Choice of two gross proceeds clauses, need help

Shales Marcellus Shale
1

i own a very small share and have been offered a lease, but need help/advice choosing between these two clauses. Which one is more beneficial to me? Thanks in advance!

Gross Proceeds at Wellhead

It is agreed between the Lessor and Lessee that, notwithstanding any language herein to the contrary, royalties payable on gas and gaseous substances, including casinghead gas, shall be based upon the MMBTu value of unprocessed gas at the wellhead, free of all costs, charges or deductions of producing, treating, compressing, transporting and marketing said gas to such purchaser, which royalty, however, shall be subject to such production and severance taxes as are properly allocable thereto.

Market Enhancement Clause

It is agreed between the Lessor and Lessee that, notwithstanding any language herein to the contrary, all oil, gas or other proceeds accruing to the Lessor under this lease or by state law shall be without deduction, directly or indirectly, for the cost of producing, gathering, storing, separating, treating, dehydrating, compressing, transporting, and marketing the oil, gas and other products produced hereunder to transform the product into marketable form; however, any such costs which result in enhancing the value of the marketable oil, gas or other products to receive a better price may be deducted from Lessor's share of production so long as they are based on Lessee's actual cost of such enhancements. However, in no event shall Lessor receive a price that is less than, or more than, the price received by Lessee.

2

The 2 clauses presented above are language that is used to describe a gross royalty position versus a net royalty position on your leased acerage.

The 1st paragraph above is a net royalty description. You will note that it assigns post-production costs and governmental severance taxes per the following wording:

shall be subject to such production and severance taxes as are properly allocable thereto.

This is NOT a good thing for you since the company determines what goes into those post production numbers. I have a sister that negotiated a net royalty lease with one of the oil & gas companies and her royalties have been reduced by 45% because of this stipulation. In effect, having a net royalty position is almost like having a working interest in the wells being drilled. You are inbusiness with the oil & gas firm and paying for your share of post production costs.

Since you are the owner of a small amount of acerage, IMO, you need to negotiate for a gross royalty position that does not assign any post production costs and the royalty received by you should be based the price received by Lessee ( oil & gas company) from a NON-AFFILIATED THIRD PARTY SALE.

In other words, the production should not be valued at the wellhead but at the point of third party sale.

You may also want to consider what the potential pay-off of your royalty position might be by looking at published production rates for wells in your area. This can be gotten off the Web by looking at State records. Is there much in the way of potential royalties to your position given the fact you have a small interest in the entore acerage being developed?

You may find out that negotiating a flat out sale of your mineral rights to the Lessee or a company that buys mineral rights might be the better option for you since your royalty position in the platform will most likely be small. This would allow you to get your money up front and not have to worry about production rates in the future and wait for a monthly or quarterly check to arrive. If you find out the sale price is not adequate, then you could go through with the lease.

The 2nd paragraph which is labeled "Market Enhancement" is one way to structure a "Gross Royalty" position in the drilling program, with an exception being in those costs that are incurred to enhance the value of the product to receive a better price. In that situation it is implies that you would be reponsible for your share of the enhancement costs.

However, I beleive the wording of this paragraph misses the mark as follows:

1) It does not define where the product will be priced, at the wellhead or at a third party sale. When it is not defined, you are at the mercy of the oil & gas company and it will be priced at the wellhead. IMO, that needs to be changed per my remarks above.

I would also modify the language above to include "POST-PRODUCTION" costs since those costs are well known within the industry and within the existing language above, they could be interpreted as not being in the list of costs above. In other words, be on the safe side and include the term "post-production costs" so there is not any question as to their inclusion to the list.

2) It does not define what types of costs could be incurred for "value enhancement" and that needs to be defined. Otherwise, a lot of costs could be designated as value enhancement costs, when in fact they are not.

These are my thoughts as to our question. Remember, you need to negotiate for gross royalties and not net royalties. Since your % of the project is small, you may find the oil and gas company prepared to grant you that change to their lease.

Lastly, please understand, that although I have negotiated an oil & gas lease in the past, I am not an oil & gas attorney. Therefore, these are my thoughts based upon my experience. You need to do your own due diligence before agreeing to any contract with the oil & gas company, whether it be a lease or an outright sale.

If you uncomfortable with doing so, yu might want to consider discussing the same with an attorney that specializes in the oil & gas business and has experience in negotiating a successful lease for he LESSOR, which is you.

3

West Virginia Gov. Jim Justice recently signed into law HB 4268, the “Co-Tenancy Modernization and Majority Protection Act.” A victory for landowners and the natural gas industry, the bill will take effect July 1, 2018 and essentially acts as a forced pooling law similar to that already in effect in Pennsylvania.

I beleive this legislation does a good job to help ensure small mineral rights owners receive fair value fo their rights- per the link below. I would recommend that you read it.

https://mcdonaldhopkins.com/Insights/Blog/Energy-Insights/2018/04/10/West-Virginia-passes-law-permitting-forced-pooling

4

I attempted to get concession of royalty at point of sale and was told that these two clauses are the only two I can choose from. Seems like 6 of one and half dozen of the other.

I had read read an article about the new legislation, but the one you posted sounds a little more confusing. The one I read said the oil companies have to give each owner the best rate that 75% of the owners received. Is that correct? I assume that means royalties only and not any signing bonus.

5

Can you point me to an example of production rates for Green District, Wetzel County online so I know where to start looking?

6

Shelley:

The link to the oil and gas production stats is as follows:

https://dep.wv.gov/oil-and-gas/databaseinfo/Pages/default.aspx

However, you may not be able to summarize the data for Wetzel County due to the amount of data available. So I have summarized the Gas production information for you by operator and attached in a pdf file. I can also summarize the oil production data if you need it, but have not done so yet. see attachement.2016%20WETZEL%20COUNTY%20GAS%20PRODUCTION%20BY%20OPERATOR.pdf

Hope this helps.

7

Wow, thank you. No, don’t do the oil. That is a lot of information to try to digest. I found another article on the co-tenancy bill that makes a little more sense to me. The way I was it, if this company isn’t willing to concede gross proceeds at the point of sale, all I have to do it wait until June 3rd for the bill to become effective, and then it becomes automatic. Am I reading that correctly?

https://www.jdsupra.com/legalnews/west-virginia-cotenancy-modernization-58843/

8

That is assuming the Lessee desires to move forward.

Since this is new legislation and requires the Lessee to perform certain tasks such as gain written consent from the other owners, there is no precedent to see how using this legislation will impact the oil company's decision making process.

It will drive up their costs of acquiring leases that have been started prior to the legislation and I beleive it will impact lease prices going forward negatively by causing them to negotiate the prices more agressively, since the highest price offered on any drilling program will be the price they must pay to the co-tenants they need to force into the pool.

Don't know if there are any studies in Pennsylvania that show the economic impact of forced pooling on overall lease prices or not.

So yes, you can essentially just sit back and wait and see what happens and the price will be set automatically. But you will also be accepting the other components of the lease without any leverage to change them. If the legal implications of the forced pooling lease agreement does not concern you, then that will not be a problem.