The typical oil and gas lease resembles an option contract. The lessee-oil company pays for exclusive oil and gas rights to the leased land, but only for a fixed term. If the lessee does nothing, the lease terminates on the expiration date with no further obligations between the parties. But, if the lessee “commences operations” to obtain oil or gas, the lease extends. This way, both parties are protected: the lessee can walk away if the land turns out to be less promising than anticipated, but cannot hold the lease indefinitely “merely for speculation,” leaving the land idle and frustrating the lessor-landowner. See 3-6 Williams & Meyers, Oil and Gas Law § 601.
Yesterday’s Sixth Circuit decision in Henry v. Chesapeake Appalachia made it easier and less costly for oil companies to extend their leases by relying on two Ohio Supreme Court cases to expand the definition of “operations” to include the filing of paperwork “to join . . . [the leased] property” to other land that was already being worked. Unlike the oil companies in the Ohio cases, Chesapeake had not commenced “preliminary physical activities pertaining to the property” in question. Nonetheless, the court found that the filed declaration–stating Chesapeake’s intent to add Plaintiffs’ properties to a previously-existing “unit” of land on which operations had unquestionably commenced—constituted an act “similar to or incidental to acts . . . ‘in an endeavor to obtain . . . oil and/or gas,’” (quoting the lease), and therefore qualified as commencement of “operations.”
Under Henry, an oil company does not have to clear timber, clear a well site or even drive a single stake into the ground (examples of “preliminary physical activities” from Ohio case law) to “commence operations” on a piece of leased land, but can do so merely by declaring its intent to pool that land with a parcel where operations had previously commenced. Until Ohio courts—who are not bound by this decision—weigh in on the limits of “operations,” oil companies in similar lease-extension disputes will have additional incentive to remove the litigation to federal court.
