Oil and Gas Protection Leases – A Good Idea?

What’s a Protection Lease?

Suppose there is an issue with the title to minerals under a 100 acre farm and it is clear that either Party A owns those minerals or Party B owns them.  Suppose further that this farm sits in the middle of a planned unit for a horizontal Utica shale well.  What can an oil and gas producer do to fix that situation?  More frequently, producers are using ‘protection’ leases to address this situation.

In the above example, the producer would obtain leases from both Party A and Party B, paying only a nominal amount upon signing of the lease.  A side agreement is also signed where all agree that any production royalties due on the acreage will be escrowed by the producer.  It then becomes necessary for Party A or Party B to file a lawsuit to have a judge determine who owns the minerals.  After such a determination, the escrowed royalties are paid to the prevailing party; also, the prevailing party is entitled to receive a signing bonus.

What are their real consequences?

At first blush, the above arrangement seems practical.  It allows the producer to proceed with a planned well and ultimately compensates the winning mineral claimant by giving him what he would have received if he had clearly owned the minerals in the first place.  Such an arrangement allows the subject land to be placed into a production unit and avoids the producer ‘working around’ the tainted acreage by relocating the planned well.  I recall an earlier case I handled where a horizontal well had been stopped short of a large parcel where the mineral rights were disputed.  Protection leases were executed and this allowed the well to be extended under the subject lands.

What are the downsides?

There are definitely some downsides with protection leases, however.  Frequently, the lessee is allowed to escrow royalties until litigation is commenced and resolved.  Not all mineral owners (or landowners) are in a financial position to initiate such a case.  Moreover, sometimes only a small tract is involved – the attorney fees and title work related to establishing ownership of minerals underlying a small tract could well exceed the amount of royalties that would ultimately be collected.  Remember, once the producer has the protection leases and agreements in hand, it has absolutely no motivation to resolve the issue of who is entitled to the royalties – it can simply escrow them.

What if a well has already been drilled?

Another issue I have seen with protection leases is that sometimes they are requested after a well has already been drilled.  This is significant because the party requested to sign may well have a claim for mineral trespass against the producer.  That is, the producer drilled a well without having obtained a lease from the proper mineral owner.  A mineral owner in that situation would be releasing any rights held concerning the trespass if he executed a protection lease.  For that reason, it would seem that additional compensation is in order.

How do protection leases relate to Ohio’s Dormant Minerals statute?

The above discussion has much interplay with Ohio’s dormant mineral statute.  In the fall of 2016, the Ohio Supreme Court made clear that landowners must follow the new version of the statute to recapture their minerals and that the 1989 version of the statute could not be used for such purpose.

In an earlier article, I wrote that there were many unanswered questions about how the dormant mineral statute operates.  It seems apparent that oil and gas producers, who obtained leases from landowners claiming mineral ownership via the dormant mineral statute, have similar concerns.  This seems particularly true in light of the fact that landowners may not use the 1989 dormant mineral statute to reclaim their minerals.  If such a landowner did not properly follow the process set out under the current statute, they would not own their minerals and the producer would need to get a lease from the family that previously reserved the minerals.

Conclusion

I believe that producers are going back through their files to verify that they did obtain a lease from the proper party.  In situations where they are nervous about that issue, they are tracking down mineral owners, or their heirs, and trying to get protection leases.  Probably best to reach out to competent counsel before signing same.