Oil and Gas Leasing Tips

THE LEASING PROCESS: 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 your right-to-drill for and produce your oil and gas to an oil company in exchange for the agreed upon terms in the lease. They will in effect “own” the minerals, but only for the term of the lease.

The initial offer to lease may come from someone at a land company hired by the oil company to buy leases for them. The land company will later assign the lease to the oil company. In some cases other individuals will contact you for a lease that do not work for an oil company. These other people are often “speculating,” and will either attempt to resell your lease later to an oil and gas company, or may use the lease to participate in any wells that are drilled prior to the lease expiring.

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.

In my opinion it is best to lease to an actual oil and gas company who has an active interest in seeing your minerals developed rather than to someone whose main goal is to resell your lease to someone else for a profit or participate in a well for their own gain. That said, if a speculator decides late in the game to start buying leases they might be willing to pay a substantial bonus to participate in a potential well with your lease so in these cases an offer from a speculator might be worth considering as long as the terms being offered are at least as good as those being offered by the company who is likely to be doing the actual drilling.

PRIMARY TERM: When you sign a lease, you are giving the lessee (or whoever they may assign it to) the exclusive right to explore for and develop your oil and gas 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 starts drilling a producing well during the primary term, their lease rights are extended past the primary term into what’s called the “secondary” term, which will continue for “as long thereafter as there is production in paying quantities from the leased premises.” This “habendum clause” stating how long the lease will be in force, is usually stated near the top of the lease itself. If the lessee does not drill a producing well during the primary term, then the lease will expire at the end of the primary term, after which point you’d be free to lease to someone else if the opportunity arose (or had arisen during the primary term.)

NEGOTIATIONS: 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 abilities, which can be greatly enhanced if you can demonstrate knowledge of the current or recent oil and gas activity in the area being leased. If you are in a “hot” area, and can show you are aware of it, you’ll likely be able to negotiate better lease terms than someone with little knowledge of the goings-on in the area. The key is to research the area prior to agreeing to lease.

Two of the better subscription websites for Oklahoma oil and gas research are Oil Law Records and PangaeaData. There are other good subscription-based sites as well, though I am reluctant to mention them as their subscription prices have gotten out-of-hand in the last few years. However, the Oklahoma Corporation Commission  has a free site available to the public now and it has a wealth of oil and gas production, permitting, and other information online. Two Pennsylvania sites that may be helpful for those who own in that state are: The Bureau of Oil and Gas Management and the Pennsylvania Attorney General’s “Consumer’s Page.” The Texas equivalent would be the Texas Railroad Commission.

When you are first contacted about a lease by your friendly neighborhood landman, keep in mind that they have their own or their client oil company’s best interests in mind, rather than yours. Those working for oil companies are limited (initially anyway) as to what they can offer in terms of bonus, royalty, or additional lease clauses, though their authority to accept “non-standard” terms may be expanded as more leases are purchased and their client oil company is trying to “wrap up” the leasing.

QUESTIONS TO ASK YOUR LESSEE: One of the first questions I ask a landman, is how much of the potential drilling area is currently leased. In areas with a history of oil and gas production it is common for the minerals under a proposed drilling and spacing unit to have been divided between many mineral owners over the years. Knowing what percentage of the mineral owners within a proposed drilling and spacing unit have already been leased is helpful. If most of them are already leased and the landman is trying to “wrap up” the leasing you may be able to negotiate a more favorable lease.

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 have only started leasing, the highest bonus they may have paid could be only $50 per acre. Determining where you are in the company’s leasing process is important, since the best offers are usually made as they are trying to “wrap things up.”

THINGS TO CONSIDER: 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.

“FORCING” YOU TO LEASE: 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 fifteen 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.

PAYMENT OPTIONS: In most cases, a lessee will send you a lease to sign, and with that will include a cover letter with instructions, and either a bank draft or an “order for payment.” The cover letter usually instructs you to mail the signed lease back to them and deposit the draft/payment order with your bank’s collection department so you can be paid. In most cases it is preferable NOT to accept a draft or payment order for payment, since in many cases (read the fine print on these documents) these are nothing more than payment “options” (rather than obligations) that tie up your ability to lease to someone else (since they probably have your signed lease) while giving the issuing company the ability to change their mind about going through with the deal anytime before the “due date”; even if there are no problems with your title.

To avoid the risk of tying up your minerals for months, I would ask the lessee to meet me in person with a check and lease in-hand, at which point I would have the lease notarized and exchange it for the check.  Since most leasing transactions are done through the mail however, this may not be practical, and some lessees will tell you (legitimately) that they need time to check your title prior to paying you and so can’t pay you immediately after you sign the lease. Other lessees that have already checked your title prior to contacting you may agree to meet you in person however.

In such cases where the lessee needs time to check title before paying the bonus (a legitimate request) another option would be to explain to the lessee that you would prefer to send them only a COPY of the signed lease, rather than the original (they can’t do anything with just a copy.) Explain that once they have the copy they can get started on your title, and you will send the original as soon as they send you a check for the bonus. Tell them you’ll give them 30 days (or whatever you agree to) to run the title and get you paid. This way, they will likely be motivated to get your title done ASAP since until they do they won’t get your lease.

A third, though less preferable option, would be to deposit BOTH the original signed lease AND payment order/draft with your bank’s collection department (rather than sending the lease to the lessee directly.) That way, once the lease and draft/payment order arrive at the lessee’s bank their bank won’t (or certainly shouldn’t) give them the original lease until the lessee has come down to the bank and paid for it. Once paid for, their bank would give them the original lease and mail a check to your bank for the bonus, which your bank would deposit in to your account once received. This method works, but is less preferable than others because the lessee can still decide to change their mind for virtually any reason (again, read the language on the draft/payment order) so your lease could be sitting at their bank for weeks before they finally decide not to go through with it by choosing not to pay the draft.

FINAL NOTES: You should understand what you are signing before signing it obviously, and if you don’t then find someone to explain it to you. An oil and gas lease 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.

Feel free to post your comments here, but if you have a QUESTION about something, it should be submitted on the FAQ page of this website in order to be considered for a response. Thanks! Sincerely, Mineral Hub

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