• The Landman is Knocking, Should You Answer the Door?
  • April 27, 2015 | Authors: Stephen C. Chambers; Kate E. Flewelling
  • Law Firm: Smith Haughey Rice & Roegge, P.C. - Traverse City Office
  • As technology changes, oil and gas companies are finding new ways to exploit and extract the wealth that lies deep within the earth. Some of those oil and gas deposits may lie under your fields or orchards, meaning that you may find yourself with an unexpected visitor - a “landman.”

    Historically, oil and gas companies have hired landmen to perform a varied array of services, one of which is to negotiate for the acquisition of mineral rights, including leases for oil and gas exploration activities.

    If you meet with a landman, his or her goal will likely be to have you sign an oil and gas lease. Caution must be exercised as you are dealing with valuable rights and assets - both those on the surface and those below the ground. Oil and gas leases, for the uninitiated, are unlike any other real estate or lease document you have encountered in the past. Here is an introduction to some of the basics and nuances of oil and gas leases:

    Know the Parties: Do not assume anything about the person who shows up at your door. He or she may be an independent agent or an employee of an oil and gas company. Do not assume because he or she presents you with a printed form for an oil and gas lease that the lease cannot be negotiated. Finally, do not assume that the company you sign a lease with will be the company that drills and operates the well that may, in the future, exist on your property. You will need to make sure you understand the role of the landman and protect yourself with respect to whomever the lease is assigned to in the future.

    Lease Terms: Unlike a typical residential or commercial lease that has a set term and possibly renewal terms, the terms for oil and gas leases work differently. Oil and gas leases are divided into two time periods:
    • A “primary” term, with fees paid in advance (a “paid up” lease). A typical term is three to five years, but can be longer.
    • If operations are commenced during the primary period, the lease enters a “secondary period.” The secondary period lasts so long as production or operations continue under the lease and is referred to as being “held by production.”
    Understand the Surface Impact: Yes, you are granting rights with regard to what’s under the surface, but oil and gas companies, by definition, will need to use and utilize the surface of your land in their exploration and drilling activities. It is important in your lease to address such surface issues as salt water disposal, water use, ingress and egress, damage to crops, radius of operations from existing or future structures, fencing, etc.

    Consider the Scope of the Lease: Considering the impact of any exploration or production activities on the activities you or your surface lessees perform on the land goes beyond what the lessee will do on the surface, you must also consider what they will do under the surface. These considerations include whether you need to restrict certain seismic or other geophysical operations, such as hydraulic fracking, restriction on underground pipe lines , making sure the pipe lines are below plow depth, dictating the method of restoring soil after surface operations are concluded and providing for meaningful reinforcement for the lessee’s obligations with respect to restoring the surface of the land as nearly as possible to its original condition.

    Economics: The economics of oil and gas leases are complicated. Among the different payment streams to lessors are delayed rentals and shut-in royalties, bonus payments, surface damages and production royalties. Make sure you understand how all of the payments are calculated, when you will receive each, which are speculative and which are certain, and which payments must be paid in time in order for the lease to remain in place. To give you a flavor for the level of sophistication of these calculations, royalty payments (i.e. your share of the production income) can, depending on the producer, be based on a number of different commodity pricing methods including “market price at the well head,” “net proceeds” or “in kind.” In calculating market price at the well head, most leases provide for the royalty to be reduced by certain “post production costs (PPC),” including transportation, compression and removal of impurities from the oil or gas. These PPCs can reduce the royalty payments significantly, so it is important to know which costs the operator can deduct from the royalty payments at the time the lease is negotiated and signed.

    If you are presented with the opportunity to lease your property for oil, gas or mineral extraction, educate yourself as much as possible before signing anything. Many resources exist to assist you in the process. For example, Michigan State University’s Extension program offers free public meetings for landowners to provide education about the oil and gas industry generally and leasing in particular. Assembling a team of experts, including competent legal counsel, will ensure that you and your land are protected as you move forward in to your new venture.