Compulsory pooling: How the unleased mineral owner gets paid

Receiving a cost-free royalty and treatment as a working interest owner are some of the benefits that mineral rights owners should understand.

From questions asked during public informational meetings facilitated by Michigan State University Extension, I have learned that the threat of compulsory pooling is not uncommon if the mineral owner is unwilling to sign the standard oil and gas lease. 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. Oil and gas attorneys have stated in public informational meetings that the terms of a compulsory pooling order for the un-leased mineral owner are attractive to some mineral rights owners and should be considered and compared to the standard industry lease.

Those terms are:

  1. 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.
  2. 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.
  3. 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.
  4. You will receive no lease bonus because there will be no lease signed.

If the mineral owner is receiving a 1/8 cost-free royalty, what happens to the other 7/8 of the revenue produced by the oil and gas well? It goes to the oil and gas development company, but not in the same manner as a lease. 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 a well, say 10 percent and receive 10 percent of the company’s share of the income and pay 10 percent of drilling, equipping and operating 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 for drilling, completing, equipping and operating the well. The penalty and drilling costs come out of the 7/8 stream of income the owner would have received as a working interest owner.

After the well is paid for, the mineral owner receives the 1/8 cost-free royalty plus the percentage of the income from their proportionate ownership in the well. For example, if it takes 10 years of cash flow to reimburse the development company to pay for the drilling, development and penalty, in year 11 the mineral owner receives the 1/8 plus their share of the working interest. Because the mineral owner can eventually receive a royalty plus working interest income, if the well is a good producer, 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, but reduced that royalty through deductions from post production costs.

For more information on pooling see “Pooling of Properties for Oil and gas Production” from the Michigan Department of Environmental Quality. Also visit the “oil and gas” webpage on the MSU Extension website.

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