Recently I wrote about Ohio’s mechanisms for forcing unleased mineral owners into a drilling unit. Oil and gas producers have increasingly started to rely on these mechanisms to drill horizontal wells to the Utica / Point Pleasant shale formation in eastern Ohio. These same laws require transparency for these procedures, and as part of a public records request, I obtained several recent orders approving the forced unitization of unleased mineral owners in various parts of Ohio. I was hoping that I could gain some insight on the issue of whether a landowner is better off signing a proposed lease or being forced into a drilling unit under the applicable statute. Having reviewed these unitization orders, I offer the following observations:
Producers do not appear to be abusing this process
Producers are relying on an Ohio law that requires that they only lease 65% of a proposed drilling unit before they can force unleased mineral owners into the unit. However, each of the orders I reviewed showed that producers had leased nearly 90% of the proposed drilling unit, and frequently that number was much higher. To me, this indicates two things: 1) that producers much prefer to negotiate with landowners than resort to this process, and 2) that the Ohio Department of Natural Resources prefers leasing efforts that go well beyond the statute’s minimum requirements.
The royalties awarded to an unleased mineral owner forced into a unit were generous
In each of the approved unitization orders I reviewed, unleased mineral owners were to receive a “monthly cash payment equal to a one-eighth (1/8) landowner royalty interest calculated on gross proceeds.” Of course, this 1/8 royalty is allocated according to how much land the unleased mineral owner was contributing to the drilling unit. This 12.5% royalty is significantly lower that what Utica producers are offering under a new lease. However, in addition to the 1/8 royalty, the unleased mineral owner will receive a “monthly cash payment equal to a seven-eighths (7/8) share of the net proceeds,” again, based on how much land the unleased mineral owner was contributing to the drilling unit. This 7/8 royalty does not become due, however, until the producer has recovered between 100% and 200% of the cost of drilling, testing, completing, and producing the initial well. The chief of the ODNR reviews each of these matters on a case by case basis and the orders issued vary somewhat. Landowners affected by the orders, unlike landowners who signed leases, did not receive any sort of cash bonus or signing payment.
Consequences to landowners
To me, there are a few benefits to being forced into a drilling unit. The unleased mineral owners receives a more favorable total royalty than a lease would typically provide (an initial 1/8th plus a 7/8ths working interest after pay-back). Moreover, the chief’s orders reviewed speak to royalties based on “gross proceeds” and no provision is made for deductions therefrom – this is different than the typical lease offered by a Utica producer. Finally, the unleased mineral owner forced into a drill unit has his surface rights protected: producers are prohibited from utilizing any of the unleased mineral owner’s surface.
The downside of being forced into a drilling unit has a significant psychological component. More concretely, the landowner receives no up-front cash bonus that is typical with the signing of an oil and gas lease. Similarly, the terms of the deal are set by the ODNR chief’s order, and not by the negotiations between the producer and the landowner. Even though orders authorizing forced unitization contain many protections for the landowner, they are not as complete as an oil and gas lease. As a result, several circumstances common with well ownership and operation are simply unaddressed. Provisions present in oil and gas lease that are not present in unitization orders include: shut-in clauses, audit clauses, as well as market enhancement protections on the 7/8 royalty. Another matter the landowner needs to worry about is whether the well will exceed the pay-back percentage set by the chief. If a 200% pay-back is required before the 7/8ths ‘bonus’ kicks in, and if the well never hits that level, the landowner will definitely fare worse than one who signed a lease.
In sum, I was encouraged by what I saw in the orders to the extent that it seems like producers and ODNR are making good-faith efforts to make sure that landowners were given an opportunity to sign a lease before they are forced into a unit. As for the impact on the landowner, it is hard to recite a hardline rule. Certain landowners would benefit more from negotiating a lease, while others may find a bigger benefit to being forced into a unit – much will depend upon how prolific the wells are in the area of concern. The variables influencing that determination should be discussed with an informed attorney. If you have been ignoring multiple offers to lease you received via certified mail, and if there is active drilling in your area, it is possible that you are about to be force-pooled and it may make sense to give us a call to determine your best options.