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What Do Landowners Need to Look for in Oil and Gas Leases?   

Curtis Talley, Jr.
Extension Business Management Educator

Landowners who have never dealt with leasing their mineral rights for oil and gas production, upon reading a lease, may find that they have difficulty understanding the lease language in layman’s terms. Are there key words or phrases that someone should be aware of?  This article discusses the language from leases utilized by the oil and gas industry that are offered to landowners. For instance, when the word “company” is stated, it is referring to the oil and gas company that is interested in leasing a landowner’s mineral rights [it is not to keep you company].  

When you, as a landowner enter into a lease negotiation with the intent to sign an oil and gas lease, you should be expecting eventual drilling and production on your property.  If you do not support the drilling of wells on your property, then signing a lease is not fair to the oil and gas company and can leave you in a bad situation.  Sometimes, an oil and gas company will negotiate a lease for the mineral rights and pay the bonus, but never actually drill. Do not expect this, as it may lead to a poor lease agreement and negative outcomes. Expect that drilling will take place and all parties will use the terms of the lease to conduct exploration and production.

Have Your Eyes Open
The company writes the lease and provides the landowner the opportunity to review it and accept its terms. In general, no matter what you are leasing, whether it is a car, agricultural machinery or mineral rights, the party that writes the lease usually has the advantage because they can include terms and conditions that are favorable to them. It is up to the other party to identify unfavorable terms and request that they be modified.

In the case of mineral rights, one of the company’s goals is to keep the land under lease as long as possible. This avoids potentially losing the land to a competitor or negotiating new lease terms with the requirement that another bonus payment be made. Most leases have automatic renewal or extension clauses that keep the lease active with minimum actions being made by the company beyond the primary 3- to 5-year period.

Some Key Phrases and Terms

1.   “Exploring by geophysical and other methods...” This allows the company to conduct seismographic studies to determine if drilling an oil and gas well should be considered. If the lease does not specifically call for the payment of surface damages for this activity, the landowner may not receive any surface damage payments when seismic work is conducted.

2. “Together with all rights, privileges or easements useful or convenient...” This denotes unpaid usage of the land surface and allows the company to place roadways, pipelines and have other unnamed “privileges” wherever it is convenient for the company. The landowner can limit the activities that are unpaid and require payment for, or not allow certain activities.

3.   “... Or any other land adjacent or appurtenant thereto…” This is called the Mother Hubbard clause and permits the company to obtain the right to develop all contiguous or “appurtenant” lands owned by the landowner or that the landowner may own in the future. These can be adjacent, or they can be located in another township.  Sometimes, landowners prefer to not lease all of their land. If the landowner accepts this provision, he/she is not reserving the right to negotiate a separate lease to the additional property in the future.

4.   “… Establish and utilize wells and facilities for the disposition of water, brine or other fluids…” This gives the company permission to dispose of these items on your land including the construction of an injection well. Because this condition is contained in the granting clause portion of the lease, there is no provision to pay the landowner for the usage. Alternatively, the lease can state that prior written consent of the landowner is needed for the construction and location of such sites. In order to obtain the landowner’s consent, a separate lump sum, annual lease or right of way payment may be negotiated.  

5. “… And construct tanks, power and communication lines, pump and power stations and other structures and facilities.” This allows the company to construct such things as compressor stations and other buildings or facilities on the land surface with no payment to the landowner. Alternatively, the lease can state that prior written consent of the landowner is needed for the construction and location of such facilities. In order to obtain the landowner’s consent, a separate lump sum, annual lease or right of way payment may be negotiated.  

6.  “… Located on said land or lands pooled or unitized …” Pooling is the company’s right to consolidate your leased premises with adjoining tracts of land. Sometimes pooling arrangements are necessary to meet the minimum acreage required to obtain a drilling permit. For example, you have a 20-acre tract and your neighbor has a contiguous 20-acre tract. For this particular well, the oil and gas company is required to have 40 contiguous acres under lease. The pooling provision allows the company to combine the two tracts into a 40-acre pool so they can obtain a drilling permit. Pooling also can be used to extend the lease beyond the primary term, even if land in the lease is not producing a royalty. Even though the lease may state it has a 3-year or a 5-year primary term, it can be extended without the landowner’s consent if pooling language allows it. Many leases contain multiple paragraphs that discuss the company’s rights to pool. Many pooling clauses will operate to extend the entire leased premises even if only a portion of the lease is located within a unit that is paying the landowner a royalty. Alternate language is to only allow pooling to the extent it is needed to secure a drilling permit.  7. “… This lease shall remain in force for a primary term of 3 years ……and in no event shall this lease terminate unless production of oil and or gas has permanently ceased.” This means that even though you are not being paid a royalty, if the well on your land or on land that is pooled or unitized with your land is capable of producing any oil or gas, even if it is not enough to market profitably, the primary term of the lease will continue. Landowners may assume that when the lease states a primary term of 3 years, if there is no well present or a royalty being paid that the lease will terminate.  Pooling and shut-in well language can be written so that the lease continues even though the landowner is receiving no royalties.   

8. “Company shall sell the oil and gas and pay Lessor 3/16 of the net amount….minus post-production costs incurred by Company…..to realize the market value…” In Michigan, rule 324.61503b of the Michigan Oil and Gas Regulations forbids the oil and gas company from deducting post-production costs unless they are agreed to in a lease. Post-production costs can reduce significantly the royalties paid to a landowner because these deductions are calculated and charged by the company. It is not uncommon to see several paragraphs in the lease that discuss the list of possible deductions including “any and all other costs and expenses of any kind or nature…..between the well head and the point of sale.” Alternatively, the landowner can require that the company pay to him/her the agreed upon royalty percentage based on gross proceeds at the well head, free of any expenses, with the exception of severance taxes. 

Conclusion
Before any exploration can begin, the landowner and the oil company must agree to the terms regarding the rights, privileges and obligations of the respective parties throughout the exploration and production stages. Negotiation of these terms may be a landowner’s first exposure to an oil and gas lease. Because of the complex legal nature of the leasing process, novice landowners may be at a disadvantage when dealing with an experienced landowner or oil company. An oil and gas lease is both a contract and a conveyance of an interest in land. When you sign an oil and gas lease, you have essentially “sold” a part of your property. Obtaining a good lease is a negotiation, with the goal that it be a win-win situation for both parties. To obtain a good lease it may take a long time and it is worth it because leases can last a life time. 

Negotiation of an equitable lease requires the assistance of an experienced oil and gas attorney or oil and gas leasing consultant. It is not advisable to sign a lease if your understanding of the provisions is not clear.

For more information regarding oil and gas leasing you can contact Curtis Talley Jr. at 231-873-2129. Michigan State University Extension also has a web site www.msue.msu.edu/oilandgas that has additional information to assist landowners in understanding and negotiating oil and gas leases and the oil and gas industry in general. line

Michigan Dairy Review is published and mailed to all Michigan dairy farmers and individuals working in allied industries. With its ever increasing on-line presence, the MDR target audience has spread beyond Michigan and the U.S.; today electronic subscribers are located in places such as Australia, The Scandinavia, Italy, Mexico, Ireland, Peru, and New Zealand.  

The MDR is the primary communications vehicle for research findings, extension programming, and teaching between faculty and staff in MSU dairy programs and the dairy industry. The MDR web site is paid for by the C. E. Meadows Endowment.

January 2012 Topics

Calving Pen Alternatives

Intensified Feeding Programs for Calves

Right to Farm: Site Selection

Treatment of Milk House Wash Water

Diagnostic Tests and Strategies for BVDV

Landowners: Oil and Gas Leases

Livestock Gross Margin [Pt 2]

Social Secuurity Basics [Pt. 2]

What BOTF Participants are Learning

MSU at Nationals Dairy Challenge

2012 Winter Dairy Program