WHAT HAPPENS AFTER YOU SIGN YOUR OIL & GAS LEASE?

This article discusses what generally happens from oil and gas lease (“Lease”) signing to royalty check arrival. Every situation is different and these steps may happen in a different order than listed below but all occur before the mineral owner (“Owner”) gets a royalty check. This article is based on Texas law but should be similar to the process in other states.

1) Finding a Surface Site

A surface site is required to drill a well. In rural areas, this is easy. But in urban areas, there are fewer surface sites because of prior developments and municipal regulations. Often in urban areas mineral lessees (“Operators”) secure a surface site first and then Lease around it.

2) Conducting a Title Search

Operators frequently take out Leases after only conducting a preliminary title search. This is why many give Owners drafts instead of checks – if title fails, the Operator does not fund the draft. After getting a Lease, the Operator will conduct a thorough title examination and secure a title opinion from an attorney.

3) Pooling Lands

Operators require a certain amount of Leased acreage to drill a well and usually a single tract is too small. To remedy this, Operators “pool” contiguous tracts to form a drilling unit. Owners grant Operators this authority in the Lease which will often limit the pooling power through pugh, depth, anti-dilution, or other clauses. Owners share production based on their respective acreage amounts in the pooled unit. Thus, an Owner with 20 acres Leased in a 100 acre unit with a 20% royalty gets twice as much royalty as an Owner with 10 acres Leased in the same unit with a 20% royalty.

The Operator must file a Unit Declaration or Declaration of Pooling in the County Clerk’s Office and a Certificate of Pooling Authority with the Railroad Commission of Texas.

4) Obtaining Permits

The Operator must apply for a drilling permit from the Railroad Commission of Texas and demonstrate that the well complies with applicable state set-back, density, and other requirements. If the well does not satisfy a requirement, the Operator can apply for an exception permit.

If the well is in a municipality, the Operator will also apply for a drilling permit from the municipality and demonstrate that the well complies with applicable municipal requirements (usually more burdensome than state requirements). Again, if the well does not satisfy a requirement, the Operator can ordinarily apply for an exception permit.

5) Drilling & Completing the Well

Drilling a typical Haynesville Shale well generally takes 30 – 40 days. Actual drilling time depend on the type of well (vertical or horizontal), depth, and complications/problems.

“Completion” consists of perforating the casing and “frac-ing” the well. Perforating the casing allows oil and gas to flow into the production casing and “frac-ing” the well allows gas to flow through the new cracks to the well bore. Completing a well takes another 10 – 15 days assuming no problems.

6) Treating the Gas

Gas must be of a certain quality before it entering the pipeline. The Operator must remove impurities (treating) and water (dehydrating). These processes occur on the well site. Lease language controls whether the Owner’s royalty bears any portion these expenses.

7) Installing Pipelines

Pipelines transport natural gas to market. If a significant pipeline infrastructure already exists, the Operator can fairly quickly connect to the existing larger lines. But if no infrastructure exists, the well will be “shut-in” until pipelines are built which can be years depending on the location and other factors.

8) Obtaining Division Orders

The Operator will obtain a Division Order Title Opinion from an attorney prior to paying royalties. This document identifies who owns what in the respective unit. For example, if an Owner has 10 acres in a 100 acres unit and a 20% royalty, that Owner’s royalty share of the unit’s production is 2%.

Next, the Operator sends Division Orders to all Owners specifying their respective interests in the unit. The Owners check their interest for accuracy and then sign and return the Division Order.

9) Selling the Gas

Once in a marketable condition and in the pipeline, the Operator sells the gas to a gas purchaser.

10) Distributing Royalties

After the Operator completes the above steps, it will distribute royalty proceeds to the Owners according to their interests specified in the Division Oder.

Other Considerations

Often Owners expect Operators to drill right after obtaining a Lease. But more often than not, the Operator will not drill the acreage until near the end of the Lease’s primary term. Why? Because the Operator probably has other Leases whose primary terms’ are about to expire. Those other Leases are the Operator’s priority because if not drilled soon, the Leases will expire and the Operator will lose its investment. If an Owner just signed a Lease with a 3 or 5 year primary term, realize that the Operator probably will not drill a well until the Lease is about to expire.

Eric C. Camp is an attorney with the law firm of Decker, Jones, McMackin, McClane, Hall & Bates, PC in Fort Worth, Texas. He is licensed in Texas and North Dakota and practices exclusively oil and gas law. Contact him at 817-336-2400 or ecamp@deckerjones.com.

Disclaimers and Acknowledgements

This article is not intended as legal advice and should not be relied upon as such. If you need legal advice, seek independent legal counsel.

These comments are the author’s own and not the official or unofficial position of any bar association. The author is an attorney licensed in Texas and North Dakota, not Louisiana.