What Is Leasing in Oil and Gas?
Leasing in the oil and gas industry in the US is standard. Unlike many other countries, private ownership of minerals below the surface is allowed in the US. So oil and gas companies looking to extract, produce and sell oil and natural gas sign lease agreements with owners.
It’s perhaps the most important document for both parties involved as it lays down all the terms and conditions of the transaction. An oil and gas lease can be a long, complicated document, and finalizing it can involve a lot of negotiation.
If you’re a landowner with mineral rights looking to lease mineral interest to another party, understanding how leasing works in this industry is essential.
Understanding Leasing Oil and Gas
Leasing in the oil and gas industry is a contractual agreement between a landowner (mineral owner) and another party (exploration and production companies or E&P companies) where the former allows the latter to extract minerals from their land in return for royalties from the production.
Lease in the oil and gas industry is a broad term that covers a lease agreement, sublease, license, or another document that gives a party the rights to produce oil, gas, and other hydrocarbons.
The mineral rights owner is the lessor, whereas the party exploring and producing is the lessee.
Usually, companies hire landmen to do surveys and reach out to mineral owners on behalf of the E&P company, offering to lease their land for mineral extraction.
It’s important to know the distinction between selling mineral rights and leasing the land and/or its depth. The mineral owner retains the ownership when leasing the rights to explore and produce minerals from the land.
The lease is contingent upon conditions, the most important being the payment of royalties. Once the lessor enters the lease, they earn a royalty interest, which entitles them to a share of the revenue from the sale of minerals.
The lease may also have to comply with federal and local laws.
Types of Oil and Gas Leases
Lease agreements in the oil and gas industry can vary by the individual circumstances of the mineral owner or the extent of their ownership. Here are the main types of leasing oil and gas industry uses:
Surface Use Lease
Such leases grant E&P companies not only mineral development rights but also the right to use the surface to set up the necessary infrastructure for operations. Companies may need to pave roads, install drilling equipment, lay down pipelines, etc., to produce minerals, for which they need to use the land’s surface.
This is, of course, applicable only in the case of a unified state where the mineral owner also owns the land.
In the case of a split estate, the E&P company would have to sign a surface use agreement separate from a mineral lease with the party that owns the surface. In the US, mineral rights supersede surface rights, so surface owners may not have much choice but to enter into a contract.
In both cases, lessors can specify the area of the surface the lessee can use for necessary development.
This type of lease does not grant rights to use the land’s surface. In such cases, the lessor can specify areas that can be used for infrastructure development and what portions of land are off-limits. They can also ask for compensation for the use of the surface.
This is typically used when the mineral owner does not have surface rights (split estate) or they don’t want to give rights to all the surface use.
Gas Storage Lease
In natural gas exploration, companies sometimes may need to pump gas back into the land to store it for later extraction. This is typically done with depleted wells that can store gas. Companies may do that because of lower demand in the market or while waiting for prices to go up.
While some lessees may want to involve this use as a provision in the original lease agreement, it’s best to have a separate lease for this purpose.
Landowners with depleted gas reserves may also enter a lease agreement for storing natural gas.
Oil and Gas Lease Duration
Oil and gas leases can last anywhere from a year to 10 years. However, the lease duration is divided into primary and secondary.
The primary term typically lasts up to 10 years, depending on the reserves in the land. The secondary term comes after the primary term expires. This term can last till production stops, or, in other words, the minerals deplete.
Lessors have the option not to include a secondary term, so they can lease to the same company or another after the primary term expires.
What to Consider When Leasing to Oil and Gas Companies?
Oil and gas leasing is a complex process that can have many repercussions, both good and bad. That’s why it’s important for mineral owners to discuss and negotiate the terms of the lease with the help of professionals. This way, you can ensure that your interests are protected.
Here are some of the crucial things you should discuss:
- Royalty interest percentage
- Rental payment before/after production
- Lease term
- Surface use limits
- Depth use limits
- Right of First Refusal
- Lease renewal conditions
- Compensation for any damages
- Legal protections
- Pugh clause
A mineral rights lawyer or a specialist in oil and gas royalties can help you understand the lease agreement and negotiate on your behalf. Oil and gas royalties can help you create wealth for yourself and future generations but only if the conditions are right.
Leasing in oil and gas industry allows companies to extract and produce crude oil and natural gas from land owned by citizens or even the government. The lessors leasing their land and minerals earn handsome royalties, typically based on commodity prices.
Even though leasing mineral interest is common in the US, every situation can vary. So it’s best to get into a lease agreement in your best interest.