Monthly Archives: September 2018

Retained Minerals & Mineral Owner Woes

As a landowner, I leased out my farmland to a farmer who did rotation between soybeans and wheat. This summer, when the wheat was absolutely ready, he took off on a vacation.  After returning, he tried to catch up, the wheat had been ready for weeks and the soybeans needed planted before a certain time to qualify for crop insurance. His combine burned up. After another 10 day delay, he borrowed a machine, harvested the wheat and declares it too dry to plant. In fact, he should have planted anyway. It rained within days and most late soybeans are maturing well. On an annual cash rent basis, no problem. But I was sharecropping. I have skin in the game, and for this year, zero income all for the lack of a farmer doing what he was supposed to. I fired him.

Oil and Gas Investor magazine, a Hart publication, in its September 2018 issue, had an article by Philip Jordan, Ethan Wood and Brittany Blakely, called “Gone, Gone, Gone”, which basically complained about a couple of recent Texas court decisions where the retained acreage clauses were at issue.  Quoting, “What can operators do to keep their acreage safe from landowners and their lawyers?”

When a lease proves productive, the operator may develop the property, but the truth is most seem more interested in simply drilling the minimum amount to hold huge chunks of land without paying the owner of that mineral land a dime.  The typical drilling unit of 640 to 1,280 acres may have a single well “holding by production (HBP)” all of the land and every landowner is at the mercy of the operator to drill and develop the unit in a timely fashion.  Without some minimum royalty clause, the landowner may get only a few pennies.

I know of a well, drilled in 1982, which has produced a lot of gas, but no development wells exist. And the royalty amounts have fell to a trickle. Yet it continues to HBP 640 acres. Additional well sites are available. Unlike my sharecropper, the mineral owners cannot fire these underperformers. While the operator continues to book reserves from this well on their K-10 and show the property as being a valuable asset with future reserves, the landowner is basically swindled, unable to break the lease, or to do so only by going to court.

The two court cases are Endeavor Energy Resources v. Discovery Operating and XOG Operating LLC v. Chesapeake Exploration LP.  In the first case, Discovery bought and developed a lease which Patriot Royalty and Land LLC had determined had expired after Endeavor’s primary term. Endeavor argued that they held 160 acres, and the 81 acre proration unit was adequate to hold the entire 160 acres. The Texas Supreme Court disagreed, and held the maximum allowables were the 81 acres and the remainder was not held by production but the lease had, indeed, expired.

The court added a punchline to this ruling. “…the operator must verify that the additional acreage is actually necessary or required to achieve the maximum allowables.”  The operator cannot simply hold acreage that is not being drained.  My reading of that is since the well cannot drain 160 acres, additional wells must be drilled or the acreage lease expires.

The XOG v. Chesapeake case is similar, basically ruling that they cannot retain a larger tract than the Railroad Commission field rules allow. The operator claiming additional acreage is not applicable, but in this case the proration was 320 acres and Chesapeake had 5 wells, or as ruled 1,920 acres (note the math here that 5 x 320 is not 1,920, so I don’t know how they come up with that, perhaps there was a typo and it was six wells, not five.)

My take way is that Oil companies feel entitled to basically take all leases to be theirs into perpetuity and the mineral owner has no real “right” to lease to others to get additional wells.  The lease expires only if they drill a dry hole and abandon the project. Otherwise, it is theirs forever.

No one should sign a lease which does not have a minimum royalty clause, something similar to what a minimum pasture rent would be. That means the minimum royalty is no less than say, $30/acre per year and must produce a minimum amount of product. An economic limit should be set upon which the lease expires. No lease should allow an operator to not produce or test every part of the lease. The prudent operator should develop a lease on a consistent basis and not simply be allowed to hold lands for decades while the mineral owner gets nothing or those miserly checks for $12 sent at the end of the year. Unlike my farmer, the oil company cannot be fired.

However, the Oil & Gas Investor article has placed operators on notice that they can lose acreage and therefore, they will redouble their efforts to stick the knife in a little deeper to the neophyte mineral owner. No legislative fix can be had because the oil companies basically have far more clout in the state politics than do the mineral owners.