Helpful Oil & Gas Definitions E-O

Economic-Out Clause. Another name for a gas contract Market-Out Clause.

Entirety Clause. A clause in an oil and gas lease or in a deed that states the agreement of the parties that royalties are to be apportioned in the event that the property is subdivided after the lease is granted. The purpose of the clause is to avoid the non-apportionment rule.

Escalation Clause. A long-term gas contract provision providing for adjustment of the base price provided for in the agreement. Adjustment may be up or down, but the parties often refer to the provision as an “escalation clause.”

Executive Right. The right to lease specified land or mineral rights. The executive right is one of the incidents of the mineral interest.

Farmout Agreement. An agreement by which one who owns an oil and gas lease (the farmor) agrees to assign to another (the farmee) an interest in the lease in return for drilling and testing operations on the lease or payment for them.

Fee Interest. A property interest of potentially infinite duration. As used in the oil and gas industry, fee interest often refers to ownership of both the surface interest and the mineral interest.

1. FERC. The Federal Energy Regulatory Commission, the successor agency to the Federal Power Commission (FPC). FERC is the agency responsible for administering the Natural Gas Act.

FERC-Out Clause. A gas-contract clause that provides that the price paid to the producer shall be reduced (or the contract terminated) to the extent that the Federal Energy Regulatory Commission or other regulatory agencies will not permit it to be included in the regulated purchaser’s cost of service (and, in effect, passed on to consumers).

Fixed-Term Lease. An oil and gas lease for a fixed period of time. For example, a 20-year lease, perhaps renewable for an additional period of time, but without the indefinite “so long thereafter” provision commonly found in leases.

Footage Drilling Contract. A drilling contract under which the drilling contractor is compensated on the basis of the footage drilled. The drilling contractor is hired by the lease operator to drill to a specified formation or depth and is given broad discretion to make the management decisions necessary to accomplish the task. The risk of unexpected delays, as well as most liabilities, is upon the drilling contractor rather than the lease operator.

Force-Majeure Clause. A lease or contract clause that provides that the lessee will not be held to be in breach if the lessee is prevented from performing by force majeure (literally, “superior force”). Typically, force majeure clauses expressly indicate problems beyond the reasonable control of the lessee that will excuse performance.

FPC Clause. Another name for an Area-Rate Clause.

Free-Gas Clause. An oil and gas lease clause, found commonly in leases on properties in colder states, that entitles the lessor or the surface owner to use without charge gas produced from the leased property. Free-gas clauses are usually limited either as to the uses permitted, such as domestic heating and light, or as to the quantity that may be taken, such as not more than 300 MCF per year, or both.

Freestone Rider. Another name for a Pugh Clause.

Further-Exploration Covenant. An implied oil and gas lease promise that, once production has been obtained from the leased premises, the lessee will continue to explore other parts of the property and other formations under it. Insome jurisdictions courts have said that the covenant for further exploration does not exist independently of the implied covenant for reasonable development. See also Reasonable-Development Covenant and Reasonably Prudent Operator Standard.

Gas-Balancing Agreement. A contract among owners of the production of a gas well setting forth their agreement for the balancing of production if one owner sells more of the gas stream than other owners.

Gas Contract. An agreement for the sale of natural gas.

Granting Clause. The clause in the oil and gas lease that spells out what rights are given by the lessor to the lessee. Typically, an oil and gas lease granting clause will specify what kinds of uses are permitted and what substances covered by the lease.

Habendum Clause. The clause in an oil and gas lease that defines how long the interest granted to the lessee will extend. Modern oil and gas leases typically provide for a primary term, a fixed number of years during which the lessee has no obligation to develop the premises, and a secondary term for “so long thereafter as oil and gas produced” once development takes place.

1. Horsehead. See Pumping

Implied Covenant. An implied promise, usually in an oil and gas lease, that imposes obligations on one of the parties, usually the lessee. Though courts describe lease implied covenants differently, there are at least six: (1) the covenant to test the premises, (2) the covenant to reasonably develop, (3) the covenant to further explore, (4) the covenant to protect against drainage, (5) the covenant to market, and (6) the covenant of diligent and proper operation. Lease implied covenants arise from the ongoing relationship of the lessor and lessee created by the lease. The lease gives the lessee the exclusive cost-bearing right to explore and develop the leased property, potentially in perpetuity. The lessor has a cost-free interest in production or revenues or value, but has given the lessee the exclusive right to drill or produce. Because the typical oil and gas lease makes the lessor’s royalty the major compensation for grant of the lease dependent upon the quantity and quality of the lessee’s actions on the property, the courts have concluded that the lessee has an obligation to perform certain unstated obligations.

Intangible Drilling Costs. Costs that (1) are incurred incident to and necessary for the drilling oil and gas wells and preparing them for production, and (2) that have no salvage value. By § 612 of the Internal Revenue Code, intangible drilling costs may be deducted in the year paid rather than capitalized and depreciated.

1. Landman. A position in the oil and gas industry responsible for acquiring oil and gas leases, curing title, negotiating arrangements for development, and managing leasedThe term is not gender specific.

Landowner’s Royalty. The share of production or production revenues or value, free of costs of production, provided for the lessor in the royalty clause of the oil and gas lease. See also Royalty Interest.

Leasehold Interest. Another name for Working Interest.

Leasehold Royalty. Another name for Landowner’s Royalty.

Lesser-Interest Clause. A lease clause that permits a lessee to reduce payments under the lease proportionately if the lessor has less than 100% of the mineral interest. Sometimes called a proportionate-reduction clause.

Marketable-Product Rule. The rule that production for royalty-calculation purposes is not complete until a lessee has both captured and held the product and made it marketable. Until there is a marketable product, the lessee must bear all costs associated with capturing and handling oil and gas. See also Capture-and-Hold Rule.

Market-Out Clause. A long-term gas-contract clause that provides that if the contract price for the gas purchased plus certain costs incurred in getting it to the purchaser’s principal market exceeds an amount that will permit the gas purchaser to resell it profitably, the contract price will be redetermined. Often market-out clauses are drafted by referring to competing fuels.

Marketing Covenant. The promise implied in oil and gas leases that the lessee will market the production from the lease within a reasonable time and at a reasonable price. See also Reasonably Prudent Operator Standard.

1. MMBtu. The abbreviation for one million British Thermal Units, one of the standard units of measurement for natural gas.
2. MCF. The abbreviation for one thousand cubic feet, one of the standard units of measurement for natural gas.

Mineral Acre. The full mineral interest in one acre of land.

Mineral Interest. The right to search for, develop, and produce oil, gas, and other minerals from land, as well as the right to present possession of the oil and gas in place. The mineral interest is granted by an oil and gas lease. See also Fee Interest and Surface Interest.

Mineral Servitude. Under the Louisiana Mineral Code, a charge upon land in favor of a person or another tract of land that creates a limited right to use of the land to explore for and produce minerals. Generally equivalent to a severed mineral interest in a common-law state.

Mother Hubbard Clause. A lease clause that protects the lessee against errors in description of property by providing that the lease covers all the land owned by the lessor in the area. Sometimes called a cover-all clause. Sometimes combined with an after-acquired title clause.

Natural Gasoline. See Distillate.

Net-Profits Interest. A share of production or production revenues or value free of the costs of production, to the extent that there is a net profit. The methodology of defining net profits is crucial to a net-profits interest.

Non-Apportionment Rule. The rule-followed in the majority of states-that royalties accruing under a lease on property that has been subdivided after the lease grant are not to be shared by the owners of the various subdivisions but belong exclusively to the owner of the subdivision where the producing well is located. The non-apportionment rule may be modified in an oil and gas lease by an Entirety Clause. See also Apportionment Rule.

Non-Executive Right. An oil and gas interest that does not possess the right to lease; e.g., a royalty interest, a non-executive mineral interest.

Non-Ownership Theory. The characterization of oil and gas rights that a severed mineral interest owner has merely a right to search, develop and produce oil and gas from land, but not a present right to possess the oil and gas in place. Because there is no right to present possession, the interest of a severed mineral interest owner in a non-ownership theory state is akin to a profit a prendre, a right to use the land and remove items of value from it. Adopted in California, Louisiana and Oklahoma, as well as various other producing states. See also Ownership-In-Place Theory.

Nonparticipating Royalty. A share of production, or the value or proceeds of production, free of the costs of production, carved out of the mineral interest. A nonparticipating-royalty owner is entitled to the stated share of production or cash without regard to the terms of any lease. Nonparticipating royalties are often retained by fee-simple owners or mineral-interest owners who sell their rights. See also Royalty and Overriding Royalty.

No-Term Lease. A lease with a drilling-delay rental clause that allows a lessee to extend the primary term indefinitely by paying delay rentals. No-term leases were common at the end of the 19th Century. Some courts refused to enforce them on the ground that they created an estate terminable at the will of either the lessor or the lessee. Other courts upheld them, but with the stipulation that the lessee had an obligation to test or release the lease within a reasonable time.

1. Obstruction. An equitable doctrine that suspends the running of time under a lease or extends the lease for a reasonable time if the lessor or one claiming through the lessor interferes with rights granted by theSome courts apply the obstruction doctrine to interference by a severed surface owner.

Operating Agreement. A contract among owners of the working interest in a producing oil or gas well or wells setting forth the parties’ agreement about drilling, development, operations and accounting.

Operations Clause. A clause frequently found in oil and gas leases providing that the lease will continue so long as operations for oil and gas development continue on the premises. There are numerous variations. Two common ones are the well completion clause and the continuous-operations clause. A well-completion clause provides that a lessee who starts drilling before the lease terminates has the right to complete the well and to maintain the lease if the drilling achieves production. A continuous-operations clause gives a lessee the right not only to continue drilling a well begun before termination but also to commence additional wells.

“Or” Lease. An oil and gas lease with a drilling delay rental clause structured so that the lessee promises to commence drilling operations or to pay delay rentals from time to time during the primary term. If the lessee fails to do one or the other, the lease does not automatically terminate; instead the lessee is liable to pay the delay rental.

Overriding Royalty. A share of production, or the value or proceeds of production, free of the costs of production, carved out of a lessee’s interest under an oil and gas lease. Overriding-royalty interests are frequently used to compensate those who have helped to structure a drilling venture. An overriding- royalty interest terminates when the underlying lease terminates. See also Royalty and Non Participating Royalty.

Ownership-in-Place Theory. The characterization of oil and gas rights that a fee-simple or mineral interest owner owns the right to present possession of the oil and gas in place as well as the right to use the land surface to search, develop and produce from the property. Adopted in Texas, New Mexico, Kansas, Mississippi, and other major producing states. The rights of a severed mineral-interest owner to oil and gas in these states are often described as an estate in fee simple absolute, but ownership of specific oil and gas molecules is subject to the rule of capture even in ownership-in-place theory states. See also Non-Ownership Theory.