Compulsory pooling: How the unleased mineral owner gets paid
A compulsory pooling order from the Supervisor of Wells is not a lease. It is a mandate that certain acreage owned by an unleased mineral owner must become part of a drilling unit permit.
The June 2012 issue of the Landowner Oil and Gas Newsletter discussed compulsory pooling in the article Compulsory Pooling and the Landowner Not Willing to Lease.
This article discusses how the landowner is paid and how payment is determined. Compulsory pooling does not happen often because it is an expensive process for the oil and gas development and production company to ask for. They would much prefer a signed lease and a win-win lease agreement can be better for the landowner. The threat of compulsory pooling is not uncommon if the mineral owner is unwilling to sign the initial lease (standard lease) offered by the company. Statements made by the company representative give some the impression that if they do not sign the lease offered, they will be forced to lease anyway by the state and it will be years before a royalty is earned. They feel they have no choice, so they give up and sign the standard lease. Numerous oil and gas attorneys who represent landowners believe the basic terms of a compulsory pooling order for the un-leased mineral owner that chooses to be carried by the company are preferable to the standard lease. Those terms are:
- It will deal with only the well in question. Only the acreage you own necessary for the drilling permit for that well will be pooled, not the entire acreage you own
- According to the Order of the Supervisor of Wells, “The nonparticipating owner of an un-leased mineral interest shall be considered to be subject to a 1/8 royalty interest which shall be free of any withholding for payment of any costs of drilling, completing, equipping, or operating costs, including postproduction costs”.
- It will be a non-development order. It will not establish any right for the operator to operate on your surface lands to place a well site, tanks, roads, etc.
- You will receive no lease bonus because there will be no lease signed.
If the landowner owns 8/8 of the mineral rights, what happens to the other 7/8? It goes to the oil and gas company, but not as it would if there were a lease, because there is no lease, it is an order from the Supervisor of Wells. The un-leased landowner is treated like a working interest owner. “Working interest” is a very important concept. A working interest owner is a partial owner of the well. Investors can buy an interest in the well, say 10 percent and receive 10 percent of the company’s share of the income and pay 10 percent of the drilling, equipping and operating of the well.
Under compulsory pooling, because the company is paying all of the costs to drill and develop the well, and they have the risk of a dry hole, the mineral owner is assessed a penalty, usually at least 200 percent of the costs of drilling, completing, equipping and the operating costs to drill and develop the well, in addition to the actual costs. The penalty and drilling costs come out of the 7/8 stream of income the owner would have gotten as a working interest owner. After the well is paid for, the mineral owner continues to receive the 1/8 cost free royalty, plus their percentage of the income and expense based on their ownership in the well. For example, if it takes 10 years of cash flow to reimburse the development company and pay for the drilling, development and penalty, in year 11 the mineral owner continues to receive the 1/8 plus their share of the working interest. Because the mineral owner can eventually receive a royalty plus the working interest income, if the well is a good producer and long lasting, it is likely that a compulsory pooled mineral owner over the lifetime of the well could earn significantly more than signing the standard lease that offered a 1/8 royalty based on net income and its associated deductions for post-production costs.