Chapter 5:
Leasing and Working Interest

Once an area has been determined to be viable for drilling, it is necessary to get a lease to drill on the property. The rights to the surface and the hydrocarbons beneath can be owned separately. An oil and gas lease is a contract between the person or corporation that owns the oil and gas rights to a property and a party who wants to drill a well on that property. If a lease is signed by both parties, the owner of the oil and gas rights is the "lessor" and the recipient of the rights is referred to as the "lessee."

The bonus, royalty, and the primary term of the lease are the three most important items considered during lease negotiations. The bonus is the amount of money required up front by the lessor and is paid whether or not a well is drilled or produces. The royalty is the interest the lessor is to receive if any oil and gas pumped or taken from the well. The primary term is the time period that a company will be allowed to explore or drill. Most leases are taken on a standard form with additional negotiated terms added at the end.

It is important to note that there are costs associated with preparing oil and gas leases, including: expenses to evaluate the property; bonuses to landowners to secure the leases; and legal fees to establish ownership of a property to make the leases legally valid.

Landman

A "landman" is an independent agent who works for an oil company to establish ownership of land and, ultimately, negotiate the lease terms between two or more parties. The landman also understands laws and rules concerning leasing in a certain area and how to file the proper paperwork with the local government. In addition, the landman works to resolve problems that may occur in disputed ownership rights, and they're generally knowledgeable about drilling that has taken place in a certain area

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Types of Legal Instruments Used for Oil and Gas

There are five main agreements an average surface or oil and gas rights owner could enter into with an oil and gas company. The first is the oil and gas lease described above. The second is a surface easement, which oil companies would need to use to create a pipeline or road. Next is a seismic agreement which permits necessary seismic testing on an owned property. Fourth is a general damage agreement for use of roads and clearing a location to drill the well. On land, rigs need a minimum of one acre to work. The final type of agreement is a water rights agreement that an oil company needs to make sure they have proper access to surface or underground water to complete their drilling.

Working Interest

Major oil companies have the capital to fund the entire cost of drilling wells. However, there are also small companies, known as "independents."

Oil well donkey pumpTypically small independents do not engage in wildcatting–drilling exploratory wells to discover new fields. Rather they choose to drill in existing fields where logs from previous wells can be analyzed to improve the likelihood of hitting productive reservoirs.

If an independent doesn't feel that it can take on the full financial risk of drilling, it will sell working interests in the well, usually to other independents. This allows several independents to spread their risk over more wells.

Another method of raising capital to fund a drilling project is by allowing individual investors who have the financial means to participate either directly or through a partnership.

There are many ways to structure a drilling project partnership. In some instances the partners are proportionally liable for any cost overruns versus estimated expenses. In other arrangements, the individual partners are at risk only for their initial investment.

Taxes

Because of the high risk associated with drilling for oil and gas, the government provides tax incentives that allow individual investors to write off the entire cost of their investment regardless of the outcome of the well. Generally, only high income or high net worth investors can take advantage of these incentives. In fact the government discourages those with limited financial resources from making direct investments in oil and gas drilling projects.



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