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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.