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Oil and Gas lease 2

Oil and Gas lease 2

Oil and Gas Royalties

What a royalty is. How it is calculated. What is it based on?

Whenever oil or gas production begins, the landowner is entitled to part of the total production. A royalty is agreed upon as a percentage of the lease, minus what was reasonably used in the Lessee’s production costs. The royalty is paid by the Lessee to the owner of the mineral rights, the Lessor in the Lease. It is based on a percentage of the gross production from the property and is free and clear of all costs, except for taxes.

Traditionally, royalty can be 1/8 of production or 12.8 percent of production; however, it can be any fraction of production, depending on the royalty clause in a lease. The landowner should negotiate for as high a royalty as can be arranged.

Previously, landowners bargained for an overriding royalty. The override was 1/16 taken from the Lessee’s interest. Today, mineral owners negotiate for a firm royalty percentage without any override.

Oil royalties may be paid in oil. The Lessor may receive oil from the Lessee and then market the oil. Unless the Lessor is wise and understands the market, electing to receive the royalty in this manner, could be a disadvantage and the landowner, electing for this arrangement, may not benefit from it. Most landowners choose to receive the royalty in cash at the posted price of the oil. A Lessor deciding to receive the oil as the royalty payment can market the oil royalty back to the Lessee for marketing and receive cash through that arrangement.

Gas royalties usually are paid in the monetary units of the country, as in dollars. Gas price is also difficult to value given the fluctuating and volatile markets. Gas royalty clauses usually state a royalty as proceeds, market value or in kind

A landowner can specify separate royalties for oil and gas production. Landowners in negotiating the lease can place a due date for receipt of royalty payments and if timely payments are not made there can be an interest charge for late payment placed in the lease.

A royalty clause in the oil and gas lease specifies the amount of royalty to be paid to the Lessor and it can include other terms and conditions of payment.

Description of Oil Lease

An oil lease is essentially an agreement between parties to allow a Lessee (the oil and gas company and their production crew) to have access to the property and minerals (oil and gas) on the property of the Lessor. The lease agreement is a legal contract of terms. It contains certain elements, which confirm all the terms of the agreement.

The lease must be dated and the lease also sets the time that the lease is effective. It establishes the primary term of the lease. The date clause is an essential.

The parties section of the lease lists the names of all parties who are bound to the lease.

In the consideration section of the lease it gives the legal terms and ensures that the lease is legally enforceable by all parties.

The use of the property and the purpose for the leasing are in the granting clause. This clause states what rights the lessee has and what is the property subject to the lease.

An important part of the lease is the Lessee rights and how long these rights are in force. There may be other provisions including drilling, delay rental, pooling, shut-in royalty, and continuous drilling clauses among others.

Of great importance to the landowner, the Lessor, is the royalty clause. This clause states the percentage or share of production proceeds that the Lessor receives and how the royalty is received.

The Lessee is given rights in the drilling and delay rental clause. This allows the Lessee to defer immediate use of the property if the Lessee completes the obligation within a period of time and pays delay rental.

In case of a dry hole is drilled in the primary term and other stated problems, the dry hole, cessation, and continuous drilling clause is in the lease.

The pooling clause in the lease establishes rights of the Lessee to combine leases and form a larger single drilling production unit.

In the Surrender clause the sets forth the rights of the Lessee and other provisions if the Lessee surrenders the lease.

The Lessees liabilities in case of damage to the property is stated in the damage clause.

If either the Lessor or the Lessee, the parties to the lease, need or want to transfer the rights to the property or change ownership, the assignment clause gives this right after giving notice to the Lessee, especially if the landowner transfer interest in the property.

In the force majeure clause, the lease is subject to state and national laws. It gives the Lessee freedom from non-performance implied or specified in the lease.

The landowner in the warranty clause states that the landowner owns and guarantees the title of the land in the lease and states the rights of the Lessee if the landowner defaults on taxes, mortgages, and other obligations.

Oil Lease Sale

An oil and gas lease broker can be an independent landman. This landman works with many operators and companies in a geographical area in which the landman is very familiar and has expertise. The landsmen knowledge of the area puts them miles ahead of other production companies and their in-house landman, who are looking for land that is adjacent to in the same geological structures. When oil and gas has been located and produced in these areas, then there are excellent prospects for achieving good production in the adjacent areas. The independent landman represents mineral owners to oil and gas companies. When brokering an oil lease sale, the landowner becomes a valued client to the landman.

Landowners typically have very little knowledge of the oil and gas industry and companies. The landowner may not know that the exploration unit of an oil and gas company is looking in their area for good mineral prospects.

Most landowners, especially absentee owners, are not aware of developments and production in their area. Few landowners are able to assess the geological significance of the land, its structure, and the oil and gas beneath the surface. Therefore, the owners receive solicitations by mail for leases of their mineral rights. The landowners do not understand that they may be receiving a low and mediocre offer that they will loose money on and have decreased royalty rights and payments.

Oil and Gas Pooling

How it works and how forced pooling affects the owner

There are many terms in oil and gas leases that may not be familiar. One of the important clauses in the oil and gas lease is the pooling clause. A quick scan of the provisions and clauses in most, if not all leases, generally will show a pooling clause. It is in the best interest of the production company that leases the property to insert a pooling clause. It can also be in the best interest of the landowner to read and thoroughly understand the pooling clause in the lease. Signing a lease without understanding what rights are included in the lease can generate legal problems for the landowner. Not understanding the pooling clause and being unaware of the pooling terms can also lead to a compulsorily pooling of the leased land under state laws.

Pooling is the consolidation and combining of leased land with adjoining leased tracts. The area is called a pool or a unit. Pooling has the benefit to the production company of uniting all landowners’ leases into a common pool under one drilling production company and utilizing one common underground geological reservoir.

There are several types of pooled units. There are voluntary pooled units, forced pooled units, drilling units, proration units, field wide/enhanced recovery units, and specially defined units in lease agreements. Of all these named units, the reality is there are only two real types of pooling that the landowner will experience.

Landowners may find that they are subject to two types of pooling on their leased land. The first and possibly the best situation is voluntary pooling. In voluntary pooling, the landowner gives free consent to the pooling and may reap some benefit by inserting various provisions in the pooling clause. Reading the pooling clause in the oil or gas lease may indicate that the clause sometimes gives unrestricted rights to the production company for the pooling of the leased land. Therefore, it is prudent in the lease terms to set the acreage to be pooled in the leased land to only the minimum acreage necessary for the drilling permit. The landowner should look at the production company’s description and the extent of the proposed area to be pooled in the pooling clause. If there is a statutory acreage specified, then the landowner should limit the acreage to that minimum number of acres. If there is no set limitation to the number of acres to be included in the pool, then the production company could extend the coverage area to the entire leased area without any limitation.

The second type of pooling is compulsory or statutory. This type of pooling is compulsory whenever state law has been satisfied for oil and gas leases. Most states have this type of provision for compelling the landowner to enter into a pooling arrangement. In compulsory pooling of leased lands, the production company files a request for a pooling order, which provides for the surrender or sharing of interest by the landowner. When filing a request for a pooling order, the production company must provide a list to the state of all persons reasonably known to own an oil or gas interest in any tract or portion, which is proposed to be pooled. If there are unknown owners of the land, the pooling order and notice of a hearing must be published in a newspaper with the largest circulation in each county where the pooling will take effect. All known owners must be notified and advised of the legal action as well as the time and place of the hearing. After the specified time for landowner notification is reached, the hearing is held before the appropriate state agency. As a result of the hearing, an order can be issued by the state concerning the setting of the cost formula for sharing costs and revenues in the pooled area. The state and the production company usually set the cost formula. Most landowners have very little input in this situation. The landowners may speak in their own behalf at the hearing. This is a compulsory pooling hearing and pooling will take place.

Both types of pooling can change the way the lease is interpreted and how the lease provisions are applied. Before signing a lease, landowners may and should insert a Pugh clause into the lease to protect their interests and the leased land. The Pugh clause states that the lease shall terminate in all non-producing areas when the primary term ends or terminates. The landowner should also read and understand all of the terms of the lease before signing the lease. The landowner should negotiate as effectively as possible before signing the lease. A landowner cannot prevent a statutory pooling; however, in voluntary pooling, there may be ways to insert increased landowner rights and to mitigate the terms to a more satisfactory level for the landowner.


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