Owning Leased Oil and Gas Minerals

Congratulations! You’ve leased your minerals, an important step towards realizing the value of your mineral property. This MontGuide is specifically written to help you understand what to expect from the time you sign a lease until you start receiving royalty checks, if and when your oil and gas minerals are produced.

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What do I need to do after I sign a lease?

Every landowner is responsible for keeping records of mineral ownership up to date. That means keeping track of whatever formal records of mineral ownership you have. This should include any mineral deeds, results of title searches, or other documentation of your mineral interests. As you sign leases, copies of those leases should be included in your records. If any questions arise in the future about the terms of the lease, you will be able to refer back to your copy. You should not count on a copy of the whole lease being recorded at that county's courthouse. In many cases, a notice of recording is filed, not the lease itself. If the lease itself is recorded, it will most likely have portions omitted or blacked out. Once you have a recordkeeping system in place, additional legal documents for each lease can be added as they accumulate. This MontGuide will explain some of those documents.

How long will it take for there to be production?

The time from leasing to production, if there is any, varies substantially. It is typical for an oil and gas company to take a year, or even two, to identify the most promising sites to drill. Original lessees often have to hire companies, or operators, that intend to develop oil and gas. Seismic surveys may be made to help identify the best drilling locations. Once an operator has identified locations to construct wells, a number of regulatory and physical hurdles have to be met. This includes acquiring necessary permits to drill and arranging for specialized equipment such as drilling rigs. A public record of applications for well permits is available from the Montana Board of Oil and Gas Conservation (BOGC). As these plans come together the operator will begin to make preparations for surface entry.

Will I get notice of surface entry?

Yes. Under Montana law, the oil and gas developer or opera- tor is required to give the surface owner (or any purchaser under contract for deed) written notice of planned drilling operations. The notice must be delivered to the surface owner at their addresses as shown by the records of the county clerk and recorder at the time the notice is given. The notice must include a copy of the pertinent state statute (MCA 82-10 Part 5) and a copy of A Guide to Split Estates in Oil and Gas Development, which was produced by the legislative research division in 2007. That guide is available online at http://leg.mt.gov/content/publications/environmental/hb790brochure.pdf. The written notice must be sufficiently detailed as to allow the surface owner to evaluate the effect of drilling operations on the surface owner's use of the property. The notice must be given between 20 and 180 days before any activity that disturbs the land surface. The surface owner may waive the notice requirement.

Is there a separate surface use agreement?

The structure of contracts depends in large part on how the minerals are owned. See the MSU Extension MontGuide, Understanding Mineral Rights (MT201207HR), for more information. There are four main possibilities:

Unified Estate – Surface-Use Agreement

In some cases, a mineral owner may include a surface- damage clause in the initial lease that is signed. In other cases, the surface-damage clause may be left out of the lease itself, but a separate contract is agreed to and signed later. This later contract governs the use of the surface as the minerals are extracted. The surface-use agreement may contain provisions for reclamation after extraction is complete. Reclamation specifies the condition of the land after mineral extraction.

Because of the risk in wildcat leases, a surface-use agreement may be signed when and if drilling does proceed. If negotiations break down over the surface-use agreement and the oil or gas company still has a valid lease, the oil or gas company will be entitled to reasonable use of the surface.

Surface-damage clauses include a wide variety of considerations. Examples include the following:

• Are roadways, pipelines, storage tanks and the like allowed?
• How much of the surface area may be used? Where, exactly?
• May these facilities be used in connection with oil/gas/ minerals removed from other lands?
• What damages to the surface is the lessee responsible for?
• To what condition must the site be restored?

Unified Estate – No Surface-Use Agreement

It is not necessary that a surface-use agreement be signed or a surface-damage clause be included in the original lease. Nor is it necessary to sign a separate surface-damage agreement, though both parties may wish to have a written agreement.

Split Estate – Surface-Use Agreement

An owner who only owns the surface may strongly desire a written surface-use agreement. In many cases, a small sum of money is given to the surface owner to defray damages or loss of use. When minerals are owned by the federal or state government a private surface owner has a good chance of being offered a surface use agreement. In both cases, the operator has the right to enter the surface without the surface-use agreement (but by posting a bond instead), so the surface owner has limited bargaining power.

Split Estate – No Surface-Use Agreement

Under Montana law there is no requirement for a surface- use agreement. Especially on private minerals, there is no guarantee that a surface-use agreement will be offered or signed.

What responsibilities does a surface owner have?

A surface owner must allow a mineral owner to reasonably use the surface to extract minerals. The surface owner is responsible for providing the name and address of the oil and gas developer or operator to any lessees, tenants, or other parties responsible for surface operations on the property.

What happens next?

After a surface use plan is finalized, the well(s) will be formally located, or staked. This entails a surveyor marking where the well will be constructed in accordance with the permit to drill issued by the BOGC.

The construction phase entails several stages and there may be a large number of subcontractors involved. There will be construction of roads, pads and other required infrastructure. This activity will be associated with increased vehicle traffic and noise. Depending on the season, dust or weeds may be an issue. Drilling is the most obvious phase of development. Depending on the location, it can last less than a month up to six months.

Once drilling is completed, there is a process that needs to happen to allow the oil and gas trapped underground to come to the surface. A series of pipes and valves left after the drilling rig moves away need to be finalized. The well may need to be perforated, and many wells today are serviced after they are drilled. Hydraulic fracturing is one example of a way that wells are serviced. The end result is a completion, which will be reported by the BOGC. Once a completion is made, you have an oil and gas well that is capable of bringing oil and or gas to the surface. Your next step will be to sign a division order.

Who do I talk to if I have questions during the development process?

Most operators want to have positive relationships with land- owners, whether they are surface or mineral owners. Usually a contact person is specified who can help explain current and planned operations to the landowner (surface or mineral owner). Such an employee is often a local resident familiar with concerns and problems specific to the area. In some cases, a landowner may be provided with a telephone contact.

What is a spacing unit?

The job of the Montana BOGC is to make sure that oil and gas are not wasted during the production process. One regulation that is used is a spacing unit, which limits the number of wells that can be drilled in a specific area. The basic spacing unit in Montana is 640 acres for natural gas and 40, 160 or 320 acres for oil, depending upon the depth drilled. In places where horizontal wells are drilled, the spacing unit is increased by optional factors of two, three or four times, up to a maximum of 1280 acres for oil or 2560 acres for natural gas. Spacing units can be temporary or permanent. The Board has final authority over creation of spacing units. Usually the operator proposes a spacing unit, but a mineral owner can challenge the definition of a spacing unit in front of the Board.

What is a division order?

After the first well on a lease has been completed, the operator will send the royalty owner an important document: the division order. The division order specifies royalty payments and, along with the lease itself, is one of the most important documents a mineral owner signs. The division order ensures that the owner will be paid for his or her share of the production.

The division order is prepared by a division order analyst, who works on behalf of the operator. It is the responsibility of the mineral owner to make sure all of these pieces of information are correct before signing a division order. Sometimes division orders contain additional information.

What is required in a division order in Montana?

The National Association of Division Order Analysts (NADOA) has created a model division order form that satisfies the legal requirement in Montana. Looking for the NADOA certification on the division order is one way to check and make sure that the legally required information is included on the form.

Montana statutes require the following information on a division order:

1. Division of interest, or decimal interest
2. Name, address and tax identification number of each interest owner to whom disbursements are made by the operator from the sale of oil or gas
3. A provision requiring notice of change of ownership

New tax provisions require oil and gas companies to include an IRS W-9 form with a division order. This will allow you to receive an IRS 1099 form to file with your income taxes. If an operator does not send a W-9 form, you can access a W-9 online at www.irs.gov. Complete the form and submit it with your division order. This will ensure that you receive a timely royalty check and comply with tax reporting requirements.

What is your decimal interest?

Calculations to determine the amount of a royalty check will use the decimal interest in the production. Decimal interest is your net mineral interest times the royalty rate. Net mineral interest is the net mineral acres (acres owned in the spacing unit) divided by gross acres – effectively this is the share of the acreage in the spacing unit.

Example 1: Ted and Ginny own 160 acres in a 640-acre spacing unit with a producing well. Ted and Ginny’s net interest is 160÷640=0.25

Example 2: The royalty rate on their lease is one-sixth, or 16.67 percent. Multiply this percentage by the net interest to find Ted and Ginny’s decimal interest. 0.25 x 0.1667 = 0.041675. This means that Ted and Ginny are entitled to 4.1675 percent of the gross value of production from the spacing unit.

Is it possible to “rewrite” a lease with a division order?

No. Montana law states that a division order may not alter or amend the terms of the underlying oil or gas lease. However, division orders sometimes include information beyond what is legally required. Landowners may want to be careful as they review this information, consulting legal professionals as necessary. After a division order is signed, its terms remain in effect until production ends or a new division order is signed to replace it. After signing the division order, the mineral owner is a royalty owner.

How long do I have to wait to get paid?

The first royalty check will cover the first six months of production, but it usually won’t arrive until sometime after the six months have passed. Remember that the check covers six months of production – it is likely to be much larger than monthly checks that come later. Although severance taxes are withheld, income tax implications may need to be considered.

After the first check, most royalty owners will receive monthly checks with a 60 to 90 day delay from the date of production. Check the stub for information about the dates covered by the check. In some cases, checks will be less frequent.

If royalty payments are withheld, the mineral owner/ lessor is entitled to the unpaid royalty plus interest.

What is on my check stub?

Montana law requires the following information on your check stub:

1. Name of the royalty owner to whom the payment is made
2. Date of the check, draft or order
3. Any royalty owner identification number used by the producer for the royalty owner
4. Time period during which production occurred for which payment is being made
5. Any number used to identify the lease under which production occurred
6. Type of product produced
7. Barrels of oil and cubic feet of gas for which payment is made
8. Amount and type of all taxes withheld
9. Net value of production
10. Royalty owner's net value
11. Contact information for obtaining additional information regarding the payment and answers to questions

The check stub should also include your decimal interest and the price received. Depending on the format, you may have to determine the post-production costs that are being levied.

Is my stub right?

This is up to the royalty owner to verify and underscores the importance of keeping accurate records. Production records have to be reported by the operator to both the BOGC and the Department of Revenue. This affords the royalty owner a chance to doublecheck figures on the check stub.

Example 3: A well produces 100 barrels of oil in a month. The production is marketed for $88 per barrel. The gross value of the production is $8800. Multiply this gross value by the decimal interest to determine if the amount on your check stub is correct.

Example 4: The well produces a gross value of production of $8800 in one month. At a royalty rate of 15 percent, the gross royalty payment is $1320. However, the operator spent $1775 trucking the oil to a pipeline where it was sold. The royalty owner’s share of these post-production costs is $266.25. The net royalty check (before severance taxes) is $1053.75.

Check stubs vary slightly by company. Although the included information should be mostly the same, different formatting may mean that it is in a different place on the check stub. For royalty owners receiving checks from multiple companies, it is important to become familiar with each style of stub that you receive.

As part of the recordkeeping that any mineral owner should do, keep all check stubs for at least seven years.

The royalty owner should receive a 1099 for your tax return at the end of the year. Check the form against the check stubs for the previous year.

Is there a minimum amount of royalty that has to accrue before I get a check?

Yes. Owners with small decimal interests or owners of property with low production may have to wait until a minimum amount of value accrues before they will see a check. Montana law allows semiannual payments for royalties less than $50 and annual payments for amounts less than $10. However, no matter how small the royalty amount, the royalty owner must be paid.

What should I do if I don’t receive a check?

In the event a royalty owner does not receive a check for a well that is known to be producing, the first place to start is with the operator. In the event that the operator does not respond to requests for information, a mineral owner has recourse to obtain production information through the BOGC. An action to collect unpaid royalty must be made by the royalty owner in the district court for the county in which the oil or gas well is located; unpaid royalty bears interest at the rate allowed by state law, and court costs and attorney fees are recoverable by the prevailing party.

Natural gas from my well is being flared. Can I get paid for the lost royalty?

In many cases, natural gas that is produced with oil is flared, or burned off, at or near the wellhead. In many cases, this is done for safety, but flaring occurs in some cases because pipelines for the gas are not installed.

Since most leases include a royalty for the production, some landowners worry that flaring is “wasting” their money. In Montana, there is a limit of 60 days after completion during which gas can be flared. If gas is flared beyond that time, a royalty owner should contact the operator.

What other resources are available?

There are thousands of royalty owners in the United States. The National Association of Royalty Owners (NARO) is an organization dedicated to protecting royalty interests. The NARO website (www.naro-us.org) provides useful information. It is important to remember that some state regulations are specific to Montana.

Glossary

Check stub: A record of the royalty check that is provided to the royalty owner along with the check itself.

Completion: Finishing the process of well construction, which allows production of oil and gas to commence.

Division order: A legal document signed by the operator and royalty owner after a well is completed and before any royalties are paid.

Drilling: The stage of development involving physical construction of the borehole, which may take from days to months to conduct. A drilling rig is on the surface and considerable traffic and business prevails.

Staking: The marking of a well location on the surface. Must occur before drilling begins.

Surface-use agreement: A contract between the surface owner (may be the same as the mineral owner) and operator regarding the terms and processes of entry onto the surface and reclamation.