The Basics of the Oil and Gas Lease

By Stephen Clayman · May 3, 2015

For the mineral owner, the Oil and Gas Lease is the most common, but also the most important legal instrument that he will have to negotiate. Many books have detailed the Oil and Gas Lease, however, we will limit our study today to the basics.

99.9% of mineral owners will lease their mineral rights to an oil company for the right to explore and drill for oil and gas. The Oil and Gas Lease is a legally binding agreement between two parties, the mineral owner, called the Lessor, and the oil company or his agent, call the Lessee. In exchange for the opportunity to lease the mineral rights, the Lessee will tender consideration to the Lessor.

There are two components to the consideration. First, the Lessee will pay a cash bonus payment to the Lessor. Bonus payments vary widely and are dependent on local market conditions. Second, the Lessee will pay a royalty to the Lessor if a well is drilled and it produces oil and gas. The royalty is a percentage of the production revenues. The most commonly negotiated royalties are 1/8th and 3/16th. This means that if a Lessor agrees to a 3/16th royalty, he will receive 3/16th of the revenues attributed to the minerals he leased in the well free of any charges.

When leasing, most oil companies will offer at least two options with differing cash bonuses and royalty percentages which are inversely related.

For Example:

Option 1: $200/net mineral acre and a 1/8th royalty

Option 2: $150/net mineral acre and a 3/16th royalty

As mineral owners have differing horizons, each may choose a different option based on his current financial situation.

The Lease will also have a Primary Term. The Primary Term is the amount of time, usually three years, the oil company has to drill an oil and gas well. If the company does not drill a well capable of producing oil and gas in paying quantities, then the lease will expire. If the oil company does drill a well, then the lease will enter its Secondary Term and will remain in force as long as the well is capable of producing in paying quantities.

The Lease will also describe the lands being leased using the legal description. These will usually include the section, township, and range along with a more specific description of the tract. Legal descriptions will be detailed more thoroughly in a later post.

Stay tuned for more information about the Oil and Gas Lease in future posts.

BR