Expert: Frederick M. - 11/1/2009

Question
Mr,Scott
If a gas company fails to get me to sign a lease and starts drilling without signing me would I be in a better profit margin by falling into the unleased royalty owner rather then the bonus and 20 or 25% royalty? It seems to me to be the better option in the end even after all expense's and royalties are paid out,Am I wrong in my thinking? Thank you.

Answer
George, it depends on what state you're in as to whether going unleased will benefit you, and in most cases it will not because you will either be forced to lease by the State, or you will have to elect to participate in the well and pay your share of drilling costs. Participating is not something I would recommend as the up-front costs can be very high, and there is a real possibility you would never recover those costs even if a producing well were drilled. There are also a lot of contracts and agreements you'd need to become familiar with before jumping in to participating.

Keep in mind that as a mineral owner, you of course have the right to drill your own well to develop your minerals if you wish. When you participate in a well, you are in essence drilling your own well though in most cases you are also sharing the costs (and any profits) with other participants since one doesn't usually own all the minerals within a unit. If you owned the entire unit of minerals (i.e. 640 acres) then, as a mineral owner, you really could drill your "own" well.

Most mineral owners however, no matter how much of a unit they own, would rather let someone else do the drilling for them as they don't want to take the risk and expense upon themselves. As you likely have surmised, they will grant their rights to drill to an oil company in the form of a lease such as the one you may have been offered, and in return will receive a portion of any production (the royalty) and perhaps a signing bonus as well. The lessee, who is then taking the risk and expense away from the mineral owner, will of course get a much larger percentage of the production.

As I mentioned in the first paragraph, if you don't lease, then in most states you will either be "forced" to lease eventually by the state in the form of a "forced-pooling order," or you will have to elect participate in the well by paying your share of the drilling costs just as the other lessees are doing (since you did not lease your interest.)

I would rather lease than participate or be force-pooled in most cases, though if the lease offer is really horrible I might elect to let myself be force-pooled (in states that have forced-pooling) as the terms might be better, though there is no guarantee I would ever be force pooled and so I might lose out on any bonus money by not leasing.

Forced pooling (or "integration") is the preferred remedy in most states in cases where the mineral owner either can't be found or can't reach an agreement with the lessee, but forced pooling only occurs once the lessee gets "serious" about drilling a well. In many cases, leases will expire without a well being drilled and so those who don't lease will not get anything from a forced-pooling because no force-pooling will occur. (Forced-pooling orders usually have bonus and royalty amounts similar to leases in the same area.)

Back to your question (again):It is true that participating in a well (i.e doing it yourself) as a working interest owner will get you a bigger monthly check usually, but you'll also be on the hook for your share of the drilling costs, which must be paid up front and can run into many thousands of dollars even if you only own minerals in a small percentage of the unit. You could also lose your entire investment if the well is not completed as a producing well. There would also be ongoing costs if a producing well is drilled, and you would also likely be on the hook for your share of the costs of drilling future wells if a majority of the participants (and there would likely be others unless you owned the entire drilling and spacing unit) decided to drill more than one well. You'd be just like a little oil company in other words, paying your share (based on your ownership percentage of the entire unit) to drill the well and taking on your share of the risk as well since you decided not to lease your drilling rights to an oil company to take the risk for you.

If it were me I'd sign a lease and let the lessees take all the risk. One caveat however; if your minerals are in Texas or Kansas, you might want to talk to an oil and gas attorney before deciding what to do. There are factors in those states that COULD affect you positively if you refuse to lease, or could affect you negatively, but detailing them here is beyond the scope of your question and additionally you did not give me any information as to where these minerals are located.

Hope this helps you out.
Frederick M. "Mick" Scott CMM RPL
Timbercreek Mineral Company, LLC