An oil and gas lease is essentially a contract between you, the “lessor”, and another party, the “lessee.” In most states a lease is also considered a conveyance, since you are essentially signing over to the lessee your rights to the minerals in exchange for the agreed upon terms in the lease. They will in effect “own” the minerals for the term of the lease. The lessee will usually be an oil and gas exploration company. The lessee who initially contacts you with an offer to lease may be a land company or landman hired by an oil company to procure leases for them. This person or company will lease you initially, but later sign your lease over to the oil company that hired them, giving the oil company the right to drill for your minerals. In some cases people other than oil and gas companies or their representatives will contact you for a lease. These people are often “speculating” and will likely resell your lease later to an oil and gas company for more money. I would rather lease to someone who has an active interest in seeing my minerals developed rather than some speculator.
Some of the bigger oil and gas companies have in-house landmen working for them, and in those cases you are dealing with the company directly, though the company may still choose to assign (or sell) your lease to another company later if they decide not to drill the prospect themselves, or they may simply retain the lease and become working interest owners in any wells that are drilled. This is not a bad thing, as long as you get a good lease from them.
When you sign a lease, you are giving that party (or whoever they may assign it to) the exclusive right to explore for oil and gas on your property for a set period of time, called the “primary term”. Currently, in “active” areas the primary term is usually a period of three years, though terms can be for as little as six months or for as long as five years. In other less developed areas primary terms of ten years are still being asked for, though I would hesitate to tie up my minerals for that long without substantial compensation; the theory being that if oil or gas is discovered in an area that has not seen much activity before, the lease prices will likely rise. Locking yourself into a 10-year lease would prevent you from sharing in any increase in lease bonus price that occurred during those ten years.
In general, if a lessee drills a producing well during the primary term, their lease rights are extended past the primary term for as long as the well is producing. If they do not drill a producing well during that time, then the lease will generally expire and someone else may then lease your minerals from you for another period.
Negotiating the lease terms in an oil and gas lease is much like negotiating any other contract. Most, if not every part of an oil and gas lease is negotiable. Your ability to effectively negotiate provisions such as length of primary term, bonus and other things you want to include depends on your bargaining power and knowledge of the area being leased. Usually the more acreage you have to lease, the better your bargaining position will be. If your acreage is close (within a mile or two) to prolific production, this will also enhance your bargaining power with a potential lessee. Having knowledge about the exploration and production activity or geology in your area is crucial if you are to negotiate effectively. These days, many sites on the Internet can provide you with information concerning leasing activity, well completions and production.
Two of the better websites that include data for Oklahoma are Oil Law Records and Drilling Info. In addition, the <a href=”http://www.occeweb.com/Orawebapps/OCCOraWebAppsone.html”> Oklahoma Corporation Commission </a> now has a wealth of well information available online, and their site is currently free. There are also a couple of informative Pennsylvania sites that may be helpful for those who live there: The Bureau of Oil and Gas Management is one. Another helpful link for those in Pennsylvania is the Attorney General’s “Consumer’s Page.”
When you are first contacted about a lease by your friendly neighborhood landman, keep in mind that they have been hired by your lessee and will therefore naturally have their best interests in mind. Because of this, they are usually limited by their employer as to what they can offer in terms of bonus, royalty, or additional lease clauses. Some unfortunately are not as forthcoming on the terms actually available as perhaps they should be. Often they are pressured by their employer to acquire leases on the best available terms for the company, who perhaps is offering the landman additional incentives to do so.
One of the first questions I ask a landman, is how much of the potential drilling area is currently leased. A drilling unit for a single gas well in most states is usually a section of 640 acres, though in states such as Texas irregular and odd-shaped spacing units are common. In areas with a history of oil and gas production it is common for the minerals under a proposed drilling and spacing unit to be divided between many mineral owners. It’s nice to know how much of them are already leased by the lessee because if most of it is already leased, then you may have a better bargaining position because they are likely trying to “wrap it up” and perhaps will give you a more favorable lease in order to help accomplish this. Also, if they can lease everyone, they might not have to apply for a forced-pooling order (common in many states) which costs money.
In less active areas companies will lease entire areas of a county in hopes of developing a reservoir that looks promising to them. The same logic would apply though as with any drilling area; find out how much is already under lease if you can. If most of the section or area has already been leased; you would want to ask the question “What is the highest bonus per acre paid so far?” The more people they’ve leased, the more likely it is that they’ve paid at least one pretty good bonus to a tough negotiator. I would expect them to offer me the same bonus amount.
On the other hand, if they’ve only started leasing, the highest bonus they’ve had to pay may be only $50 per acre and could tell you that $50 is the highest they’ve paid, and they’d be telling the truth, even though later the bonus amounts (perhaps yours) may be higher as more leases are signed.
Often you will first receive a lease offer in the mail before being contacted by a landman personally. The lease offer you receive by mail will usually contain at least two options for bonus and royalty. Before choosing one of them, consider the following.
The royalty share received by the mineral owner usually ranges between 1/8th and 1/4th, with the most common being 3/16th’s. In leases where my acreage is small, such as 3 acres or less, I usually go for a bigger royalty fraction, rather than a bigger bonus. My reasoning is that the bonus for a few acres is usually only a few hundred dollars, and over the long run having a higher royalty could add up to much more than that. In areas where there is little or no production nearby, and the chances of getting a producing well are small, I may opt for the smaller royalty and the bigger bonus, even though I may own less than three acres. Knowledge of the area around my minerals dictates which I choose.
Unless I am desperate for cash, I very rarely agree to anything less than a 3/16th royalty! They usually offer more of a bonus if you’ll agree to only a 1/8th royalty, but I rarely accept that, even if there is no production nearby. You never know, a well could come in anywhere, and I don’t ever want to be stuck with 1/8th royalty. 3/16th’s is better.
Also, keep in mind that a smaller company may be willing to give you a bigger royalty share, or a shorter lease term in lieu of a large bonus. They may prefer this because they don’t have the cash available for bonuses that some of the bigger companies do. A bigger company on the other hand may be more stubborn about the actual contents of the lease, and be willing to give you a substantial bonus in lieu of a big royalty fraction or a favorable lease form. I usually try to determine the wealth and strength of a company before negotiating bonus and royalty with them. This helps me determine what to ask for in my lease negotiations, and whether I can realistically expect to get it.
I would not demand too big a bonus from a smaller company, because they may just decide to force pool me (via state forced-pooling laws) if I price myself out of their budget. I would instead try to negotiate some favorable lease clauses into the lease and/or obtain a 1/4th royalty. I also consider the production nearby and negotiate my royalty accordingly. If there are no producing wells nearby, I would not consider royalty to be as important a factor in my negotiations, though I would still not lease for a mere 1/8th.
Some things to consider about primary term length:
If you are asked to sign a lease with a primary term of longer than five years, and agree to do so, then you should demand a bigger bonus per acre too, since you are agreeing to tie up your minerals for a longer period of time. Lease amounts may go up in the next few years, especially in currently undeveloped areas if production is eventually found. If you sign a ten-year lease, and prolific wells are completed near your property a couple of years after you sign, you will not be able to participate in any increase in bonus amounts that occur because of these wells. This is why I usually don’t like to sign “long” leases unless there is some sort of provision that increases the bonus amount during the later part of the lease…i.e. an “option” to extend the lease from five years to ten, at double the amount per acre originally paid if exercised.
In an area that’s already active, I would think twice about signing a lease for longer than three years, even if you do get a bigger bonus. Sometimes a company will try to get long leases from people because they don’t have time to drill all the leases they already have, but want to control the right to drill in sections they can’t get to right now. They also may think the price (bonus amounts being paid) being paid for leases will go up in the future and they want to “lock-in” a good lease price now. Remember, leases are assignable, and they may in fact “sell” the lease to another company later for a higher price than they paid you! Five years these days in active areas is too long! Prices change frequently. Remember that there are probably other companies leasing in the same section as the one who wants you to sign the five-year lease. Lease to them instead for three years. Competition between lessees often allows lessors to negotiate better lease terms. I have done this on several occasions. When more than one party is after your lease, you will likely be able to negotiate better terms.
Forced Pooling and Forced Integration: A forced pooling (Oklahoma and other states) or integration (Arkansas) order is granted to lessees by the state’s oil and gas regulatory body in cases where the lessee either can’t locate or can’t reach an agreement with all of the owners who own the minerals and/or the right to drill in their proposed drilling and spacing unit. These recalcitrant or un-locatable owners are “force pooled” in such cases, which “forces” their consent. This is necessary because an operator must obtain “permission” from ALL the owners in a drilling unit before drilling. Obtaining a forced –pooling order costs money however, and so some effort is made to avoid them. If you drive too hard a bargain in your lease however, a lessee may still prefer to apply for permission to force pool you. It’s a delicate balance, and that is why knowing your bargaining power is important. Many states have forced-pooling laws, though not all. The easier it is for a company to force pool a mineral owner, the less bargaining power the mineral owner has. Most laws state that the company must at least “attempt” to get a lease from everyone before applying for a forced-pooling.
It is not always bad to be force pooled. If I absolutely can’t come to an agreement with a potential lessee, I will sometimes just tell them to force pool me. Since pooling is regulated by the state, the terms in a pooling order are often better than the terms in some of the leases I am offered. Questions do remain however as to exactly what protection exists for mineral owners in forced pooling orders. In addition, a forced pooling order generally expires after six months, whereas a lease is often for three years. After the forced pooling order expires, you are free to lease to someone else but have still kept the bonus (if you chose a bonus option). The National Association of Royalty Owners NARO (www.naro-us.org) sells some publications that further explain the forced-pooling option.
Normally an operator won’t apply for a forced pooling order unless they are planning to drill before it expires, so I keep that in mind whenever I notice that a section has been pooled. In addition, once a pooling order is granted, in Oklahoma at least, you often have about ten days to lease to someone else before the pooling becomes binding on you. If you make a deal to lease with another company (or the same company) within the prescribed time, then you will not be pooled. Often companies that may not have been interested in leasing you before will become interested once a pooling order has been issued. This is because it is now much more likely that a well will be drilled. Companies that want to “get a piece of” the well can do so by leasing you.
These blog posts are just the tip of the iceberg so to speak. The lease must be analyzed and read carefully before signing it. It creates obligations which can last for decades and so it deserves some attention. If you don’t want to deal with analyzing the lease yourself, it would be wise to pay someone to do it for you if necessary. Many people just sign anything given to them and hope they are being paid fairly. This sometimes costs them a lot of money in the long run.
In closing, I would like to point out that the personal views expressed in this article are my own, and further, though I believe the facts stated herein to be correct based on my current knowledge, this article should nonetheless not be used to determine matters of law, or be taken as actual legal advice. My intent has been to present a mineral owner perspective on some of the many leasing choices faced by mineral owners. I hope it has been helpful.
