We can add to our knowledge of leases a new term:  held by production.  The article in the Wall Street Journal, “Second Life for an Old Oil Field; Texas’ Permian Basin, Where Output Peaked in ’70s, Now a Hot Site for Horizontal Drilling,” describes how oil companies in the Texas Permian oil field have increased their investing activities by discovering new ways of tapping oil by drilling horizonally  through several layers simultaneously.  The article mentions that since this is an established oil field “drillers don’t have to rush in before their leases on land expire; most leases automatically continue in effect once oil starts coming out of the ground (the industry calls this “leases held by production”).

Negotiating leases as held for production provides oil companies great savings and advantages.  The “held by production” provision allows the companies to continue drilling activities on the property as long as it is producing a minimum paying amount of oil or gas, thereby extending the lessee’s right to operate the property beyond the initial lease term. Energy companies can avoid renegotiating leases upon expiry of the initial term. This results in considerable savings to them, particularly in geographical areas that have become “hot” due to prolific output from oil and gas wells. With property prices in such areas generally on an upward trend, leaseholders would demand significantly higher prices to renegotiate leases.

For accounting puposes FASB  defines a lease is an agreement conveying the right to use property, plant, and equipment (PP&E) and excludes lease agreements to explore or exploit resources such as oil, gas, and minerals. This means that if a company leases land to drill for oil, that land land can be kept off the balance sheet if it treated as an operating lease.

In a dramatic change on May 16, 2013, the FASB and IASB jointly issued a revised exposure draft (ED)on lease accounting. Under the proposal, lessees would record most leases that are currently treated as operating leases on the balance sheet by recognizing a right-of-use (ROU) asset and a corresponding lease liability. This would affect the oil and gas industry because of its extensive use of fixed assets under contracts that may qualify as leases under the proposed guidance.

References:

Second Life for an Old Oil Field; Texas’ Permian Basin, Where Output Peaked in ’70s, Now a Hot Site for Horizontal Drilling. WSJ. Noveber 19, 2003.

Investopedia.com

Oil and Gas Spotlight- FASB and IASB Re-Lease proposed standard. Issue 2, July 2013. Deloitte.

Second Life for an Old Oil Field; Texas’ Permian Basin, Where Output Peaked in ’70s, Now a Hot Site for Horizontal Drilling