Three Key Considerations for Any Landowner Contemplating an Oil and Gas Lease

During the past several months oil and gas leasing activities in many counties in southeastern Ohio have been on the rise with a particular focus on leasing land in Noble, Guernsey, Jefferson, and Belmont counties. Negotiating an oil and gas lease agreement can be challenging and making sure that you will be fairly compensated and that your property will be adequately protected in the event that you lease your oil and gas rights can be challenging.   

Plakas Mannos has been a leader in landowner advocacy on oil and gas-related legal issues since the Utica Shale boom hit southeastern Ohio and in the last decade alone has represented hundreds of landowners in mineral rights sales, leases, litigation, and everything in between, in transactions ranging from hundreds of thousands of dollars to tens of millions of dollars. 

Here are some issues we commonly see and that you should consider if you are approached by an oil and gas exploration company about leasing your oil and gas rights. 

Gross Royalties 

While many landowners become enamored with the up-front signing bonus they are going to receive when they enter into their lease, the ongoing revenue stream - the royalties - are just as important. A shrewd landowner focuses on maximizing royalty payments. 

For decades the standard in the oil and gas industry was to pay landowners a “net” royalty on the revenues from the sale of oil and gas produced from the landowner’s land. A “net” royalty is a royalty calculated using the net revenues received by the oil and gas company after all of the company’s costs for things like transportation, gathering, processing, and compression have been deducted. As you can imagine those deductions can be significant and the royalties received from a net royalty lease are substantially less than those received from a gross or cost-free royalty lease. 

For the past several years, the oil and gas leasing market has evolved such that landowners now are routinely able to negotiate gross or cost-free royalty payments. A gross or cost-free royalty is calculated based upon the gross revenues from the sale of oil and gas produced from the landowners’ land without any deductions for the cost of compressing, treating, processing, extracting, transporting, or marketing the oil and gas. Currently, in Ohio, landowners are receiving gross royalty percentages between 15% and 20%. But like every contract, the devil is in the details, and you need to make certain that the royalty language in your lease provides for a true cost-free royalty. 

Surface Protection 

Another important consideration when negotiating a gas and oil lease is to provide limits on the use of the surface of your land by the oil and gas exploration company. Many oil and gas leases give the oil and gas company nearly unfettered access to the surface of your land to use it for the construction of roads, well-pads, compression stations, pipelines, and the like. Such unrestricted access could be devastating for your property. Therefore, it is extremely important that your oil and gas lease contain terms that protect the surface of your land. You may be able to negotiate a non-surface use lease. A non-surface use lease contains terms that prohibit an oil and gas company from entering upon or using the surface of your property for any reason whatsoever unless you and the oil and gas company enter into a separate agreement with specific terms and additional payments that will permit the oil and gas company to use the surface of your land for specific limited purposes. 

If you are considering entering into a lease that will permit the oil and gas company to utilize the surface of your property in connection with exploring for and producing oil and gas it is important to make sure that you include terms in the lease that limit the types of surface activities that may be engaged in, give you the right to approve the locations on your property where surface activities may take place, and provide for additional compensation to you for the portions of your property that may be used or damaged in connection with surface activities. 

Pugh Clause for Oil & Gas Leases 

A pugh clause is an oil and gas lease term that requires the oil and gas company to release from the oil and gas lease acreage that has not been included in a drilling unit during the primary term of the lease. In an oil and gas lease without a pugh clause, all of the acreage that has been leased will continue to be subject to the oil and gas lease so long as any portion of the acreage subject to the lease is included in a drilling unit that is producing oil and gas.  This acreage is said to be “held by production.” A pugh clause requires the oil and gas company to release from the lease any acreage that is not included in a drilling unit at the end of the lease’s primary term. By way of example, if you leased 10 acres for a 5-year primary term and at the end of that 5-year term only 5 acres have been included in a drilling unit, a pugh clause would require the 5 acres that are not part of the drilling unit be released from the lease. Without a pugh clause, the entire 10 acres would be considered held by production and would continue to be encumbered by the lease. Under these circumstances, your entire 10 acres could be subject to a lease for years or decades even though you are receiving royalties on only 5 acres.    

Similarly, a vertical pugh clause is a provision in an oil and gas lease that requires the oil and gas exploration company to release its rights below a specified depth after the lease’s primary term ends.  The purpose of a vertical pugh clause is to release the lease’s interest in any deeper zones that have not been drilled.   

Work with the Gas & Oil Lease Experts 

Because of the complexity of oil and gas lease terms and the generational impact an oil and gas lease can have on your property and your family, you are well-advised to seek professional guidance when considering an oil and gas lease. Plakas Mannos has represented hundreds of landowners in eastern Ohio and negotiated millions of dollars of oil and gas leases. If you would like to retain one of our experienced oil and gas attorneys to assist you in negotiating your oil and gas lease, please call Plakas Mannos at 330-455-6112.

About the Author

Gary Corroto is an attorney and partner for Plakas Mannos practicing law in various areas, including energy, oil and gas, commercial litigation, and more.