27-555

27-555. Lease of state lands not located within
known geological structure of producing oil and gas field;
application; lease extension; provisions of lease; withdrawal of
lands from leasing

A. When state lands are not located within any known geological structure of a
producing oil and gas field, as determined pursuant to section 27-554, the person making
the first application for the lease shall be issued a lease covering the lands without
competitive bidding.

B. The noncompetitive leases shall provide for the payment by the lessee of a
royalty of twelve and one-half per cent of either:

1. The oil, gas and other hydrocarbons produced and saved from the leased premises.

2. At the option of the department, the market value of such products determined as
follows:

(a) At the arm's length price prevailing on the day the product is run into a
pipeline or otherwise removed from the leased premises if the production is being sold
for an arm's length price.

(b) If an arm's length price is not available for the production, at the publicly
available arm's length prices for sales of production of comparable type and quality, in
generally comparable quantities, in the vicinity. For the purposes of this subdivision,
"vicinity" means the smallest geographical local area containing sufficient data to
establish an arm's length price.

(c) If an arm's length price is not available for the production and there are no
publicly available arm's length prices for sales of production of comparable type and
quality, in generally comparable quantities, in the vicinity, the department may
establish market value through appraisal completed by an independent licensed appraiser
that conforms with generally recognized appraisal methodologies. The appraisal is not
binding on either the department or the lessee, but may serve as evidence of market
value.

(d) If a price is determined under subdivision (b) or (c) and a price under a
higher ranked alternative becomes available, the price determined under the higher ranked
alternative shall be used. If a price is determined under subdivision (b) or (c) and the
basis for determining that price is no longer available, the price determined under the
next highest-ranking alternative that is available shall be used. If a price is
determined by the lessees under subdivision (a), the department may require the lessee to
certify that the price used is an arm's length price.

(e) For the purposes of this paragraph, "arm's length price" means a price
negotiated between a willing buyer and a willing seller, where the buyer and seller are
not affiliates and the seller is not receiving property or other noncash consideration as
part of the transaction. For the purposes of this subdivision, "affiliate" means parties
that are related by blood or marriage, or, in the case of entities, that are under direct
or indirect common control or one of which controls the other.

C. Royalties, including shut-in gas royalties, reserved to the state on production
from any state lands leased pursuant to this article and committed to a unit plan of
development by virtue of a unit agreement shall be paid only on that portion of
production allocated to such state lands or any part of the state lands, pursuant to the
terms and conditions of the unit agreement.

D. The leases shall provide for the payment in advance of an annual rental of one
dollar per acre per year for each year of the primary term of the lease. All leases
shall provide for a minimum rental of forty dollars per year.

E. Each lease issued under this section shall be for a primary term of five years
and as long thereafter as oil or gas is produced in paying quantities from the lands
covered by the lease, except that:

1. If oil or gas is not being produced from the leased premises at the expiration
of the primary term of the lease, the lessee shall have a right to an extension of the
term of the lease for an additional term of five years and as long thereafter as oil or
gas is produced in paying quantities from the leased premises by paying each year in
advance double the rental payable during the primary term of the lease, except that the
lessee will have no further right to any additional extension for successive terms. In
the exercise of such right, the provisions of section 27-556 relating to sales made upon
competitive bidding by sealed bid shall not apply in any case, but all such extensions
shall be upon the terms and conditions contained in the original lease, except that the
rental for the extended term shall be as provided in this paragraph, and except further
that the rental for the extended term of any lease amended pursuant to subsection L of
this section shall be as provided in that subsection.

2. If oil or gas is not being produced from the leased premises at the expiration
of the primary term of the lease or any extension of the lease pursuant to paragraph 1,
but the owner of the lease is diligently engaged in drilling, completion or reworking
operations, the lease continues in force for a period of two years from the date on which
the lease would have otherwise expired and as long thereafter as oil or gas is produced
in paying quantities from the lands. If oil or gas is produced from any such well or any
other well drilled during any two year extension, the lease shall continue in force after
such two year extension as long as oil or gas is produced in paying quantities from the
leased premises, except that rental requirements at the beginning of any lease extension
shall be at the rate in existence at that time.

3. Oil or gas that is produced from any part of a unit in which state lands are
included by virtue of a unit agreement and that is allocated to all or any part of such
state lands pursuant to the terms and conditions of the unit agreement is deemed to be
produced from the state lands or that part of the state lands to which the production is
allocated.

4. If for any reason production of oil or gas from the leased lands ceases after
the primary term or after extension of the lease, the lease shall not terminate if the
lessee commences drilling, completion or reworking operations on the land within ninety
days from cessation of production, and if drilling, completion or reworking operations
are conducted with reasonable diligence, the lease shall remain in force as long
thereafter as such drilling, completion or reworking operations are conducted or as long
thereafter as oil or gas is produced in paying quantities from the leased lands, but in
no event to extend beyond two years if production is not restored.

F. Each lease shall provide that the state's royalties shall be computed after
deducting any oil or gas reasonably used in operations on the lease.

G. The leases shall contain other terms and provisions, not inconsistent with the
provisions of this article or other laws of the state, as in the opinion of the
department are for the best interest of the state. The lease shall not contain any
provision for a premium, tax, fee or other assessment other than the application fees,
rentals and royalties provided in statute. Application fees, rentals, royalties or other
charges shall be based upon the application fees, rentals, royalties or other charges as
provided in statute in effect at the time that the completed application is received by
the department.

H. Not more than six miles square shall be included in any one lease. The lands
shall be in as compact a body as possible but may include noncontiguous land within the
six mile area. A discovery well capable of producing oil and gas in paying quantities
will perpetuate a lease of not more than two thousand five hundred sixty acres which must
be designated by the lessee within thirty days of completion of the well. The department
shall adopt rules that will assure due diligence in the drilling of development wells to
fully define the field.

I. Each lease shall provide that any combination, understanding or agreement
entered into by the lessee, written, verbal or otherwise, for the purpose of delaying
discovery or development of oil or gas is an illegal practice, and that upon legal
determination thereof shall constitute grounds for cancellation of the lease. In the
event of such an illegal practice, appropriate proceedings may be instituted by the
attorney general against the lessee in the county in which the land or any part thereof
is located. A cooperative or unit plan entered into pursuant to this article or any
other conservation statute of this state shall not be held to violate this subsection or
any other statute of this state prohibiting monopolies or acts, arrangements, contracts,
combinations or conspiracies in restraint of trade or commerce on account of operations
conducted under such a plan.

J. Applications for noncompetitive leases shall be in writing addressed to the
department, shall contain a description of the lands sufficient to identify them and the
name and address of the applicant and shall be accompanied by a filing fee and the rental
payment for the first year. Each application shall be stamped when received by the
department with a stamp showing the day and hour when received. If valid applications
covering the same lands are filed simultaneously, the department shall offer the lease to
the parties involved in the simultaneous applications by competitive bid, as follows:

1. The department shall issue a notice of the competitive bid containing a
description of the land proposed to be leased and the time when the bids will be received
and opened.

2. The department shall offer the lease to the highest qualified bidder submitting
a sealed bid, on the basis of a cash bonus.

3. All bids, together with a certified check in the amount of the bonus bid, must
be submitted to the department at the state capitol and shall be opened at the office of
the department at the time specified.

4. If identical bids are received, within ten days of the opening of the bids the
department shall request new bids from the submitters of the identical bids, and shall
repeat the process until a high bidder is determined.

5. Before accepting any competitive bid for a lease under this subsection, the
department shall establish to its satisfaction the responsibility of the bidder.

6. The department shall return all checks accompanying rejected bids.

K. The department may withdraw from leasing any specific area of land not located
within any known geological structure of a producing oil and gas field when it appears
that the withdrawal is in the interest of the state, but no lands shall be withdrawn by
the department without the consent of a committee composed of the governor, who shall be
chairman, the attorney general, and the dean of the college of mines of the university of
Arizona. The committee shall consider the proposed withdrawal presented by the department
and determine whether the withdrawal shall be permitted. The land, after being withdrawn
from leasing, may again be offered for leasing at any time the department deems in the
best interests of the state, subject to the advice and consent of the committee provided
for in this section, and pursuant to notice as the committee deems necessary.

L. The owner of any state oil and gas lease issued by the department and maintained
in good standing according to the terms and conditions of the lease and all applicable
statutes and regulations shall have the right to elect at any time to have such lease
amended to contain the same term and extension provisions and the same provisions
relating to unit operations and unit agreements which have been or may be approved by the
state land commissioner as are provided by law for state oil and gas leases upon filing a
written notice of such election with the department. Upon such written notice to the
department the lease term and extension provisions and the provisions relating to unit
operations and unit agreements shall be deemed amended. The lease as amended shall
include all other provisions, except those providing for rents, contained in the original
lease and shall bear the same commencement date as the original lease. The lease as
amended shall require the payment in advance of an annual rental of one dollar fifty
cents per acre per year for each year of any extension of the lease beyond the primary
term of the lease, except extensions of the primary term based upon the production of oil
or gas.