What do landowners need to look for in an oil and gas lease? Part 3

Keywords: Expiration of Primary Term, Royalty and Negotiations, are covered in this article.

Landowners who have never dealt with leasing their mineral rights for oil and gas production, upon reading a lease, may find that they have difficulty understanding the lease language in layman’s terms. Are there key words or phrases that someone should be aware of? This article will discuss language from leases utilized by the oil and gas industry that are offered to landowners. When the word “company” is stated, it is referring to the oil and gas company that is interested in leasing a landowner’s mineral rights.

Expiration of the Primary Term

“…This lease shall remain in force for a primary term of three years …and in no event shall this lease terminate unless production of oil and or gas has permanently ceased.” This means that even though you are not being paid a royalty, if the well on your land or on land that is pooled or unitized with your land is capable of producing any oil or gas, even if it is not enough to market profitably, the primary term of the lease will continue. Landowners may assume that when the lease states a primary term of three years that if there is no well present or a royalty being paid that the lease will terminate. Pooling language can be written so that the lease continues even though the landowner is receiving no royalties.

Royalty

“Company shall sell the oil and gas and pay Lessor 3/16 of the net amount… minus post-production costs incurred by company…to realize the market value.” In Michigan, rule 324.61503b of the Michigan Oil and Gas Regulations forbids the oil and gas company from deducting post-production costs unless they are agreed to in a lease. Post production costs can significantly reduce the royalties paid to a landowner because these deductions are calculated by and charged by the company. It is not uncommon to see several paragraphs in the lease that discuss the list of possible deductions including “any and all other costs and expenses of any kind or nature… between the well head and the point of sale.” Alternatively, the landowner can require that the company pay to the landowner the agreed upon royalty percentage based on gross proceeds at the well head, free of any expenses, with the exception of severance taxes.

Negotiations

Before any exploration can begin, the landowner and the oil company must agree to the terms regarding the rights, privileges and obligations of the respective parties throughout the exploration and production stages. Negotiation of these terms may be a landowner’s first exposure to an oil and gas lease. Because of the complex legal nature of the leasing process, novice landowners may be at a disadvantage when dealing with an experienced land man or oil company. An oil and gas lease is both a contract and a conveyance of an interest in land. When you sign an oil and gas lease, you have essentially sold a part of your property. Obtaining a good lease is a negotiation, with the goal that it be a win-win situation for both parties. To obtain a good lease it may take a long time, because leases can last a long time.

Negotiation of an equitable lease requires the assistance of an experienced oil and gas attorney or oil and gas leasing consultant. It is not advisable to sign a lease if your understanding of the provisions is not clear.

For more information regarding oil and gas leasing you can contact Curtis Talley Jr. at 231-873-2129. Michigan State University Extension also has an oil and gas website that has additional information to assist landowners in understanding and negotiating oil and gas leases and the oil and gas industry in general.

This article is one part of a three article series regarding oil and gas leases. You can learn more about geophysical testing, useful or convenient easement and mother hubbard clause by visiting What do landowners need to look for in an oil and gas lease? Part 1 or about disposition of brine or other chemicals, construction of support facilities and pooling by visiting What do landowners need to look for in an oil and gas lease? Part 2.

Related Articles