$1.9B Omaha private bank team joins Private Wealth. Meet the team here →

private wealth

Mastering the Art of Oil and Gas Lease Negotiations

oil and gas leases

The Importance Of Negotiating Oil And Gas Leases

A landowner with oil and gas resources beneath their property holds a valuable asset. Understanding the best practices of negotiating lease agreements is essential for maximizing the economic benefits of your land while protecting your rights. 

Negotiating oil and gas leases can be a complex and overwhelming process. With the right information and strategies, you can level the playing field and secure favorable agreements that align with your goals. 

As a landowner, you have the right to negotiate terms that work best for you. Be sure to balance financial gain with environmental and community concerns. When approaching negotiations, a few key steps can enable success:

  1. Understand the dynamics of the oil and gas industry.
  2. Arm yourself with the right information.
  3. Adopt effective negotiation strategies.

Do this correctly and you can secure a favorable lease agreement that safeguards your land for generations to come.

Let’s dig into the various elements of a typical negotiation. We’ll look at lease structure, bonus payments, production royalties, environmental factors and legal considerations. By the end, you’ll have a better understanding of the key factors to consider and potential pitfalls to avoid.

Understanding The Lease Agreement

A lease agreement outlines the terms and conditions of the transaction. It includes the royalty rate, the length of the lease and the surface use agreement. It is crucial that you read and fully understand the lease agreement before signing any contract. Your goal is to ensure that both parties benefit from the agreement. 

Following are some of the critical elements to consider when reviewing and negotiating the lease agreement.

Who Is the Operator?

The operator is the company that will be responsible for drilling and extracting the minerals from the land. They are the ones who will be conducting the drilling operations. They make the necessary decisions to ensure that the production of oil or gas is successful.

In most cases, the operator is the company that holds the majority of the working interest in the lease. They are responsible for coordinating all aspects of the drilling operations:

  1. Hiring contractors
  2. Obtaining necessary permits and licenses
  3. Managing the production of oil or gas

For landowners and mineral interest owners, it is important to know who the operator is when negotiating a lease agreement. This information can help to determine the level of experience and resources the company has in conducting drilling operations. It can also help to ensure that the lease agreement includes provisions for environmental protection and safety measures.

Are They a Reputable Company?

Here are some tips on how to identify a reputable oil or gas company:

  1. Look for a company with a strong track record. You can research the company’s drilling history to see if they have drilled successful wells in the past. Companies with a history of successful drilling operations are more likely to handle the drilling effectively. While you’re researching them, don’t forget to review any environmental impact reports and inspection records to make sure they have a good safety record as well.
  2. Check the company’s reputation and reviews. In addition to their track record, research the company’s reputation in the industry and the local community. You can check industry publications and online reviews to get a sense of how the company is perceived. A company with a good reputation is more likely to be reliable, trustworthy and professional.
  3. Research the company’s financial position. Verify the company’s financial stability and ability to handle post-production costs. You can research their financial reports, stock prices and credit ratings to get a sense of their financial strength. Companies with a strong financial position are more likely to handle unexpected expenses and liabilities. 

By doing your research, you can identify a company that is experienced, reliable and trustworthy. This will help ensure that the drilling operations are conducted safely, efficiently and effectively.

Will They Sell the Lease?

In some cases, the company taking the lease may intend to sell it to another party. It’s important to clarify whether the lessee plans to operate the property or if they intend to sell the lease.

Keep in mind that a change of ownership may result in a shift in bargaining power. The new buyer may have different priorities and resources. This could impact the value of the mineral rights and potential royalty payments.

Royalty Rates

Determining the appropriate royalty rate depends on various factors such as the potential for future profit and immediate cash needs. Therefore, it’s essential to consider both short-term and long-term goals when negotiating royalty rates.

It’s important to note that royalty rates vary by location. Different regions have different rates, so researching the current industry standards and legal requirements in the area can be beneficial.

In some cases, a mineral owner may choose to negotiate a lower bonus payment for a higher royalty rate. A lower bonus payment means less immediate cash. It can, however, lead to more significant returns over time with a higher royalty payment. However, a higher bonus payment may be desirable for those with immediate cash needs.

Another factor to consider when negotiating royalty rates is post-production costs. Some leases require the mineral owner to pay deductions for post-production costs. In contrast, others have royalty payments free of all production costs. It’s essential to compare these different options and determine what works best.

Length of Lease

When negotiating an oil and gas lease, one crucial factor to consider is the length of the lease. This term can vary, but it is generally between one and five years. For example, in a state such as Texas, we recommend nothing more than three years. 

Surface Use Agreements

There is a key difference between a surface use agreement and a mineral lease agreement. A surface use agreement pertains specifically to the access and use of the surface. A mineral lease agreement pertains solely to the subsurface minerals.

A surface use agreement typically provides compensation to the surface owner for any damages caused by the drilling operation. Such damages may include any removal or damage to trees and crops as well as any disturbance to the land itself. Additionally, the agreement may provide for access rights to the property, including drilling equipment and vehicles.

Thoroughly review and negotiate the terms of a surface use agreement. Ensure that compensation for damages caused to the surface is fair and reasonable. The agreement should also outline the scope of access rights granted to the oil or gas companies as well as any limitations or restrictions on drilling operations.

Hiring Professionals

Negotiating oil and gas leases can be a complex and challenging process. This is why many mineral owners may choose to hire professionals to assist with lease negotiations. First, it’s important to determine whether or not professional assistance is necessary for your specific situation. 

Consulting a Landman

A landman, or land manager, is a professional who specializes in examining the legal and financial aspects of mineral rights ownership. They can help in several ways:

  1. Researching ownership records 
  2. Evaluating mineral values
  3. Negotiating lease terms with oil and gas companies on behalf of mineral owners

Consulting with a landman during the negotiating process can provide mineral owners with valuable insight into the leasing process. A landman can advise mineral owners on what a favorable lease agreement looks like. They can also assist owners in negotiating bonus payments and annual payments based on production.

With a landman’s help, mineral owners can avoid common pitfalls and ensure that their lease terms are in their best interest.

Do You Need an Attorney?

Consulting with a landman is often the first step in negotiating a lease. Mineral interest owners may also consider hiring an attorney to provide valuable legal insight. An attorney can help review the lease agreement to ensure that the terms are favorable to the owner.

While not always necessary, hiring a qualified attorney can provide peace of mind. In the end, consulting with a landman and hiring an attorney can be a winning combination. 

Tips for Mineral Owners When Negotiating Oil and Gas Leases

Do Your Research: Knowledge Is Power

Before entering into any negotiations, gather as much information as possible. Research the geological formation of your land and the potential for oil and gas production. You can also research recent oil and gas activities in your local area. Consult with other mineral rights owners to gather insights on favorable lease terms and activity, in general.

Be Patient: Negotiating a Lease Agreement Can Be Lengthy and Complex 

Take the time to review all aspects of the lease. Understand any legal documents, clauses and forms. Don’t be pressured by an operator—or a broker who was hired by an operator—to sign a lease immediately, and never sign something you don’t understand. Take the time to consider your options and don’t be afraid to walk away if the lease terms are not favorable.

Have a Depth Severence Clause

Including a depth severance clause is important for several reasons. First, it clarifies the areas that the lessee can and cannot explore for oil and gas. This helps to reduce the risk of disputes between the lessor and lessee concerning the extent of the leased premises. Without a depth limitation, the lessee could potentially access mineral resources that could be of tremendous value in the future.

Moreover, a depth severance clause can also impact the potential earning power of future leases. Sometimes, oil and gas reserves are only present at a specific depth. By specifying a depth limitation, the lessor can essentially reserve future royalty payments and/or bonuses for other depths to be developed at a later date.

Include a Transportation Clause

The transportation clause must specify how the cost to transport the minerals will be carried out. It addresses the issue of who will bear the cost of transportation. In most cases, the operator should bear this cost. A good lease document should impose certain limitations on the amount that can be charged to the mineral owner.

There should also be a mechanism for calculating deductions from royalty payments to cover transportation costs. The costs incurred during the transportation of leased minerals may be deducted from the royalty payments due to the mineral owner. The transportation clause must specify how this deduction will be calculated.

Risks: What to Look Out for

Owning mineral rights can be a lucrative asset, but it also comes with potential risks. It’s important to understand these risks and take appropriate steps to minimize them.

Mineral Risks

Mineral rights owners may not receive any royalty payments if there isn’t any production from their property. It’s essential to research the property’s history and evaluate the potential for production before negotiating a lease agreement. This will ensure that the property has a good chance of generating revenue.

There is also a risk that the operator may incur post-production costs. These costs include transportation, processing and marketing. Sometimes these costs are passed onto the lessee. It’s crucial to have clear discussions about these potential costs and negotiate favorable terms to minimize the potential financial burden.

Another risk is that the agreement may not address certain issues that may arise during the lease’s lifetime. This could include changes to laws and regulations, the bankruptcy of the operator, and environmental issues. 

Surface Risks

Surface risks can include soil erosion, pollution, water contamination and damage to property infrastructure.

The surface use agreement must be detailed and specific. This protects the landowner from potential damage. Ensure that the operator and any associated work is held fully liable for any damages caused during their activities.

Ensure You’re Getting the Best Deal

If you’re a mineral interest owner negotiating an oil and gas lease, seek the advice of an experienced landman. Conduct thorough research to ensure you’re getting a fair deal. Remember, the decisions made during the negotiation process can determine the future benefits of mineral development. Take control of your bargaining power and secure a lease that works in your best interest.

Schedule a strategy session with one of our professional landmen.

Investment Advisory Services offered through Private Wealth Asset Management, 1901 Howard Street, Suite 312 Omaha, Nebraska 68102. 888-611-7926. This report is being provided for informational purposes only and should not be used as the sole basis for financial decisions, nor be construed as investment advice designed to meet the particular needs of an individual’s situation. Contact your investment advisor to discuss your specific goals and objectives.


Expert insights delivered straight to your inbox.

We write to our friends and family every few weeks or so with big news, big ideas, and big updates. Sign up now and get the inside track.

wealth planning
hanging with grandson