Lease and lease agreement are terms frequently used in the real estate world, but these terms also serve an important purpose in the oil and gas industry. As you can guess, an oil and gas lease agreement is similar to a property lease, except there are minerals involved as well in the lease.
A lease agreement is undoubtedly one of the most important documents in the oil and gas industry. It sets out the terms and conditions, which have direct consequences on production, and ultimately, the revenue as well.
So it goes without saying that for any party involved in the leasing of land and mineral rights regarding crude oil or natural gas, it’s important to fully understand what a lease agreement is and how to read it.
Oil and Gas Lease Agreement
The very basic definition of a lease agreement in the context of oil and gas is that it’s a document that outlines the terms and conditions regarding the development of land and extraction of minerals.
This document also states the duration of the lease and what’s included in it. This may include the extent of the surface as well as depth that an extraction/production company can use. Plus, it also sets out the royalties the land and/or mineral owners would receive and how those royalties will be calculated.
A lease agreement for minerals may be incredibly detailed. Typically, land or mineral owners are reached by landmen representing oil and gas companies. They present an oil and gas lease form to the owners, offering royalties in exchange for buying a working interest for the minerals underneath their land.
In other words, if an oil and gas company estimates that there are minerals buried underneath a land, it may want to lease it from the rightful owners for exploration and, ultimately, extraction purposes.
A lease agreement would take place between a lessor and the lessee. The former is the owner leasing some or all the rights to the latter. The lessor receives royalties as payment.
Surface Use vs Mineral Lease Agreement
Lease agreements in the oil and gas industry can be complex, especially in the US. This is because, in the US, oil and gas companies are often dealing with a split estate. What that means is that someone who owns land surface may not own the minerals underneath it.
In many cases, the owners of land and minerals are the same, which essentially makes the company and landman’s job easier.
In the case of the split estate with different owners for land and mineral rights, respectively, an oil company may have to sign a surface use agreement with the landowner and a mineral lease agreement with the mineral rights owner.
Of course, just signing a mineral agreement won’t be enough because to explore, dig, and extract the minerals underneath, the company would need to use some parts of the land.
In the scenario, when both land and depth belong to the same owner, there won’t be a need for different lease agreements. All the terms regarding surface use as well as depth access can be articulated in the same document.
Provisions in Oil and Gas Lease Agreements
As mentioned, oil and gas lease agreements can be long and complicated. There are many provisions to be determined and included in the document.
Ideally, a lease agreement would have terms acceptable to both parties. However, that’s not always the case, and parties negotiate over exact terms.
That all said, there are some important provisions that must be made before signing a mineral lease agreement:
- Development Plan: The lessor should review and approve the development plan of the lessee before any construction work. This ensures that the development plan is in line with the terms of the lease agreement.
- Surface Use: Depending on the ownership, the surface owner should know how much surface the lessee plans to use and what facilities will they be creating on the surface.
- Disposal of Waste: The lessee is responsible for the disposal of all the trash and waste generated through mineral exploration and extraction.
- Insurance: The lessee must have the necessary insurance in place, such as Worker’s Compensation and Commercial General liability. This ensures a long-term protection of the owner’s royalty interest as well.
- Law Compliance: Both lessee and lessor should comply with the laws of the state regarding mineral extraction and land use. The lease agreement should lay down these rules.
- Damage Compensation: This provision protects the rights of the lessor in case of damage to the property before or during the exploration and production activities by the lessee.
This is just a brief list of important provisions that should be made in a lease agreement before any operations begin. There are many other equally important provisions that should be there. This is why it’s important for owners to use an oil and gas attorney or royalty’s company that specializes in these matters.
Importance of Lease Agreements
Like any other legal documents, lease agreements are legally binding for both the lessor and the lessee. It’s incredibly important for both parties to come to an agreement with terms and conditions they both understand, agree to, and plan to comply by.
In case of disagreement later or violation, the result can be a lawsuit that can cost either party a lot of money.
So when it’s time to sign a lease, it’s important for the lessor to have their attorney or any other expert present to evaluate the lease document. This ensures that they get fair compensation for the right they are leasing.
On the other hand, it’s equally important for oil and gas companies to have necessary provisions in the agreement that allow easy access and extraction.
An oil and gas lease agreement is one of the most important documents when leasing land and mineral rights. The duration of the lease can vary, but as long as it’s valid, both parties must legally comply with the conditions as well as any applicable government laws.
For owners, it may make sense to consult with a professional first to ensure that the lease includes their fair compensation in the form of royalties.