Choosing which operator to lease with is one of the most difficult choices a mineral owner must make. In plays that are considered hot or active, a single mineral owner can get offers from dozens of companies, each claiming they are offering the best deal. Owners will have different needs and need to balance those needs with offers. We will evaluate some of the top lease clauses and offers to help you make a better decision in choosing your operator. Remember—all terms of a lease are negotiable and you should lead with what you want from the operator.
Lease Term
The length of your lease will be one of the most basic terms. The length of time in which the lease is valid is known as the primary term length. Most leases have a term of 36-72 months. We have seen some leases as long as 120 months, but those owners have supplemented their lease with other provisions as a sweetener. Most operators also include an extension, the right to extend a lease when the primary term expires. Extensions generally are 12-36 months. These extensions are pre-negotiated so that they operator knows the cost to extend the lease if they cannot drill a well within the primary term. Some owners strike out extensions or include a provision that their bonus will be the prevailing rate or a specific dollar amount. Do not overlook this clause; when oil prices are down, extensions are more likely to be enacted and most have very little bonus money tied to them.
Owners should also pay attention to the clause of right of first refusal in your lease term. Many operators hold the right to re-lease your minerals if you get another offer prior to the primary or extension terms expiring. There are companies that top-lease or try to lease from the owner prior to the expiring of the primary term. This is common when an owner is not happy with an operator or feels the new company trying to lease their minerals has a better deal. Ensure that you, as the owner, have the right to receive other offers and that the company you currently lease with will have to meet or exceed the offer as a right of first refusal.
Royalty Rate
Standard royalty rates are 1/8th or 12.5%. Many conventional operators are still able to lease for this rate, but very few owners in active plays lease for under 20% royalty rates. In today’s environment, royalty rates are typically 25%.
Post-Production Charges
Transportation and distribution expenses are also known as post-production charges. Prior to shale, these charges were minimal and in good faith. Since shale, there have been numerous lawsuits based on the exorbitant amount of charges levied to owners. Many owners are not aware that they are charged for the transportation of the oil & gas that is produced from the well on their property. Sometimes these charges can exceed the payment, meaning your check will be zero or negative. Many states have enacted laws that protect owners and enforce a minimum royalty payment, but they very rarely protect owners to eliminate the overcharging of these fees. There are specific clauses you can include in your lease to ensure that these charges are kept to a minimum or eliminated. An owner may have to take a lower royalty rate or longer term to get these clauses within your lease. We would recommend getting this clause in place by extending your term and lowering your royalty rate so that your terms are honored even if the company that leases your minerals sells to another, as some companies will not allow for this provision to be included. It also ensures that you will be paid something, as it is rare that a higher royalty rate would cover the losses from these charges. Consult a lawyer to get your state-specific phrasing to have this clause included.
Pricing
While rarely used, pricing clauses can help protect mineral owners from an operator who has a poor midstream contract. The most common situation we have seen is owners negotiating to be paid the highest monthly sales price within a county or multi-county region. For example, your payor sells oil at a wellhead price of $42.00/bbl and an offset producer sells oil for $42.75/bbl. This clause would provide an extra $0.75 of revenue per barrel sold. Realize that this clause is difficult to enforce due to oil & gas having varying compositions, even offset wells.
Shut-in provision
In a low-price environment, many operators will shut in wells to preserve revenue. It is better to hold oil & gas in the ground then produce it at a loss. If you are an owner being charged post-production fees, you will be thankful for this as those fees will generally be more than the revenue of selling the produced volumes. For many years, operators have used standard language on the fees paid to royalty owners if the wells must be shut in for more than a specified number of days. Always have shut-in provisions within your lease and try to negotiate down the number of days until the clause kicks in. Our recommendation is closer to 15-30 days. You can also try and negotiate the fee paid for shutting in the well. Understand that shutting in a well is generally a last option for an operator; they also lose money when not producing.