WHAT HAPPENS AFTER YOU SIGN YOUR OIL & GAS LEASE?

I want to welcome Eric Camp as a regular contributor to the GHS blog feature. Eric has been an integral part of the GHS community for some time now. I look forward to hearing from him in this new medium.

Keith "Haynesville"
Site Publisher


WHAT HAPPENS AFTER YOU SIGN YOUR OIL & GAS LEASE?

by Eric Camp

This article discusses what generally happens after signing an oil and gas lease (“Lease”). 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.

1) Finding a Surface Site

Oil and gas companies (“Operators”) require surface sites to drill wells. In rural areas, this is easy. But in urban areas, there are fewer options because of prior developments and municipal regulations. In urban areas, Operators often secure a surface site first and then lease around it.

2) Conducting a Title Search

Operators frequently take out Leases after conducting only a preliminary title search. This is why many Operators 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 frequently limits the pooling power through pugh, depth, anti-dilution, and 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 pooled unit with a 20% royalty gets twice as much royalty as an Owner with 10 acres leased in the same unit with the same 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 Texas Railroad Commission.

4) Obtaining Permits

The Operator must apply for a drilling permit from the Texas Railroad Commission and demonstrate that the proposed 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 must also apply for a drilling permit from the municipality and demonstrate that the proposed 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 Haynesville Shale well usually takes 30 – 40 days. Actual drilling time depends 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 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 of 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.

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 interests for accuracy and then sign and return the Division Orders to the Operator.

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 as 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, the Operator probably will not drill a well until the Lease is about to expire.

Eric C. Camp is an associate in the Fort Worth, Texas law firm of Whitaker, Chalk, Swindle & Sawyer, LLP where he practices oil and gas law (http://www.whitakerchalk.com). He can be reached by phone at (817) 878-0500, by email at ecamp@whitakerchalk.com, or by mail at 301 Commerce Street, Suite 3500, Fort Worth, Texas 76102-4186.

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 or his law firm. The author is an attorney licensed in Texas, not Louisiana.

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Comment by Skip Peel - Independent Landman on March 30, 2009 at 9:21am
Tilly. The member that I depend on for reliable information from Sabine County, TX. is jffree1.
Comment by Tilly on March 30, 2009 at 8:58am
Wow, great information! Thank you so much Eric!
If I live in Alabama and my lease is in Sabine Co. TX, how can I find out it's status?
Comment by Dan Arnold on March 29, 2009 at 3:24pm
There may be some operator that invests millions of dollars in drilling "to hold previously leased acreage", but typicallyy drilling only happens when a legitimate producer believes that they can establish production in enough paying quantity to make it profitible. The only value in holding previously leased acreage is if you plan to drill more wells at some point in the very near future and/or to prevent another company from acquiring that acreage so that another company cannot establish production. That says alot about someone's mindset.
When you consider the hundreds of thousands of acres that get leased, it is fair to say that for the vast majority of Lessors, nothing will happen. Even a major producer can only drill a limited number of wells within the (typical) three year lease period. The amount of time and resources required to get any single well into place and producing is staggering.
Comment by Dan Arnold on March 28, 2009 at 10:42am
Right, but the idea was to explain what happens after the mineral owner signs the lease. I think what the mineral owner wants to know is:
A. How does the E&P decide where to drill, or will they drill on my land? Complicated, with many variables.
B. If they do decide to drill, then when? Outlined above.
C.) What happens next? Outlined above.
C.) If/when they establish production, what happens next? Outlined above.
D.) How long will I have to wait for my Royalty check? Outlined above and subject to State regulations and contractual considerations. IE - months, not years.

For the vast majority of Lessors, NOTHING will happen. The lease will expire or be extended and then a whole new round of leasing MIGHT begin again.
Comment by Dan Arnold on March 27, 2009 at 5:49pm
Jim,
Actually most of it applies to Louisiana. The process is exactly as laid out. There are some variables as he indicated at the beginning (the Texas Railroad Commission is not involved), but otherwise, I'll bet it is pretty much the same way.
So, now you had better point out exactly how "NONE of this applies to Louisiana"
Since
Comment by Wolverine on March 27, 2009 at 9:14am
Thank you Eric!!! Great Post!!!
Comment by intrepid on March 26, 2009 at 11:57pm
Once again, Eric Camp has proved why this site is so valuable. Thank you, Mr. Camp!
Comment by Big Daddy, bcnr on March 25, 2009 at 8:43pm
Great post Eric! This should be titled After the Lease 101. A must read for anyone who is about to or has signed a mineral lease. Thanks.
Comment by Joe Dyer on March 25, 2009 at 2:17am
Very good information to know, Thank You Eric, Joe Dyer
Comment by Skip Peel - Independent Landman on March 24, 2009 at 12:13pm
Eric. I especially appreciate posts from experienced members when they are couched in simple and straight forward layman's terms. Nice job. Thank you.

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