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Seek legal help when considering oil contract



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January 30, 2013 - If your doorbell rings, and there's an oil and gas representative on your porch seeking your signature on a lease agreement, you may not want to sign right away.

"That lease is written by and for the company," and "every paragraph and every word has long-term meaning," cautions Curtis Talley, Farm Management Educator at Michigan State University Extension.

Before moving to Michigan in 2008, Talley was employed in private industry in Colorado. As a part of his job, he negotiated with oil and gas companies, and now he seeks to educate landowners before they sign.

According to Talley, oil and gas producers offer private property owners contracts they've drawn up. "No standard lease form is universally recognized and used by the oil and gas industry. Instead, each company (or independent lessee) has a pre-drafted agreement that has proven suitable to them in the past," he said.

It's the responsibility of the landowner (lessor) to understand the language in the contract and decide what they are comfortable signing.

To get started, Talley encourages property owners to be patient. "Check out every thing that oil and gas company tells you," he said.

While representatives from Jordan Exploration or West Bay Exploration may give you a time limit for signing a lease, "it may be true or it may not be," Talley noted. "If they tell you everybody in the neighborhood has signed a lease except you, call your neighbors and find out if that's true. Many times, it's not."

Seek legal advice from an oil and gas attorney

One of the best ways a landowner can feel confident about entering into a lease agreement is to get an attorney. But not just any lawyer will do, Talley points out. "They need to have an attorney that understands oil and gas or they're not going to get much help."

Without proper legal guidance, a landowner who accepts the standard agreement offered by the oil and gas company may end up with a well near their home, gas stored on their land, damages to their water supply, or post-production costs.

"When they sign an oil and gas lease, they should expect there to be drilling on their property," said Talley. "If they do drill, your world changes. There's all kinds of truck traffic and noise. Your area becomes an industrial zone," he described.

Protect your property

The standard lease most residents will see allows for well installation within 150 feet of their house, but a landowner can change that. In fact, "if you know what to do, you can put certain areas of your property off-limits," said Talley.

If a property owner wants to only allow drilling operations on particular parts of their land, they can use a lease addendum, which is a separate agreement.

"Most people change leases by a lease addendum," Talley said. In it, a landowner can address how the surface of their property will be treated. For example, those concerned about the operation's impact on their water quality can designate in an addendum that their water is tested before drilling occurs. "If there's any change in that water quality either before, during, or after drilling, it's recognized that it was caused by the company," said Talley. "I've seen companies agree to that language."

If a landowner wants their land restored in a particular way once the oil and gas company is finished, "they need to put language in their lease as to what 'restored' means," he stated.

Unless property owners make the language of a standard lease more specific, the oil and gas company could place a brine disposal well on site or they could store gas underground, Talley explained.

Because disposal wells and gas storage aren't a part of production, "landowners can be paid separately for that if they don't allow it for free." If a property owner signs a standard lease, however, often "the landowner is giving the company the right to store gas for free," Talley pointed out.

In addition to addendums, property owners may have another option. "There's another kind of lease called a non-development lease that the company usually doesn't tell you about," said Talley.

In Jordan Exploration's proposal to the Independence Township Board of Trustees, the lease was designated as "non-developmental," which means the township won't see any surface impact on their property.

"With the technology today of horizontal drilling, they can actually put all the facilities on another parcel of land and go under ground to harvest your minerals if they have a non-development lease," Talley explained.

Get the deal best for you

Besides concerns about the impact mineral extraction could have on the surface of the property, landowners also want to get the best bang for their buck.

"You will earn every bit of your royalty if you go through this correctly," said Talley.

"The 1/8 in that standard lease is based on net income; how they calculate the net is by calculating what are called post production costs, and there are a whole laundry list of them in the lease. Oil and gas attorneys have told us they will reduce your 1/8 royalty by a third to a half," Talley explained.

Instead of a royalty based on net income, landowners should seek royalties based on gross income, which won't include post production costs. Such charges involve the treatment of oil and gas after it's been taken from the ground and can include charges to the landowner for metering, dewatering, compressing, transporting, return on capital, return on depreciation, reasonable return on investment, and reimbursement of pipeline.

"In the state of Michigan, it's illegal to withhold post production costs unless the landowner agrees to it in the lease. Most landowners don't know that," Talley said.

In addition, he suggests property owners "make sure your lease is limited to harvesting hydrocarbons. Sometimes it says 'oil and gas, and other minerals.'"

Because some minerals are worth more than others, landowners may want to negotiate a different royalty percentage and can even seek a lease specific to the mineral. Talley knows of one lessor who has both an oil and gas agreement and a potassium lease, and the landowner receives a different percentage of the royalties depending on the lease.

Furthermore, lessors should carefully consider the upfront bonus offered in the lease. Most agreements are for five years with a five-year renewal option. The sign-on bonus is a one-time payment, not an annual payment.

"If they're offered a $25 per acre bonus for a five year lease, that's $5 an acre a year. It's not an annual payment of $25 per acre; it's a one time payment," Talley specified.

A property owner's negotiating power depends on many factors including how much land they own and how certain the oil and gas company is of finding valuable minerals.

Compulsory pooling may offer a better deal

From Talley's point of view, landowners who struggle to negotiate with an oil and gas company shouldn't feel that they might get a bad deal if they are subject to compulsory pooling.

Oil and gas companies sometimes make compulsory pooling "appear very negative for the landowner, that they're going to have to wait years to get a royalty, and they're going to have to sign the lease anyway – that's all incorrect," he said.

Actually, Talley said, "I've had a number of oil and gas attorneys tell me it's better than the standard lease."

The agreement made after compulsory pooling is non-developmental, and the 1/8 royalty is based on gross income. Additionally, "it only involves the amount of their property the company and supervisor of wells deem they need to get a drilling permit for one well."

While everything in a lease may be negotiable, Talley points out that landowners will likely not get everything they want. So, property owners should consider what is most important to them.

"These leases get sold and transferred all the time," he said. It's unlikely the property owners will ever see the representative who spoke to them when signing the lease. "So, whomever ends up eventually with this lease, they are going to go by what's in the lease. Anything the landowner wants done has to be in writing; you can't go by anything that's verbally said."

While landowners can benefit from royalties and many companies are responsible and avoid damaging one's property, "oil and gas attorneys tell me it's much better to wait than sign a lease you're going to regret, and these leases can last for generations," said Talley.

Go online to msue.anr.msu.edu/program/info/oil_and_gas to view a state of Michigan lease agreement, list of oil and gas attorneys, and other information about oil and gas lease negotiations.

Clarkston News reporter
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