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Mineral Rights in Oil & Gas

The high demand for oil and gas in today’s world means that those holding mineral rights have positioned themselves to make considerable profits. Not surprisingly, investing in oil and gas mineral rights can generate healthy profits over time. Understanding how mineral rights work can help investors better protect their interests when dealing with mineral rights contracts.

Surface Rights vs. Mineral Rights

In areas known for their abundance of minerals, it’s not uncommon for property contracts to separate the sale of the land rights from the sale of the rights to the minerals underneath the land. In cases where both are included in the purchase, the buyer becomes what’s known as a “fee simple owner” of the land and its contents.

Investing in oil and gas mineral rights means purchasing these commodities at the production level in terms of actually extracting these minerals and putting them to use. This means a production company must actually hold the rights to the minerals contained in a parcel of land regardless of whether the company owns the land itself.

Much of the risk involved with oil and gas investments has to do with:

  • Not knowing the geology of the land a production company works in
  • Not understanding how the contract between the company and the land owner is structured and
  • Not knowing the production company’s track record.

Understanding the contract set up between the production company and the land owner can go a long way towards avoiding unexpected losses.

Lease Contracts

Since there’s no real way of knowing whether a piece of land houses oil or gas materials, contracts for oil and gas mineral rights are usually set up as leases instead of transfers of ownership. These contracts include a signing bonus or upfront payment made to the landowner and a set timeframe allowing the production company to explore the property to determine whether oil or gas reserves exist.

If no oil or gas is found, the contract expires. If the company does find a marketable reserve of minerals, the company must then pay the land owner royalty payments or a share of the value of what they produce. In this case, the lease contract remains in force for as long as the royalty payments continue. Royalty payments typically range around 12.5 or 1/8th of the value of the oil or gas.

Contract Terms

For the most part, under a lease contract, the landowner and the production company agrees to share the property for a set period of time. As landowners still maintain rights to the land surface, this includes any dwellings and buildings on the land. Since drilling, excavation and mining involves digging up large plots of land using heavy machinery and tools, the landowner has the right to place contract conditions on what types of activities can take place. Landowners can also require a certain amount of restoration be done once the production company finishes its work.

As property laws are put in place by state governments, laws surrounding mineral rights transfers can vary from state to state. State laws may also dictating mining and drilling activity. If a production company fails to adhere to the laws of the state, any investments made in a particular project may be placed at risk should litigation become an issue.

Oil and Gas Unitization

Because of their physical structures, both oil and gas are capable of moving through rock surfaces and across tiny pore spaces, such as those present in sand. This means mining that takes place on one property can potentially drain oil or gas materials from neighboring properties. For these reasons, many states have regulations that dictate how oil and gas royalties will be shared between two or more properties. These regulations require production companies to specify how royalties will be distributed before drilling can begin.

Production companies employ a procedure known as unitization to determine how royalties are divided. While these companies may still hold the mineral rights to the oil or gas, a failure to follow state regulations can jeopardize a project to the point where any profits made are lost in fines, penalties and litigation costs.

How Gas Leases Differ from Oil Leases

As oil is easily contained and gas is not, gas production processes are much more extensive than those used with oil. While oil can be easily transported and stored in local refineries, gas must be compressed and liquefied before being transported through pipelines. These differences affect how a mineral rights contract is set up in terms of what types of laws apply. In cases where a gas pipeline runs and stays within state borders, state laws apply. Pipelines that run across state lines must adhere to both state and federal regulations. In effect, the potential for setbacks and red tape increases dramatically with interstate production processes.

Ultimately, investors would do well to research any oil or gas investments they’re considering. As global oil and gas materials continue to dwindle, production companies will become more competitive in an effort to meet increasing demands for these materials. Companies with strong track records are less likely to cut corners and take the types of risks that leave their investors in the lurch.

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