Leases are essential when buying and selling mineral rights. They have been the staple of the industry since the completion of the first well in 1859. An oil and gas lease is a special legally binding document that is governed by peculiar rules and languages.
Oil and gas lease terms have been improving over the years to cater to the needs of mineral owners and mineral investors. The contract permits private companies to exploit minerals and property owners to retain ownership of mineral rights.
In Texas, for instance, the appellate courts have played a significant role in influencing the development of oil and gas leases by elucidating contract terms to fulfill the objectives of both the lessors and lessees. This, in turn, has fostered tremendous development in lease forms. While leases vary from one transaction to another, they share some common terms, which will be discussed later in the article.
If you are qualified accredited investor and have never participated in oil and gas lease negotiations, you must know the process can be overwhelming, but with professional tips as the ones discussed below, you can successfully negotiate your way through this business transaction.
Understand the basic terms
It is important to understand the various clauses stipulated in the oil and gas lease. Also, it is equally imperative to know their functions to ensure a reasonable and fair negotiation process.
Here are the most crucial terms to read in an oil and gas lease:
Oil and gas lease definition
In oil and gas, the term “lease” means the transfer of mineral right from the lessor to the lessee for a given period, and at a fee. The lessee owns the minerals for as long as the contract is in force. The lessor, on the other hand, holds the royalty interest accrued from the transaction.
As an investor, it is essential to know how these clauses function in a conventional oil and gas lease contract. Note a lease features primary and secondary terms. The former represents a fixed period whereas the latter is the term after the fixed period has ended. A standard contract will state, “This agreement shall remain active for a term of two years and for as long as gas, oil, and other minerals are exploited from the leased site.”
The primary term is critical. It is one of the primary subjects that the lessor and the lessee need to discuss. Also, it is not mandatory for the lessor (who is the oil and gas driller) to start operation during the primary term because it does not have any effect on the lease agreement.
According to the lease agreement, the lessor reserves the royalty interest accrued from production.
Royalty interests oil and gas definition
A royalty interest is described as the ownership of a small portion of production revenues or resources as per the lease agreement. The person or company that owns the royalty interest is not liable for drilling and production costs. Thus, the lessor receives the benefit as it is, without any deductions. A royalty interest is calculated as a percentage or fraction, which ranges between 1/8th and 1/4th.
The lessor is entitled to a bonus as consideration for lease execution. However, the bonus amount is not included in the lease but remitted when the lessor signs the contract and delivers it to the lessee. The payment is usually paid as per “net mineral acres” that the lessor owns in the property of interest.
What is a net mineral acre?
Petropedia defines mineral acres as the amount of minerals present in a given piece of land that an extractor is allowed to exploit, as per the terms stipulated in the lease agreement.
How to calculate net mineral acres
To calculate net mineral acres, multiply the number of acres in the leased property by the mineral interests owned by the lessor. For example, if you have a ¼ mineral interest in a land of 80 acres, it means you own 20 net mineral acres: in other words, you own ¼ of 80 acres. Notably, the bonus is calculated in dollars and expressed per net mineral acre. For example, if the lessee pays a bonus of $200 per acre, they should also receive $200 from the offer for each net mineral acre the lessor owns.
Know whom you are transacting with
Once you have read and understood all the basic terms, perform due diligence on your ideal mineral investment company. Google is the best place to start your search. Perform a thorough background check on the firm. This is extremely important if you are not familiar with the company’s profile.
Another place to check for a company’s credibility is on your state’s oil and gas commission site. Here, you will see the company’s history including the number of wells it operates, drilling permits, violation notices (if any), and production operations.
While navigating through the state’s official oil and gas commission site, search for current activities near your property. Look at where producing and licensed wells are located. Also, check the legal description of your land and find the right area to determine what activities are currently going on.
If you live in states such as Texas and Oklahoma, the law allows you to review spacing and pooling orders. You can search each township to see what is happening out there. Alternatively, you can use the clerk and recorder’s site of your county to check for recorded leases, to assess the current royalty rates from the mineral investment.
Hire a skilled and experienced lawyer
Oil and gas leases have different terms and conditions; hence, it is difficult to understand the specific terms of an offer. A credible lawyer will help answer your questions and analyze the lease with your concerns in mind. Often, a lawyer can add a few provisions, which may protect vital property interests, increase bonus payments, and so forth. Your attorney can also raise concerns that you may never have thought about before. An attorney can help protect you from signing an unfavorable contract.
Lease negotiation is a crucial process. A good lease can give you years of financial freedom, while a lousy one may provide you with years of frustration. There is no method of creating a good lease because terms and conditions tend to vary. However, knowing how the process works is the best way to prepare for a successful negotiation.
Lastly, if you are an investor looking for a qualified investment partnership, contact United Exploration for more information, but keep in mind nothing in this article is to be considered tax or investment advice. Please consult with your attorney and tax professional.