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Fracking and Alternative Energy

McNees Insights: Post-Production Issues and Oil & Gas Leases

By J. Corey Reeder 

So your oil and gas lease has now converted from the primary term to the secondary term – now what?  There are several issues that a landowner or mineral interest owner should be aware of at this stage of the lease.  Specifically, you should analyze the Declaration of Pooling Units (DPUs), Division Orders and Royalty Statements.  

In the current resource plays like the Marcellus and Utica Shale, horizontal wells are standard and almost all wells are unitized among various surface/mineral owners.  At some point after the Lease converts to the secondary term, you should have received a DPU.  Although a DPU is not required under Pennsylvania Law, unless the Lease specifically provides for it, most gas companies will provide one to the owner and record the same in the Recorder of Deeds for the county in which the unit is located.  A DPU is a document that identifies the size of a production unit for gas development and the corresponding parcels of real property that comprise the production unit.  The first step you should take upon receipt of a DPU is to confirm that all the information related to the parcel is accurate.  Specifically, you will want to confirm that title to the property is in your correct name, the total acreage size of your property is correct, the amount of your acreage that is in the production unit is correct, and consequently the percentage of your land in the unit is accurate and that the map that is attached to the DPU is correct.  Further, if you have a Pugh clause in the Lease related to either horizontal or vertical portions of the total leased premises that would be released if not placed into a unit, then you should carefully review the DPU to determine whether or not the primary term of the original Lease has expired and if so, that the vertical depths and/or surface acreage that is not part of the DPU have been released.  If a Pugh clause does exist and acreage should be released, you will need to review the Lease to determine what requirements the gas company has with respect to recording any such releases. With respect to the map contained in the DPU, carefully examine to confirm that the parcel is correct from a metes and bounds standpoint as the gas company may not have the correct survey information.  This is important because it would impact the amount of your acreage that is in the unit and ultimately the percentage of the royalties that you would get from the unit.  

In addition to the DPU, once the secondary term commences you should expect to receive a Division Order from the Lessee or by the Lessee and any other gas companies to whom the Lessee may have assigned a working interest.  The first thing an owner should do when a Division Order is received is review the Division Order to make sure that the information is accurate.  Specifically, you should review the title to the property, the tax parcel ID number to the property, the number of acres of the property, the number of acres of the property in the unit, and also the royalty percentage that you are entitled to.  In addition, you need to make sure that the Division Order does not contain any language that would change the terms of the Lease.  If you receive multiple Division Orders from various gas companies, you will want to review your Lease to determine whether or not the Lease had any language related to the assignment of the Lease.  A well drafted Oil & Gas Lease should provide that the Lessee is permitted to assign a working interest in the Lease to one or multiple entities, however, notice of the assignment would have to be provided to the owner/lessor as well as contact information related to the assignee.  If you have such language in your Lease, you will want to obtain copies of all the assignments from the original Lessee gas company and make sure they have complied with the terms of the assignment provision.  If you do not have such language, then you should try and request this information from the gas company.  Once these items have been confirmed, you need to confirm that the decimal interest that you will be receiving from the unit is accurate.  The decimal interest is calculated by dividing the amount of acreage that you have in the unit by the total acreage in the unit and then multiplying that number by the royalty interest that you are to receive.  This calculation will give you a decimal interest number which will tell you what fraction of the total royalties out of that unit you should expect to receive.  For example if you have 100 acres in a 600 acre unit and the royalties under the lease are 16%, the decimal would be calculated as follows: 

               (100/600) X 16%=0.0266667

Once you have determined that the Division Order is accurate and have signed and returned it to the gas company, you should expect, in the near future, to receive your first Royalty Statement. 

Royalty Statements can be confusing documents to review as there is no statutory standard for the format and each gas company uses different forms.  That being said, all Royalty Statements should contain similar information.  The key items that you should be concerned with are: (i) confirm that the decimal interest that was calculated in the Division Order is the same listed on the Royalty Statement; (ii) determine whether or not the royalty check received is made payable to the right person or entity; and (iii) review post production deductions in light of any restrictions contained in the Lease.  Obviously, if the Lease provided that no post-production cost are permitted to be deducted from the royalty, then there should be no items listed in the deduction column on the Royalty Statement.  To the extent that deductions were permitted, then you want to confirm that the proper deductions were taken.  For example, if the Lease provided that the only deductions that could be taken were for transportation and compression, you would want to make sure that based on the key in the Royalty Statement that those were the only two deductions that were taken and deductions for dehydration and/or marketing, etc. were not taken.  In addition to determining if the correct post-production deductions (if any) are being taken, you should review the amount of deductions as a percentage of the revenue received to determine if the deductions are in line with industry standards. 

In addition to the aforementioned items, the conversion of a Lease from the primary term to the secondary term is also a good time to review the Lease for other Lease compliance issues which may include timber removal, surface restoration, fence installation around any compressor stations, valve sites, etc., gates on access roads, and post-drilling water testing. These are just a few examples of some surface issues that may be an issue once a lease is put into production.  Obviously there can be many more and these should be reviewed on a per lease basis. 

© 2014 McNees Wallace & Nurick LLC 

McNees Insights is presented with the understanding that the publisher does not render specific legal, accounting or other professional service to the reader. Due to the rapidly changing nature of the law, information contained in this publication may become outdated. Anyone using this material must always research original sources of authority and update this information to ensure accuracy and applicability to specific legal matters. In no event will the authors, the reviewers or the publisher be liable for any damage, whether direct, indirect or consequential, claimed to result from the use of this material.

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