Written by Eric Johnson about Drilling and Producing + Leases + Ownership and Transfers + Royalties on June 22, 2011
Frequently Asked Questions About Oil and Gas Leasing and Drilling
A. Usually, a long time. Most leases have two terms that affect their duration. The primary term is a fixed period of time (e.g. five years) during which the lessee has to achieve a certain result. If that result is achieved, then the secondary term kicks in, which is of indefinite duration. Most often, a lease will specify that a well must be drilled within the primary term and that once this happens the secondary term commences and continues for so long as there is production from the well. Wells can often produce for decades, so the lease continues in effect for a long time.
A. If drafted properly, a gas lease should have no impact upon the value of your property and may, in fact, enhance the value of your property. On the other hand, I have seen instances where an oil and gas lease had a detrimental effect upon a property’s value. Initially, because so many wells have been drilled in Ohio, title companies, when they find an oil and gas lease on a prospective property, do not normally flag that lease as being a title problem. Instead, a potential purchaser of the property would simply receive notice that the lease existed and it’s up to the purchaser to inquire further. Often, such a purchaser will learn, for example, that a well exists and that the landowner receives free gas for heating from the well along with a monthly royalty check. Assuming the well and related equipment are located in a good (out of the way) location, the purchaser may likely deem the existence of the lease as enhancing the value of the property. I have seen situations, however, where a potential purchaser wants to buy the land for purposes of development (e.g., a shopping center) and an existing lease can sometimes scare away such purchaser, who may be afraid that a well could be drilled in the middle of his new parking lot. A properly drafted lease can address that situation.
A. Most wells in Ohio take somewhere around 7-10 days to drill and drilling goes on 24/7. It’s noisy and muddy. At least an acre of your land (200 feet x 200 feet) is going to be pretty torn up. Trees within that area will need to be removed. A basic road will be put in to allow the equipment to be moved onto the site. Following drilling, the well will later need to be “fracked” where large amounts of water are trucked in and pumped into the producing reservoir to stimulate production. Oil and brine storage tanks will need to be located upon the property, along with a separator unit (these are normally located fairly close to the public road). Pipelines will be installed to remove the gas. Once all of this work is done, the lessee is required by law (and hopefully by terms in the lease) to restore the property. The well itself and the storage tanks typically take up very little space. Following the above process, the lessee will have an employee (the “pumper”) visit the well regularly to make sure it is operating efficiently. Occasionally, after the well is drilled, it may be necessary to bring in a service rig, which is much smaller than a drilling rig, to do work in the well.
A. You certainly have no obligation to do so and, without a lease, no well could ever be drilled upon your property. It is possible, however, that gas could be drained from under your property if you declined to sign a lease. Ohio, and most other oil producing states, have enacted regulations concerning well spacing that are designed to make sure that income produced from a well is fairly distributed to the landowners surrounding the well. For example, any well deeper than 4,000 feet must have at least 40 acres of leased land and must include any land that falls within 500 feet of the well. That rule compels an oil company to go talk to all the landowners that fall within those parameters. If an oil company gets all the leases it needs but one or two, it can apply to the State for a variance to allow it to drill the well anyway. The well could not be drilled upon the hold-out’s property, but it might drain gas from it.
A. Normally, yes you do. The only time you would not is when a prior owner of your land inserted language in a deed that carved out some interest in the minerals. Such a carve-out should be noted in the title report you received when you bought your property. In Ohio, this does not happen frequently. It is more common in some of the bigger oil producing states like Texas or Oklahoma. As the owner of the oil and gas, you have a right to sign a lease with an oil and gas company which conveys to it a right to develop the oil and gas. If a prior owner of your land carved out the mineral rights of land you bought, that prior owner could execute an oil and gas lease involving your property.
A. Yes you can. As explained above, you could carve out the right to receive future royalty payments by having a lawyer include appropriate language in the deed you use to convey the farm to the new owner.
A. If you do nothing, maybe never. I’ve encountered a number of people who assume that once they buy property, royalty checks will automatically begin coming their way – not so. Remember that oil and gas companies often manage hundreds or even thousands of wells and even more leases. They do not monitor the lands under lease to see when they might change hands. They assume that they are sending the royalty check to the rightful owner. Under most leases, a new owner is required to contact the lessee about the change of ownership so that future royalty checks go to the new owner. If the lessee is not notified, it is permitted to keep sending checks to the old owner with no liability to the new owner.
A. The benefits to a landowner flowing from a lease primarily consist of three things. First, the lease may provide the landowner with the right to use a certain amount of free gas from the well for household use. This could easily add up to $2-3,000 each year and this could go on for decades. Second, the lessee is often willing to pay a signing bonus or delay rentals in return for your execution of the lease. These numbers are scattered all over the board and really depend on how “hot” your neighborhood is for oil and gas production and the current market price for oil and gas. Finally, if a well is drilled, you will also be receiving a royalty that is based upon the amount of oil and gas sold from the well – again, all over the board. Information is available to the public in most states concerning production from oil and gas wells. For Ohio production, start here: http://www.dnr.state.oh.us/oil/database/tabid/17730/Default.aspx If there are wells in your area, such information can be used to see how much oil and gas was produced from them which would allow you to estimate what a well on your property might be capable of.
A. Yes, but …….. Initially, you’ll need to obtain a drilling permit from the State. You’ll need to be insured/bonded as an oil and gas producer. You’ll also need to raise some serious money. You’ll also need to find someone with experience in getting a well drilled – it’s much like building a house. You’ll need someone who can act like a general contractor who is responsible for rounding up all of the sub-contractors necessary for drilling a well. Assuming you have the funds and can find someone to do the work for you, it’s nevertheless a pretty risky venture. Wells in Ohio cost hundreds of thousands of dollars to drill and there is no guaranty that you will ever see a return of your investment. By putting your money into a single well, you are putting all of your eggs in one basket. Oil and gas producers typically drill dozens or hundreds of wells in a year and can afford to drill some dry holes. If you want to invest in oil and gas, there are less risky ways to do that than putting a well on your land.
A. Free gas clauses open up a whole host of issues for the landowner. One is – how do I get it. Some leases simply say you have a right to hook up to a well to take a limited amount of gas for free. Some provide that the lessee will run a line to your home at its cost. In either event, you will need to secure a capable contractor who can make the final connections to your home and make sure that the free gas system is properly installed. Remember that we are dealing with some high pressures here coming off the well (hundreds of pounds per square inch) and that pressure needs to be safely regulated down to a pressure for use in your home. There is often fluid mixed with the gas that needs to be separated out so you don’t gunk up your furnace. You need the right equipment to make sure your system is safe and will operate properly – you ought to have that system checked periodically by your contractor. As a land owner, you need to take the initiative to get the free gas to your home – don’t expect the lessee to do it.
A. Most leases mention a specific amount of free gas to be received annually (e.g., two hundred thousand cubic feet – or 200 mcfs). If you exceed that amount, the lease will typically require you to pay for any over-usage – often the rate you are required to pay is the retail rate for gas in your area. In general, most leases provide enough gas to heat a normal sized home. If you are heating your barn or a swimming pool, you are probably going to blow through your allowance. Some lessees are fairly lax in monitoring your free gas usage and you can get away with some over-usage, however, many are more strict and will periodically bill you for extra gas that is used. If you don’t pay that bill, leases often permit the lessee to deduct the amount due from your gas royalty check.
A. Leases are often not real clear on this point. I’ve always taken the position that there is no benefit to the landowner in setting, maintaining or reading a free gas meter, so why should the landowner pay for it? If a meter is set, the lessee will take periodic readings of the meter. A landowner would seemingly have a right to take a look at the free gas meter himself, but chances are you will not be able to make heads or tails of the readings as there is usually a factor that needs to be applied to the meter to know how the reading converts over the cubic feet of gas. Call the lessee and find out what factor they are using so you can determine your gas usage. If you believe the meter is not accurately measuring your gas usage (and this can happen) I think the fair process is to have the meter tested by a third party – if it’s accurate, you pay for the test; if it’s not, the producer pays and adjusts your past usage to reflect the error in the meter.
A. One of the better articles I’ve seen on the Marcellus shale is here: http://geology.com/articles/marcellus-shale.shtml In a nutshell, the Marcellus shale is an enormous resource for natural gas that is located in the Appalachian basin. Until the last 15 years or so, producers, for the most part, ignored shales, even though it was know that they held natural gas. The problem is that shales are tight and gas does not easily move through them. Shale production really took off in the 1980s when Mitchell Energy figured out how to produce from the Barnett shale in Texas. Essentially, the technique was to drill the wells horizontally through the shale and then use massive amounts of fluid at high pressures to fracture the formation, allowing the gas to travel through the shale into the well bore. Since then, other shale plays have been discovered in the U.S., with the Marcellus being the most recent and largest find. During 2006-2008, an enormous amount of land was leased in Pennsylvania, New York, West Virginia, and Ohio for shale gas. Some of my clients received very hefty lease signing bonuses during that period. The initial wells that have been drilled, while very expensive, look promising. The crash in oil and gas prices in 2008 has put a damper on additional leasing and drilling for the Marcellus.
About Eric Johnson
ERIC C. JOHNSON attended Ohio State University, earning a degree in economics and then graduated from the University of Cincinnati Law School in 1983. His areas of practice are personal injury law, real estate, oil and gas, contracts, litigation and appeals.