Beginner's Guide to Oil and Gas Leasing
This is an introductory course for non-oil and gas practitioners. It covers the basics of oil and gas leasing and mineral ownership. It also covers common oil and gas problems which appear in unrelated litigation, for example probate or family law. This course is designed to help general practitioners protect their clients cheaply and efficiently.
- Hi, my name is Josh Stein. I'm an oil and gas lawyer from Houston, Texas. I'm here to talk about CLE for general practitioners. It's a beginner's guide to oil and gas leasing, and it's meant to cover the basics of oil and gas for people who don't practice in this area too often. I'm actually a Texas and a New Mexico lawyer. I'm gonna be focusing on Texas law in this CLE for the purposes of this CLE they're basically the same between the two states. There's a couple of exceptions in New Mexico idiosyncrasies and Texas idiosyncrasies, but for the most part, most states follow what Texas does in oil and gas production. And this... The information here should carry over into those other states by and large. Anyway, to begin with oil and gas, like all real property follows the bundle of sticks theory. The first set of sticks in oil and gas is the mineral estate and the surface estate. The mineral estate and the surface estate are totally different to estates and land. They are completely severable. It's very common for one person to own the surface and for a group of people to own the mineral estate. And it's the exception rather than the rule that the surface owner in Texas owns a large portion of the minerals. Typically the minerals have been reserved over a period of time. The mineral estate has five components, so there's five sticks within the mineral stick. The first is the right to develop the property, which means to drill the property yourself. The second is the right to sign an oil and gas lease. This is also called the executive right. That's the right to let somebody else drill the property and to sign a lease allowing that. The third is the right to receive a bonus payment. A bonus payment is a one-time payment made to landowners in exchange for signing an oil and gas lease. It's an incentive to sign now and get paid now, as opposed to waiting what could be several years before oil and gas is actually produced from the property. The fourth right is the right to receive delay rentals. Delay rentals are historical. They're not really used anymore. A delay rental is a payment by the oil company to the landowner to continue the lease without drilling the well. Typically those are now included in the bonus. So an oil and gas lease with no delay rentals where the bonus has been fully... Has included the delay rentals is called a paid up oil and gas lease, which is far and away the industry standard. It's very rare to see delay rentals in a modern oil and gas lease. And the fifth and most important stick is the right to receive royalty payments. A payment of on-production is a royalty payment and it's where people either make money or go broke in the oil and gas business. It's where the bulk of money goes and it's what you need to be focused on when you're negotiating an oil and gas lease is to make sure that your royalties are as high as they possibly can be. There's a couple other clauses that I'm gonna talk about later on in this presentation, but for now, these are the... These are the five bundles to keep in mind. One of the common severances in oil and gas is a severance of the leasing rights from the royalty rights. So a landowner will reserve the right to receive royalty, but not the right to sign an oil and gas lease or to receive a bonus or to develop, and that is called a non-participating royalty interest. It's non-participating because they don't sign leases. And it's a nonposessory right to receive money without any right to lease the property. It's an important distinction to keep in mind because typically the two... The two types of interests in mineral property are the mineral estate, which is the right to sign an oil and gas lease and the non-participating royalty interest which is the right to receive payments. Typically, a mineral owner will also own some royalty rights although it is not unheard of for the mineral owner to have no royalty rights and only leasing rights. A lot of them don't know that they own only leasing rights, but sometimes they learn the hard way. Anyway, oil and gas leases are not leases in the typical sense of the word. They're not leases in the sense that you can lease a car or lease an office or an apartment, they're called leases for historical reasons and oil and gas lease is a fee simple determinable conveyance of the mineral estate reserving a nonposessory interest in royalty and reserving a reversionary interest in the mineral fee. That is a very convoluted way of saying that it's not a lease and that is really the primary reason they're called leases because if you approach someone and ask for a fee simple determinable interest in the mineral estate, they're not gonna know what you're talking about, but if you ask for an oil and gas lease, then they'll probably sign. There's also a historical reason for why this convoluted definition exists, when oil and gas was first being developed in Texas and when oil and gas law as a body of law was first developing there was questions as to whether an oil and gas lease is a violation of the rule against perpetuities. The courts determined that because an oil and gas lease is a fee simple determinable, it is not a violation of the rule against perpetuities, it is a present conveyance of the mineral fee with a future interest in the reversion after the lease terminates. And the future interest is vested in the landowner when the lease is signed, therefore it's not a violation of the rule against perpetuities and that's an important distinction to keep in mind, it's a historical distinction, but it still exists. There's incidentally, there are a lot of areas in law with interesting foundations that are no longer cited because they're all just sort of accepted. If you wanna read more about those, you should look into a guy named Lemuel Shaw. He was the chief judge of the Massachusetts Supreme Judicial Court in the 1850s and 1860s. He wrote a lot of opinions that at the time were cutting edge and very important. He dealt with a lot of fugitive slave laws and was one of the leading abolitionist figures at the time, one of the best judges to sit on the bench. And nowadays he's completely forgotten because fugitive slave laws are not part of modern American law and we don't have to cite his opinions anymore, but at the time they were very important and he had a son-in-law who was a total deadbeat. Couldn't make a dollar, couldn't support Lemuel Shaw's daughter and Lemuel Shaw hated the guy. It's just a tragic story. His son-in-law wrote a book about a whale. His name was Herman Melville. And the true tragedy of Lemuel Shaw is that this great legal scholar is now completely forgotten about and we all know his deadbeat son-in-law. So there's truly no justice. Anyway, oil and gas... Oil and gas leases as a fee simple determinable are similar to Lemuel Shaw in that they are foundational, but they are... But the cases are not particularly important nowadays. They are important in the sense that Texas law has two cause of action for disputing royalties under an oil and gas lease. One of them is the trespass to try title cause of action. The other is the declaratory judgment cause of action. Trespass to try title does not allow for attorney's fees, declaratory judgment does. Trespass to try title has a couple of weird idiosyncrasies that the court has recently lightened up on. And there's some distinction in Texas case law as to which cause of action is appropriate. I'll get into that later. But the fact that oil and gas lease is a fee simple determinable where the landowner reserves a nonposessory interest in royalty is actually dispositive in answering which of those... Which of those two causes of action is going to apply. So it does have relevance today. And you'll also seem smart if you know that an oil and gas lease is not a lease. There is a important distinction to be made between the surface estate and the mineral estate. The mineral estate in Texas is dominant over the surface estate. It doesn't matter if it's urban or rural. It doesn't matter if you're rich or poor. If the surface estate is worth millions of dollars and the mineral estate just has marginal production, the mineral estate is still dominant. It is a one-size fits all sweeping rule. It exists for historical reasons. When oil and gas was first being developed in this state, it was in rural areas. There were fewer landowners out there. There were fewer restrictions on use of the surface, title is easier out in rural areas as opposed to in urban areas 'cause you have to trace title for 100 different residential properties as opposed to one different... One discrete 640 acre section or something like... Something to that effect. So when I say the mineral estate is dominant, what I mean is a mineral owner can use as much of the surface as is necessary to develop the mineral estate. And the surface owner really has very few rights. The seminal case on this is Getty Oil versus Jones. That case involved a sprinkler system that was used on a farm, the oil company wanted to put a pumpjack on the farm which would've interfered with the sprinkler system. It was one of those rolling sprinklers that wasn't able to roll past the pumpjack 'cause it wasn't tall enough. And the surface owner said that the mineral estate needed to accommodate him by getting a smaller pumpjack or digging a shallow ditch and putting the pumpjack in the ditch so that the sprinklers could roll over it. The oil company refused to and he filed a lawsuit and he won. And Texas court said that a mineral estate needs to reasonably accommodate the prior existing use of the surface. But that's about it. It has to be a prior existing use and there has to be a way to reasonably accommodate it. And if the mineral estate can't reasonably accommodate the surface estate, that's too bad for the surface estate. Texas courts have moved more in favor of the mineral estate over the years, it's gotten worse and worse for surface owners and they have relatively few rights at common law, which is something that often surprises people who are not familiar with the oil and gas business is the mineral estate really controls everything. You can add new rights to the common law through contract. You can get a surface use agreement. I always advise surface owners to get one of those. You have a lot of negotiating power if you own the surface and some of the minerals. If you own only the surface, then you're kind of reliant on the oil company being a good neighbor, but typically they want to be good neighbors. They wanna have good relations with the surface estate because you're gonna be stuck with them for a long time and they don't wanna get locked outta the property. They don't want the surface owner shooting their crews, that kind of thing. So it's usually a good idea to sign a surface use agreement whether you're the mineral owner or the surface owner and by mineral owner in this case, I mean oil company, not the individual who owns the minerals and that'll just ensure good relations and create rights that don't exist at common law for the surface owners. So if you want to see an extreme example of the surface estate being subservient to the mineral estate, you need to look no further than the Oklahoma State Capital Building. There is a working oil well in the parking lot of the Oklahoma State Capital, and they've got a Derrick and a couple of oil tanks out there and it's been in operation for many years. It'll probably continue that way. And all of the state legislators walk by it on their way to work every day. It's... You can drive right up to it and look into it. It's an interesting little site and these are gonna become more and more common as oil and gas production extends into populated areas. And as populated areas extend into old oil fields outside of cities. So there's a case that I like to talk about whenever I'm talking about the surface and mineral estate distinction. Texas has done a very good job of screwing up the definition of minerals. For a long time everybody wanted to be an originalist and follow Scalia. And when a deed reserves minerals, it's unclear as to whether the word minerals refers to what a scientist would consider a mineral or whether it refers to coal, carbon dioxide, caliche, sand, that kind of thing. You know, a typical oil and gas reservation in a deed will say oil, gas, and other minerals. And the definition of other minerals has never really been clear. So for a while there the Texas courts would apply what they called the surface destruction test, which meant that if the operations to extract the minerals destroyed the surface, then the mineral is part of the surface estate, but if it did not, then it's part of the mineral estate. So you would have these crazy scenarios where coal, which could be mined without destroying the surface is a mineral, but coal close to the surface is not a mineral. And obviously that is an untenable legal distinction. We don't have it anymore. It's beyond the scope of this paper, but it's convoluted and stupid. And for our purposes here, oil and gas are minerals that are always within that definition whenever they're talked about. So the case I mentioned earlier is State versus CEMEX Construction Materials South. It's an El Paso Court of Appeals case from 2011. And in this case, CEMEX, which is a cement company from Mexico acquired some property in west Texas in the Trans-Pecos region and the property that they were mining for cement precursors for sand and things like that had a reservation from the state of Texas when it was originally patented and the reservation covered, "Precious stones or any other non-metallic mineral "and stones valuable for ornamental "or building purposes or other valuable building material." So the question is, what is that? That's a extremely broad language. It seems to cover everything. And what does CEMEX actually own if that much has been reserved, right? If you're reserving stones, precious stones, or any other non-metallic mineral and stones valuable for ornamental or building purposes or other valuable building material, what are you actually selling? So the El Paso Court of Appeals held that the state of Texas had reserved, "Title to all deposits of granite, "limestone, gravel, sand, and any other mineral substance "of whatever kind or character having commercial value." It's a shocking outcome for CEMEX because I'm sure they must have asked their lawyers this, what do they own, right? They don't own sand. They don't own gravel. They don't own other mineral substances of whatever kind or character having commercial value. If you go to Home Depot, you can buy a bunch of crushed up rocks for your garden. Those have commercial value. Those have been reserved. If there's cow shed out there, that's fertilizer, that has commercial value, that's been reserved. Seems like any rock has been reserved. Building material has been reserved. If there's a tree out there, it's been reserved, maybe a small bush would not be reserved. The physical space that the stones occupy is not reserved. And it's just... It's an outrageous case. It's a shocking distinction. And it's one that pretty much follows under Texas law of allowing parties to reserve various aspects of the surface and mineral estate. And here the state has pretty much reserved everything. Unfortunately it didn't get to the Texas Supreme Court, I believe it got settled, but it's a fascinating case and a warning to those who would take title to land without reading all of the deeds because you could have something crazy in it like this. And unfortunately for CEMEX it was the state of Texas that had reserved this insane reservation and you can't adversely possess against the sovereign. So they pretty much bought an empty bag. Anyway, one of the other... One of the other interesting aspects of the surface estate which is often overlooked is the value of the surface estate for easements and for pipelines. I've represented a couple of landowners who have small parcels of land out in East Texas and the Piney Woods that are pretty much forgotten about. It's just a bunch of pine trees that grow out there. There's no roads. They've never been there, but they still own the surface 'cause their great grandparents did and they've been paying the taxes all these years for whatever reason. Unfortunately for these guys, the land is crisscrossed by pipelines. It's very common for a pipeline to... A company seeking to install a pipeline, to stack the pipelines parallel to prior existing pipelines. So you'll end up with sort of a highway of six or seven pipelines all next to each other running down a piece of property. And if you own land crisscrossed by pipelines like that, the value of that land for easement purposes is often fairly high. You know, the pine trees aren't worth very much, but the pipelines and the right to install pipelines are. So it's hard to figure out what the value of an easement is. Typically easements are paid for by the rod, which is a measurement of some number of feets. These various measurements always escape me. We should switch to the metric system, but we haven't. So a rod is a length used for easement purposes and you usually get paid per rod. In East Texas, in the Piney Woods, they're maybe six, seven, $800 a rod, in Central Texas, in the pretty part of Central Texas, in the hill country, it's worth a lot of money, in the ugly parts of Central Texas, which will be unnamed it's not worth as much because apparently if the surface estate is not visually attractive people don't demand a lot of money for pipelines. I don't understand why that distinction exists, but it does. So if you have land in a flat and arid region, you won't get paid as much as you would in a hilly and tree covered region. The exception to that of course is the Permian Basin and the productive oil and gas counties where there's a lot of competition for pipelines and pipeline companies pay a higher dollar value to put easements on the property. The location of the pipeline matters in that sense, the size of the pipeline matters, right? It's the area of a circle is PI R squared. So a five-inch pipeline is substantially smaller than a 10-inch pipeline or a 30-inch pipeline. And the bigger the pipe, the more the surface owner can get for the value of the easement. The duration also matters and so does the substance. A pipeline carrying water or salt water will... Well, a pipeline carrying fresh water will get you less money than a pipeline carrying salt water, which is corrosive and will kill vegetation, and will get you less money than a pipeline covering oil, which is more hazardous or gas, which is explosive. So the substance being transported is very important in valuing the pipeline and the duration is also relevant. A lot of old easements will last forever even if the pipeline is abandoned and the ground collapses and the pipeline hasn't been used for 50 or 100 years, the easement is still there unless it expires by its own terms or unless you can show an intent by the easement owner to abandon the pipeline. And of course, that's very hard to do because if the pipeline owner has a right to abandon the pipe in place without terminating the easement and he does just that, then he hasn't expressed an intent to abandon his legal rights so much as an intent to let the pipe rot. So they do tend to last forever and a way to avoid that is to contract around. Didn't just say that the pipeline will expire if it's not used for some period of time, usually about a year. It's hard to put a dollar value on these things. The pipeline companies keep their valuation very close to the vest for obvious reasons. What you wanna do if you encounter... If you have a client who is offered an easement on his property is hire somebody who knows about the value in that area, find a landman or someone who gets easements for pipeline companies. And they should have a pretty good handle on how much it's worth. So you can hire a landman for 200 bucks and they'll tell you what an easement is worth per rod in their area. And sometimes they'll do it for free if you're nice to 'em. So it's a easy way to increase the value of your client's property substantially. And there's a lot that goes into the calculation of what they're worth. They now... Another thing to keep in mind here is, pipeline companies have eminent domain powers. You cannot say no and you really don't wanna say, no. You want the pipeline on your property because if the pipeline is next to your property, you don't get paid for it. If it's across the property line by six inches, then your neighbor gets the money. And if there's a spill or some kind of disaster, then you get to deal with all of the problems and you don't get paid to have it installed in the first place. You also have the work crews coming over to your property to dig the hole and put the pipeline in without getting paid for it. So really you want these things to be on your land as opposed to adjacent to your land. The same is true of course for overhead transmission lines. People will fight those tooth and nail to keep them off their property, but if they just hop across the street and put them on your neighbor's property, you still have to look at it and you probably still have to drive under it on your way to your ranch. So you might as well get paid. It's just a, you know, people have a knee-jerk reaction to fight these things, but the alternative is they build next door and you don't get any money. So you get the worst of both worlds. Mineral owners on and oil and gas lease do have a right to put pipelines across the surface to the extent that their minerals are contiguous with the surface. So for example, if a oil company has a lease on farm A and they wanna put a pipeline across farm A and farm B to get to connect to an existing pipeline and sell their gas into that pipeline, they have a right to cross farm A, which is what the oil and gas lease covers, but they do not have a right to cross farm B. So you can use the surface of farm A to benefit the minerals of farm A, but you cannot use the surface of farm B to benefit the minerals of farm B. You have to get an easement from farm B in order to cross farm B. That's an important distinction that a lot of people ignore. Anyway, there's some interesting oil and gas lease problems that tend to crop up. One of them is adverse possession. Adverse possession of the surface will apply to any unsevered minerals. It does not apply to severed minerals. So if you have a squatter on the surface and the surface owner owns half of the minerals, the squatter will get half of the minerals. He will not get the other half, which would be owned by a third party. If the squatter enters the property and a year later the minerals are severed, the squatter will still get the minerals. The severance has to be prior to the squatter entering the property. So one of the things that I typically advise people to do is to sever their minerals from the surface estate and make sure that a different person owns the surface from the person who owns the minerals. Set up a trust for an LLC or something like that to avoid this problem. Particularly if you're a landowner in another state and you're concerned about squatters or you have some small parcel of property like... There are a lot of... There are a lot of places in South Texas where they planted towns and little subdivisions and sold off 10 and 12 acre lots of property, but the town never got built 'cause the railroad never came through. And all of a sudden you end up with these enormous ranches that surround little paper subdivisions that don't exist except in the deed records. And so you'll have a different owner of those little 10 acre parcels than you do of the surrounding parcels and adverse possession happens and the owners of those small towns tend to lose out unless the minerals are severed. So it's very important to sever the minerals and get rid of the surface if you possibly can. It's an interesting area of litigation. And if one of those ever comes up, by the way, the surrounding landowner has to jump through a bunch of hoops to adversely possess enclosed property. They have to enclose the property that they're adversely possessing, the little parcels with a substantial fence. A fence around their entire ranch won't work. You have to have a fence around the interior parcels that are being squatted upon. They also have to actually possess them, right? If you have a... If you have a 10,000 acre ranch that you have cattle on, you're not necessarily adversely possessing the interior parcels because maybe the cows aren't walking on those interior parcels. So that's another thing that the adverse possessor is gonna have to establish before they can get to the minerals. Now, adverse possession of severed minerals does exist in Texas. When somebody drills an oil well and they don't have a lease, but they produce it anyway for 10 years and they pay royalties anyway for 10 years, they will adversely possess an oil and gas lease covering those unsevered minerals. This typically happens when you have a property with 100 mineral owners and 99 of them have an oil and gas lease that stays in full force and effect and one of them has a lease that terminates for some reason and the oil company by paying royalties as if the lease did not terminate can adversely possess an oil and gas lease covering that mineral interest. That's natural gas pipeline versus pool. Texas has several adverse possession statutes of limitation, adverse possession of minerals under natural gas pipeline versus pool was the 10 year statute of limitations. Another interesting oil and gas problem are rivers and streams. So let's say your property is bounded by a river and in 1950, the mineral owner or the surface owner reserves all the minerals and sells only the surface and the river moves over the next 70 years, the movement of the river or stream, right? We all probably remember this from One L Property Law. Erosion will destroy property and property will decrease. Accretion will increase property and you get, you know, as a river builds up dirt and silt and sand, the bank on which it is built up gains at the loss of the bank on which it is taken away. There's also reliction and evulsion which are sudden movements of water. Those don't change property lines, but accretion and erosion do. If the property line is changed by manmade action, like the core of engineers builds a dam or moves the river for some reason, that will not change the property line, only accretion and erosion. So accretion and erosion will alter the shape and size of the mineral estate. And if you think about it, it makes a lot of sense because it's easy to see where a river is today, but it's much harder to see where a river is in 1950 like in the example because it moves, you know, evidence disappears, that kind of thing. So allowing the river to alter the shape of the mineral estate will ensure uniformity and prevent a jagged edge to mineral owners. And as severances occur over time and minerals and... I'm sorry, and rivers move over time. That's another interesting area of law. If you are representing an oil company and a river is wide enough, I believe it's 50 feet from bank to bank or something like that. You have to get a lease from the state of Texas. They'll also enter into a pooling agreement because the state owns rivers. They'll enter into a pooling agreement with you to get that river leased, but you have to lease it. You can't leave it unleased. Otherwise you have an unleased mineral owner in the middle of your unit. So that's sort of a general overview of oil and gas in at 30,000 feet. As far as practical guidance goes, when you're negotiating an oil and gas lease, you wanna get a quarter royalty. That's the payment on production the landowner is gonna receive. So for every dollar that comes outta the ground with a quarter royalty, you get 25 cents paid to the landowner. The lease could last forever, in the early days of oil and gas, one eighth was the standard royalty and people would buy and sell fractions of what they called the usual one eighth which results in all kinds of complicated cases and deed interpretation problems that we're still dealing with. But for the purposes of signing an oil and gas lease the standard in the industry is now a quarter royalty. And once again, this lease could last forever. So you don't wanna be like the guys who signed a one eighth royalty back in 1950 and are still getting a one eighth royalty when their neighbors are getting a quarter. You wanna get as much as possible and you wanna include a most favored nations clause in your lease to ensure that if royalties in the future are more than a quarter, if they're a third or 30% or something like that, then you'll be able to increase your royalty as well. Typically, oil companies will try to avoid that, but if the lease is already a quarter, then you know, what are the odds they sign up someone with a higher royalty nearby? It's fairly low. So sometimes they'll go for it. There are sometimes royalties that are more than a quarter I've seen a couple of them. They're very rare. Usually it's because the oil company screwed up and didn't lease somebody and gave them more negotiating power. If they drill the well and the well is productive, a mineral owner will probably demand a higher royalty then he would have otherwise. I'll get into that later on another. Another practical guide is to get a good bonus. A bonus payment like I said earlier, is a payment as a consideration for signing the lease. Some people will be tempted to cheat the royalty owners. So if your client owns only minerals and only the executive rights and does not have a right to receive royalty payments, they may be tempted to say, "I want a $1 million bonus "and a 0% royalty or a 1% royalty." You can't do that. A mineral owner has a duty of utmost good faith and fair dealing to the royalty owners. It is not a fiduciary relationship, but it's pretty close. So you're not allowed to get a large bonus at the expense of a low royalty for the royalty owners, but you should get as good a bonus as you can. A bonus is a covenant not a condition, So is a royalty payment. This means that if you get an oil and gas lease and you don't get paid royalty or you don't get paid the bonus, the lease is still effective. You have a breach of contract cause of action against the oil company for not paying the bonus or not paying the royalty, but you do not have a right to terminate the lease. And that applies whether or not the royalties are not paid to the correct party. If they pay the wrong person, the lease is still effective. If they don't pay because there's a title problem and they put you in suspense, then the lease is still effective. If they don't pay because they're just stealing the money, then the lease is still effective. So it's very important that landowners understand that they have to be paid upfront and that they are aware of who they're doing business with. There's a lot of people in the oil and gas business who will go out in a hot area and acquire as many leases as they can and they'll say something like, "I'm gonna pay a $10,000 bonus in 60 days." And the plan is within those 60 days to flip the lease to some other company, get paid a bunch of money for it and then pay the bonus out of that money. That's more common than you would think. And it's not necessarily a good thing for the landowner because if the lease does not get flipped or if the lease is not effective or if the lease... If they're drilling a test well in the area that doesn't pan out and nobody wants to buy the leases then you don't get paid your bonus and the landman who took the lease from you changes his phone number and disappears. So get paid up front and be aware that you're not going to be approached by EOG or by Chevron or by Exxon to sign an oil and gas lease. You're gonna be approached by a landman with a innocuous sounding name who is working for Chevron or EOG to sign a lease. That's, you know, that's the way they do it. Like when they built Disney World in South Florida, Walt Disney didn't go to a bunch of people who owned a swamp and say, "I'm gonna turn this place into a magical kingdom." They had a bunch of lawyers who were just buying land for them surreptitiously. So the same thing happens with oil and gas. Another practical guidance is to get a vertical and a horizontal pub clause. Typically an oil and gas lease will last for as long as production continues from the property, could be forever and it will hold the entire property in effect if they have one well. So if you have a 640 acre ranch, which is a one square mile and you sign an oil and gas lease with no pub clause, then one well producing one barrel a day will keep the lease in effect for the entire 640 acres. So what you wanna do is get a pugh clause that says, a well can only hold 40 acres around the well and the lease will expire as to all other acreage if production from the... If production doesn't continue. If you don't keep drilling new well after new well, the lease will expire as to all acreage except 40 acres around the producing well. That's called a Putte clause. They can be vertical and horizontal in the sense that you can sever 40 acres around each well or you can say, it'll expire as to 40... As to everything except 40 acres around each well and as to every non-productive zone. So when you think about oil and gas, it's not a lake of oil underground. It's a series of geological layers and many of them will have oil and gas possibilities in them. You know, there's the Wolf Camp, the Bone Spring, the Mississippi, there's a bunch of different zones, you know, vertically underground and oil companies will typically enter the most productive one or the deepest one first and produce from there and then move up the hole and produce from other zones as time progresses. And what you wanna do in a sophisticated area is to sever the different zones from each other and say that this lease will continue for as long as production continues as to the deepest producing formation and 100 feet above that or something like that. And that way, if they move up the hole, they have to take a new lease from you with a 40 acre puke clause, they'll have to get new lease from you if they drill a different well. That will ensure that you get more bonuses as time goes on. You get more and newer royalties. So if the royalty on an oil and gas lease goes to a third, instead of a quarter, you'll be able to get a higher royalty in the future. And it will allow you to lease the property to other oil companies as opposed to the one who is out there with their individual well. So that's something a lot of people miss, if you get a quarter royalty with no Pugh Clause, you haven't really done a very good job unless of course your client owns less than 40 acres. In which case, you know, who cares? Like I said earlier, get a surface use agreement. If you own the surface and you own the minerals, get a surface use agreement, you can set out which roads the oil company is allowed to use whether they're allowed to build new roads, you can set exactly where the tanks are gonna be, where the pump jacks are gonna be and what they're allowed to do on the property. Most of them say, no fishing, no hunting, no sleeping, no dogs, no drugs, no guns, things like that, no driving more than 25 miles an hour, but you also get surface damages. You get to say, if you cut down a tree, I get a $1,000 and that that's all very valuable. You get to make sure that oil field equipment is not placed physically close to houses or barns or out buildings. You get to make sure that the oil companies don't use the wrong road or don't drive off road and that kind of thing. It's just... It's very, very important. If you are the surface owner to get a surface use agreement. And you know, one of those reasons is without one, the common law really doesn't protect a surface owner very much in the state of Texas. And you don't wanna discover a bunch of weird stuff on your property. Usually it takes the form of garbage and abandoned equipment and things like that. If they are abandoned, they become property of the surface owner, but typically they have no value and that's why they've been abandoned. And you can also get environmental remediation damages. You don't... If you look at my slideshow you don't wanna be either of these two people. Anyway, one of the common things going on certainly nowadays, this is being recorded in the summer of 2022 when oil is, I don't know, $5,000 a barrel and a million dollars a gallon or something got awful like that. So there's a lot of people who are now buying oil and gas property and buying minerals from folks who own them. It's a fairly mature industry and it is an aggressive industry. It's typically the advice that everybody gets is never sell your minerals. That's sometimes good advice, sometimes bad advice, but everybody will say, my grandpa lived out on that farm and he knew there was oil under there because he used a defining rod and he could tell and I'm never gonna sell my minerals no matter what. If oil's $120 a barrel and you're getting a price can measure it with that. It might not be a bad idea to sell. One of the things to be aware of, if your client gets a solicitation to sell their minerals is the difference between net mineral acres versus net royalty acres. It is a confusing and stupid distinction. A net mineral acre, one surface acre equals one net mineral acre, right? So if you think about one acre of land on the surface, that's one acre of minerals. Minerals that are subject to an oil and gas lease become royalty acres and 100 mineral acres under a one quarter oil and gas lease is calculated as follows, 100 mineral acres times eight royalty acres per mineral acres times a quarter royalty reserved in the lease is 200 royalty acres. So confused yet? A one mineral acre is eight royalty acres. And the reason for that is, once again historical. Back in the day people would buy and sell in terms of one eighth. They used to buy stocks in terms of an eighth as well. And then I guess somebody figured out you could use a 10th and the math would be easier, but for historical reasons, one mineral acre is considered eight royalty acres and royalty acres are counted in factors of eight, whether least or not. So if you have 100 mineral acres, then you have 800 royalty acres. And if you sign a lease with a one quarter royalty, then you have a quarter of those. You have 200 royalty acres. So if you look through my slideshow, I have a bullet point in here under one of the slides that says, what if you have a floating 25% non-participating royalty interest in 100 surface acres under a three 16th oil and gas lease? And so that's too complicated. Use the decimal. The distinction between mineral acres and royalty acres is stupid and esoteric and it is designed to confuse people. Everybody in the business uses the distinction. There's no reasonable purpose for using the distinction other than information asymmetry and fraud. It's just... It's just a stupid thing to do. Incidentally one of the things I haven't really touched upon, I say in here, what if you have a floating 25% non-participating royalty interest and that is sort of industry speak. A royalty of one half is considered a fixed one half royalty. You get paid half of the royalty regardless of what the royalty is. Back in the day when everything was done in terms of one eighth, landowners would typically buy and sell fractions of what they referred to as the usual one eighth. So if you have a deed that says, I'm reserving one half of the usual, one eighth being one 16th, Texas courts have struggled to try to interpret whether that language one, half of one eighth being one 16th is one 16th or if it is one half of whatever the royalty is because people would use one eighth as a sort of shorthand to refer to the landowner's royalty. So if a deed conveyed half of an eighth, is it conveying half of whatever the royalty is, whether it's an eighth or a quarter or is it conveying half of an eighth, which is a 16th, regardless of whether the royalty is a quarter or an eighth? Texas courts are moving very strongly in the position... In the direction of saying that those royalties float. A floating royalty. So if a reservation of half of the usual one eighth means half of the royalty reserved by the landowner, then that royalty is called floating. It will go up if the landowner has a larger royalty and it will go down if the landowner has a smaller royalty. Half of the usual one eighth floating is half of a quarter, if the lease has a quarter in it, it's half of a sixth... Of three 16ths. If the lease has a three 16ths royalty in it and so on. It's an active area of litigation. There's millions and millions of dollars being misallocated based on this small and idiosyncratic issue. And it's a fun area to practice law in. So other advice for landowners is to always lease. Unleased drill site tracks get nothing until the well reaches payout. So if you have a... If you have a subdivision and they're drilling a well in the subdivision and there's say, it's a 40 acre unit, there's 40 houses in the subdivision each one have one acre. A person who owns a tract where the drill does not go into the ground is a non-drill site tract. And if you are a non-drill site tract and you do not sign a lease you will never get paid anything. You don't have a lease. There's no contractual obligation for the royalty owner to pay or for the lease owner to pay you. You get nothing. If it's a horizontal well, it's a little more complicated. The underground horizontal borehole, if it crosses under your property, you're a drill site tract. If it does not, then you're a non-drill site tract and you have to sign a lease. So if you're not on the property where the drill goes into the ground, you get nothing. Very important thing to keep in mind when someone is leasing in a residential area or in an area with small parcels of land. If you are in unleased drill site tract, meaning that if they say they're drilling in a 40 acre unit and everybody owns an undivided portion of all 40 acres, then you will get paid nothing until the well reaches payout. So that means that the oil company gets to make the money back that they spent drilling the well before they're obligated to pay any unleased co-tenants anything. And as you can imagine, oil companies don't inform unleased co-tenants when they reach payout and they just never tell them, they put the money in their pockets. There's a rolling four-year statute of limitations for nonpayment of royalties. And a lot of people just don't think about it and don't realize it. But if you are unleased on a drill site tract and the well does reach payout, then you get 100% of your interest. So say you own 10% of the minerals and if you sign a one quarter lease, you get paid a quarter of 10%. If you do not sign a lease, then after the well reaches payout you get 10% with no quarter reduction. So if you're sophisticated and if you're gonna keep an eye on the property and if you think the well is actually gonna reach payout, quite a few of them don't, then it may behoove you not to sign an oil and gas lease. But that is by far the exception, not the rule. When you're negotiating an oil and gas lease, a lot of people will go onto online forums to try to find out how much a good bonus is in their area. What a good royalty is in their area. That's typically not a good idea. They're somewhat helpful, but you have to be aware that a lot of unscrupulous landmen will go onto these websites and post as if they are landowners and say, "Well, I got $100 an acre and I got $200 an acre." When in fact they're paying a lot more than that so that people will go onto the websites and see, oh, this guy who owns land near where I own land got $100 an acre, I guess I'm doing pretty good at 150 when in fact you could get more for the bonus. So there's a lot of false information on websites like that. It's very hard to find out what the market rate for a bonus is, that information is kept pretty close to the vest. And you just do the best you can. Another thing to keep in mind is that drainage is real. If you look at my slideshow, there's a picture of some property. This is from the Railroad Commission, is in Central Texas and the property to the left has a bunch of little green dots. Those are oil wells. The property to the right doesn't have any green dots. The guy on the left signed oil and gas lease, the guy on the right did not and the guy on the right got drained by all the wells on the left. So drainage is real. It happens. Daniel Plainview was right when he talked about drinking someone else's milkshake and you want to... You wanna sign an oil and gas lease to make sure it doesn't happen to you. Another thing landowners don't do is check their division orders. A division order is a document that oil companies will send out and you're supposed to sign your name, sign your social security number and your address and if you read it, it says, "I am indemnifying the oil company "and verifying that my interest in the property "is some small decimal 0.00001 or something like that." And by signing that you are promising the oil company that you will not sue them if they pay you incorrectly. If you're paid incorrectly, you can sue the other mineral owners or the other royalty owners, but after signing a division order you cannot sue the oil company. Division orders are typically required before you're put in pay status. Texas law allows oil companies to require these. Everybody signs them. I've got some small mineral properties, I sign them. Of course, I'm an oil and gas lawyer so I check to make sure the small decimal assigned to me was correct and I think it is. But a lot of people don't and it's actually kind of alarming if you think about it. If you go to a store and you buy a stick of gum, you look at your change to make sure you're getting the correct amount, right? And make sure that there's two nickels and a quarter if that's what you're owed as opposed to two nickels and a penny. But when it comes to a division order where millions and millions of dollars change hands, the oil company basically sends out this one page document that says your interest is 0.0001 and people just accept that. They don't look under the hood. They don't think about it. They just accept it. I don't know why they do it, but they do. Well, probably the reason why they do it is it's hard to figure out whether that decimal is correct, but oftentimes it is almost certainly worth your money to hire a lawyer to go and find out and go read the deeds and look at the title and make sure that you are not, for instance, getting paid a fixed royalty when you should be getting paid a floating royalty. There are numerous idiosyncratic title issues that will alter the size of a mineral estate and a lot of them are very easy to miss. For example, there's a difference between land conveyed versus land described. If I sell a quarter interest in 640 acres which are described in the deed, then I've sold a quarter interest period. If I sell a quarter interest in 640 acres which are conveyed in the deed and if it turns out that I only own a half of the minerals, then I've sold a quarter of the half that I own. So that minor distinction between the word conveyed and the word described could double or worse the size of the interest being affected. So long story short, when you have a client who's getting paid a lot of oil and gas money, hire someone to go look at the title and find out whether they are getting paid correctly because huge numbers of people are getting paid incorrectly and nobody thinks about it. It's just something that is not part of the social consciousness and like I said, you get short changed on a stick of gum. You think about it. You get short changed on millions of dollars of oil and gas royalty while that's hard to think about. So I'm just not going to. And that's the world we live in. Anyway, the statute of limitations for getting paid the incorrect royalties is four years. It is a rolling statute of limitations for breach of contract or quasi contract. A lot of defense lawyers will tell you it's two years for unjust enrichment. There's some case laws supporting this, in my humble opinion the correct case law as a plaintiff's lawyer is that there should be four years of unpaid royalty. And I've cited some cases in my slideshow supporting my vexatious position on that. One thing to keep in mind when you're signing a division order is division orders do not convey anything. They are... They benefit the oil company. They are binding until revoked. They can be revoked at any time. You can call up the oil company and say, "I revoke my division order today." The problem with that is they'll probably put you in suspense, which is a status where they do not pay you until you comply with some kind of title requirements. And they hold your money in an escrow account for the... Held by the oil company. It doesn't bear any interest until the title requirement is resolved. Incidentally, if you are put in suspense and you don't get the money out of suspense, typically that is paid over to the permanent school fund and is cheated to the state after I believe, seven years, but I could be wrong about that. And your money will go to fund books and pencils for the school children of Texas which is not what you wanna be doing unless you're a philanthropist. So anyway, division orders, binding until revoked, can be revoked at any time, they're between the landowner and the operator. They are not between cotenants. So if I sign a division order and my neighbor signs a division order and I discover that he's getting paid my royalty, the division order doesn't matter. I can sue him for my royalty totally irregardless of what the division order says, they're really a non-issue unless you are suing the oil company. There's no estoppel. There's no waiver. They just don't mean anything unless you're an operator. Causes of action. I talked about this earlier, alluded to it for recovering incorrectly paid royalties. The declaratory judgment act applies to nonposessory interests. There's no limit on declaration of title. There's no statute of limitations. You can bring a case for declaratory judgment on what a deed from 1850 says, if you really want to. So there's no statute of limitations on bringing a declaratory judgment. There is a statute of limitations on collecting damages under it. Attorneys fees are available for a declaratory judgment, of course, and they apply to royalties. They do not apply to minerals. So if you have minerals under an oil and gas lease, then you have a declaratory judgment cause of action because they are producing minerals. You have conveyed the mineral estate and reserved a royalty interest only, therefore it's nonposessory, therefore declaratory judgment. Trespass to try title is the cause of action for determining title to land in Texas. Outside of narrow confines of determining boundary lines and adverse possession, there is no attorney's fees available for trespass to try title. If you have non-producing minerals, then you have a trespass to try title case. If you have producing minerals, it's typically gonna be a declaratory judgment case. And the reasoning is byzantine and arbitrary and confusing. The distinction that courts seem to make is that a non-participating royalty interest or minerals under lease which are royalty interests are nonposessory as opposed to possessory. Trespass to try title relies on the legal fiction that you are trespassing and entering upon property which is not your own. You can't trespass on a nonposessory interest, therefore a declaratory judgment applies to nonposessory and trespass to try title applies to possessory. I can't make head nor tail out of these cases. If you think too hard about it, you'll probably go insane. But suffice to say that royalties and minerals under lease are a declaratory judgment. And whenever you have a lawsuit involving this you should plead both causes of action in the alternative just to be absolutely sure. Adverse possession, by the way, does not apply to a nonposessory interest once again, because it's nonposessory, you can't possess it adversely. So minerals under lease are not subject to adverse possession. Non-participating royalty interests are not subject to adverse possession. And that's probably all you need to know about that unless you are very unlucky and have a case about it. Anyway, let's talk about something interesting, other than this dry legal fictions. Scams. So if you've ever been in the Wichita Falls area, you may have noticed a skyscraper dominating the skyline of Wichita Falls. And during the 1919 oil boom, a guy named JD McMan raised the equivalent of $3 million to build a skyscraper in Wichita Falls where six oil companies decided they were gonna lease their offices because it was a land rush. They couldn't sign up leases fast enough, everyone was gonna be rich. So JD McMan circulated blueprints showing the building would be 48... 480 inches instead of 480 feet tall. He used a little one apostrophe versus two apostrophes trick that tricked the guys in spinal tap as well. And he actually, after raising the money, he went out and built the building and it still stands today. There is a 480 inch skyscraper in downtown Wichita Falls. It's not located near the main drag, but it was on the main drag in 1919. When construction was complete, JD McMan did the wise thing and left town and disappeared from history. So that's a... Scams have been around in the oil and gas business for a long, long time. Hopefully you don't fall for anything that's sophisticated, but there is another scam going around nowadays that is quite prevalent and it is easy to fall for, it is called an oil and gas royalty lease. So it's a document that looks like an oil and gas lease. Sometimes the scam artists even format it to look like an oil and gas lease just by opening up a lease in Microsoft Word and changing the language around and nobody reads it. Nobody notices. So these documents will recite that they are paid up leases. They refer to the parties as lessor and lessee the granting clause says lessor or grants lessee and lessor and lessee and they cover a non-participating royalty interest. That's the critical thing to be aware of is they cover a non-participating royalty interest. The royalty owner gets a bonus and the documents typically contain a long arbitration clause. Anytime you see a long... Anytime you see a document that's two-pages long and one and a half pages is an arbitration clause. It's a pretty good indication that you should not sign it. A lot of the royalty leases do that. Some of them are more sophisticated and don't contain an arbitration clause, but a lot of them still do. So if you look at my slideshow, I've got some language from one of them. This one is an agreement between two people and it refers to the parties as lessor and lessee it has the granting language, grants leases and lets and at leases all of lessor non-participating royalty interest. Goes on to say, this is a paid up lease. Has a three-year... Three-year primary term and a addendum clause for as long thereafter as oil and gas are produced and the less so reserves a quarter of the royalty. I actually litigated this case, it's an interesting area of law. And the question is, what is this document? What is a "Lease of a non-participating royalty interest?" We all know that a lease in Texas terminology is not a lease like you normally think of it. It's a conveyance of a fee simple determinable interest, blah, blah, blah. And here we have a lease covering a nonposessory royalty interest and the proponents of this document took the position that this was a term conveyance of royalty which you can do. If you have a non-participating royalty interest you can convey it for some period of years and as long thereafter as oil and gas is produced, that's fairly common. But if you fill your document with language saying, this is a paid up lease, saying lessor and lessee and using all this oil and gas leasehold terminology, then the argument that the opponents of this document made was that if you design a fraudulent document that is supposed to trick royalty owners into thinking they're signing an oil and gas lease and thereby divest them of their royalty interest. What you've done is you've created an oil and gas lease. If it walks like a duck, if it quacks like a duck, if it looks like a duck, it's a duck. It's not a wolf in duck's clothing, to mix my metaphors. And so we brought a declaratory judgment action to terminate this documents and we were successful. There's a lot of these still floating around out there. The Texas legislature has recently updated the Property Code with section 5.152 to attack these documents, but be aware that if you have a client who is offered an opportunity to lease their royalty, that person is the target of a scam. There is no such thing as an oil and gas lease covering a non-participating royalty interest. It simply doesn't exist because a non-participating royalty interest is non-participating. It's nonposessory, it has no leasing rights. You don't have to sign an oil and gas lease for them to drill. If you're an NPRI owner you just have to sit back and wait. Anytime a non-participating royalty interest owner gets offered a lease, it is either a scam or an incompetent landman who's trying to do his job, but doesn't know how to. There's simply... There's no reason to lease an NPRI, it doesn't exist under Texas law. It's not allowed. You can convey it for a period of years, and if you wanna do that, use a standard term conveyance or use a regular conveyance without the period of years and make it simple for everybody. Anyway, if you have one of these cases, your causes of action are declaratory judgment, common law fraud, securities fraud, Texas has the securities act that you can use for this. It applies to both buyers and sellers of securities, and you can also use Property Code section 5.551 and 5.152. They're not perfect, but they are clear expressions of legislative discontent at this particular scam. So that about wraps it up. That covers everything I have to talk about. Once again, my name's Josh Stein, a lawyer in Houston. If you have any questions about oil and gas, I'm happy to talk to you, and thank you for listening.