Offset Drilling Clause.
As a Petroleum Landman, have you ever run into a situation in a lease regarding an ‘Offset Drilling Clause’ where, either your potential Lessor is demanding such a clause in his new lease or in your chain of title where you’ve found a lawsuit regarding a Lessee’s failure to drill an Offset Well and the Lessor demanding payments for the Compensatory Royalties, he claims are due him. In other words, payment for his lost revenue due to his claim that his reserves are being “drained” due to the wells drilled adjacent to his land.
Offset Drilling Clause Definition
Offset Well means a well drilled before or subsequent to the effective date, and contained in any spacing unit laterally or diagonally adjoining the leased lands, completed for production of the leased substances on the leased lands, which spacing unit is not owned by the lessor, or if owned by the lessor, not under lease to the Lessee.
Generally speaking, an Offset Drilling clause is a ‘covenant’ and not a ‘condition’ of the oil and gas lease. If a potential Lessor make the demand for such a clause in his lease, by being an implied covenant protects the Lessee from losing his leasehold rights in producing wells that are producing in other formations. NOTE: Try to make this clause formation specific.
Offset Drilling Clause Application
It has been reported in different sources that courts have long held that oil and gas Lessees have an implied obligation to drill an offset well to prevent a neighboring well from draining the hydrocarbons underneath the leased land. As is often the case with implied covenants, Lessors and Lessees responded by including explicit, negotiated duties in their leases to address potential drainage, which modify or displace the implied “offset” covenant.
In the case of “deemed” drainage, the Lessee has a choice to either drill an offset well, provide geological or technical evidence that no drainage is occurring, release acreage, or pay “compensatory” royalties. Generally, this time period is around 180 days.
Dangers with the Offset Drilling Clause
As an example, the unaware Landman may not know there is a problem without reading any filed litigation between the disgruntled Lessor and Lessee and the oil and gas lease. Another issue is to pay close attention to the “setback requirements” in the oil and gas lease and any set “response timeframes” for the Lessee to drill the Offset Well.
Example of the Offset Drilling Clause
While drilling and operating wells in Santa Barbara County, California, I had purchased an oil and gas lease that had an Offset Drilling Clause. However, there were no set timelines to respond in kind to a well drilled adjacent to the property nor was there any setback footage requirements in the oil and gas lease.
The offset operator drilled a horizontal well that traversed 600 feet down our lease line for a distance of 3,000 feet. The well was in a formation that produced vertically, as ‘stripper production’, in the area but not on either lease. The were no previous horizontal attempts in this formation anywhere in the field or nearby.
The Lessor gave us a demand to respond in kind and demanded our new well be drilled within 90 days. We informed the Lessor that 90 days was not enough time to properly assess the new horizontal well’s performance due lack of commercial production from the formation as a horizontal well completion. We also reminded the Lessor that his lease had no setback guidelines or response times.
The main issue to consider is what a well’s production and pressure decline curve rates are in determining timeframes to respond in kind. This can take some time due to the offset Operators reports they turn into the state.
After explaining this to the Lessor, they said they were going to pursue us legally. This process of dealing with their attorney and due to the lack of information regarding the horizontal well, and overall concerns about the pitfalls of drilling horizontally in that formation, we informed the attorney we would “see them in court.” This pre-lawsuit timeframe took approximately 90 days.
At the end of the 5th month, the horizontal offset well’s production had dropped from an initial rate of 400 bopd to 10 bopd. In the pursuing 120 days the well was not commercial and was plugged. Good lesson here!
The Petroleum Landman School, Professional Landman Schools, and the Institute of Energy Management’s courses deal with many other critical issues to help a Petroleum Landman become more aware of things which could become critical issues.
Please visit www.instituteofenergymanagement.com for a complete list of the most comprehensive and applicable Petroleum Landman training courses available.