A synopsis of what happens when an oil company wants to lease your minerals.
Your first contact is typically with a landman, who works for an oil company and is part of an exploration team.
The landman searches records to determine available acreage and mineral rights ownership.
If favorable, the landman secures a buying order and works to obtain leases from property owners.
Title work is done to examine the history of mineral property ownership.
The landman may need to address title defects, requiring additional documentation.
Property ownership can be separated from mineral interests, resulting in complex divisions.
The landman may promote trades or joint ventures with other companies or operators.
The drilling of a well on your land may involve different parties than those who signed the lease.
You may receive notice of well staking, followed by drilling and production preparations.
There's a small chance (about 2%) that you'll receive a well on your property.
You'll sign division orders to verify your ownership for oil or gas sales.
Royalty checks will continue until well production declines, and secondary recovery may be considered.
Field unitization may occur, and agreements between companies and mineral owners are negotiated.
If the field is abandoned due to unprofitability, you can lease again if new technology makes it viable.
The oil and gas lease defines rights and obligations between you (lessor) and the oil company (lessee).
It differs from other leases and is highly negotiable.
Key components of the lease include:
The "bonus," which is the amount paid for signing the lease.
The "term," specifying how long the land will be leased (primary term).
The "royalty," indicating your share of producing minerals.
"Delay rental," paid during the primary term when no well is drilled.
The "secondary term," the period when your property has a producing well.
There are many types of oil and gas leases, with most referred to as "Producer's 88s."
Your main benefits come from these five basic areas and any negotiated special covenants or clauses.
The "bonus" amount varies widely, from small sums to over a thousand dollars per acre, depending on local activity and prospects.
It is typically paid as a lump sum shortly after signing the lease.
Negotiating the right bonus is important; too low a price means losing money, while demanding too much might deter drilling.
In areas with no nearby production, the landman may be the only buyer offering similar prices to everyone.
If there is known production nearby, favorable bonus and lease terms can often be negotiated.
You can inquire with neighbors, bankers, and others to gauge the existing market.
Some states allow a 22 percent depletion allowance on the state tax return for cash bonuses, but federal returns only permit a 15 percent depletion allowance.
Mineral owners sometimes prefer to defer or spread their bonus and federal tax over several years.
The lease may not specify the exact bonus amount; instead, it may list a token amount like "five dollars and OV.C." (other valuable considerations).
The bonus payment typically grants the leasing party the right to hold the lease for a set period (usually one year) before drilling or paying delay rentals.
The "primary term" of the lease is agreed upon and typically written in the lease. It can vary in duration.
The lease's duration can be extended by starting drilling or oil/gas production, into a "secondary term."
The secondary term lasts as long as oil and gas are produced in profitable quantities, subject to state laws and a prudent operation obligation.
Some landowners favor longer primary terms to encourage property development, even with less favorable terms or prices.
Others prefer shorter terms, hoping the lessee won't drill, allowing them to renegotiate with new terms and bonuses at higher market levels.
Some investors, like Jack Thompson, prefer frequent leasing without drilling to ensure a steady bonus and rentals.
Once oil or gas production begins, you receive a percentage of the total production as specified in your lease.
The royalty is usually paid by an oil or gas purchaser and is typically free of operating costs for the lessee.
The traditional share for mineral owners used to be 1/8 or 12.5 percent, but higher royalties, like 3/16, 1/5, or 7/32, are becoming common in many areas.
However, demanding too high a royalty may lead the buyer to seek alternative legal avenues, such as pooling orders, which could leave you with production costs and no bonus or rental.
The practice of bargaining for an "overriding royalty" (typically 1/16) is less common today. Most mineral owners now negotiate for a direct royalty percentage (e.g., 3/16, 1/5, 7/32) without an override.
Negotiating for a favourable royalty percentage to maximize your earnings is important.
When the lease term extends beyond the period for which the bonus was paid, the leasing party is typically obligated to pay you an agreed-upon sum to keep the lease active instead of drilling a well.
This payment is known as "delay rental".
Delay rental can be paid directly to you or to your bank and is due on or before the "anniversary date" of the lease.
When delay rentals are paid upfront, alongside the bonus or as part of it, it's referred to as a "paid up lease," which some companies prefer for simplicity.
Failure to pay the delay rental on time results in lease cancellation. The lessee can choose to pay the rental or surrender the lease, which is the case in most states.
Keeping a record of delay rental payments is crucial to knowing the lease's status and whether you can lease the minerals again.
When the lease expires, the leasing party should provide you with a "release" upon request. This release should be recorded with the County Court House in the area where the mineral property is located, although some states may require automatic release and recording by the lessee. Verify the requirements in your state.
Implied covenants are legally upheld commitments in an oil and gas lease.
These covenants include ensuring the lessee prevents property drainage, develops the property after drilling a productive well, operates as a prudent operator, and seeks a market for production.
Leases often favor the lessee, with clauses requiring approval from the oil company's legal counsel for lessor-injected clauses like overrides or changes to pooling and shut-in gas clauses.
Final lease approval typically comes from the company's home office, not the broker or landman.
The Date: Establishes the lease's effective time, usually for the primary term and related obligations.
The Parties Section: Identifies the parties bound by the lease terms.
The Consideration Section: Ensures the lease's legal enforceability.
The Granting Clause: Specifies lease purposes, lessee rights, and subject properties.
The Habendum Clause: Determines the duration of lessee rights, subject to various provisions.
The Royalty Clause: Specifies your share of production proceeds.
The Drilling and Delay Rental Clause: Grants the leasing party the right to delay exploration by fulfilling obligations and paying delay rentals.
The Dry Hole, Cessation, and Continuous Drilling Clauses: Address actions in case of a dry hole, production cessation, or ongoing operations without immediate production.
The Pooling Clause: Outlines lessee rights to combine leases for drilling units.
The Surrender Clause: Defines lessee rights if they decide to surrender the lease.
The Damage Clause: Defines lessee liabilities.
The Assignment Clause: Grants either party the right to transfer property rights and often requires notice of interest transfer.
Force Majeure Clause: Subject to state and national laws, it grants lessee relief from obligations due to uncontrollable factors.
The Warranty Clause: Addresses title ownership, obligations, and adjustments in payments.
The Legal Effect Clause: Legally binds the parties to the lease.
Most parts of a mineral lease are negotiable, so it's essential to consider potential additions or amendments that might be needed when you're contacted for a lease deal.
Leases can be initiated through phone calls and correspondence, and any agreements or promises should be documented in the lease, signed, notarized, and recorded in most states to be legally binding.
It's crucial to ensure that every representation is covered in a "rider" or attachment to the lease.
Efforts should be made to secure better lease terms to avoid future problems related to pollution, surface damages, easements, and to get the best deal possible, especially if you're the mineral owner only.
While the lease bonus may seem lucrative, it's essential to examine all aspects of the lease, considering potential tax implications and whether you might price yourself too high or too low.
A thorough assessment includes consulting with experts like accountants, lawyers, and experienced individuals in the oil and gas industry.
Check your area's going rates, terms, and planned activities, and consider hiring a consulting geologist if necessary.
Local and regional associations, state and federal lease sales, and commercial oil and gas information services can provide valuable data and guidelines.
Royalty percentages vary, and even a small change can significantly impact your investment returns, so negotiate for the best terms.
When countering an offer, aim for a fair deal based on your needs and preferences. The final agreement will fall between the initial offer and your counteroffer, considering various factors.
The "Oklahoma Law Review" highlighted the trend in the oil and gas industry where operators aim to retain the major portion of any market price increases.
Operators attempted to resist increases in the traditional 1/8 royalty, leading to alternative strategies.
Instead of raising royalties, operators offered higher bonuses, installment bonus payments, "free gas clauses," annual rental payments, security fees, and shorter primary lease terms.
Mineral owners began collaborating in regions like Western Oklahoma, New Mexico, and Illinois, monitoring lease prices at state sales and applying these criteria to their properties.
The 1/8 royalty standard started to decline in favor of royalties like 1/6 and 3/16 in various parts of the nation.
Limiting Acreage Under Lease: Some landowners limit lease sizes to acreage units depending on well spacing practices, ensuring proper development and preventing the operator from holding large tracts out of production.
Don't Lease Land in More Than One Section: Avoid leasing land in more than one section in a single lease to maintain control and protect your mineral assets.
Non-Producing Zone Releases: Include clauses stating that well completion in one zone does not extend the lease for other zones beyond the primary term.
Market Value Clause: Ensure the lease includes a market value clause for fair payment of oil and gas production based on market prices.
Shut-In Clauses: Include shut-in clauses that encourage the operator to seek ways to sell the product and provide some return on the property during market fluctuations.
Free Gas Clauses: Negotiate for free gas for your dwelling and the option to buy gas at the wellhead price for various uses.
Equipment Placement: Some landowners insist on consultation regarding the placement of drilling and producing equipment.
Utility Lines: Address buried utility lines, specify plow depth provisions, and consider the replacement of topsoil.
Plat Map Approval: If you own both surface and mineral estates, seek plat map approval to protect specific land features.
Negotiate Reclamation: Include clauses requiring reclamation of the well site, tanks, pipelines, and access roads after drilling and exploration activities.
Warranty Clauses and Tricky Situations: Be cautious about warranty clauses regarding title and seek legal advice in situations that require it.
These trends and tips illustrate the evolving landscape of oil and gas leasing and the importance of carefully negotiating lease terms to protect your interests.
Controversial clauses that "free up" non-productive or unexplored areas at the end of a specified time.
These areas can be either "horizontal" (acreage not in production) or "vertical" (sands or zones not in production).
Lawyers draft combinations of these clauses, including those releasing all non-pooled tracts after a specific period.
Typically inserted in the "habendum" section of the lease.
Included in states where not automatic.
Requires the operator to file a "release" at the courthouse when the lease expires to indicate the minerals are available or face penalties.
To add your own clauses, strike out the portion to be changed, type the amendments, both parties initial and date the change, and have it notarized.
For lengthy changes, strike out clauses to be modified and make corrections on separate pages.
Attach these pages to the original lease.
Legal advice may be needed for extensive changes.
Formation Clause: Requires drilling within a specified time to maintain the lease.
Pugh-Type Clauses: Determine when non-producing formations or acreage outside the production pool are released.
Market Value Clause: Specifies payment based on the current market value for oil and gas.
Shut-In Clause: Addresses payments during well inactivity due to market conditions.
Well Commitment Clause: Requires drilling within a specific radius to keep the lease in effect.
Overriding Royalty Clause: Reserves a royalty interest for the lessor.
Free Gas Clause: Grants the lessor the privilege to use gas from the well.
Gas Purchase Clause: Allows the lessor to buy gas at the wellhead price.
Surface Damage Clause: Specifies compensation for surface damage and crop loss.
Pipeline Depth Clause: Requires burying pipelines to a specified depth.
McClurey Clause: Addresses the termination of producing zones.
Payout Clause: Determines when royalty payments change based on exploration expenses.
Access to Drilling Site and Operations Information Clause: Grants access for inspection and information.
Production Payment Clause: Reserves a portion of proceeds for the lessor.
Additional Royalty Clause: Adds an extra royalty to the existing one.
Non-Development Clause: Prohibits drilling operations on the land.
Saltwater Disposal Clause: Restricts well usage for disposing of saltwater.
Water Clause: Limits water use to drilling operations.
Plow Depth Utility Line Depth Clause: Requires burying utility lines to a specified depth.
Placement of Buildings and Equipment: Specifies the location of equipment and storage tanks.
These clauses represent some of the most commonly negotiated amendments in oil and gas leases, though specific clauses may vary by region and preference of legal professionals.
Cancelling an oil and gas lease in Texas typically depends on the specific terms and conditions outlined in the lease agreement. Here are some common ways to terminate an oil and gas lease in Texas:
Lease Expiration: Most oil and gas leases have a primary term and a secondary term.
Once the primary term has expired, the lease may terminate automatically unless there
are provisions for extensions or renewals. Review the lease agreement to understand
the specific terms regarding lease duration.
Failure to Meet Lease Conditions: If the lessee (the oil or gas company) fails to meet the conditions outlined in the lease, the lessor (the landowner) may have grounds to terminate the lease. These conditions might include drilling within a specified timeframe or making royalty payments.
Mutual Agreement: The lessor and lessee can mutually agree to terminate the lease. This might involve negotiating a termination fee or other conditions. Make sure to document any such agreement in writing.
Breach of Lease: If the lessee breaches any material terms of the lease, the lessor may be able to terminate it. Consult with an attorney to determine if the breach is sufficient for termination and follow any dispute resolution processes outlined in the lease.
Force Majeure: In some cases, an oil and gas lease may contain a "force majeure" clause, which allows for lease termination or suspension in the event of unforeseen circumstances such as natural disasters, war, or government actions.
Legal Action: Legal action may be necessary if disputes arise over the lease or its termination. Consult with an attorney who specializes in oil and gas law to assess your options and protect your interests.
Lease Renegotiation: In some cases, it might be possible to renegotiate the lease terms, including termination conditions, with the lessee. This approach can be less adversarial than legal action.
A Division Order is a complex document outlining how mineral rights holders will distribute the oil and gas revenue percentages. It also typically implies a guarantee of your correct percentage, grants certain rights to the purchaser, and specifies accounting procedures and market values. This first purchaser will often withhold the "windfall profits tax" and send a significant portion of your earnings to the government.
Legal experts often caution against sending a Division Order for gas production without consulting them first, as some gas division orders may attempt to extend lease provisions, potentially clouding or negating lease agreements. The original purpose of the Division Order was to protect fund distributors from liability due to improper payments.
There's also something called a "Rental Division Order," typically signed around the same time as the lease, which outlines the distribution of delay rental payments.
The purchaser conducts a title check to verify the seller's authority to sell the produced minerals. Then, you and the lessee must execute a Division Order, specifying who will receive payments and in what amounts.
If any party decides to sell all or part of an interest, a transfer order is required, which is essentially an authorization to adjust the Division Order.
While leases do not always mandate the signing of a Division Order, it is commonly accepted practice to do so.
However, some experts caution against signing any Division Order that amends lease terms. Courts have sometimes upheld the lessor's rights if the Division Order infringes upon them. In other cases, the Division Order has legally taken precedence over the lease until contested. It's crucial to consult with local legal counsel to understand the specific implications in your situation.
In Gas Division Orders, a Kansas attorney typically removes parts that don't explicitly pertain to the division of interest. For instance, in the term "proceeds," they replace the word with "royalty interest in oil and gas."
Warning: There is a concerning trend among large and small production entities to alter Division Orders without proper legal review, potentially risking your rights. Always exercise caution when dealing with Division Orders and seek legal advice when necessary.
For transferring or conveying land, a precise legal description is essential. The original 13 states, along with Vermont, Maine, Kentucky, and Tennessee, employed what they referred to as Colonial Surveys. This method involved laying out areas around towns or settlements in townships, typically measuring six miles square. Within these townships, land grants were surveyed, plats were recorded, and these records continue to be used in subsequent property transactions.
During the periods when the land was under French, Spanish, and Mexican ownership, grants of land were made to individuals. These historical land grants now serve as the foundation for property titles in Florida, Louisiana, Texas, New Mexico, Arizona, California, Colorado, Utah, and Nevada. These grants are often referred to as "Spanish land grants."
In 1785, Congress introduced the "rectangular" survey system in Ohio. Later, the government extended this system to include large portions of Alabama, Florida, Mississippi, and all states to the north of the Ohio River, as well as west of the Mississippi, excluding Texas.
States not covered by the U.S. Survey System developed their own survey methods. For example, New York was divided into tracts but did not follow any rectangular survey system.
While still a part of Spain's colonial empire, Texas issued land grants. Mexico also granted significant tracts of land upon entry into the region. Texans retained titles to these lands even after becoming part of the United States.
First and foremost, if you find yourself involved in a "pooling" situation, it's imperative to seek the services of the best lawyer your money can buy. Family members who are lawyers don't count in this case. The topic of pooling is highly complex, with hundreds of legal texts written on the subject, thousands of court cases, and the entire matter is a legal quagmire.
Pooling essentially entails the consolidation of various tracts or portions of mineral interests to create a drilling unit in accordance with the well spacing regulations of the state where the proposed well is to be drilled.
There are two primary forms of pooling. The first is voluntary pooling, initiated typically by a group of leaseholders to enhance their economic interests. The second, which often becomes a lucrative venture for lawyers, is known as "compulsory" or "forced" pooling.
Pooling is common in Oklahoma and 36 other states with oil and gas production. To the uninitiated, it may seem straightforward. One key aspect of pooling is that "each mineral owner included in the pool will receive a fractional share of the production from the entire pooled area."
It originated, along with "proration," which involves setting monthly production limits for each well, during the boom years of the 1920s and 1930s. During this period, operators drilled wells one after another to extract oil rapidly, repay investors, and move on to new fields. This led to an oversupply of oil, causing prices to plummet and excessive waste. Laws like force pooling were enacted to conserve energy. However, many people now feel it has become excessively complicated.
Here's a potential scenario in some states:
Suppose an operator has been acquiring leases in your area, and you've been holding out. However, the operator has managed to persuade several other landowners to agree to their terms. The operator then seeks approval and spacing orders from the state regulatory body for the prospective area. These orders cover not only the operator's leases but also include your mineral rights. The operator subsequently applies for a forced pooling order from the relevant regulatory commission. They may return to you, and if you have not agreed to their terms, you might be subjected to forced pooling.
You still resist. Next, you'll receive notification of a hearing before the state commission, which will decide whether your property will be included in the pooled area for oil and gas exploration.
If you had signed the lease, it would have been applicable to all production zones in most states. But if you resist, the order in many states will apply selectively to the zones being force pooled. This might enable the leasing party to secure orders for those production zones (or sands) where drilling is complete while keeping other zones available for future lease opportunities. This is why many individuals in these states never sign a lease when under forced pooling and always strike the pooling and unitization clause from their leases. They believe they can usually secure a fair deal, except in states like Louisiana, where they could risk substantial losses. This strategy has worked in some cases but has also led to complications. Again, it's essential to "look before you lease."
Here are additional reasons why you might want to resist forced pooling:
You may find the mineral bonus, royalty rate, and lease term to be unfair.
Geological considerations may not be in your favor at the proposed location.
You might believe that the spacing regulations are inadequate for the proper development of your mineral rights.
Consider this economic horror scenario: John E. Quicksand owns undivided minerals and is forced pooled into a unit with 11 other mineral owners. Let’s say they each have an equal share of the unit.
Under forced pooling, Quicksand's return on production would be only 1/12 of the 1/8 royalty negotiated unwisely by his neighbors. If the monthly production from the well were $10,000, Quicksand would receive a meager $104 per month. After taxes, it might cover the cost of a tank of gasoline.
However, had the well been drilled solely on Quicksand's property without pooling, he would have received $1,248 per month, plus benefits from any offset wells.
In essence, forced pooling often serves the interests of the operator rather than the mineral owner. To the operator, it's an economic boon. To you, it could mean financial survival or a significant loss. To navigate these economic complexities, consulting with a knowledgeable attorney specializing in oil and gas regulatory laws is crucial.
Understanding the oil and gas lease process can be challenging, mainly because of the confusion surrounding the terminology used. For instance, there's a significant difference between a "mineral owner" and a "royalty owner," yet these terms are often incorrectly interchanged.
To clarify these concepts, let's explore some fundamental forms of ownership:
1. Fee Simple:
In fee simple ownership, you possess both the surface rights and mineral rights, giving you the rights to lease, receive bonus payments, delay rentals, and royalty payments from production.
2. Surface Fee:
A surface fee owner owns the land's surface but not the mineral rights, which may have been sold separately. This owner has limited control over oil and gas development on the property.
3. Mineral Interest Owner:
A mineral interest owner holds the property interest created by either a mineral deed or an oil and gas lease. This owner has the right to enter and use the property for exploratory and drilling activities and can benefit from royalties, rentals, and bonuses.
4. Royalty Owner:
A royalty owner, subject to the operator's rights, owns a portion of the minerals produced on the land. They typically receive payments from the sale of oil, gas, or other hydrocarbons.
5. Overriding Royalty Interest Owner:
Overriding royalty interest owners are similar to royalty owners but receive a fraction of the payments from the sale of oil or gas specifically allocated to the operator of the well. This interest terminates when the lease expires.
6. Production Payment Owner:
Production payment owners receive payments from production, but this interest terminates once a specified amount of money or barrels is received from production.
7. Term Mineral Interest Owner:
A term mineral interest owner holds their interest for a limited time or as long as oil or gas is produced, depending on the terms of the agreement.
8. Reversionary Interest Owner:
Reversionary interest owners hold interests that revert to them after a specified period or condition, such as no production after a set number of years.
9. Working Interest Owner:
A working interest owner holds the exclusive right to explore for minerals on the land. They are responsible for exploration and development costs and typically receive a portion of production after deducting these expenses.
It's essential to keep these ownership forms in mind when negotiating mineral deals, as they can significantly impact your rights, responsibilities, and financial outcomes.
Family Mineral Interests