklahoma, described as follows, to-wit: the NW/4 of Section 1, Township 1 North, Range 1 East. Containing 160 acres, more or less. An oil and gas lease must describe the land covered thereby with such certainty that it can be located.

9 7. HABENDUM CLAUSE It is agreed that this lease shall remain in force for a term of three (3) years from date above (herein called primary term) and so long thereafter as oil or gas, or either of them, is produced from said land by the lessee. One of the most important clauses in the oil and gas lease is the habendum clause, which provides the length of the oil and gas lease. While the lease recites that the lease is to remain in force as long as there is production, almost every state has interpreted this provision to indicate that it must be production in paying quantities. Produced and produced in paying quantities have substantially the same meaning. The court stated that production in paying quantities.means production of quantities of oil and gas sufficient to yield a profit, even though the drilling and equipping costs are never recovered, and even if the undertaking as a whole may result is a loss to the lessee.

10 8. ROYALTY CLAUSE In consideration of the premises the said lessee covenants and agrees: 1st. The royalties to be paid by Lessee are: (a) on oil and other liquid hydrocarbons, three-sixteenth (3/16) of that produced and saved from said land, the same to be delivered at the wells, or to the credit of Lessor into the pipeline to which the wells may be connected; Lessee may from time to time purchase any royalty oil in its possession, paying the market price therefore prevailing for the field where produced on the date of purchase; (b) on gas and the constituents thereof produced from said land and sold or used off the premises or in the manufacture of products therefrom, the market value at the well of three-sixteenth (3/16) of the product sold or used. On product sold at the well, the royalty shall be three-sixteenth (3/16) of the net proceeds realized from such sale. All royalties paid on gas sold or used off the premises or in the manufacture of products therefrom will be calculated after deducting from such royalty lessor's proportionate amount of all post-production costs, which shall include, but shall not be limited to gross production and severance taxes, gathering and transportation costs from the wellhead to the point of sale, treating, compression, and processing, line loss/fuel, separating and dehydration.. On product sold at the well, the royalty shall be three-sixteenth (3/16) of the net proceeds realized from such sale, after deducting from such royalty lessor's proportionate amount of all of the above post-production costs and expenses, if any. The royalty clause is the main provision in an oil and gas lease for compensation for the lessor; therefore, it has been the subject of a relatively large proportion of the litigation involving the lease. Royalty is generally free of costs of production through the wellhead; however, it may be subject to post production costs such as costs involving the sale of natural gas.

11 9. SHUT-IN CLAUSE 2nd. If a well capable of producing gas in paying quantities is completed on the above described land or acreage pooled herewith and is shut in, this lease shall continue in effect for a period of one year from the date such well is shut in. Lessee or any assignee may thereafter, pay or tender to Lessor as royalty, on or before one year from the date such well is shut-in, the sum of $1.00 per acre, and, if such payment or tender is made, this lease shall continue in effect for a further period of one year. In like manner and upon like payments or tenders annually made on or before each anniversary of the shut-in date of such well this lease shall continue in effect for successive periods of twelve (12) months each. Notwithstanding any other provision to the contrary, this lease shall not terminate because of a failure to properly or timely make shut-in gas well payments unless Lessor shall have given Lessee written notice of such failure to properly or timely make such shut-in gas well payment and Lessee shall have failed for a period of thirty (30) days after receipt of such notice to tender such late payment or such payment in the proper amount, together with a late or improper payment penalty of $ The function of the shut-in clause is to compensate the lessor for extension or maintenance of the lease when there is no actual production. The shut-in royalty clauses were included in the oil and gas leases because of the assumption that a lease would terminate at or after the end of the primary term unless there was actual production and marketing at that time. In Texas, following the majority of the states, the courts have held that an oil and gas lease is terminated at the end of the primary term unless there is actual production and marketing Oklahoma holds to the minority position that a well that is capable of producing will maintain a lease as long as the lessee is reasonably diligent in its marketing efforts.

12 10. COMMENCEMENT CLAUSE If the lessee shall commence to drill a well or commence reworking operations on an existing well within the term of this lease or any extension thereof, or on acreage pooled therewith, the lessee shall have the right to drill such well to completion or complete reworking operations with reasonable diligence and dispatch, and if oil or gas, or either of them, be found in paying quantities, this lease shall continue and be in force with like effect as if such well had been completed within the term of years first mentioned. This clause allows that for a lease to be preserved, it is necessary for drilling to start prior to the expiration of the oil and gas lease and production to be obtained as a result of the particular drilling operations specified in the clause. If the initial operations do not result in production, it will not suffice that other drilling operations, even though commenced while the former drilling operations were being pursued, result in production.

13 11. POOLING OR UNITIZATION PROVISION Lessee is hereby granted the right at any time and from time to time to unitize the leased premises or any portion or portions thereof, as to all strata or any stratum or strata, with any other lands as to all strata or any stratum or strata, for the production primarily of oil or primarily of gas with or without distillate. However, no unit for the production primarily of oil shall embrace more than 40 acres, or for the production primarily of gas with or without distillate more than 640 acres; Lessee shall file written unit designations in the county in which the leased premises are located. Operations upon and production from the unit shall be treated as if such operations were upon or such production were from the leased premises whether or not the well or wells are located thereon. The entire acreage within a unit shall be treated for all purposes as if it were covered by and included in this lease except that the royalty on production from the unit shall be as below provided, and except that in calculating the amount of any shut in gas royalties, only the part of the acreage originally leased and then actually embraced by this lease shall be counted.

14 11. POOLING OR UNITIZATION PROVISION continued Pooling is the consolidation and combining of leased land with adjoining leased tracts. The area is called a pool or a unit. Pooling has the benefit to the production company of uniting all mineral owners leases into a common pool under one drilling tract and utilizing one common underground geological reservoir. Operations upon and production from the unit shall be treated as if such operations were upon or such production were from the leased premises whether or not the well or wells are located thereon. The concept known as pooling in the oil and gas industry refers to the process used by production companies to bring together tracts of land for the purpose of drilling a single well on an established spacing unit. The chief mechanism enabling production companies to pool various tracts of land and mineral interest into a single spacing unit is the pooling clause in an oil and gas lease.

15 12. PROPORTIONATE REDUCTION CLAUSE If said lessor owns a less interest in the above described land than the entire and undivided fee simple estate therein, then the royalties herein provided shall be paid to the lessor only in the proportion which his interest bears to the whole and undivided fee. The proportionate reduction clause permits lessees to reduce the royalty payments that they make to the owners of the minerals that are leased. This is because the granting clause often makes no provision for multiple owners of mineral interests. Even if the owner owns full ownership of the parcel's surface rights, a lessor who owns just a fraction of the underlying mineral rights must accept a proportionate reduction clause that curtails the lessee's royalty, bonus (or rental) obligations by the appropriate amount.

16 13. TOP LEASE CLAUSE If at any time within the primary term of this lease and while the same remains in force and effect, lessor receives any bona fide offer, acceptable to lessor, to grant an additional lease (top lease) covering all or part of the afore described lands, lessee shall have the continuing option by meeting any such offer to acquire such top lease. Any offer must be in writing, and must set forth the proposed lessee s name, bonus consideration and royalty consideration to be paid for such lease, and include a copy of the lease form to be utilized which form should reflect all pertinent and relevant terms and conditions of the top lease. Lessee shall have fifteen (15) days after receipt, from lessor, of a complete copy of any such offer to advise lessor in writing of its election to enter into an oil and gas lease with lessor on equivalent terms and conditions. If lessee fails to notify lessor within the aforesaid fifteen (15) day period of its election to meet any such bona fide offer, lessor shall have the right to accept said offer. A recent phenomenon in oil and gas leases is the inclusion of a preferential right to purchase any top lease that is acceptable to the lessor.

17 14. ENTIRETIES CLAUSE If the leased premises are now or hereafter owned in severalty or in separate tracts, the premises, nevertheless, may be developed and operated as an entirety, and the royalties shall be paid to each separate owner in the proportion that the acreage owned by him bears to the entire leased area. There shall be no obligation on the part of the lessee to offset wells on separate tracts into which the land covered by this lease may hereafter be divided by sale, devise, or otherwise, or to furnish separate measuring or receiving tanks for the oil produced from such separate tracts. Texas, Oklahoma and all other jurisdictions apply the non-apportionment rule. In a non-apportionment state, the owner of a subdivided tract will receive only that royalty attributable to wells drilled on his tract or his unit. He will not receive royalties from wells drilled on a portion of the leased premises that he does not own at the time of production. If the well is drilled on X s tract, only X will receive royalty. An example of the effect of the entirety clause can be seen in the situation where A executes an oil and gas lease providing for one-eighth royalty covering the northwest quarter to XXX Oil Company. A subsequently conveys the east one-half to B. XXX Oil Company drills a productive well on the east onehalf of the northwest quarter. Under the non-apportionment rule (and in the absence of an entirety clause in the lease) B is entitled to all of the royalty. In the event of an entirety clause, both A and B receive royalty.

18 15. NOTICE TO LESSEE OF CHANGE IN OWNERSHIP However, no change or division in ownership of the land or royalties shall enlarge the obligations or diminish the rights of Lessee. No change in the ownership of the land or royalties shall be binding on the lessee until after the lessee has been furnished with a written transfer or assignment or a true copy thereof. In case lessee assigns this lease, in whole or in part, lessee shall be relieved of all obligations with respect to the assigned portion or portions arising subsequent to the date of assignment. The effect of the assignment clause is to permit the lessee to rely upon the identity of the lessor with regard to royalty payments. If there has been a conveyance, the lessee is to be provided with proof of such assignment. Without this clause, the lessee may be obligated to frequently review the county records to determine who should be paid royalty and in what proportion.

19 16. CESSATION OF PRODUCTION CLAUSE A typical cessation of production clause recites: If, after the expiration of the primary term of this lease, production on the leased premises shall cease from any cause, this lease shall not terminate provided lessee resumes operations for drilling a well within sixty (60) days from such cessation, and this lease shall remain in force during the prosecution of such operations and, if production results therefrom, then as long as production continues. Under the clause, a literal reading of the lease would indicate that the lease would terminate after a period of sixty days of nonproduction.

20 16. CESSATION OF PRODUCTION CLAUSE While the lease indicates that it is to remain in existence as long as there is production, courts excuse periods of temporary cessation. If the temporary cessation is reasonable, the lease will continue, and the burden of proving that the lessees failed to use reasonable diligence in the operation of the well squarely rests with the lessor. The Supreme Court in Pack v. Santa Fe Minerals, held that a lease does not terminate under the terms of a habendum clause when the well was at all times capable of producing in paying quantities. Pack. The court explained that a sixtyday cessation of production clause requires the well to be capable of producing in paying quantities, but that a lease capable of producing in paying quantities will not terminate under that clause for a failure to market gas for sixty-day period. Rather it is the failure to comply with the implied covenant to market which could result in cancellation of the lease.

21 17. LEASE SUBJECT TO LAW All express or implied covenants of this lease shall be subject to all Federal and State Laws, Executive Orders, Rules and Regulations, and this lease shall not be terminated, in whole or in part, nor lessee held liable in damages, for failure to comply therewith, if compliance is prevented by, or such failure is the result of any such Law, Order, Rule or Regulation. It is implied in law, if not contained in the lease language that the conservation clause provides that the lease shall comply with all state and federal regulations.

22 18. EFFECT OF EXECUTION OF LEASE This lease shall be effective as to each lessor on execution hereof as to his or her interest and shall be binding on those signing, notwithstanding some of the lessors above named may not join in the execution hereof. The word Lessor as used in this lease means the party or parties who execute this lease as Lessor, although not named above.

23 19. SURRENDER OF LEASE Lessee may at any time and from time to time surrender this lease as to any part or parts of the leased premises by delivering or mailing a release thereof to lessor, or by placing a release of record in the proper County.

24 20. WARRANTY CLAUSE Lessor hereby warrants and agrees to defend the title to the lands herein described. A warranty creates a promise to defend the lessee against future unlawful claims and demands. If there is a failure of title, the warranty permits the lessee to recover damages. In Walker & Withrow, Inc. v. Halley, the mineral owners granted a one-year oil and gas lease to a landman representing an oil company for $12,000. The landman solicited the lease from the appellants and said that he had checked the records and their land was open for leasing. The oil company subsequently asked for an extension of 90 days for a $5,000 bonus. The oil company discovered that the mineral owner s land was being held by production. The oil company demanded that appellant return the $17,000 bonus money because the oil company had breached the warranty.

25 21. SUBROGATION CLAUSE Lessor... agrees that the lessee shall have the right at any time to redeem for lessor by payment any mortgages, taxes or other liens on the above described lands, in the event of default of payment by lessor, and be subrogated to the rights of the holder thereof.

26 22. ACKNOWLEDGEMENT STATE OF OKLAHOMA COUNTY OF SS (ACKNOWLEDGMENT FOR INDIVIDUAL) Before me, the undersigned, a Notary Public, in and for said County and State, on this day of, 20, personally appeared personally known to me to be the identical person(s) who executed the within and foregoing instrument, and acknowledged to me that executed the same as free and voluntary act and deed, for the uses and purposes therein set forth. IN WITNESS WHEREOF, I have hereunto set my official signature and affixed my official seal the day and year first above written. My commission expires, Notary Public

27 22. ACKNOWLEDGEMENT Under most state statutes, a lease cannot be recorded without being acknowledged.

28 23. PUGH CLAUSES A Pugh clause is the lessor s answer to the lessee s desire to hold nonproducing leased land lying outside a producing unit. If the lease has a Pugh clause, the land outside the producing unit is not held by production from the unit well. Typically, it will require a release of the nonproducing land 90 days after the end of the primary term. Oklahoma has enacted a statutory Pugh Clause which provides that a lease will expire as a matter of law a) as to all leases executed after May 25, 1977, b) 90 days after primary term has expired, c) as to all land covered by a lease that lies outside a drilling and spacing unit, d) where the drilling and spacing unit is 160 acres or more.

29 24. DEPTH LIMITATION Many modern leases provide for termination at the end of the primary term as to depths below the deepest depth drilled. In connection with this, if the minerals or leasehold are owned in different depths or are to be released, a land professional should note whether the dividing depth is in terms of feet, the base of a specific formation or the stratigraphic equivalent of a formation in a specified well.

30 25. CONTINUOUS DEVELOPMENT CLAUSES A Continuous Development Clause is sometimes included in very large leases or by sophisticated lessors. The continuous operation clause typically recites that in a specified time, the lessee is required to designate a specified tract around each well then producing on the leased premises and the lessee must continue drilling oil and gas wells. Typically, such clause gives the lessee a reasonable time to fully develop the lease premises after which the lessee should either a) commence the drilling of another well or b) release that portion of the leased premises not necessary for the production of wells that is drilled. Many times the clause will recite, in general terms the following:

31 25. CONTINUOUS DEVELOPMENT CLAUSES PUGH CLAUSE. A producing oil or gas well on the land leased herein will perpetuate the lease beyond the primary term only as to such lands as are actually contained, within the pooling, unitization, or spacing unit, as the case may be, for the producing well: such lands leased not included in such unit shall remain subject to the terms and conditions of this lease, but shall be unaffected by the pooling, unitization, or spacing of any other part or parts of this lease. It is the intent of this paragraph that the lands that are not producing oil or gas shall not be held by production after a primary term except as allowed in this paragraph. However, said lease shall continue beyond primary term if Lessee is engaged in drilling or reworking operations in accord with the provision of this lease; all of the lands under this lease shall be held by such drilling or reworking operations so long as not more than 180 days shall elapse from the completion or abandonment of one well to the commencement of the drilling of or reworking of another well; Upon failure of Lessee to maintain said continuous drilling program, this lease shall automatically terminate as to such lands not contained within the pooling, unitization, or spacing unit and sharing in action production. Once 180 days elapses after the Primary Term without Lessee drilling a new or replacement well or reworking an existing well within the 180 day period, all acreage leased but not sharing in production shall not be held by the terms and conditions of this lease. It is the intent that lands not sharing in production shall not be held beyond primary term unless there is compliance with the continuous drilling program on said lands as set out above.