Oil and Gas Lease Payments
There are several different payments mineral interest owners may receive from an Oil and Gas Lease. These payments include bonus payments, delay-rental payments, and royalty payments. Read on to learn more!
To begin our discussion of Oil and Gas Lease payments, let’s review mineral rights, since these payments are generally made to the mineral interest owner. As we discussed in our post HERE, mineral rights consist of five separate and distinct elements:
The right to develop and produce the minerals
The right to sell and lease the minerals, also called “executive rights”
The right to receive bonus payments
The right to receive delay rental payments
The right to receive royalty payments (including shut-in royalty payments)
Typically, mineral interest owners do not produce the oil and gas underlying their land themselves due to the high cost, but instead lease their right to development and production to an oil and gas company through an Oil and Gas Lease. With the execution of an Oil and Gas Lease come certain payments, discussed as follows:
Bonus Payments:
Bonus payments are made to the mineral interest owner by the oil and gas company upon execution of an Oil and Gas Lease in exchange for the right to develop the minerals. Bonus payments are made to the mineral interest owner at the time they sign the lease. You can think of this payment as a signing bonus, similar to what you might receive at a new job. Lease bonus payments are calculated based on the number of acres that the mineral interest owner owns, though this value can vary based on other market factors.
Delay Rental Payments:
Each Oil and Gas Lease has a primary term, which is the number of years the oil company has to explore and drill for minerals. Traditionally, the oil and gas company had to make a payment to the mineral interest owner every year that drilling was delayed. So, if the primary term was five years and drilling did not begin until that final year, the mineral interest owner would have received a payment every year for four years to compensate for this delay in drilling. These payments were strictly enforced, and if the oil and gas company missed a payment, the lease would automatically terminate. To avoid this automatic termination, these delay rentals are generally all paid upfront to the mineral interest owner upon execution of the Oil and Gas Lease.
Royalty Payments:
If a well is successfully drilled and minerals are produced, then the mineral interest owner receives a royalty payment on that production. Note that if the well does not produce oil or gas (called a “dry hole”), then the mineral interest owner receives no royalty payments. A royalty payment is a certain percentage of total production profits (called “gross production”), minus any reasonable production costs undertaken by the oil and gas company. These production costs, for example, include the costs to maintain and operate the well. The percentage of gross production is negotiated in the Oil and Gas Lease. Traditionally, this percentage was 1/8 of production, being 12.5%. In recent years, this percentage has generally increased to 3/16 of production, being 18.75%.
Shut-In Royalty Payments:
Sometimes, the oil and gas company may temporarily not want to produce the minerals from a well capable of production. This could be due for a number of reasons, including poor market conditions, failure to find a buyer, or broken operating equipment requiring repair. If the lease has been perpetuated into its secondary term, any cease in production can cause the lease to expire and all royalty payments to stop. Shut-in royalty payments are used to keep a lease from expiring when the oil and gas company temporarily stops production of a well. The oil and gas company can cease production of the well (i.e., “shut-in” the well) and pay the mineral interest owner a shut-in royalty in place of the stopped royalty payment. These shut-in payments are temporary, and their length is governed by the terms of the lease. Typically, shut-in payments can be made in lieu of production for a maximum two or three years.
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