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CONSIDERATIONS FOR MINERAL OWNERS

The next several web pages discussing topics often addressed in by the mineral owner and oil company in the mineral lease.

Also see North Dakota Petroleum Council's Royalty Owner Information Center for additional ideas for mineral owners to consider.

The topics on this page include understanding what mineral rights one owns, co-owning mineral rights, why lease mineral rights to a company, the role of a landman in the leasing process, and other introductory thoughts about mineral leasing.

OVERVIEW

The next several pages discuss mineral leasing considerations. A mineral owner may not succeed in incorporating all of the considerations into a mineral lease.  Moreover, each situation is different and a lease should contain those lease provisions that pertain to the mineral owner's unique circumstances. The most important matters are:

1. Do not lease large acreages under the terms of a typical company lease form because one well, even a marginal one, can hold the entire leased premises for the life of production, which could be many decades. Lease in surveyed quarter sections or lease larger acreages subject to a properly drafted “retained acreage” (“continuous development”) clause.
2. Delete the pooling clause and any references to unitization. If a pooling clause is retained, be sure that it is limited to the creation of a normal spacing unit for the drilling of a single well.
3. Maximize both the fraction (percent) of royalty and the calculation of royalty.
4. Insist on gross proceeds of sale but not less than gross market value, and do not permit deductions other than the royalty proportion of production taxes.

The need for and the importance of the various lease provisions outlined in this discussion could change substantially because of constantly improving technology, state and federal legislation, future court decisions, and oil and gas prices. Even so, the information should alert mineral owners and surface owners to various alternatives and promote a more informed discussion with an oil company before any contract or lease is signed.

WHY WOULD A MINERAL OWNER LEASE THE MINERAL RIGHTS?

Now that we know who owns the mineral rights, what am I going to do with them, especially if I do not have the resources or know-how to develop them.  A common practice is to lease the mineral rights to a company that is interested in exploring for and developing minerals.

Why Lease

Subject to certain regulatory requirements, any landowner who owns mineral rights has the right to develop any deposits on his or her land. However, few owners attempt to do this because of the tremendous costs and risks involved in exploration and development. Instead, most landowners lease these rights to companies having the necessary capital and technical know-how for effective exploration and efficient production. As a result, the petroleum industry is based largely on leasing rather than outright ownership of land and mineral resources.

DO NOT OVERLOOK THE NEED TO DO SOME TAX AND ESTATE PLANNING

Landowners may incur some minor risks and inconveniences by leasing their oil and gas rights. However, if oil and gas are found, the disadvantages will likely be small compared to the royalties received. Consequently, the decision is not whether to lease but rather when and to whom.

When to Lease?

With little or no competition for leases, the landowner must decide whether to accept the current offer or hold out until competition creates more favorable terms and higher bonuses. If the initial offer is accepted, the landowner may give up the chance of leasing at a larger bonus and higher royalties in the future. If the landowner decides to hold out for higher returns, she may not get an offer if competition does not develop in the area or if oil and gas prices decline.

Where there is little competition, most landowners are interested in getting exploration started in the area and many of them can be expected to sign leases at the first opportunity if the lease is equitable and meets their needs. Remember that the lease bonus is the only real lease benefit if oil and gas are not found.

To Whom Should Landowners Lease?

If there is competition for leases, landowners may have a chance to choose between two or more prospective companies. Comparing the merits of the prospective companies, the lease rates and bonuses offered, and various provisions of the lease will help decide.

However, there are other factors to consider:

1. Landowners may prefer to lease to a well-financed, well-managed company that has shown the ability to carry out an effective exploration and development program. However, this may be difficult to determine because companies often obtain leases through brokers.
2. If lease provisions are about the same, landowners should try to deal with the broker or company that has leased the most land in the area. Development may be delayed if two or more companies hold inter-mingled leases.
3. If landowners own only part of the oil and gas rights in a tract, they should try to lease to the same broker or company holding the leases from the other mineral owners. This will avoid problems that often arise when two or more companies control fractional interests in the same tract and the company that already holds most leases for a tract will likely offer better terms to secure the remaining rights.

LEASE CONSIDERATIONS

Once signed, an oil and gas lease becomes a binding contract between the landowner and the company. Therefore, landowners should avoid making hasty decisions. They should gather all relevant information and find out what their neighbors have been offered and what they decided to do. Remember that a lease will potentially govern the rights and obligations of both parties for decades. There may be no opportunity to correct negotiating mistakes.

When the decision can no longer be delayed, the landowner should think through the probable outcome of each decision before making a choice. They should also notify the holder of any mortgage against the land before signing the lease. Some mortgages stipulate that income from mineral leases must be used to retire the mortgage debt, but the holders may agree to “subordinate” the mortgage to the lease, thus not requiring the company to remit all lease payments to reduce the mortgage debt.

Most importantly, landowners should not sign a lease without the advice of knowledgeable legal and tax counsel.

Basic points to consider in reviewing/negotiating an offered mineral lease.  This process generally begins with the company offering a lease.  The company negotiator may try to take a firm stance and  discourage the mineral owner from making any counter offer.  Remember, the lease is a contract; it can be negotiated!! Seek legal counsel.

TYPES OF OIL AND GAS LEASE FORMS

This page discusses mineral leases that will be negotiated between a mineral owner and a mineral developer.  There is no standard lease agreement, but the mineral developer will likely offer an agreement to the mineral owner.

The State of North Dakota owns mineral rights and leases them to mineral developers, not much different than an individual would do.  The State also offers a mineral lease for mineral developers to consider – obviously the State, due to its size, has some negotiating power with the mineral developers.  The State’s lease agreement is available as public information, see North Dakota State Land Department’s Mineral Management website:  Sample of Oil and Gas Lease.  This discussion refers to some provisions in the State lease to illustrate specific topics addressed in this discussion.  However, do not assume the State lease will reflect the lease offered by the mineral developer, nor assume that the State lease is appropriate for your situation.  The State lease is being used only as an educational tool in this discussion.

This web site is NOT a substitute for advice from an attorney or other professional knowledgeable about oil and gas matters.  Consult an appropriate professional for answers to questions about the ownership, leasing, and development of mineral rights.

THE ROLE OF THE LANDMAN

When mineral rights are leased, the legal rights and duties of the mineral owners depend in large part upon the terms of the lease. Therefore, extreme care must be taken to insure that the unique needs of a mineral owner are met.

Each company representative (landman) normally uses a pre-drafted agreement which has proven suitable to them in the past. Most of these lease forms are favorable to the company, are characterized by brevity and simplicity, and are meant to cover typical situations. Since the typical lease form is company oriented and since each leasing situation is unique, these pre-drafted agreements are not in the best interest of the mineral owner. Some companies may even use lease forms that are applicable to unique situations in other states but, if applied in North Dakota, could create problems for mineral owners.

Most provisions of a lease are negotiable. Even though the company landman soliciting the lease may contend that the form is not negotiable, the reality is that the mineral owner does not have to sign the lease that is offered. The mineral owner may request specific lease amendments and additions, or even use a different and more mineral owner-oriented lease form. Of course, the mineral owner's ability to negotiate more favorable terms will vary in each situation. In all cases, however, recognize that the landman works for the company and is duty bound to represent the company’s best interests.

IMPLIED COVENANTS

The courts in a number of states have held that an oil and gas lease implicitly obligates the company to do certain things. Significant implied covenants are duties 1) to protect against drainage of oil or gas from the leased premises by wells on adjoined land, 2) to develop the lease after production by drilling additional development wells, 3) to produce and market the product, 4) to conduct further exploration of the leased premises, and 5) to use reasonable care in the conduct of operations. However, North Dakota law is not well established on these implied obligations and the burden of establishing these implied obligations and of proving their breach is likely to rest with the mineral owner. Thus, when negotiating a lease, a mineral owner should not assume the existence of any implied covenants.

Compliance with implied covenants, if existent, is usually determined by a "prudent operator standard," which means that the company must do what a reasonably prudent operator in the same or similar situation would have done to discharge the duty. Legal interpretation of this standard would depend on the facts established in each individual situation, and a mineralowner ordinarily carries the burden of proof.

Not all mineral owners will be able to successfully incorporate all of the following considerations into a lease nor should all of them need to be included in every lease. However, each situation is different, and a lease, to be effective, should contain specific provisions that address the relevant concerns.  If an acceptable lease agreement cannot be negotiated, a mineral owner can simply refuse to execute a lease.

Next Pages

The next several pages discuss common mineral lease clauses.

Mineral Lease -- Introduction and Habendum clause

Mineral Lease -- Granting clause

Mineral Lease -- Royalty clause

Mineral Lease -- Saving clauses

Mineral Lease -- Other clauses and Closing Thoughts

Last Updated August 9, 2010

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