A Cure for the Common Coronavirus – Keeping Your Lease Alive
Many oil and gas leases and contractual arrangements that made sense a few weeks ago make no sense at current oil prices. The law may, however, provide some relief for those stuck between low oil prices and the need to spend millions of dollars to develop oil and gas to maintain a lease past its primary term.
FEDERAL AND INDIAN OIL AND GAS LEASES
For operators with federal leases, the Bureau of Land Management (BLM) may suspend those leases under 43 C.F.R. § 3103.4-4. The regulation provides that an authorized officer may approve suspension of both operations and production only in the interest of conservation of natural resources. A suspension of either operations or production may be granted where the lessee is prevented from operating or producing because of force majeure, “that is, by matters beyond the reasonable control of the lessee.” The primary term of the lease is extended for the period of suspension.
The BLM issued an interim guidance on April 21, 2020 outlining procedures to apply for suspensions as a result of the coronavirus. To apply for a suspension, all owners of operating rights must apply to the appropriate BLM State Office and include a statement detailing how the pandemic makes suspension necessary. Lease suspension does not relieve the lessee from rental or minimum royalty obligations.
Before the advent of the current national emergency, the Carlsbad field office had been granting lease suspensions because its administrative backlog prevented it from processing Applications for Permit to Drill in a timely manner. Now the BLM is likely to see applications for suspension, not because of its large backlog, but because oil price and over-supply issues make drilling and operations uneconomic.
Neither the BLM’s interim guidance nor 43 C.F.R. §3103.4-4 apply to leases covering Indian lands. Applications for suspension of those leases must be made to the Bureau of Indian Affairs and should include an economic analysis and the consent of the Indian mineral owners. Suspensions are available for reasons including economic conditions and force majeure and should be available during the pandemic. Suspensions may be granted for up to a year and do not relieve the lessee from rental or minimum royalty obligations.
STATE OF NEW MEXICO OIL AND GAS LEASES
The Commissioner of Public Lands for the State of New Mexico (Commissioner) is taking steps to provide relief for lessees of state lands. The Commissioner has promulgated Rule 19.2.100.71 entitled “Temporary Shut-In of Oil Wells due to Severe Reduction in the Price of Oil.” The rule was proposed under Rule 19.2.16.14 of the New Mexico Administrative Code, giving the Commissioner authority to promulgate emergency rules. The rule provides that no oil and gas lease shall expire so long as there is a well located on the leased lands capable of producing oil and the well was shut in after March 1, 2020 because of a severe reduction in the oil price. The lessee must pay a shut-in royalty within 90 days of shut in and annually thereafter. To take advantage of the rule, the lessee must send notice to the State Land Office within 30 days of shutting in the well.
OIL AND GAS LEASES COVERING PRIVATE LANDS
Because suspension of oil and gas leases covering private lands is less straightforward, your first move should be to call the lessor. You may find the lessor, faced with the reverse side of the same grim choices with which you are faced, willing to grant a lease extension.
Failing a negotiated extension, the terms of your lease may provide relief.
One of those terms is the force majeure clause. A typical force majeure clause, taken from a Producers 88 lease, is a follows:
Should Lessee be prevented from complying with any express or implied covenant of this lease, from conducting drilling or reworking operations thereon or from producing any oil, gas or other minerals therefrom by reason of scarcity of or inability to obtain or to use equipment or materials, or by operation of force majeure, and Federal or state law or any order, rule of regulation of governmental authority, then while so prevented, Lessee’s obligation to comply with such covenant shall be suspended, the Lessee shall not be liable in damages for failure to comply therewith; and the lease shall be extended while and so long as Lessee is prevented by any such cause from conducting drilling or reworking operations on or from producing oil or gas from the leased premises; and the time while Lessee is so prevented shall not be counted against Lessee, anything in this lease to the contrary notwithstanding.
Courts generally examine the precise wording of such a clause and will enforce it as written. The quoted provision provides relief in the event of shortages of materials, force majeure, or governmental action. It also provides that the term of the lease is extended for the period during which the lessee is prevented from producing or conducting operations.
A lessee in the current environment can argue that its operations are prevented by force majeure as a result of the pandemic. A low price alone, however, will not trigger most force majeure clauses.
Another common lease term is the shut-in clause. You should carefully examine the terms of any shut-in clause on which you rely. Some clauses apply to gas but not oil. Some clauses are restricted to those circumstances in which no market exists. Some clauses may not be relied upon for more than a certain number of years. You should also keep in mind that shutting in a well does not abrogate the implied duty to market. That duty will require you to periodically reexamine the shut-in decision to evaluate whether the reasons for the shut-in still exist.
Many leases contain savings clauses that may provide some temporary relief. Those clauses generally provide that the lease will not expire on cessation of production so long as operations for drilling or reworking are commenced within 60 days.
Yet another avenue for relief may lie in the common law doctrine of impracticability. The doctrine provides that failure to perform contract obligations may be forgiven if the failure to perform results from unanticipated circumstances. Although this doctrine may provide relief from contract damages, it may not result in lease extension.
JOINT OPERATING AGREEMENTS
Article XI of the AAPL Form 610-1989 Operating Agreement, a joint operating agreement commonly used in the industry, provides that a party’s obligations under the agreement are suspended during events of force majeure, provided that the party gives notice to the other parties. Although price changes are almost never deemed to constitute force majeure, the fact that a pandemic has made contract performance untenable may provide an excuse for performance, provided that the parties comply with the Operating Agreement’s procedures.
SALES AGREEMENTS
When hydrocarbons are developed, they lose their character as real property and become personal property. Sales of personal property are governed by Article 2 of the Uniform Commercial Code. Section 2-615 provides that performance may be excused where a contingency has occurred that affects a basic assumption of the contract. The comments to Section 2-615 make it clear that a party whose performance is hindered may find excuse for non-performance where performance has been made impracticable by “unforeseen supervening circumstances not within the contemplation of the parties.” A worldwide pandemic that dramatically changes the price of oil may fall within that section.
Modrall Sperling’s Natural Resources group can guide you through the complexities of maintaining your lease and obtaining relief from contractual duties that have become onerous as a result of the Coronavirus. For more information, please contact Earl DeBrine at edebrine@modrall.com, Deana Bennett at dmb@modrall.com, or Chris Killion at ckillion@modrall.com.
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