Oil and Gas Leases
Petroleum Evaluations Group's experts review and evaluate oil and gas leases to ensure mineral owners are entering into a reasonable lease agreement.
What is an Oil and Gas Lease?
An oil and gas lease is an agreement between an oil and gas company and a mineral owner. In this agreement, the mineral owner allows a company to explore for, and produce, oil and gas on their land. In exchange, the company covers all the expenses and must pay the mineral owner a percentage of any revenue generated from oil and gas production.
Oil and Gas Lease 101
A mineral lease has four key components: a signing bonus, a royalty rate, a term limit that establishes how long an oil and gas lease lasts, and rentals. Petroleum Evaluation Group helps mineral owners negotiate these four components.
What is an Oil and Gas Lease Signing Bonus?
A signing bonus is a one-time cash bonus payment the mineral owner receives for entering into an oil and gas lease agreement. This is usually offered as a price per acre amount (For example, $5,000/acre). The cash bonus can vary depending on the associated royalty rate. If a mineral owner wants a high royalty rate, they will typically receive a lower signing bonus. If a mineral owner accepts a low royalty rate they usually receive a higher signing bonus.
What are Oil and Gas Royalties?
A royalty rate is the percentage of revenue that a mineral owner receives from the sale of oil and gas. Royalty rates typically are of either 12.5%, 18.75%, 20%, or 25% (also described as 1/8 , 3/16, 1/5, and 1/4). Some lease agreements allow energy companies to deduct processing and transportation costs from royalty payments. This can be extremely disadvantageous to mineral owners and there are numerous cases of mineral owners seeing their royalty payments disappear as a result of poorly negotiated oil and gas royalty deductions.
How Long Do Oil and Gas Leases Last?
An oil and gas lease typically has a primary term and a secondary term. In oil and gas lease contracts the Habendum clause establishes the primary term. A primary term is usually defined in the “habendum clause” and establishes the amount of time a company holds the mineral right lease but is not obligated to start exploring and producing oil and gas. Primary terms are usually either three years or five years. For mineral owners, a shorter primary term is better. If a company fails to start exploring for oil and gas during the primary term, the lease expires. If a company produces oil and gas, then the lease enters the secondary term. A secondary term is active as long as that well is producing commercial quantities of oil and gas. If a well stops producing oil and gas is what is referred to as “paying quantities”, the lease expires.
What are Oil and Gas Rentals and Paid-Up Oil and Gas Leases?
An oil and gas lease agreement will often offer a mineral owner a small amount of money every year until oil and gas royalties start being paid. This is referred to as rentals and is usually a small amount of money, often not more than a few dollars per acre every year. A lot of companies prefer to not deal with the hassle of making these small payments every year and will simply pay all the rentals for the entire primary term of the lease up-front. This is referred to as a paid up oil and gas lease. Most mineral owners benefit more from a paid-up oil and gas lease than receiving rentals every year.
Other Legal Considerations
In addition to these components, there is a lot of legal language that can overwhelm a mineral owner and put them at a disadvantage with an oil and gas company. Petroleum Evaluations Group helps mineral owners review the legal language and key components of oil and gas leases. For example, our geologists can help add a Pugh Clause, which limits the rights of the energy company to specific oil and gas reservoirs and requires knowing the depths at which these reservoirs are buried in the subsurface.
Oil and Gas Leases for Dummies
Mineral owners who have little knowledge of the oil and gas industry are put at a disadvantage when negotiating oil and gas leases with oil companies. We strongly advise hiring a mineral appraiser or mineral broker to help level the playing field during the negotiation process. The cost for these services is minimal and will ensure that you are well protected when leasing your mineral rights.
If you have questions concerning valuation of lease terms, contact Petroleum Evaluations Group.
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