Legal Definitions - marketing covenant

A marketing covenant is an unwritten, but legally recognized, obligation within an oil and gas lease. It requires the company extracting oil or gas (known as the lessee) to actively and diligently sell the produced resources. This implied promise dictates that the lessee must market the oil or gas within a reasonable timeframe and at a fair market price, consistent with what a careful and responsible operator would achieve under similar circumstances.

Essentially, this covenant protects the owner of the mineral rights (the lessor) by ensuring that the extracted resources are not left idle indefinitely or sold for less than their true value, thereby guaranteeing the lessor receives their rightful share of the production.

• Example 1: Delaying Sales for Speculation

  Imagine an energy company, after successfully drilling a productive natural gas well, decides to store the gas for six months rather than selling it immediately. Their reasoning is that they anticipate a significant price spike in the future, even though current market prices are already favorable. This scenario could be a breach of the marketing covenant. A prudent operator would typically market the gas within a reasonable time, especially when good prices are available, to ensure continuous revenue for both the company and the mineral rights owner. By holding the gas off the market for an extended period based purely on speculation, the company might be failing to market the production within a "reasonable time," potentially depriving the lessor of timely royalty payments.

• Example 2: Selling to an Affiliate at a Discounted Rate

  Consider a situation where an oil producer extracts crude oil from a leased property and then sells all of it to a refining subsidiary that it also owns. The price at which the crude is sold to the subsidiary is significantly lower than the prevailing market price for similar crude oil in the region. This could violate the "reasonable price" aspect of the marketing covenant. The covenant implies that the lessee must seek the best available price for the production, not an artificially low one that benefits an affiliated entity at the expense of the lessor's royalties. A truly prudent operator would ensure the sale price reflects fair market value.

• Example 3: Failure to Connect to Infrastructure

  Suppose a company drills a successful oil well in a remote area, but then delays for over a year in constructing a pipeline connection to the nearest transportation hub or negotiating access to an existing one. During this prolonged period, the oil remains in storage tanks at the well site, unmarketed. This situation illustrates a potential breach of the marketing covenant. A responsible operator would prioritize establishing the necessary infrastructure to bring the product to market within a reasonable timeframe. The failure to do so means the production is not being marketed at all, thereby preventing the lessor from receiving any royalties.