Written by Eric Johnson about Drilling and Producing + Leases + Ownership and Transfers + Royalties on January 4, 2011
The first commercial well drilled for oil was the “Drake” well, which was drilled in 1859 in eastern Pennsylvania,. Many years and many wells have passed since that time and, as would be expected, many disputes have arisen concerning the leasing, drilling and operation of oil and gas wells in the United States.
Since I began practicing law in 1983, I have been involved in all manner of such disputes – some of which ended up in court. Some involved claims between landowners (Lessors) and the company who took an oil and gas lease (Lessees). Some involved claims between co-owners of a lease rights. Some involved claims between competing oil and gas companies. Sometimes, I’ve represented an oil and gas company facing a claim by a state regulatory agency or I’ve represented an employee injured while working on a gas well. Oil and gas law encompasses a big universe. Below I’ll set out some of the more common issues and disputes that might arise in the realm of oil and gas.
Oil and Gas Leases
In law school, I had a real estate professor who taught me that owning real estate was like owning a bundle of sticks. As an owner, I was free to take one stick out of the bundle and sell it to someone else. That stick could represent a mortgage given to a bank or an oil and gas lease given to a producing company. Once given, I’d still hold the rest of the sticks, but the stick representing the right to produce oil and gas from my land would be held by a third party.
The oil and gas lease should therefore represent an attempt to balance a producer’s right to economically extract oil or gas with the landowner’s right to exercise the rights held in the remaining bundle of sticks. For example, a farmer should have the right to cultivate as much of his land as possible even though one or more wells may be drilled on the property. A good lease will therefore permit the landowner to have input into the location of any wells, roads or holding tanks and will require that pipelines be laid below plow depth. Alternatively, the oil and gas producer’s rights must be sufficient to allow a decent return upon its investment. Requiring a producer to drill a well on the only swampy ground on the farm is likely overreaching, due to the added costs created by such a condition.
Entering into an oil and gas lease is much like entering into a partnership, where the ultimate goal is the successful extraction of oil and gas and where both producer and landowner share in the income generated therefrom. The landowner contributes his rights to the oil and gas and, to some degree, his right to have unfettered use of his land; the producer contributes its money and expertise to the venture. Any good partnership requires a degree of trust and cooperation on both sides. Landowners need to pick their producer / partners with care. Get some references. Call your state department of natural resources or farm bureau. Ask to be shown some existing wells drilled by the producer. Talk to your neighbors. You could even check with the Clerk of Courts to see if this producer likes to litigate or has been sued before.
Even if you have total faith and trust in a producer, it pays to be smart. You need to negotiate a good oil and gas lease. I believe there are two primary components to oil and gas leases: the money component and the land use component. The money component would include things such as signing bonuses, delay rentals, royalty calculations and spud fees. These are by no means consistent among producers in the same area or in different areas by the same producer. If you have undrilled land in the middle of a known “sweet spot”, I can negotiate a much better money component in your lease that if your land is in an area of poor production.
The land use component of an oil lease is equally important. Any oil lease presented to a landowner was almost certainly drafted by an attorney representing a producer – it’s going to be slanted in a producer’s favor. THERE IS NO SUCH THING AS A “STANDARD” OIL AND GAS LEASE. It’s important for any landowner, particularly one who has never had oil and gas wells located on their property, to be educated as to the procedures involved in drilling and operating wells and the impact this can have upon their subsequent use of the property. By way of example, I’ve seen situations where, long after the lease was signed, former farm land has become a potential shopping center. A good lease will have language permitting the land to be commercially developed without unnecessary interference from the producer, by allowing, for example, existing tanks and pipelines to be moved to allow for construction of new buildings.
Encumbering your valuable land with an oil and gas lease is a significant undertaking. My advice to you – don’t be penny wise and pound foolish. Consult with an attorney experienced in this field prior to signing any lease presented to you.
Oil and Gas Litigation
All litigation is expensive and risky; as a result, litigation should be your last course of action. Oil and gas issues are often very technical and require expert testimony, adding to the cost of the lawsuit. Nonetheless, sometimes folks are just not reasonable and settlement is not possible – a lawsuit is your only choice.
Because oil and gas leasing, financing, drilling and producing is very specialized, any counsel you might choose to represent you should have some experience in this area. If your lawyer doesn’t know the difference between a rutabaga and a roustabout or the difference between a dog house and an out house, he or she is likely going to have some problems handling your case.
There are many areas of litigation that can arise in the field of oil and gas:
- Claims by workers injured on an oil and gas well
- Claims by landowners whose lands were damaged by a producer
- Claims between working interest owners in the well against the party operating the wells for its negligent performance
- Claims by landowners for under payment of landowner royalties
- Claims by a producer against a drilling company for failing to competently drill a well
- Claims by sub-contractors on a well who did not get paid by a producer (can anyone say “mechanic’s lien?”)
I’ve handled all of the above over the years, and many others. If you need help, please let me know.
Oil and Gas Investing and Financing
Although I have an undergraduate degree in economics and finance, I don’t hold myself out as a financial planner. Nevertheless, over the years I have been called upon by clients to review situations where they invested or intended to invest in an oil and gas venture. These investments sometimes take the form of limited partnership or joint venture interests or in the form of stock.
To be blunt, while the vast majority of producers are hard working, honest and intelligent people, there are some shaky operators out there with designs on preying upon inexperienced investors. The best course, obviously, is to have someone with experience take a look at the venture before you put your money down. If you feel you have already been burned, however, give me a call.
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.