What is Held by Production?
Many of the oil and gas leases used by the gas companies leasing in the Marcellus shale include a primary term of five years. This means that the gas company has five years to begin drilling operations on the leased premises or the lease will expire at the end of the primary term. Although the lease may not specifically include the expression “secondary term”, the gas lease moves into the secondary term when drilling operations begin and then is extended as long as gas is produced in paying quantities. The industry term used to describe a gas lease that is extended in this manner is “held by production”.
The gas leases used by the oil and gas companies operating in the Marcellus shale also include a provision allowing the gas company to pool the landowner’s premises with other leased properties to form a production unit. Landowners signing a gas lease must understand that commencement of drilling operations anywhere on the unit extends the entire production unit into the secondary term. As a result, a producing well holds by production all of the property placed in the unit.
The oil and gas companies operating in the Marcellus are spending millions of dollars on lease cash bonus payments. Naturally, the companies don’t want these leases to expire as they may be forced to approach the landowner with a new lease at the end of the primary term. Negotiating another lease is particularly unattractive to the operators in light of the general trend for cash bonus payments to increase as the Marcellus play matures. To avoid this result, the gas companies have increased drilling activity despite low natural gas prices. Chesapeake Energy CEO Aubrey McClendon has said that up to 50% of all natural gas drilling is done to retain leases that would otherwise expire.
Clearly, it is the goal of the gas companies to hold as much land by production as possible. Because production of gas will hold all of the acreage in the pooled unit, the gas companies have an incentive to make large production units. In fact, some companies have requested that landowners sign an amendment to their gas leases to remove any limit on the size of a production unit. Before signing any amendment to a gas lease, landowners need to understand the impact the amendment may have on their future royalties.