Paid Up Oil and Gas Lease
Oil and gas lease agreements are typically quite long and complex. There are many terms and clauses that not everybody may be familiar with. Then there are different types of leases in the oil and gas industry, mainly dependent on the lease terms.
A paid up oil and gas lease is not different from any other lease on mineral rights. However, there is one major distinction, so it is called paid up. This post will cover everything you need to know about this kind of lease agreement.
What is Paid Up Oil and Gas Lease?
A paid up lease in the oil and gas industry is where the lessor receives the delayed rental income in advance for the primary term. In simpler words, the oil or gas company pays the mineral owner an advance on the lease upfront before the royalties from production kick in.
You can think of it as a bonus, but the bonus on the lease is different, which is also paid upfront when the lessor signs the lease.
The main purpose of this one-time advance payment is to cover the rent for the leased land for the primary term. Now, what is a primary term?
The primary term is when the oil and gas lease is in effect, but production has not begun. This is the time when the oil and gas company is digging and constructing the well to produce. Since this term can be months long, the land and/or mineral owners who are leasing the property are entitled to rent for that period, which the company pays upfront.
There are provisions in lease agreements that can extend the primary term past the initial period specified in the lease, in which case, the royalties from production may not start further on.
Advantages of Paid Up Lease
The advantages of signing a paid up lease agreement are different for different parties.
Oil and gas companies usually use paid-up leases to incentive mineral owners to sign the lease. Because they are getting rent for many months in advance, which sums into a big amount, they are more likely to agree to the lease.
For mineral owners, the advantage is similar as they get a lump sum amount upfront, often with bonus considerations, as soon as they sign the lease. This gives them money they can invest or use for months before royalties also kick in.
Another benefit is that sometimes oil and gas companies don’t begin exploration or construction till late, and ,the lease may expire by that time. With a paid up lease agreement, the mineral owner walks away with some cash, even if they don’t receive any royalties because there was no production.
Like many other things in the oil and gas industry, a paid up lease can have drawbacks. For mineral owners, a paid up oil and gas lease that is too good to be true is perhaps too good in reality.
While they may get a handsome amount upfront, they might not get any more money until the production starts. And if the production is delayed, they might not be compensated for the extra time it takes for production to begin unless specified in the lease terms that the lessor would receive rent should the primary term exceed the initially stated timeframe.
This is why mineral owners must consult with an expert when signing any lease with an oil and gas company, including a paid up lease agreement. That way, they can ensure that they don’t embroil themselves in unfavorable terms.
How is Paid Up Lease Payment Calculated?
The specific terms for the paid up lease and the payment the lessor receives may vary case by case.
Typically, the payment the lessor gets upfront at the beginning of the lease is for the whole term of the lease. And it is dependent on the area or depth (size) of the land because it is essentially the rent for using that land, not minerals (for minerals, you will get royalties). So therefore, it is calculated based on the acreage of land.
Lessors can also negotiate shut-in royalties in the lease and the advance payment. These royalties will ensure they receive money even if production has not begun by the stipulated time.
It’s important to consult with a third party, especially an expert in oil and gas royalties, to ensure you’re getting fair remuneration for the land usage in the primary term. Also, ensure that you understand the terms carefully.
Certain clauses are often not illegal, but they are not favorable for the lessor. For instance, most commonly, the lease may extend for continuing operations without payment because the lease says so. This can be disadvantageous to the mineral owner, as they won’t get money for this period.
Paid up oil and gas lease is very popular now because it mostly works in favor of both parties. However, it’s not that difficult to get duped by complex terms and clauses in the lease. Therefore, make sure that you understand the lease terms fully as a lessor and mineral rights owner.
Getting paid upfront the rent for the lease’s primary term is a good idea. However, make sure that there are provisions in the lease to ensure payments continue if the primary term exceeds the initial period.
In many cases, royalties will begin by the end of the primary term if the oil and gas company successfully starts production from the well.