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Below are a few concise write-ups of some basic Oil & Gas lease provisions. These types of lease provisions are central to the relationship between a land owner and an E&P company and have a major impact on both parties.
Shut in Royalty Provisions
A Shut-in Royalty Provision within an oil & gas lease is a provision that allows the lessee to halt production (i.e., shut in a well) and pay a Shut-in Royalty to the lessor, substituting the original royalty payments that the lessee would normally pay the lessor while the well is producing.
It is often the case that Shut-in Royalty payments are made by the lessee to the lessor in order to keep a lease valid, in the event that an oil or gas well is not being utilized. A Shut-in Royalty might be paid because there is simply no commercially viable market for oil and gas production while the lease is active, or there may be no pipeline ready to take on production.
The shut-in royalty clause in most current oil and gas leases is designed to prevent the automatic termination rule.
The process of shutting-in a well is not a foregone conclusion simply because the well is producing minimally and/or there is no commercial viability to market the product. Shutting-in a well and tendering shut-in royalties as a substitute for production royalties must be stipulated as part of the lease.
If there is an absence of a Shut-in Royalty Provision, then there is a risk that the lease may be forfeited due to a non-producing well. Only including the Shut-in Royalty clause will prevent a termination rule from going into effect and invalidating a lease.
Rentals and Delay Rentals
In Oil & Gas leasing, a Rental Payment is a type of payment that is paid by the lessee (operator) to the lessor (owner) for the purpose of maintaining the validity of a lease. Rental payments are subject to different timelines and can be made out monthly, quarterly, or annually. The timeline of a Rental Payment is specifically stipulated in an Oil & Gas lease.
Similar to Shut-in Royalty payments, Rental payments maintain an Oil & Gas lease in lieu of non-producing wells generating revenue, and/or an absence of drilling activity. Depending on the terms and conditions of a lease, Rental payments are sometimes paid with Shut-In Royalties.
However, the primary difference between a Shut-in Royalty and a Rental payment is that the Shut-in Royalty applies when the absence of well production is temporary. Rental payments are paid out when there is an indefinite suspension of drilling activity and therefore no generated revenue from a well.
Delay Rental is another type of Rental payment.
Within the lease, a Delay Rental is a yearly payment made to the lessor by the lessee during the primary term of the lease to compensate for drilling that is going to be delayed. This differs from drilling being suspended indefinitely, as discussed previously with Rental payments.
Royalty Payment Clauses
When oil or gas production begins, the landowner is entitled to part of the total production. A royalty is agreed upon as a percentage of the lease, minus what was reasonably used in the lessee’s production costs. This is stipulated in a Royalty Clause. The royalty is paid by the lessee to the owner of the mineral rights, the lessor in the lease.
This clause also governs when a royalty payment is due (i.e., 60-90-120 day periods). There must be a minimum amount of production in order to issue royalty payments, which varies between states. In most states, the minimum amount of production is $100 of commercial production until a royalty owner can receive their dividends. For example, if production is very minimal and does not yield a royalty of at least $100 (based on an owner’s interest), the operator of the minimally producing well will not pay the owner.
The Royalty Payment Clause also defines the proportion of expenses that are taken on by the royalty owner. These expenses typically include the costs of operation and production. The landowner usually does not bear the expenses of initial well development, which is almost always assumed by an E&P company.
Joint Operating Agreements (JOA)
Joint Operating Agreements (JOA) are the second most common legal agreements in the oil and gas industry (after Oil & Gas leases). With a Joint Operating Agreement (JOA) in place, multiple lease-holding co-tenants can lay a contractual foundation for any cooperative development, exploration, or production of oil and gas from a site.
Companies engaged in a Joint Venture (JV) in which all parties participate in exploration and production activity within the same play will often do so under a Joint Operating Agreement. The JOA is the underlying contractual framework of the Joint Venture. The JOA most commonly involves Exploration and Production (E&P) companies, however JOAs may also include non-operator parties to the agreement.
A JOA is typically entered when more than one single party holds the title to the mineral leasehold estate.
It is required that a JOA be in full compliance with and determined by the original lease between a lessor and lessee. While the exact provisions vary according to state, it is the lessee that is impacted the most by the terms and conditions of a Joint Operating Agreement.
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