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OIL & GAS MINERAL RIGHTS
Fee Simple – Complete Ownership
In most countries of the world all mineral resources belong to the government. This includes all valuable rocks, minerals, oil or gas found on or within the Earth. Organizations or individuals in those countries cannot legally extract and sell any mineral commodity without first obtaining an authorization from the government.
In the United States, Canada and a few other countries, ownership of mineral resources was originally granted to the individuals or organizations that owned the surface. These property owners had both “surface rights” and “mineral rights”. This complete private ownership is known as a “fee simple estate”.
Fee simple is the most basic type of ownership. The owner controls the surface, the subsurface and the air above a property. The owner also has the freedom to sell, lease, gift or bequest these rights individually or entirely to others.
If we go back in time to the days before drilling and mining, real estate transactions were fee simple transfers. However, once commercial mineral production became possible, the ways in which people own property became much more complex. Today, the leases, sales, gifts and bequests of the past have produced a landscape where multiple people or companies have a partial ownership of or rights to many real estate parcels.
Most states have laws that govern the transfer of mineral rights from one owner to another. They also have laws that govern mining and drilling activity. These laws vary from one state to another. If you are considering a mineral rights transaction or have concerns about mineral extraction near your property it is essential to understand the laws of your state. If you do not understand these laws you should get advice from an attorney who can explain how they apply to your situation.
“Mineral Rights” entitle a person or organization to explore and produce the rocks, minerals, oil and gas found at or below the surface of a tract of land. The owner of mineral rights can sell, lease, gift or bequest them to others individually or entirely. For example, it is possible to sell or lease rights to all mineral commodities beneath a property and retain rights to the surface. It is also possible to sell the rights to a specific rock unit (such as the Pittsburgh Coal Seam) or sell the rights to a specific mineral commodity (such as limestone).
Surface Rights vs. Mineral Rights
“I’ll pay you $100,000 for the coal beneath your property!” This type of transaction has happened many times. The fee simple owner may not have the interest or the ability to produce the coal beneath his property but a coal company does.
In this type of transaction the owner wants to sell the coal but retain possession and control of the surface. The coal company wants to produce the coal but does not want to pay an additional price to acquire the buildings and the surface. So, an agreement is made to share the property. The original owner will retain the buildings and rights to the surface, and the coal company will acquire rights to the coal. The transaction can involve all mineral commodities (known or unknown) that exist beneath the property, or, the transaction can be limited to a specific mineral commodity (such as “all coal”) or even a specific rock unit (such as the “Pittsburgh Coal”).
Mineral Leases and Royalties
Sometimes a mining company does not want to purchase a property because they are uncertain of the type, amount or quality of minerals that exist there. In these situations the mining company will lease the mineral rights or a portion of those rights.
A lease is an agreement that gives the mining company the right to enter the property, conduct tests and determine if suitable minerals exist there. To acquire this right the mining company will pay the property owner an amount of money when the lease is signed. This payment reserves the property for the mining company for a specific duration of time. If the company finds suitable minerals it may proceed to mine. If the mining company does not commence production before the lease expires then all rights to the property and the minerals return to the owner.
When minerals are produced from a leased property the owner is usually paid a share of the production income. This money is known as a “royalty payment”. The amount of the royalty payment is specified in the lease agreement. It can be a fixed amount per ton of minerals produced or a percentage of the production value. Other terms are also possible.
When entering into a lease agreement the property owner must anticipate any activities that the lessee might do while exploring the property. This exploration might include drilling holes, opening excavations, or bringing machines and instruments onto the property. Defining what is allowed and what restoration is required is part of a good lease agreement.
Oil and Gas Rights
Mineral rights often include the rights to any oil and natural gas that exist beneath a property. The rights to these commodities can be sold or leased to others. In most cases, oil and gas rights are leased. The lessee is usually uncertain if oil or gas will be found so they generally prefer to pay a small amount for a lease rather than pay a larger amount to purchase. A lease gives the lessee a right to test the property by drilling and other methods. If drilling discovers oil or gas of marketable quantity and quality it may be produced directly from the exploratory well.
To entice the property owner to commit to a lease the lessee generally offers a lease payment (often called a “signing bonus”). This is an up-front payment to the owner for granting the lessee a right to explore the property for a limited period of time (usually a few months to a few years). If the lessee does not explore or explores and does not find marketable oil or gas then the lease expires and the lessee has no further rights. If the lessee finds oil or gas and begins production, a regular stream of royalty payments usually keeps the terms of the lease in force.
One problem that can occur is when the lessee discovers oil or gas but has no way to transport it to market. Some lease agreements have a “waiting on pipeline” clause that extends the lessee’s rights for a limited or indefinite period of time.
In addition to a signing bonus, most lease agreements require the lessee to pay the owner a share of the value of produced oil or gas. The customary royalty percentage is 12.5 percent or 1/8 of the value of the oil or gas at the wellhead. Some states have laws that require the owner be paid a minimum royalty (often 12.5 percent). However, owners who have highly desirable properties and highly developed negotiating skills can sometimes get 15 percent, 20 percent, 25 percent or more. When oil or natural gas is produced the royalty payments can greatly exceed the amounts paid as a signing bonus. (Royalty estimation tool for dry natural gas).
Oil and Gas Unitization and Pooling
Below the surface, oil and gas have the ability to move through the rock. They can travel through tiny pore spaces – such as between the grains of sand in sandstone or through the tiny openings created by fractures. This mobility allows a well to drain oil or gas from adjacent lands. So, a well drilled on your land could drain gas from a neighbor’s land if the well was drilled sufficiently close to the property boundary.
Some states have recognized the ability of oil and gas to cross property boundaries underground. These states have produced regulations that govern the fair sharing of oil and gas royalties. These states generally require drilling companies to specify how oil and gas royalties will be shared among adjacent property owners when a permit for drilling is filed. The proposed sharing of royalties will be based upon what is known about the geometry of the oil or gas reservoir compared to the geometry of property ownership at the surface. This procedure is known as “unitization”.
Some states do not have rules for unitization of oil and gas royalties. Other states have them but only for wells that produce from certain areas or from certain depths. These rules can play a critical role in a leasing or resource development strategy. Some people tell stories about landmen saying “Lease to me now or we will drill your neighbor’s land and drain your gas without paying you a cent.” In some situations, an absence of state regulations allows this to occur. If you are contacted about leasing your mineral rights you should contact an attorney for advice on how the laws of your state will apply to your property.
(Note: In Pennsylvania the rules for natural gas sharing change at certain depths below the surface and at certain positions in the stratigraphic column. See the section labeled “Stratigraphic Column” near the bottom of the right column of this page for more information. In some areas the rules used for sharing Marcellus Shale gas can be different from the rules used for sharing gas from the underlying Utica Shale. Consult with an attorney on how these might apply to your property.)
What Qualifies as a “Mineral”?
The word “mineral” is used in a variety of contexts. Generally, ores of metals, coal, oil, natural gas, gemstones, and dimension stone, construction aggregate, salt and other materials extracted from the ground are considered to be minerals. However, there is no definition of “mineral” that applies in every situation and what is considered to be a “mineral” can vary from state to state and even change over time!
Disclaimer: The information above should not be considered as legal advice. It simply provides educational topics, information that might occur when valuable commodities exist beneath the land. It repeatedly suggests seeking professional assistance if you are considering a mineral rights transaction.