There are a few major parts to each Oil Lease, and many minor parts. In particular, there are three major parts that need careful consideration before signing. They are:
In short, this is the time period in which the lease is valid. The term can vary between 1-50 years, but in general it is 3-5 years. Depending on the specific leasing document, Drilling operations usually will have had to start before the expiration of this time period, and drilling operations will have to be continual until either a completion or an abondonment. If the Lease is a “Paid-Up” lease, then the lease is only enforceable for the stated term, and cannot be extended without additional agreements. If however the lease allows for “delayed rentals”, then the lease will have a primary term, within which drilling operations must begin, or the leasing party must pay a delayed rental if it chooses to extend the lease. For example, a lease will state that drilling operations must commence within 1 year of the date the lease was entered, or the lease will terminate, unless an agreed sum is paid to the lessor. This delayed rental must be paid on each subsquent anniversary date of the primary term whenever drilling operations or production are inactive.
Royalties are the portion of produced substances that goes to the mineral right owner. This will be based off of market price, income, or proceeds in kind. Royalties traditionally vary from 1/8 (12.5%) to 1/4 (25%). This significant variance is determined by: Distance to nearby production, nearby production amounts, geophysical data (seismographs, geologic trends, electromagnetics, etc), and going rates of other leases in the area. A landowner might get a wonderful value for a 12.5% royalty lease in a “wildcat” area whith no nearby production, whereas in a proven high production area, he/she should be able to negotiate a 25% royalty on their lease.
Another major part to consider is the “Bonus Payment”. This is the dollar amount paid to the landowner at time of signing the lease offer. On a “Paid Up” oil lease, this amount will be significantly greater than for a “Delayed Rental” type lease. The lease term can also greatly affect the amount given for the bonus payment. This amount will vary between $5-$30,000 an acre and depend on the same things that the royalty payment depends on, namely geology, proximity, and going rates.
The better informed a landowner is on his/her property, the more negociating power he/she possesses. It is in the very nature of the “Landmen” to negotiate the best deal possible, and thus many times they will send many lowball offers before sending a competitive offer. A landowner who has been properly helped and tutored will be much better prepared to understand what constitutes a competitive lease offer.
Always keep in mind, that the most financially successful oil and gas leases come in the form of royalties paid to the landowner. Often times large bonus payments will be paid in exchange for lower royalty payments. Though this might be good in the short run, if the property is drilled and significant amounts are encountered, small changes in the amount of royalty percentage could lead to huge changes in the amount of income. Ultimately it is in the Landowners best interest to negotiate with incentive to drill, and many drilling projects from leases that were signed in July (when oil/gas prices were highest) are now stagnant. Chesapeake for example has recently announced that they are currently trying to re-negotiate a big portion of their leases because the terms that they agreed to are no longer feasible. The high royalty rates are not economically feasible given the lower oil/gas prices of the troubled market of today.