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Permalink Reply by Dion Warr, CPL on January 3, 2009 at 20:34

Bruce:

You are correct in your assessment of "paying quantities" being pretty nebulous from the l/o - m/o perspective. Some of this ground has been covered on several other previous threads, so you might want to check the discussions on these as well.

Probably the most straightforward way of addressing this issue is to utilize a minimum royalty clause, which may look something like this:

"Notwithstanding anything to the contrary in the printed form of this lease or elsewhere in this Exhibit 'A', it is expressly understood that once production has been established under the terms of this lease, either on the leased premises or on lands pooled therewith, the royalties paid under the terms of this lease must constitute a real and adequate consideration in maintaining this lease. Irrespective of the proportional payment of royalties due Lessor under the terms and provisions in this lease, Lessor shall be paid no less than one hundred dollars ($100.00) per net mineral acre per month as a minimum royalty in order to maintain this lease in full force and effect..."

To appease the lessee as to their pouring money down your bottomless pocket, lessee generally would like to see something like this in conjunction with the above passage:

"Lessee shall have the right to recoup the payment of royalties in excess of lessor's proportional share of royalties ordinarily due as defined elsewhere in this lease, as paid according to the minimum royalty provisions in this article, from any future royalty payments due to lessor, as long as the payment of royalty in any month after production has been established shall not be less than the minimum royalty stipulated in this article."

The addition of the above would allow the lessee to treat minimum royalty over and above the usual calculated royalty payment as an advance on future royalty, such that if you were paid $100 in a month in which you otherwise be entitled $10, and the next month your royalty payment would be $200, in essence you would be paid $100 for the first month, and $110 the following month (as you were "advanced" $90 the month before, which lessee would recoup out of the $200 (which would be $100 above the minimum, more than enough to pull the extra $90 from).

Of course, if you do not feel that generous...

Do not feel obligated to stick to $100 per acre as a minimum royalty payment. Just realize that too high of a mimimum royalty payment would likely be rejected by lessee.

Hope this helps.

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Permalink Reply by Dion Warr, CPL on January 5, 2009 at 2:28

KB, Bruce:

Yes, I like your (KB's) suggestion and the elements of your clause suggested here. I would graft the suggested language in this to the clause in between the first and second sentences.

Bruce, the idea of furthering the contract definition of 'paying quantities' in some definite manner (to your benefit) is particularly salient considering that if the lessor does not address the issue at the point of negotiation, standard and prevailing industry practice (as well as the reasonable and prudent operator test) becomes the definition or standard, subject to judicial review on a case-by-case basis. Currently, the Mineral Code (Art. 125) makes it a point to disassociate the expectation of royalty payments to be of a similar (or comparable) amount to the bonus payment or rental payment as a means of measure.

Particular to this issue, but general to the discussion of oil and gas leasing, one must consider this: if the contracting parties fail to particularly address a certain issue in specific terms, the above (underlined) standard is used to measure what is consider whether the lessee is operating in good faith or not. The Mineral Code is intentionally written to leave some "wiggle room" in order to be and remain applicable in a myriad of situations and circumstances; that being said, it is up to the lessor to ensure that their reasonable expectations are addressed on a case-by-case basis. What one would expect from a Hosston well completion in your area may be quite different from what one would expect from a HA completion.

The implementation of a minimum royalty payment may very well be part of a strategy used by the lessor to economically dictate the type of HA completion to be used in just such a manner. At an expectable range (say, $10/mcf), a HA well (unitized on a section basis) would economically have to meet a threshold of approximately 10 mcf/ac/mo. net payable royalty to meet the minimum payment required under the terms of the lease. This translates to approximately a net payable of 215 mcf per day (10mcf/ac./mo X 640 ac. = 6400 mcf/mo. = ±215 mcf/d), a production level which a singular vertical HA wellbore will not hold very long (as cited elsewhere by Jay (Shalegeo), single vertical HA completions at initial flowrates of 500 mcfd is what is being used to hold leases HBP in other sections by Camterra and others). As postulated by others on this site (see discussions of decline curves), at T+5 yrs., a hypothetical single HA horizontal completion initially completed at 10mmcf/d would be expected to be producing at a 673 mcf/d. Subtracting about 12% for severance and 'reasonable' uplift charges, this would leave a net payable of approximately 600 mcfd, translating to an approximate minimum royalty payment of, say, $250/ac./month (dependent on current gas price (spot or gas contract). This level of payment would be easily sustainable with timely development plan based upon horizontal completions, but hard to sustain on a vertical completion program, unless HA production is combined with other strata (such as HOSS/CV/LCV sands) which strata could be excluded from the lease if lessee were willing to accept such an arrangement.

Keep in mind, the minimum royalty provision contemplated above would not 'kick in' until a well is brought in on the lease (or on lands pooled therewith), so a lessee's posturing of an unreasonable ongoing payment structure is at least partially negated by that fact. One could reply that same is not unreasonable in the HA zone if one utilizes horizontal completion techniques with multistage fracing and is particular mindful of steady and timely development of the resources.

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Permalink Reply by Bruce on January 4, 2009 at 11:28

Thanks Dion, I really appreciate your valuable input on this and KB would you mind further explaining your idea of paying quantities in terms of serious consideration? I freely admit I'm lost and would like it if you could clarify what you mean. Thanks.

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Permalink Reply by Bruce on January 4, 2009 at 13:54

Thanks KB for your help. If anybody has a clause like KB is talking about, please share it. Thanks for all of your help!

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Permalink Reply by Bruce on January 4, 2009 at 16:42

Thanks KB for adding this! Do you know if there has been any court case or mineral board rulings on what constitutes, "a serious or adequate consideration to the Lessor to maintain this lease in effect." What would keep the gas company from saying 10 dollars a month? What recourse would a mineral owner have? Thanks in advance for everyone's help.

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Permalink Reply by Bruce on January 4, 2009 at 16:54

Thanks KB for your response, I will certainly include this with the other ideas you have given us into any negotiations to lease my property. Once again thanks for all of your advice.

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