What should I know before signing an oil and gas lease?

Shale-related development is bringing Ohio more than $12 billion in economic development projects, according to a recent report cited in Columbus Business First—and that’s just the tip of the iceberg. None of this development would be possible if landowners were not leasing their oil and gas mineral rights. The oil and gas lease defines the rights of the landowners and the oil and gas company. Here are some issues landowners and developers alike should keep in mind regarding oil and gas leasing issues.

Question: Do I automatically own the rights to oil and gas that may exist beneath my property?

Answer: No; it is possible for you to own the surface of a piece of land without owning the mineral rights underneath it. That’s because the mineral rights can be severed from the surface rights. Usually, this happens when the property owner sells the surface rights to someone else, but keeps (or “reserves”) some or all of the mineral rights. This is called a mineral rights reservation.

Q: How do I know who owns the rights to oil and gas under my property?

A: The best way to figure out who owns what interests in the land is to have a reputable, experienced mineral rights title abstractor conduct a search of the public records in the county where the land is located.

Q: What does an oil and gas lease actually do, and how would I, the landowner, get paid?

A: An oil and gas lease gives a developer (the “lessee”) the legal right to develop oil and gas from your property. In return, you likely would receive a per-acre “bonus payment” and, if a well is drilled, a royalty payment based on a percentage of the oil and gas sold.

Q: What issues can come up when negotiating the granting clause?

A:  The granting clause contains important language setting out the parties’ rights under an oil and gas lease. Common issues include whether: the lease includes all minerals underlying the property, or just oil and gas; roads, driveways, fences, and pipelines can be constructed on the property; Class II underground injection control wells can be located on the property; the developer can use water, oil, or gas from the property free of charge; all geologic formations are being leased; and the developer can store gas under the property.

Q: What issues can come up when negotiating the term of the gas and oil lease?

A: The habendum clause in an oil and gas lease establishes the duration of the lease. The habendum clause includes two terms: the primary term and the secondary term.  The primary term generally lasts for a fixed amount of time—commonly, five years—and establishes the oil and gas company’s deadline for drilling a well on the property (or including the property in a drilling unit). In addition to negotiating the length of the primary term, one must consider whether to include an extension or renewal option and the amount of any payment associated with the extension or renewal payment. The secondary term is triggered by oil and gas drilling on the leased property. In the vast majority of oil and gas leases, the secondary term will continue as long as oil or gas “is produced in paying quantities” or operations are conducted on the leased property. Defining the terms “operations,”  “production,” and “production in paying quantities” can be very important.

Q: I’ve heard a lot about lawsuits over calculation of royalty payments. How can I avoid that?

A: Leases typically provide that a landowner will receive a continuing royalty payment based on a percentage of the oil and gas sold. Although royalty disputes may be difficult to avoid, defining the types of post-production costs and expenses that can be deducted prior to paying royalties could minimize the risk. In addition, a landowner should consider adding an audit provision that allows for annual audits of production and royalty records.

This “Law You Can Use” column was provided by the Ohio State Bar Association. It was prepared by attorney Dan Gerken, a litigation associate at Bricker & Eckler LLP in Columbus, and member of the firm’s Shale Task Force. This article offers broad, general information about the law. It is not legal advice. Seek an attorney’s advice before applying this information to a specific legal issue.

© 2014 Metro Monthly. All rights reserved.

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