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Who should the landowner lease to?

Landowners may have an opportunity to lease their oil, gas and minerals to more than one company. Which company should the landowner choose? The choice may carry significant consequences. Not all companies are equal. The best choice is not always the company which pays the most up-front bonus money.

In order to make the right choice the landowner must understand the types of companies which may offer him or her a lease or an agreement. There are three general categories of companies:

  1. Operators/Drillers

  2. Landowner groups

  3. Flippers/speculators

The terms of the lease are obviously important and may dictate any given situations. But, when the up-front bonus payments are significantly different, the natural inclination is for the landowner to lease to whoever pays the largest up-front payment. That may be a mistake. If the lease terms are generally equivalent and the landowner’s interests are protected by the lease, the most significant consideration may be: which company is most likely to facilitate or expedite the inclusion of the land in a drilling unit so that royalties will be received?

The primary goal for most landowners is to have all or the majority of his or her land included in a drilling unit in order to receive monthly royalty payments on natural gas or oil produced from his or her property. Normally (all other factors being equal), land will be included in a drilling unit more quickly if the lease is with an operator/driller as opposed to a landowner group or a flipper/speculator. The landowner must know which type of company he or she is leasing to.

Flippers/speculators are individuals or companies who will not and cannot, on their own accord, put your land into a drilling unit. They may pay more up-front bonus money than an operator/driller but the flipper/speculator does not drill. Their goal is to secure a lease and then sell that lease, for a profit, to another flipper/speculator or to an operator/driller. Flippers/speculators come in various shapes and sizes. Some are small “mom and pop” operations and others are larger regional or national operators.

It is not wrong to lease to a flipper/speculator, particularly if that is your only option. However, that lease may carry with it certain negative consequences. A flipper/speculator is removed and distant from the operation and drilling decisions and unitization process. Frankly, flipper/speculators are often intentionally misled about drilling plans and drilling operations. More often than not, operators/drillers don’t want the flipper/speculator to know, in advance, about production operations, drilling plans, timing and yield expectations. As such, the flipper/speculator is often “out of the loop”.

If the flipper/speculator is looking for “too much profit”, leasing to the flipper/speculator may actually decrease the landowner’s chances of receiving monthly royalty checks. There may be a direct conflict between the flipper/speculator’s desire for a profit and the landowner’s desire to receive royalty payments. The flipper/speculator does not drill, does not produce gas and does not pay royalties. When the landowner leases to a flipper/speculator, he or she is entrusting his or her valuable oil, gas and minerals to the flipper/speculator. Once the land is under lease with the flipper/speculator, the landowner has no control.

Landowner groups may present other impediments to drilling. Landowner groups are often successful for their “members”. They are able to speak with “one voice” with regard to much larger tracts of land, because individual landowners voluntarily put their tracts into the “pool”. They have been particularly effective in areas that are being leased but not being drilled.

Normally, landowners sign marketing agreements or options to lease when they “sign-up” with a landowner group. Landowner groups offer the expectation of higher up-front bonus payments than the landowner will receive from the driller/operator.

However, in areas with active, ongoing drilling, landowner groups can be counterproductive for the landowner. Keep in mind that the ultimate goal of most landowners is to be part of a drilling unit and receive monthly royalty payments. The expectation of higher up-front bonus payments can fail on two (2) fronts. The driller/operator does not have to yield to the demands of the landowner group, particularly if drilling is eminent. In that event, the driller/operator will simply drill and avoid the lands which are included in the landowner group or, the driller/operator will not drill, leave the area and never return. In either event, the landowner receives no up-front bonus payment and no monthly royalty payments.

Also, many landowner marketing agreements or options to lease limit the landowner’s ability to remove his or her land from the “pool”. Once a landowner signs up with the landowner group, he or she may not be immediately free to negotiate with a driller/operator, even if a particularly favorable lease is presented to the landowner.

The essence of the matter is this. Landowner groups and flippers/speculators are not bad, wrong or to always be avoided. Furthermore, the details or terms of any given lease may change the analysis. But, where the primary issue is a larger up-front bonus payment with a flipper/speculator or a landowner group versus a lesser up-front bonus payment with a driller/operator, give very serious consideration to accepting the lesser up-front bonus payment in favor of the increased likelihood of being included in a unit and receiving monthly royalty payments.

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