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Permalink Reply by Dion Warr, CPL on August 22, 2008 at 15:15

Father:

Joining in with KB's suggestion: a specified drilling commitment would suffice, preferably with a liquidated damages provision tied to any failure of specific performance.

A different angle would be to make the payment of a minimum royalty a covenant of the lease. Limit the shut-in clause such that the operator can simply maintain the lease by payment of shut-ins for more than a specified period of time (say, two years). Also, increase the per acre rate for the shut-in payment (plenty of folks are signing or have signed leases in which their rights can be held under the shut-in provisions for a few dollars per acre).

Although not used as often in N LA, the use of a rental lease form would ramp up pressure to drill earlier in the primary term. You could even specify an increase in rental payment (and/or royalty) in later years of the primary term to incentivize the operator to get moving.

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Permalink Reply by Snake Stewart on August 22, 2008 at 17:48

Where did you get the emoticans Shalelover ? I need somthing like that so people will be able to see when I am seathing or sneezing. It is difficult to get one true intent sometimes.

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Permalink Reply by Dion Warr, CPL on August 23, 2008 at 19:18

Geez, KB, you're overstepping your bounds. (;-D)

Actually Shalelover, I like KB's advice. I would tend to be a little more lenient on the shut-in (2 years), b/c I would believe that if the drilling and production goes swimmingly, it would behoove the landowner to give pipeline infrastructure builders a little time to bolster capacity.

Many companies have stepped away from using rental leases due to the increased lease maintenance issues associated with annual rentals, but frankly, a 3-year PT + option contract with multiple clauses requiring payments has just about as many headaches for the O&G company as a rental lease.

A rental lease basically says that for your bonus payment, XYZ Oil Co. has a lease which will expire in one year (although this can be bent according to how the blanks are completed), unless on or before the expiration date XYZ commences operations to drill a well or pays a rental. The rental must be paid on or before the initial expiration date. Not paying a timely rental is fatal to the lease. Other than that, the lease agreement largely functions in the same manner.

As a matter of practice, the rental payment is usually at least 50% of the bonus payment and no more than 100% of the bonus payment. So, if you wanted to create a rental lease with a similar payout amount to a paid-up lease, you could set up a payout structure like this:

Ex. $20K/ac. 3 yr. pd. up w/option to extend 2 yr. at initial bonus

Rental lease:
Bonus: $10K/ac., Rental $5K/ac., Option to extend annually at $10K/ac./yr. OR specific clause in lease stating rentals to increase to $10K

Payout structure is a matter of preference. Some l/o's prefer the rental lease for income tax purposes by having payments spread out over time rather than having a single lump sum bonus catapult their income into the stratosphere.

Some folks even like to tie their shut-in payments or Pugh rental payments to the rental payment (since it is a convenient per acre figure already specified in the lease). Also, in many paid-up lease forms, the shut-in is made in the form of a royalty payment (which is an obligation, and generally a late payment of a royalty is NOT fatal to the lease), and reclassifying the shut-in payment as a rental payment (thus making the shut-in a lease covenant, in that if XYZ misses the payment, the lease expires) is to the Lessor's advantage. Of course, if a well is being drilled or reworked around or on the anniversary date, Lessee does not have to pay a rental.

Some of the comparisons and discussion of rental lease vs. paid-up lease gets a little deep (going from the technical to the philosophical), and could get to running a little long. Ask me any specific questions, and I will tell you no lies.

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Permalink Reply by ETOilman on August 24, 2008 at 6:02

I've seen a few peaks and valleys myself Jim. I hope that this one doesn't "pop" like the early 80's.

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