Tips for Successful Negotiation of an Oil and Gas Lease
By Michael J. Hammond
Oil and gas production in Texas has long been an iconic symbol in our State. From
Spindletop to the oilfields of West Texas, perhaps no other image is more frequently
associated with our great State. True to the commitment to explore and produce every
resource available, a new energy has emerged within the past decade to take center stage
in the landscape of Texas energy: natural gas.
Natural gas has long been a resource that was known to exist in the geological shales
that hold the liquid, yet only recently has the technology been perfected to make exploration
and production of liquefied natural gas financially feasible. Through horizontal
drilling and high-pressure fracturing of the rock, natural gas is now one of the fastest
growing resources available. With all of the new gas exploration, with it comes new
opportunities and challenges to advise our clients on how best to address the potential
windfalls and pitfalls that come along with a developing market.
For some mineral owners, entering into an oil and gas lease too early may not be the
best course of action to take, especially when accounting for geographic trends and
potential for actual development. In the case of gas-producing shale, one of the most significant
indicators of how successful a well might be is the thickness of the shale under
any given property. While there are some geological anomalies within an otherwise producing
region (carsts, caverns, fault lines, etc.), generally the shale tends to be thicker
and thinner in certain areas. If a client lives in an area where there has been little to no
natural gas production, it would be wise to obtain seismic data indicating the probability
of drilling a successful well. The risk in failing to do so, of course, is that the owner could
be the “guinea pig” in a thinner area of shale. Of course, if the bonus is high enough and
the area might otherwise never be developed, it might be prudent to at least consider
leasing.
For those mineral owners in stable, proven shale fields, the decision whether or not to
lease is often one that is made in the affirmative rather quickly, and with the potential
benefits, it is not difficult to see why. Counseling a client to lease or not is only the
beginning of the process to secure the best possible deal for your client. Negotiating the
oil and gas lease, and knowing what terms and market rates prevail, is crucial. With that
backdrop, there are several key terms to any oil and gas lease that should be negotiated.
Some of these terms are fairly self explanatory,
some are more publicized,
but they all play in concert to the entirety
of a favorable oil and gas lease.
1. Primary Term
The length of any oil and gas lease is
known as the “primary term,” and is often
anywhere from 2-5 years. Keep in mind
that the lease will be held in effect for as
long after the primary term as there is a
producing well. Because a lot of leases
allow for pooling of various properties to
form a large “pooled unit,” the lease may
be held by production for a very long time
after the end of the primary term.
Pay close attention to any provision
allowing for an automatic extension of the
primary term at the option of the Lessee.
Many of the older leases only required the
oil or gas company to deliver to the
landowner a relatively small amount of
consideration to extend the life of a lease
an additional two or more years. A
growing trend now is to allow for an
extension only if an amount equal
to the original bonus is paid.
2. Granting Clause
The “granting clause” describes the property
being conveyed and the subject of the
oil and gas lease. Pay close attention to this
provision to ensure that the land described
is the land that is both owned and intended
to be leased by your client. This is especially
important if you have a client who
owns multiple tracts of land and is only
entering into oil and gas lease negotiations
for one or some of them.
Also important to note is whether or
not the granting clause contains any mention
of whether or not the property leased,
and subsequently bonus to be paid, contains
any acreage lying within an adjacent
roadway, street, easement or body of
water. This is especially true for urban
areas, where many operators, in an effort
to secure leases in an increasingly competitive
market, are agreeing to pay individual
lot owners for a proportionate amount of
the road in front of their house (whether
or not the actually own it).
3. Bonus
Perhaps no other term of an oil and gas
lease garners as much attention as the
bonus payment. This is the amount that is
being offered to the landowner as an up -
front “bonus” for agreeing to sign the
lease, usually reflective of net mineral
acres being leased. Historically lease
bonuses were not overly significant,
between $15-$50 per acre as recent as five
or ten years ago. This is not the case now,
however, especially in the competitive natural
gas shale regions of the state. Where a
few years ago, a landowner would have
leapt for joy at an offer of $2500 per acre,
now bonuses are exceeding $25,000 per
acre for some urban locations.
How much of a bonus to expect, and
what is a reasonable amount to negotiate
for, will largely depend on the geographical
area in which you are negotiating and
how much leverage you bring to the table.
Obviously, the larger the tract of land, the
more persuasive your arguments are likely
to be, although neighborhood groups and
associations that have the foresight to band together and negotiate collectively have
secured some of the largest bonuses.
4. Royalty
One of the most important terms of any
oil and gas lease is the royalty, that portion
of the revenue (which may be contractually
defined in a number of ways) that will
be paid to the mineral owner by the operator.
Historically, the usual and customary
royalty was 1/8, or 12.5%. Royalties on natural
gas wells now go for double that figure.
Depending again on what the market
will generally support, the royalties are
now anywhere between 20% and 25%.
Much like exorbitant bonuses, some operators
are agreeing to break what was once
thought of as the ceiling of 25% and paying
up to 27% or even 28%, although these
amounts are typically limited to a lessor
with considerable bargaining power in a
very desirable area.
5. Pooling
Of all of the important terms of an oil and
gas lease, perhaps the most important is
the “pooling” provision. This clause, if
added, gives the lessee the ability to pool
the leased property with other land to
develop a “pooled unit.” In Texas, the
Railroad Commission has established that
for a gas well, the maximum amount of
acreage that can be held by any one well is
640 acres, and although many operators
try to present this provision as “standard,”
this is really a misnomer. It certainly does
not require anywhere near 640 acres to
drill a horizontal gas well, and if you represent
a client with any substantial acreage
(anything over 25 acres), you would be
providing a true disservice by not
demanding a lower, more reasonable
pooling clause. The benefit of a smaller
pooled unit, of course, would be the
increase in overall percentage of the unit
any one lessor owns, and thus fewer royalty
owners with whom to share a royalty.
Depending on the seismic data and the
geographic layout of the land, a decent
and efficient natural gas well can be drilled
by pooling less than 200 acres. Some
smaller operators even drill wells with as
few as 80 acres of pooled lands.
Of course, in an urban setting, the ability
to negotiate a smaller pooled unit is
reduced drastically by the availability of
padsite locations, and the general temperament
of most urban landowners that
drilling is great, and to benefit from the
drilling is even better...so long as they
don’t see or hear the rig! Naturally, the farther
away the rig is located from any given
property, the larger the pooled acreage will
have to be to accommodate inclusion of
that property.
The terms discussed are certainly not all
of the important items to review, understand
and negotiate on behalf of clients,
but with an working knowledge of these,
you are much better equipped to advise
your client and to better situate them to
allow the ever-growing oil and natural gas
market to work to their benefit.
MICHAEL J. HAMMOND attended law
school at Texas Wesleyan University School
of Law, where he earned his Juris Doctor in
2004. Mr. Hammond is a general practice
lawyer with an emphasis on real estate and
oil and gas.
|
