Oil and Gas Lease

Extending an Oil and Gas Lease

It can happen to the best of us, it was three years ago and nobody was drilling deep gas in Custer. You signed an oil and gas lease with an option to extend the primary term. Now, things are different, the "macro-headwinds" have shifted. There are folks with deep pockets paying 3x what you will be paid for your option. Even though $500/acre for a 160 acre lease on the home place would make most smile, you have a yellow equipment problem...

Is $10 Actually the Bonus Per Acre?

Oklahoma Mineral Rights Owners,

Berlin received another call from Bruce today. He was angry and slightly confused. Bruce was sure that some fly-by-night lease flipper was fixin' to cheat him out of his lease bonus. The Duncan, Oklahoma based outfit had offered him $1,100 per net mineral acre for a 3 + 2, oil and gas lease at a 3/16 royalty for some of his granddaddy's minerals in Beckham County, Oklahoma, which Bruce accepted...

Crooks on the loose in Caddo County, Oklahoma

Oklahoma Mineral Owners,

Pretty Boy Floyd looking awfully content with himself after cold drafting an Oklahoma oil and gas mineral owner.

Pretty Boy Floyd looking awfully content with himself after cold drafting an Oklahoma oil and gas mineral owner.

As we have discussed previously, it is important that you are aware of the financial condition of your potential lessee before agreeing to an oil and gas lease. While exchanging a check for an oil and gas lease is the best way to trade, many fly-by-night lease turning operations still prefer bank sight drafts. The reason for this is simple, it allows them to control mineral rights (your mineral rights) for a specified period of time, without paying for them. Be aware that receiving a draft usually implies that the lessee has not run title on your interest and likely won't close on the oil and gas lease you negotiated unless he can find a buyer to flip it to during the term of the draft. 

Berlin has received a number of calls recently regarding an Oklahoma outfit leasing in Caddo County who has been sending 90 business day sight drafts (that's four months) and filing the leases in the meantime. Some of the lessors have been without payment for over six months. This is borderline criminal behavior and gives all landmen in the area a bad name. If approached by a company like this, it is recommended that you call other active parties in the area for better payment terms. If would you like the respectable parties leasing in Northern Caddo County, Oklahoma, please drop Berlin a line or an email to inquire. 

More to follow,

Berlin

Four Key Pieces of Correspondence for the Oklahoma Mineral Owner

(This post originally appeared on www.oklahomaminerals.com on November 8,2016)

All,

Landmen are no busier than most professionals during the work day, but it is often stated that company landmen never return the calls of mineral owners. While this might be true of the bottom 10% of the profession, most landmen know that by placing a single call to a mineral owner, he could spend 30 minutes explaining knowledge that could easily be obtained throughsimple internet research. An informed mineral owner, who asks a poignant question, is much more likely to receive the answer he needs than the owner who calls to ask the difference between a spacing application and a well proposal.

Admittedly, if one owns a single tract of minerals or maybe just inherited the minerals, then the inaugural process of leasing and receiving the regulatory paperwork while the company is assembling the drilling and spacing unit would surely baffle most.

In general, there are four key pieces of correspondence that an Oklahoma mineral owner will receive from the landman. These occasions are detailed in brief below.

The Offer to Lease

Often, the first time an Oklahoma mineral owner will be contacted by a landman is when the landman’s company is assembling a prospect. The mineral owner will be contacted by phone and/or mail with an offer to lease their mineral interest. Most landmen will offer at least two options which will differ in the amount of cash bonus per net mineral acre and the royalty.

The Well Proposal

After the landman has made a bona fide effort to reach an agreement with all owners who own the right to drill a well in the proposed unit, he will send a well proposal to the parties with whom he has not yet reached an agreement. The well proposal will offer final terms in lieu of participation in the well and details of the well to be drilled such as location, proposed depth, target formation, estimated depth and cost of the well in the event the party would like to participate. It is important to note that in Oklahoma, an election to participate in the well is not binding until the party elects under the pooling order.

Oklahoma Corporation Commission Applications

Initially one of the most confusing aspects of being an Oklahoma mineral owner is the receipt of Oklahoma Corporation Commission (“OCC”) applications and orders. Some owners ask why they are being sued and others ask to be removed from the mailing list. Owners receive the applications and orders because Operators and applicants are required by law to provide notice of their activities to the owners who their activity affects. These applications are orders are mailed from an attorney who represents the applicant in OCC matters. The three most common applications that an owner will receive are the spacing application, location exception application, and pooling application. These applications will be discussed in detail at a later date, but the pooling application will be the application that will have the largest effect on the mineral owner’s rights and pocketbook. The OCC publishes a handbook for mineral owners that can be found http://www.occeweb.com/og/PubAsst/WebRoyaltyOwnersHandbook3-2015.pdf

The Division Order

If an operator successfully drills and completes a well, the next correspondence the mineral owner will receive from the company is the division order. A division order is an instrument which sets forth the proportional ownership in the produced hydrocarbons. The proportional ownership is communicated to the owner on the instrument in a decimal form. After the division order is signed and curative title issues are completed, the mineral owner should receive their first check within six months from the date of first production from the well.

In conclusion, the four key pieces of correspondence that an Oklahoma mineral owner will receive from the landman and the company, are the offer to lease, the well proposal, Oklahoma Corporation Commission applications and orders and finally, the division order. All four of these topics will be expanded upon in future articles. If there are any other topics you would like to discuss, please mention your ideas in the comment section.

More to follow,

Berlin

Canadian County, Oklahoma SITREP

Oklahoma Oil and Gas Mineral Owners,

Because of its premier position in the heart of the STACK, leasing and transaction activity has not slowed in Canadian County, Oklahoma in 2016 despite the lower oil prices. To date in 2016, there have been 1014 oil and gas leases filed of record in El Reno by numerous operators and brokers. Because bonuses have remained competitive, the most important question that you should ask before leasing is how likely the lessee is to drill your lease during the primary term. The path to generational wealth is not periodic lease bonus payments, but the passive cash flows generated by regular royalty checks. The lessee should be a stable company focused in Oklahoma and not a fly-by-night lease flipper.

That being said, there have been only 8 companies this year who have been granted Pooling Orders in Canadian County by the Oklahoma Corporation Commission. For this discussion, Pooling Orders will be our metric to measure presence and activity level in Canadian County. The Companies and the number of Pooling Orders issued are detailed on the chart below.

Company
Number of Pooling Orders
Chaparral Energy, LLC
2
Cimarex Energy Co.
5
Citizen Energy II, LLC
6
Devon Energy Production Company
3
Felix Energy, LLC
5
Newfield Exploration Mid-Continent, Inc.
14
Payrock Energy, LLC
14
SCOOP Energy Company, LLC
8

The chart deserves a bit more analysis. Chaparral Energy, LLC declared bankruptcy which we have previously written about. SCOOP Energy Company, LLC is affiliated with American Energy Partners. As it was announced here in the Wall Street Journal, that all non-spun off entities will shut down. As SCOOP Energy Company has not been spun off, it is expected to shut down this summer. As an Oklahoma Oil and Gas Mineral Owner, I would not expect Chaparral or SCOOP to drill any wells in the foreseeable future.

Felix Energy was purchased by Devon Energy so Felix can also be struck from the list. Some in the industry say that Devon got out a bit over their skis with the purchase price and it might affect their ability to fully develop the acreage. Cimarex, the plodding tortoise of the group, moves extremely slowly. Their insistence on risk mitigation severely limits the amounts of exploratory drilling they are willing to conduct. It was well detailed in the 2016 company guidance presentation that they will focus on in-fill drilling in their East Cana field.

Newfield Exploration announced that it is closing its Tulsa, Oklahoma office this summer. With its staff mired in the morass of the Houston metro-plex, the company will be less competitive in the Mid-Continent region and will continually find excuses in the future to commit capital to other projects.

With those dominoes down, it appears that Payrock Energy, LLC and Citizen Energy II, LLC will be the development leaders going forward in Canadian County in 2016. Both appear to be accelerating their drilling to take advantage of the publicly traded companies hesitation in committing drilling dollars and other finite resources to the development of Canadian County, Oklahoma.

It's worth it as an Oklahoma Oil and Gas Mineral Rights owner to consider your lessee's plans for development before executing your oil and gas lease.

More to follow,

Berlin

Shut In Royalty Payments

Oklahoma Mineral Rights Owners,

Most oil and gas leases contain what is commonly known as a shut-in royalty clause.  The clause developed over the years to mitigate the harshness of the automatic termination rule.  Under the automatic termination rule, an oil and gas lease will generally terminate any time after expiration of the primary term unless there is a well on the leased premises producing gas “in paying quantities.”  This rule, in a majority of jurisdictions, requires actual production and marketing of natural gas.  Unlike oil, natural gas cannot be produced and then stored or transported in railroad cars or tank trucks – post-production facilities such as pipelines, compressors and dehydrators are generally required to process and deliver the gas to market.  In such circumstances where a gas well has been completed, but no market exists for the gas, the shut-in clause enables a lessee to keep the non-producing lease in force by the payment of the shut-in royalty.  Such payment serves as “constructive production” and avoids application of the automatic termination rule.

A standard shut in royalty is usually a nominal $1.00 per acre per year. If there are no additional provisions to address the shut in, then the operator can hold the lease if he continues to pay the shut in royalty. When negotiating the oil and gas lease, the lessor should ask for a provision such as the following:

"After the end of the primary term, this lease may not be maintained in force solely by reason of the shut in royalty payments, as provided heretofore, for any one shut in period of more than three (3) years, or from time to time, for shorter periods which exceed three (3) cumulative years."

Any questions regarding shut in royalty payments for the Oklahoma Oil and Gas lessor? More to follow.

BR

 

 

Option to Extend Primary Term in Oklahoma Oil and Gas Leases

Oklahoma Mineral Rights Owners,

One of the most common provisions an oil company landman will try to negotiate is an option for the oil company to extend the primary term of the lease. For most oil and gas leases in Oklahoma, the primary term of the lease is three years. The landman will ask for an option to extend the primary term of the lease for two years. This oil and gas lease is sometimes referred to as a 3 + 2 lease.

While a 3 + 2 oil and gas lease is more favorable to the Oklahoma mineral rights owner than a oil and gas lease with a 5 year primary term, it is still worth the mineral owner's time to try to negotiate it out of the oil and gas lease and here's why:

  • If the area turns into the next SCOOP (South Central Oklahoma Oil Province...thanks Harold Hamm...) then the bonus amounts per acre will increase substantially and the Oklahoma mineral rights owner will most likely be locked into a reduced bonus amount that was negotiated several years prior.
  • If the area turns out to be a bust (think Mississippi Lime...) then the oil company would let the option expire and if they were going to re-lease, would negotiate a lower bonus amount. This leaves the Oklahoma mineral rights owner in no better shape than if they didn't have an option.

If a landman won't strike the option, request that the option to extend be priced at 125%-150% of the current lease bonus. Most will hem and haw, but will usually concede that point.

More to follow.

BR

 

Oil and Gas Lease Clauses and Provisions Part 2, The Pugh Clause

The Pugh Clause is named after the Louisiana Barrister Lawrence Pugh in 1947 after the state Supreme Court ruled on Hunter v. Shell Oil Co., 211 La. 893 (1947). In this case, the Court, held that production from a unit with maintain the Oil and Gas Lease in force as to all lands described on the lease even if they are not contiguous.

What does this mean for the mineral owner? It means than if he leases multiple tracts of land on the same oil and gas lease, all lands with be held by the lease even if only one well is producing in paying quantities. As the mineral owner, you should request a Pugh clause from the lessor.

An example of a vertical Pugh Clause:

  • "If at the end of the primary term, a part but not all of the land covered by this lease, on a surface acreage basis, is not included within a unit or units in accordance with the other provisions hereof, this lease shall terminate as to such part, or parts, of the land lying outside such unit or units, unless this lease is perpetuated as to such land outside such unit or units by operations conducted thereon or by the production of oil, gas or other minerals, or by such operations and such production in accordance with the provisions hereof."

With the remarkable advances in engineering with regards to horizontal drilling, many of the wells drilled in the past few years in these areas are indeed horizontal wells. Often times, the lessors are now requesting Pugh clauses to release the deeper geological formations after the expiration of the primary term.

An example of a horizontal Pugh Clause (also known as a depth clause):

  • All rights 100' below the deepest depth drilled shall be released one (1) year following the expiration of the primary term, or upon completion of any drilling or reworking operating conducted thereunder which was commenced during the primary term, whichever occurs last.

Many lessors will want a clause such as " Lessee will release all depths below the stratigraphic equivalent of the deepest producing horizon." This sentence injects ambiguity and uncertainty in the oil and gas lease. While this clause initially seems more restrictive to the lessee, there is current on-going litigation regarding the term "stratigraphic equivalent," and neither party should desire to end up in court.

Interestingly enough, the State of Oklahoma enacted a statutory “Pugh” Clause*, Title 52 O.S. Section 87.1(b), which provides that “in case of a spacing unit of one hundred sixty (160) acres or more, no oil and/or gas leasehold interest outside the spacing unit involved may be held by production from the spacing unit more than ninety (90) days beyond expiration of the primary term of the lease. ”This law became effective May 27, 1977 and may or may not apply in your case depending on the date of your lease. For the Oklahoma mineral owner, this means that he does not have to insert a vertical Pugh clause into his lease, but may still request a horizontal Pugh clause or depth severance.

More to follow.

BR

Oil and Gas Lease Clauses and Provisions Part 1

In our last post, we discussed the basics of the Oil and Gas Lease. Today we will discuss some of the finer points, provisions, and clauses of the lease.

Granting Clause: Usually, the opening paragraph of the lease is the granting clause. It outlines the purposes of the lease and describes the substances that can be explored and produced.

Duration: Both the Primary and Secondary Terms were discussed in yesterday's post and will not be rehashed here. However, there are three important provisions that should be discussed.

  • Shut-in Provision: Allows the lease to remain in effect whenever the production from a well capable of producing in paying quantities is not being sold. The lessee must pay shut-in royalties to the lessor to maintain the lease after the expiration of the primary term.
  • Dry Hole Provision: Will extend both the primary and secondary terms of the lease if oil and gas is not discovered when a well is drilled and certain conditions are met.
  • Cessation of Production: Will extend the secondary term of the lease if certain conditions are met.

Royalty Clause: Again, discussed yesterday.

Surface Damages: Unless stated otherwise, the granting of an oil and gas leases carries the implied right to use as much of the surface as in reasonable necessary for the development of the minerals. This is because the surface estate is subservient to the mineral estate.

Pooling Clause: A provision giving the lessee the right to consolidate the leased premises with adjoining leased tracts in order to meet the requirements for the state mandated size for drilling and spacing units. Pooling, both compulsory and voluntary, will be covered in a post at a later date.

Assignment Clause: A provision permitting the lessor and the lessee to assign their rights under the lease to other parties.

Warranty Clause: A clause requiring lessors to defend their interest in, or title to, the leased premises.

Force Majeure Clause: The clause that protects the lessor from liability and loss of the lease whenever an "Act of God" causes the lessor to suspend operations. These acts can range from a tornado to a terrorist attack to the unavailability of a drilling rig.

More to follow.

BR

The Basics of the Oil and Gas Lease

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