Landowner Royalty Calculations

One of the questions we've been getting a lot of recently is: "how are my oil and gas royalties calculated?"  There are actually a few different ways to answer this question.  The first angle has to do with how a royalty is calculated as part of a drilling unit.  Let's say that you own 50 acres in a 100 acre drilling unit.  Your lease probably says you are to earn 1/8 (or 12.5%) of all oil and gas produced from the premises.  The premises in this instance is the 100 acre drilling unit, of which you only own 1/2 (50 acres = 1/2 of 100 acres).  Therefore, the entire drilling unit will earn 1/8 as a royalty.  Because your land is about 1/2 of that 100 acre drilling unit, your royalty would be 1/2 of the 1/8 the entire drilling unit receives.  In other words, a 50 acre landowner in a 100 acre drilling unit receives a 1/16 royalty.Another way to answer the question of "how are my royalties calculated" has to do with other language in the lease allowing the energy company to deduct various costs.  Typically, the landowner royalty is calculated as (using the above example) 1/8 of the value of whatever comes out of the well.  Older leases might have had some language allowing the energy company to deduct transportation costs, but that language wasn't very common.  That is because older, shallower wells didn't always need to be treated before it could be put to use.  The wells currently being drilled in the Utica play are much deeper, and what comes out of these wells isn't immediately useful: the gasses and liquids need to be send to a treatment plant.  In many cases, energy companies have passed this cost on to the landowner in the form of deductions in the underlying lease.  Well-written leases provide for "gross royalty" payments.  This allows landowners to escape costs that are associated with "net royalty" payments.A further complication to "net royalty" language has to do with how companies account for these various deductions.  Much has been written about energy companies that sneakily deduct landowner royalty payments in the form of gathering costs, compression costs, transportation costs, and processing fees.  Other times, energy companies can simply sell the oil and gas to one of its own subsidiaries at a low cost.  This effectively lowers the price at which the landowner's royalty is calculated while also allowing the subsidiary to later sell it to another entity at a higher price.  The methods by which they accomplish this aren't always readily apparent to landowners, and even savvy accountants.The good news is that there has been some reporting on such practices, indicating that the public is generally aware of them.  Nevertheless, it is a good idea to keep records of whatever statements you might receive as a landowner.  Learn what the information on these statements means, and do not hesitate to call the energy company to ask questions.  Some landowners may have a term in their lease allowing them to audit the energy companies books, effectively allowing the landowner an opportunity to see just how their royalties are being calculated.Thankfully, we have yet to see this happen to our clients.  Even so, if you believe your royalty is being calculated inappropriately, get in touch with the energy company, study the statements you have been sent, and if you still have questions, please don't hesitate to contact us.

Mortgage Subordinations

Lately we have spoken with a number of clients about mortgage subordination.  Drillers typically ask the landowner's bank to subordinate their interest in the land (the mortgage) to the driller's interest (the oil and gas lease).  The driller, of course, was concerned that they would lose their interest in the land if the bank foreclosed on the property.  If the bank's interest was subordinated to the driller's, however, the driller would retain their interest even in the event of foreclosure.  In the past, banks granted subordinations without hesitation.  Lately, however, banks are approaching mortgage subordinations much more carefully.  The general concern involves the enormous amounts of money involved in recent Utica shale drilling.  Larger banks sometimes have a policy against granting subordinations.  Smaller, regional banks, on the other hand often approach subordinations on a case by case basis.  Other banks sometimes will charge a fee for giving consideration to a subordination.  All banks, regardless of size, need to assure themselves of how an oil and gas lease for Utica shale affects the value of the landowner's property.  A lot of times the answer to this question can't be so easily ascertained.  However, our firm is well-positioned to provide valuations for Utica shale rights, and can help.From our standpoint, much of the refusal to grant mortgage subordinations is confusing because Ohio has a law that expressly protects oil and gas leases in the event of foreclosure.  ORC 1509.31(d) states that:

"If a mortgaged property that is being foreclosed is subject to an oil or gas lease, pipeline agreement, or other instrument related to the production or sale of oil or natural gas and the lease, agreement, or other instrument was recorded subsequent to the mortgage, and if the lease, agreement, or other instrument is not in default, the oil or gas lease, pipeline agreement, or other instrument, as applicable, has priority over all other liens, claims, or encumbrances on the property so that the oil or gas lease, pipeline agreement, or other instrument is not terminated or extinguished upon the foreclosure sale of the mortgaged property. If the owner of the mortgaged property was entitled to oil and gas royalties before the foreclosure sale, the oil or gas royalties shall be paid to the purchaser of the foreclosed property."

Even in light of this protection, drillers continue to insist on mortgage subordinations before commencing drilling operations.  Similarly, even though the oil and gas lease is -by statute- superior to a mortgage, banks continue to systematically refuse to grant subordinations.  Lately we have been advising our clients to meet with their bank and approach them as partners in a venture.  Both parties have an awful lot to gain if a good Utica well is drilled on the property.

Oil and Gas Valuations for Businesses

Nearly all of our oil and gas clients ask us "what are my oil and gas rights worth?" Having been a producer in the oil and gas industry for over 25 years, I am well attuned to the business side of the industry.  Having practiced oil and gas law for over 25 years, I am also well versed in the legal side.  This positions our firm nicely to handle a wide variety of our client's concerns, such as estate planning for oil and gas revenues, valuations for probate courts, creating trusts to shelter oil and gas money from inheritance taxes, and helping businesses simply evaluate their current assets.  Recently I have been asked to ascertain the value of nearly 100 wells in Alabama.  Doing this requires deep knowledge of geology, oil and gas markets, global production trends, as well as local industry practices.The circumstances in which I'm called on to use this unique skill set are always surprising to me.  If you have questions about the value of your oil and gas rights for a legal or professional matter, please contact me at the number above.

Arbitration Considerations

Just what is arbitration and how does it differ from court proceedings?  Generally speaking, both court proceedings and arbitration proceedings are adversarial processes in which a third party (or parties, in the case of a jury trial) is asked to settle a dispute.   In both court and arbitration, an award of some kind will be issued to the prevailing party.  Courts issue final judgments against parties that usually require them to take some action (i.e. pay damages).  These judgments carry the full weight of the law and must be followed by the parties.  Similarly, the award issued via arbitration proceedings is also legally binding on the parties.  That is, the results from an arbitration proceeding carry no less weight than results from a courtroom proceeding.  Because of this, it is essential that arbitration proceedings be taken very seriously.One advantage of arbitration is that the third party arbitrator (also known as "the neutral") typically has some personal expertise in the dispute's subject matter.  Oil and gas arbitration is no exception: neutrals often have a background including extensive oil and gas experience.  It is therefore in a person's best interest to prepare for arbitration proceedings with the appropriate guidance and expertise.  Our attorneys' knowledge of oil and gas law is well-known.  Perhaps less well-known is our arbitration experience.  At proceedings in which specialized knowledge often influences the outcome, it helps to have knowledgeable attorneys at your side.  Contact us today if you need representation in an oil and gas arbitration proceeding.

Hydraulic Fracturing Law Seminar

The folks at the National Business Institute have asked me to speak about oil and gas leasing at a seminar in early April.  The seminar title is Hydraulic Fracturing Law, and it promises to feature a number of interesting and valuable presentations on energy-related topics such as land valuations, regulatory challenges, as well as environmental concerns.  I will be discussing the basic structure of an oil and gas lease from the perspective of both the landowner and the energy company.  I will also discuss current litigation issues with respect to oil and gas leases, and offer insight about where these trends might lead.The event is scheduled for April 10, in Cleveland and April 11, in Akron.  For more details, or to register, please see NBI's website for the event.

Oil and Gas Update - December 2012

Since my last update in July, I have perceived a trend of a southward movement of the Utica play. Thereis presently a good deal of leasing activity in Belmont, Harrison, Noble and Guernsey Counties. Wordis that some of the best wells to date have been drilled in that area. Certainly, Carroll County andColumbiana Counties are seeing large numbers of wells drilled, but leasing there is not as active as itonce was; companies are primarily focused on filling in planned drilling units and not much interested intaking random leases. The basic attitude seems to be – ‘don’t call us, we’ll call you if we need you.’ Inareas where there is a single company with a dominant lease position, lease prices are actually trendingdownward as there is little competition for leasing.The far western and far northern areas of the play have seen some bad drilling results that arelikely to stall rapid development until the boundaries and characteristics of the Utica shale arebetter understood. For the time being, most companies are likely to stick tight to what is believedto be the narrow “wet gas” window of the play – the low hanging fruit. For a map, click here.I am presently spending a good deal of my time dealing with older leases or old mineral reservations,in an attempt to clean up title in favor of my landowner clients. This sometimes requires litigation. Icurrently have cases pending in courts from the top of the play (Trumbull County) all the way down tothe southern part of the play (Monroe County).

Title Defects

Before a landowner will be paid a signing bonus for executing an oil and gas lease, the Lessee needs to make sure that the person who signed the lease is the person who owns the oil and gas underneath the subject property.   To know for sure, the energy company has to spend a good amount of time doing research at the local courthouse.   There, they search through old deed books and try to determine if any prior owner to the land had reserved the oil and gas rights.  If another person reserved the oil and gas rights, then that party is, by law, the only person entitled to enter into the oil and gas lease.  In this case, the landowner who just signed the lease and was expecting a nice bonus payment would not be entitled to it.  This unhappy landowner has a title defect.This situation is not uncommon.  Given that the energy company pays sizable signing bonuses, it makes sense that they take their time to make sure they are paying the right person.  The basic idea - from the energy company's perspective - is this: am I 100% certain that the people who have legal rights to these minerals have given me permission to extract them?  The last thing they want is to drill a well and later find that they haven't obtained the proper person's permission to do so.  Aside from mineral reservations, there are other defects in title that might make an energy company nervous about issuing a signing bonus.  These can range from gaps in title, prior oil and gas leases, active wells, as well as probate issues.   Most title defects are easily cured, and our oil and gas attorneys are thoroughly experienced in curing them.  Other title defects can be more complicated, and can require some clever lawyering.  Has an energy company notified you that a title defect is preventing you from obtaining an oil and gas lease?  Call us to set up an appointment, and our attorneys will help determine what's stopping you from entering into an oil and gas lease. 

Arbitration

Before the recent interest in eastern Ohio's utica shale, gas leases were written a little differently.  One big difference between the leases of old and the new leases has to do with how the Lessor (the landowner) and Lessee (the energy company) settle disputes.  Where old leases didn't quite restrict the methods by which the parties could settle their disputes, new leases can include some pretty strict language that make landowners follow specific procedures for addressing their concerns.Arbitration clauses have become common in oil and gas leases here in Ohio.  The leases that include such language usually require the landowner to have their concerns addressed by a neutral arbitrator rather than a judge or jury. Because most folks (and most attorneys) prefer to avoid lengthy litigation and court costs, arbitration can be an attractive alternative to quickly and efficiently settle claims between parties, though you need to be careful in drafting your arbitration clause.  We have significant experience in oil and gas matters and in representing clients in arbitration proceedings.If you have questions about how arbitration might affect your oil and gas lease, please contact us today.  For your benefit, a sample arbitration agreement follows.

Any dispute arising out of this agreement shall be settled through binding arbitration.  Either party may initiate an arbitration proceeding by notifying the other party in writing. The parties shall agree thereafter upon a single person to act as arbitrator; said person to be selected within 20 days after written notice is served.  In the event the parties cannot agree upon a single arbitrator, each party shall immediately select an arbitrator and the two so chosen shall promptly select a third.  The place of arbitration shall be ________________ and the laws of the State of ________________ shall govern the proceedings. The procedures to be followed by the arbitrator(s) and the parties shall be those prescribed in the Commercial Rules of the American Arbitration Association, although the AAA shall not administer the arbitration proceeding.  The arbitrator(s) and the parties shall take reasonable action to conclude the arbitration within 90 days after the initial written notice is served.  Judgment upon the award rendered by the arbitrator (or a majority of the arbitrators if more than one serves) may be entered in any Court having jurisdiction thereof.  The arbitrator(s) shall have the authority, but not be required, to assess costs and/or attorneys fees against the losing party.