A Landman’s Perspective on Free Gas Provisions in Oil and Gas Leases
June 15, 2012
2012 American Association of Professional Landmen Conference
San Francisco, California
Joseph L. Stephenson©
Copyright 2012 by Joseph L. Stephenson. All rights reserved.
About the Author
Joseph L. Stephenson is a native of Jasper, Alabama. He graduated from the University of Alabama in 1976 with a B. S. in Commerce and Business Administration. His land-related work experience consists of ten years as a landman in the surface coal mining industry of Alabama and twenty-three years as an oil and gas landman. He has worked for River Gas Corporation, ConocoPhillips Company, Dominion Exploration and Production Company and is currently employed as Land Manager of GeoMet Operating Company, Inc. in Birmingham, Alabama. Mr. Stephenson is a member, director, and past president of the Black Warrior Association of Professional Landmen. He is also a member and past director of the American Association of Professional Landmen. His other professional affiliations include the Appalachian Association of Professional Landmen, the National Association of Lease and Title Analysts, and the National Notary Association.
Disclaimer:
Joseph L. Stephenson is not an attorney and cannot render legal advice, nor does he purport to do so herein. Joseph L. Stephenson makes no warranty or representations and assumes no responsibility or liability as to the usefulness, reliability, correctness and/or acceptability of the information, ideas and/or interpretations of the written/oral material presented herein. The reader is encouraged to consider the contents of this paper as an introduction to the subject matter. This paper is prepared solely for educational purposes to enhance the reader’s knowledge and understanding of the subject matter. It is not intended to be a substitute for consultation with legal counsel. Prior to application of any procedure or suggestion stated herein, consultation with, and assistance from, an attorney should be sought. Anyone relying upon the statements, contents and/or comments found in this paper and/or presented during the associated seminar agrees to do so at his/her own cost, risk and expense and agrees to indemnify Joseph L. Stephenson and the American Association of Professional Landmen for such reliance. GeoMet Operating Company, Inc. was not involved in the preparation of this paper and the opinions and views expressed herein do not represent any view of GeoMet Operating Company, Inc.
This paper is based on the personal experience of the author, on situations that have been reported in court cases in different parts of the U.S., and instruments that have been placed of record at courthouses or otherwise made known in the public domain. The reference to court cases, and any commentary on same, reflects only the personal views of the author. Each case is fact-specific and comments on one case may not be applicable to a case in another jurisdiction that considered similar issues but may have reached a different conclusion of law. Every attempt was made to ensure that the materials contained herein are accurate, but errors or omissions may be contained herein. When reviewing a West’s Digest for a specific state, the West Key Cite Number relevant to free gas is 79.5 under “Mines and Minerals” (“furnishing gas or oil to lessor”). When using the Westlaw database for free gas, it is 260k79.5.
INTRODUCTION
This paper is intended to focus on various aspects of free gas provisions, background on the history of free gas clauses in oil and gas leases (and court cases related to their use), how the clauses have evolved, current trends in their use, and providing the reader with insight gained by the author in his experience insecuring leases with and without free gas clauses. A free gas provision might be styled to address either “domestic use” or “agricultural use.” Discussion on those terms is found further in this paper. The use of the term “lessee” and “operator” will be used interchangeably herein, recognizing that an operator of a well might not be the lessee burdened with the free gas obligation.
Why should we be concerned about gas produced from a well being delivered to a house in accordance with a free gas provision? The date of March 18, 1937 is certainly one to remember. On that day, there was a school explosion in New London, Texas that killed 300 students and teachers. The explosion was the result of untreated gas that was being delivered to that facility from nearby wells. The gas was not odorized. The explosion was heardfour (4) miles away. When it was confirmed that an undetected leak in a pipeline allowed gas to accumulate under the building, thus being the cause of the explosion, laws were passed in Texas and elsewhere requiringan odorizing agent (such as mercaptan)to be added to natural gas delivered to consumers.
The free gas clause originated when natural gas did not have much value or marketable use. A little history will set the stage for how and why this clause came into use. A few thousand years ago, the Chinese were aware of the burning aspect of natural gas that seeped out from fissures and springs. They installed bamboo piping to transport the gas to a location on the sea shore to speed up the evaporation process of drying brine by boiling it over a gas flame so that salt was the end product. In1770, oil and gas was discovered by people drilling salt wells in what is now West Virginia. When gas was encountered, the gaswas sometimes piped away in hollow logs and flared or used at a location where the salt water could be boiled (such as what William Tompkins did in 1841 at his salt furnace at Burning Springs, West Virginia). The gas would then be used to boil the salty water so that salt was rendered. The use of this natural fuel eliminated the need to use wood to fuel a fire (or wait on the water to evaporate when diverted to drying pans). This simple and effective use of natural gas demonstrated that gas could be put to a limited, but beneficial use.
Depending on whose land the salt well(s) was drilled onif a well had a surplus of gas, or the operator had no use of the gas, the operator of the salt well(s) had no objection to a landowner connecting to the well and taking the surplus gas for his use at a home on the premises. If several houses or a town was in close proximity and if a great deal of gas was produced, it became evident that the gas could be used for indoor lighting, streetlights, etc. Recognizing the value of the gas, although of limited use, the first commercial well drilled for the purpose of producing natural gas was drilled in 1821 by William Hart in Fredonia, New York. Mr. Hart located his well site near a creek that had gas bubbles visible on the surface. He drilled 27 feet and found gas. More wells were drilled in that area, and the Fredonia Gas Light Company was formed and became the first U.S. natural gas company.[1] As contracts were entered into for the purpose of drilling for oil and gas (with oil being the primary reason for drilling where oil could be piped into tanks and hauled away), lessees did not object to agreeing to allow the lessor to lay a pipe to the well and take gas for use at a home on the lease, especially if there was no market for the gas in view of the remote location of the well, or if the lessee did not need to use that gas for its operations on the lease. The earliest instrument that this author has seen that granted the right to develop “petroleum and natural gas” is a West Virginia “Agreement” dated 1894 that provided: “First party to have gas free for household use from any well on the premises making his own connections.” Free gas clauses also evolved from the custom and practice of deeds being prepared to convey surface rights that also included a right for the new surface owner to use coal found on the land for domestic (or “shop”) use.[2]
Oil and gas leases have been “held by production” in the eastern part of the U.S. for over 100 years. For example, the 2005 Pennsylvania case of Deynzer v. Columbia Gas of Pennsylvania, Inc., 2005 PA Super 122, 875 A.2d 298 (PA. 2005) addressed a dispute over a free gas provision in an oil and gas lease dated 1900. In those early days of oil and gas drilling in areas where shallow wells could be drilled that wouldproduce gas, it was not practical to lay pipelines a great distance to pipe gas from a well that might be a low producer. However, companies were formed like “cooperatives”[3] (like people paying someone to grow a garden and the cooperative members having the right to either pick vegetables themselves or have vegetables delivered to their home). While not directly tied to the issue of free gas, there has been a fair amount of litigation involving liability associated with the companies that contracted to deliver gas from a well(s) to the members that contracted for gas service. In the past, a high degree of responsibility for the safe delivery of gas and liability for failure to do sohas been placed on companies that serve the public by commercially providing gas as opposed to lessees/operators that had a contractual agreement to provide free gas via an oil and gas lease.
In the northern part of Alabama, use of free gas provisions in oil and gas leases were phased out of use by the mid 1970’s. The typical provision in Alabama leases was: “Lessor shall have the privilege at his risk and expense of using gas from any gas well on said land for stoves and inside lights in the principal dwelling thereon out of any surplus gas not needed for operations hereunder.” Such clauses were typically used in Alabama by companies with offices outside of Alabama that may have been accustomed to taking leases in other parts of the country where this provision was more prevalent. The cited provision is identical or very similar to what had been in common use in other states. Various printing companies in Alabama provided such lease forms. Hederman Brothers in Jackson, Mississippi likewise printed a lease form with a free gas clause in it in up to the mid-1970’s.[4] The Kansas Blue Print Co., Inc.’s 1977 book of oil and gas forms illustrates42 oil and gas leases it offered to print, with 36 of those pre-printed lease forms having a free gas clause in them.
Free gas clauses in oil and gas leases are still being used in other parts of the country, especially in the eastern U.S.[5] A 2001 Kentucky case stated that it is common for a producer’s lease to require the lessee to allow one household to receive free gas.[6] Lessor free gas provisions have been prevalent in Appalachian states where oil and gas production has been taking place for over 100 years. Those leases are held by production and the free gas provisions in those leases are still valid. Some companies in the eastern U.S. have departments that are designated to handle “fee gas” issues. The Internet has provided mineral and surface owners access to a tremendous amount of information to assist them in learning more about the management of their property rights. The use of a free gas clause in an oil and gas lease, or commentary on such use, has beenthe topic of discussion by state agencies and land-related companies in areas such asNew York[7], North Dakota[8], Ohio[9], Pennsylvania[10], and West Virginia.[11]
A lot of thought should be given by a lessee as to whether or not it will agree to have a free gas provision in an oil and gas lease, and if so, consultation with legal counsel is necessary in order to address the wide range of issues that must be taken into account in such a lease provision.
When a free gas clause is drafted, the provision can be styled so that the free gas is being reserved by the lessor. Or, it might be designed so that the lessor grants the lessee all of its rights in the gas in exchange for a royalty and an obligation to provide free gas. One attorney has written that the lessee may find it difficult to impose conditions for use upon the lessor if those conditions are not cited in the free gas covenant.[12]
Free gas clauses are found in the royalty clause of oil and gas leases, or in the clause that grants the lessee free use of gas and water from the premises, or in a part of the lease that addresses the free gas right as a separate lease provision by itself. However, such clauses might be a special provision (“rider”) added to the lease as an addendum. Or, it can be a handwritten note beside the printed text of the lease. They can also be found as letter agreements with surface owners as part of the consideration of granting a surface use agreement. In that situation, consultation with the lessor should take place in order to secure the lessor’s consent to allow that use of gas and to treat the surface owners’ use of gas as an authorized aspect of the lessee’s use of gas on the premises. Otherwise, the lessor might expect payment of royalty on the gas consumed by that third party.
The typical oil and gas lease executed by a mineral owner (lessor) and favored by the lessee grants the lessee the right to use gas produced from the leased premises for the benefit of the lease without an obligation to pay for that gas. Some people might argue that that it is only right for the lessor to have the right to use gas produced from a well drilled on his land for the benefit of a house or some other structure located on the leased premises. However, while such benefit to the lessor has the appearance of being reasonable, this paper will discuss various issues that can lead to a dispute and/or litigation between the lessor and his lessee.
If a mineral owner (prospective lessor) is adamant on wanting a free gas clause, the challenge is on the landman to have a lengthy discussion with that mineral owner as to all of the issues that should be addressed either in the lease provision specifying the right, or a side agreement that addresses the gas use. The landman can use this paper as a resource tool in going over the wide range of issues that the mineral owner needs to be briefed on. After the first meeting, the landman can meet with the mineral owner again (after having discussed the free gas issue with his attorney) and present a draft free gas clause to that prospective lessor for his review. The landman should stress that the landowner consult with an attorney in view of the risks involved. Since the landman discussed the issues with the mineral owner and notes were taken as to the mineral owners’ concerns and the lessee’s concerns, it might be appropriate for the agreement to be written with a provision stating that both sides participated in its creation, and that both sides consulted with legal counsel, or had the opportunity to do so. If a side agreement is to be used in a state such as Alabamawhere the notarial certificate must state that the signer acknowledged that he/she was informed of the contents of the instrument, there might be advantages to having that side agreement notarized. Alabama’s courts have been somewhat consistent in ruling that the signer was charged with knowing the impact of what they signed, regardless of who prepared the document.[13] Therefore, an acknowledgment before a notary in a state such as Alabama might prove useful later if the landowner claims he did not know (or was not informed of the contents of the instrument) that he was signing.
A deed conveying surface rights (reserving mineral rights to the grantor) and granting the new surface owner the right to have gas from wells drilled on the grantor’s mineral ownership at a nominal price might be an inducement for someone to buy property.[14]A real estate advertisement on the Internet for a farm in Ohio described a residence and several farm structures on it (barn, garage, shop building, corncrib, and sheds) and was touted as being a “great and rare auction opportunity” for purchase because one of the perks was a “free gas allocation.” That advertisement reminded me of how a lessee/operator could find itself in the middle of litigation when someone buys propertyand does not confirm the existence or limitation of the “free gas” right and the use of that gas is called into question.[15]
TERMS AND PHRASES
►Abandonment of Well/Availability of Gas–Oil and gas leases taken today that include a free gas provision typically state that such use is subject to the right of abandonment and surrender bylessee under the terms of the lease without liability or obligation to the lessor in respect to the free gas. As long as the lease grants the lessee the undisputed right to plug and abandon a well,regardless of whether the well is profitable or not, a lessor typically cannot interfere with that action simply because it will eliminate the lessor's ability to take free gas from a well.[16] However, older leases were not styled as they are today. Those older leases sometimes had language obligating the lessee to leave a well in good condition upon abandonment, and thus the lessee might not be able to remove its equipment and fixtures so that the lessor could take the well over.[17] When the well take-over issue comes up, courts will take into account the fair market value of the pipe, etc. that is being left behind by the lessee.[18] If a lessee decides to postpone its abandonment plans for a reasonable period of time so that its lessor can continue to have free gas from the uneconomic well, that delay in abandonment should not work as a waiver of the lessee’s right to abandon and remove its equipment and fixtures.[19] Depending on the situation in which abandonment took place, equipment left on the premises upon abandonment may become part of the realty of the lessor.[20] The right of the lessee to remove casing that may be of value may also be a factor to take into account. The lessee also wants to avoid being prohibited from having the right to test, re-work, deepen, plug-back, shut-in, or perform any other type work on the well if such work is deemed as an interruption of availability of gas to the lessor. The lessee should take care to make sure that the free gas clause does not guarantee the availability or deliverability of gas to the lessor. Also see MINING PLANS.