assignment of working interest in oil and gas lease

Assignment Of Oil And Gas Lease

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What is an assignment of oil and gas lease.

An assignment of oil and gas lease is a contractual agreement between a landowner and an oil or gas company in which the company gains the right to explore for, develop, and produce oil and gas from the property. The leaseholder typically compensates the owner with periodic payments (called royalties) based on the amount of oil or gas produced. Leases can be assigned to another party, such as a drilling contractor, if the original leaseholder decides not to pursue development. Assignment of an oil and gas lease should be done in writing and filed with the appropriate government authority.

Assignment Of Oil And Gas Lease Sample

Reference : Security Exchange Commission - Edgar Database, EX-10.1 6 exh101.htm ASSIGNMENT OF OIL AND GAS LEASES. , Viewed October 27, 2022, View Source on SEC .

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Oklahoma Bar Journal

Interpreting assignments of the oil and gas lease.

By Jereme M. Cowan

Under Oklahoma law, an oil and gas lease grants a cluster of rights in land,1 forming an estate in real property with the nature of fee.2 Like many of the sticks in the metaphorical bundle, the estate created under the oil and gas lease is freely assignable and divisible.3 As a result, oil and gas leaseholds can be transferred, in whole or in part, by the holder of the oil and gas lease, such practice being a central element to oil and gas development.4 Furthermore, the transfers of leasehold are usually executed and delivered by legal instruments ubiquitously titled “assignments,” which are filed of record in the same manner as any instrument affecting title to real property.5 Given the history of Oklahoma’s oil booms,6 not to mention Oklahoma’s current role in the U.S. shale boom, assignments inundate many of the county clerk records where oil and gas exploration is prevalent. Therefore, it is likely that an examination of oil and gas land titles in one of these counties will require the interpretation of assignments. BASIC RULES OF CONSTRUCTION Assignments are a contract and a conveyance.7 As such, they are to be read in accordance with the basic rules of contractual interpretation,8 which comprise not only those findings in Oklahoma’s case law but also the statutory provisions of 15 O.S. §§151-178. In a nutshell, Oklahoma’s rules on interpreting assignments begin with prioritizing the true intent of the parties, as gathered from the four corners of the instrument.9 If the assignment is unambiguous, then the written instrument will govern,10 along with all technical terms in the assignment being interpreted as commonly understood among persons in the oil and gas industry.11 However, if there is an ambiguity, then the contractual interpretation can be aided by extrinsic evidence in order to resolve the intrinsic uncertainties of the assignment.12

These rules make it imperative for an attorney conducting a title examination to understand the business and terminology of the oil and gas industry as it pertains to the transfer of leasehold, not to mention understanding general rules of land titles and the law of oil and gas. The purpose of this article is not to give a complete account of the oil and gas industry nor an account of all rules governing the transfer of oil and gas rights in the record title. Rather, the purpose is to give an introductory and cursory overview, presented on a step-by-step basis, for an attorney who may find themselves, either willingly or unwillingly, examining assignments of oil and gas leases filed in Oklahoma. STEP 1: WHAT TYPE OF INTEREST? First and foremost, the title examiner needs to determine the type of interest being assigned (or reserved) in the leasehold. More often than not, if the assignment is transferring an interest in a lease without overriding royalty language or net profits language, then a working interest is being assigned. When there is ambiguity, the title examiner should remember that a working interest is the right to  work  on the leased property — searching, developing and producing oil and gas. On the other hand, an overriding royalty interest is share in production attributable to a particular lease. STEP 2: WHAT AMOUNT OF INTEREST? Working interests tend to be relatively straightforward. Either the assignor is purporting to assign all of its right, title and interest under a lease, all of a lease (read 100 percent) or a fractional interest in a lease. Digressing a bit, now would be a good moment to discuss the difference between all right, title and interest  of the assignor  and 100 percent of a lease. All of the assignor’s right, title and interest could be 100 percent or could be some fractional interest. It depends on what the assignor owns of record. If an assignor assigns a lease without any fractional limitations or without the foregoing language limiting it to the assignor’s right, title and interest, then the assignor is purporting to assign 100 percent of the lease. The prudent examiner notes the distinction.

Overriding royalty interest can sometimes not be as straightforward. Often, the assignor decides to use a formula for the computation of the assigned or reserved overriding royalty interest. For example, a recitation in the assignment reads as follows: an overriding royalty interest equal to the difference between 20 percent and lease burdens. Here, the overriding royalty interest would be calculated by first adding up all the lease burdens, such as a one-eighth landowner’s royalty and a previously conveyed one-thirty-second overriding royalty interest, and then subtracting that number from 20 percent, which is represented mathematically as: 20% - (1/8 + 1/32) = 4.375%.

There are various business reasons for computing an assigned or reserved overriding royalty interest with the subtraction of lease burdens from a certain percentage, the most prominent being that assignments of leases typically cover a block of leases, which contain various lease net revenue interests. Showing the overriding royalty interest as a formula rather than a specific number allows the assignor to either retain or convey the leases at certain net revenue interest. In the prior example, assuming the assignor was assigning the overriding royalty interest, it was retaining an 80 percent net revenue interest in all the leases covered by the assignment except, of course, those leases which were already burdened greater than 20 percent. STEP 3: WHAT LEASE IS COVERED? All leasehold interests derive from a lease. Therefore, it is imperative that the examining attorney determine what lease is covered by an assignment. If the assignment covers one or just a few leases, then the lease(s) will probably be described somewhere in the body of the instrument. If the assignment covers multiple leases, then typically they will be described in an exhibit “A” attached thereto. However, it should be noted that in some cases an assignment may not describe a particular lease or leases but instead will include language that it is the intent to assign all leasehold rights in a particular tract of land, usually the unitized area. For example, an assignment may read that all of the assignor’s rights in the leasehold covering the SW/4 are transferred to the assignee without giving further explanation as to the underlying leases.  In this particular example, the assignor is conveying whatever leasehold rights it may own from whatever source such rights might derive as to the SW/4.

STEP 4: WHAT ARE THE LIMITATIONS TO THE ASSIGNED INTEREST? By far the most challenging (and often most ambiguous) aspect of an assignment is the limitations to the assigned interest. Like land itself, a lease is a bundle of sticks. A lease can be cut and carved any which way, limited only by the imagination of the oil and gas industry. If an assignor wants to assign a lease insofar as that lease covers a particular formation in the strata, then the assignor can do so. The following are standard limitations that the examining attorney should recognize.

An assignment can be limited to the wellbore of a well. A wellbore limitation means that the assignor is assigning only those rights to production from the wellbore of a certain well, arguably at the total depth it existed at the time of the assignment. All interest outside the wellbore are excluded from the assignment, entailing that a wellbore assignee can produce from shallower formations in the wellbore but cannot produce from deeper formations or lands outside the wellbore.

The central problem with wellbore only assignments is determining when in fact there is a wellbore only assignment. The title examiner should be aware that a wellbore assignment is the narrowest of assignments. Very limited rights to the lease are being assigned. It can be argued that the lease or unit and the lands covered by the lease or unit need only be described for informational purposes, as it is rights to the wellbore being assigned. Furthermore, the fact that a well or unit is mentioned in the description of the lease does not entail that the assignor intended to convey wellbore rights only. More often than not, a reference to a well or unit in Oklahoma is for informational purposes.

Some assignments are limited to certain depths or to a particular formation. For instances, an assignment may limit the assigned leases “insofar as said leases cover the Woodford Formation” or “insofar as from the surface to a depth of 8,100 feet.” Depth limitations are usually more prominent than wellbore limitations and are considerably less ambiguous. Furthermore, title examiners should always read an assignment thoroughly to determine whether a depth limitation is pertinent. Many times, such a limitation is buried in one of the numerous special provisions of the assignment or placed in one of the exhibits attached thereto.

In order to accommodate the formation of units, leases will often be assigned only as to a portion of the lands covered thereby. For example, a participant enters into a joint operating agreement with the operator that has proposed the drilling of a 40-acre unit well located in the NW/4 NW/4. If the participant owns all of a certain lease covering the N/2 NW/4, the participant may decide to assign only that portion of the lease covering the NW/4 NW/4, thereby retaining all rights in the NE/4 NW/4. Therefore, assignments may contain limitations as to the area acreage being conveyed.

CONCLUSION The foregoing steps serve as an introduction to interpreting assignments of oil and gas leases. Most certainly, each step of analysis could be accompanied by a more detailed explanation. That said, the key point to be made here is that the interpretation of assignments in oil and gas land titles requires a familiarization of the business practices of the oil and gas industry, not just an understanding of the governing law.

ABOUT THE AUTHOR Jereme M. Cowan is a managing partner at Cowan & Fleischer PLLC. Mr. Cowan’s practice fo-cuses on oil and gas land titles. He has planned, moderated and spoken at a number of oil and gas seminars sponsored by the Oklahoma Bar Association.

1.  See Hinds v. Phillips Petroleum Company , 1979 OK 22, 591 P.2d 697, 698 (1979) (stating that “[t]he cluster of rights comprised within an instrument we refer to ‘in deference to custom’ as an ‘oil and gas lease’ includes a great variety of common-law interests in land”). 2.  See Shields v. Moffitt , 1984 OK 42, 683 P.2d 530, 532-33 (1984) (finding that “the holder of an oil and gas lease during the primary term or as extended by production has a base or qualified fee,  i.e. , an estate in real property have the nature of a fee, but not a fee simple absolute”). 3.  See Hinds  at 699 (concluding that leasehold interests are freely alienable “in whole or in part”); Eugene Kuntz,  Kuntz, a Treatise on the Law of Oil and Gas , Volume Five, §64.1, 259 (1987) (asserting that the oil and gas lease is freely assignable “in the absence of a provision to the contrary”);  see also Shields  at 533 (holding that a lease clause restricting alienation was void). 4. John S. Lowe,  Oil and Gas Law in a Nutshell , Sixth Edition (2014). 5. Joyce Palomar,  Patton and Palomar on Land Titles , 3rd Edition, Volume One, 3 (2003). 6. Kenny A. Franks,  The Oklahoma Petroleum Industry  (Norman: University of Oklahoma Press, 1980). 7.  See Plano Petroleum, LLC v. GHK Exploration, L.P. , 2011 OK 18 (2011). 8.  K & K Food Servs. v. S & H, Inc. , 2000 OK 31, 3 P.3d 705, 708. 9.  See Messner v. Moorehead , 1990 OK 17, ¶8, 787 P.2d 1270, 1272. 10.  Messner  at 1273. 11. 15 O.S. §161. 12.  Crockett v. McKenzie , 1994 OK 3, ¶5, 867 P.2d 463, 465.

Originally published in the  Oklahoma Bar Journal --  OBJ 88 pg. 285 (Feb. 11, 2017)

3 Texas Law of Oil and Gas 16.5

§ 3A:249. Assignment of working interest in oil and gas lease | Secondary Sources | Westlaw

§ 3A:249. Assignment of working interest in oil and gas lease

Tx lf § 3a:249 texas forms legal and business  (approx. 2 pages).

The Oil and Gas Report

What Are the Types of Interests in Federal Oil and Gas Leases and How Are They Assigned?

Federal oil and gas leases are administered by the Bureau of Land Management (“BLM”) pursuant to the Mineral Leasing Act of 1920, as amended (“MLA”), and the implementing federal regulations. Federal leases have a slightly different ownership scheme than fee oil and gas leases. As to fee leases, the lessee owns a leasehold interest that includes the right to drill for and produce the leased substances, subject to royalty payments to the lessor. The term “working interest” is commonly used and is generally considered synonymous with the lessee’s interest and the term “leasehold interest.” As to federal leases, the lessee’s leasehold interest includes both record title and operating rights. Initially, these two types of interests are merged together as  the record title interest, but the operating rights interest can be severed from the record title interest by assignment.  The record title interest includes the obligation to pay rent and the rights to assign and relinquish the lease. [1] The operating rights interest authorizes the holder to drill for and conduct operations and produce the leased substances. [2] When all or a portion of the operating rights have been severed from the record title, the operating rights interest owner is primarily liable for its pro rata share of payment obligations under the lease while the record title interest owner is secondarily liable. [3] At the extreme, if all of the operating rights as to all depths are severed by assignment from the record title interest, the lessee owns “bare” record title interest and has no rights to drill for and produce the leased substances. The term “working interest” is generically associated with the operating rights interest unless said operating rights interest has not been severed from the record title interest, then it is associated with the record title interest. Otherwise, the range of interests that may be created out of federal leases is nearly the same as fee leases.

The interests in federal leases are generally conveyed by a “transfer,” being defined in the federal regulations as “any conveyance of an interest in a lease by assignment, sublease or otherwise.” [4] Set forth below is a discussion of the different types of interests that may be transferred in federal leases and whether the instrument transferring the interest must be filed with and approved by the BLM. [5]

Record Title Interests

The MLA and federal regulations use the term “assignment” for a transfer of all or a portion of the lessee’s record title interest in a lease. [6] All assignments of record title interests must be on the currently approved BLM form Assignment of Record Title Interest in a Lease for Oil and Gas or Geothermal Resources, Form 3000-003. [7] Record title interests may be transferred as to all or part of the acreage in the lease or as to either a divided or undivided interest therein. [8] Record title interests may not be transferred as to limited depths or horizons, separately as to either oil or gas, less than part of a legal subdivision, [9] or less than 640 acres (outside of Alaska). [10]

Upon receipt of the assignment, the BLM will engage in an “adjudication” process whereby the BLM will determine and identify the owners of interests and their percentage interest in the lease as a consequence of the assignment and approve the assignment if it meets all statutory and regulatory requirements. The rights of the assignee will not be recognized by the BLM until the assignment has been approved. [11]

Operating Rights Interests

The MLA and federal regulations use the term “sublease” for a transfer of a non-record title interest in a lease, including a transfer of operating rights. All transfers of operating rights interests must be on the currently approved BLM form Transfer of Operating Rights (Sublease) in a Lease for Oil and Gas or Geothermal Resources, Form 3000-3a. [12] For transfers of operating rights interests, the MLA and federal regulations do not contain any limitations on such transfers other than it must be as to “all or part of the acreage in the lease.” [13]

Upon receipt of the transfer, the BLM will engage in the adjudication process to determine and identify the owners of interests and their percentage interest in the lease as a consequence of the transfer and approve the assignment if it meets all statutory and regulatory requirements. The rights of the transferee will not be recognized by the BLM until the transfer has been approved. [14]   However there was a period of time where most state offices of the BLM did not adjudicate transfers of operating rights.

Beginning in 1985, the BLM issued internal guidance, Washington Office Instruction Memorandum No. 1986-175 (Dec. 30, 1985) (“IM 1986-175”), stating that it was not necessary for the BLM to “adjudicate” operating rights assignments [15] on the grounds that they are third-party contracts. The BLM adjudicators were instructed to stop adjudicating operating rights transfers, and to instead “rubber stamp” them within 30 days of their submission when there was no “evidence to the contrary regarding qualifications and proper bonding.” [16] Accordingly, most BLM offices began accepting transfers of operating rights and “approved” the transfers without confirming and determining the ownership of the operating rights interests. In 2013, the BLM issued Instruction Memorandum No. 2013-105 (April 4, 2013) (“IM 2013-105”), directing all BLM offices to immediately begin again adjudicate transfers of operating rights interests. [17]  Understanding that there would be a backlog to carry this out this directive, IM 2013-105 provides a priority schedule for adjudicating existing and future transfers of operating rights as follows: if first production occurs on or after October 1, 2012, adjudicate all transfers of operating rights immediately; if first production occurred prior to October 1, 2012, adjudicate as necessary to enable the Office of Natural Resources Revenue (“ONRR”) to issue appropriate orders to the owners; and adjudicate all remaining unadjudicated operating rights transfers when time and staffing allows.

Obviously, the BLM offices are faced with trying to adjudicate and determine the current operating rights interest owners based on over thirty years of potentially incomplete and possibly erroneous transfers contained in the BLM lease files. A survey was conducted in 2017 of the following BLM State Offices to determine how they were implementing IM 2013-105 and adjudicating transfers of operating rights. [18]

For leases occurring prior to 2012, the Colorado State Office is only conducting reviews for leases with production at the request of ONRR. When it discovers discrepancies, it considers those transfers null and void from their inception and does not provide or send out unapproved operating rights decision letters because the transfers were never adjudicated. Colorado is not willing to accept county records or other outside sources to assist in curing title deficiencies. For leases occurring after October 1, 2012, the Colorado Office will adjudicate all transfers accordingly.

Montana, North Dakota, South Dakota, and Utah [19]

The Montana and Utah State Office never stopped adjudicating transfers of operating rights; accordingly, IM 2013-105 did not change how they are adjudicating such transfers.

New Mexico, Kansas, Oklahoma, and Texas [20]

The New Mexico State Office is conducting a piecemeal review of its lease files. Initially, when the New Mexico State Office received a new assignment and could not account for the purported interest to be assigned, they retroactively denied previously approved transfers either (a) all the way back until the title examiner could account for the purported interest; or (b) through 1991. It appears that recently, the New Mexico State Office has become willing to consider outside records in examining title to fill in gaps in currently filed assignments, such as recorded assignments, evidence of corporate successions, etc.

The Wyoming State Office adjudicates operating rights for all new leases, as well as any adjudications requested by ONRR. It also has plans to adjudicate operating rights for all producing leases according to staff availability. The Wyoming State Office is currently using the Lease Interest Worksheet to chain title retroactively and adjudicate operating rights at the request of the ONRR. During this review, and when any new transfer is filed, if the State Office examiner cannot account for the purported interest to be assigned, they stamp the Lease Interest Worksheet “discrepancy.” Thereafter, the Wyoming State Office will not approve any subsequent transfer until the problem in the chain of title is resolved. No notice of the discrepancy is provided to the parties who received interests through transfers now marked with a discrepancy, so without review of the current BLM case file for each lease or subsequently denied transfer, parties who believed they previously owned operating rights are not aware their rights have been called into question. This requires the Wyoming State Office to deny any subsequent transfers for leases containing a discrepancy, and to disregard any assignments occurring before the discrepancy that were previously approved.

In an attempt to complete a chain of title, bring current its files, and resolve any discrepancies, the Wyoming State Office is accepting a certified copy of an assignment recorded in the county records and attached to a BLM form Transfer of Operating Rights that is completed by general references to the attached county assignment. The Wyoming State Office will issue a decision stating that its records are incomplete and in order to complete its records, it is accepting and approving the assignment.

Overriding Royalty Interests, Production Payments, and Other Interests

The federal regulations make specific reference to only two other types of interests, overriding royalty interests and production payments. [21] Transfers of these interests must be filed with the BLM and will be included in the lease file, but are not subject to BLM approval. [22] While they can be filed on either a BLM form assignment, [23] any form of assignment may be used.

While net profits interests and carried interests are not expressly mentioned in the regulations governing assignments of interests, such interests are included in the definition of “interest.” [24] The usual practice is to follow the same filing procedures prescribed from assignments of overriding royalty interests and production payments above.

Liens and Security Interests under Mortgages and Other Financing Instruments

Liens and security interests in federal leases created under mortgages and other financing instruments do not fall within the definition of “interests” under the regulations and are not required to be accepted for filing under the regulations. Most BLM offices will discourage or even reject the filing of mortgages and other financing instruments. As a result, mortgages and other financing instruments are typically only filed in the county records.

Transfers by Operation of Law

The regulations identify two types of transfers by operation of law: death and corporate reorganization. When an owner dies, his or her rights will be recognized as having been transferred to the heirs, devisees, executor, or administrator of the estate, upon the filing of a statement that all parties are qualified to hold an interest in a federal lease. [25] The BLM office will typically also require, along with the statement, supporting information concerning the demise of the owner.

In the case of corporate name change, merger, or conversion, no assignment is required unless otherwise required by state law. The regulations require that notification of the name change, merger, or conversion be furnished in the proper BLM office. [26]

_____________________

Prior to filing any transfer with the BLM, it is always to the advantage of the parties to the transfer to make inquiry of the oil and gas adjudication personnel at the applicable BLM office to confirm that the parties have prepared the transfer in compliance with the office’s policies and procedures.

[1] 43 CFR § 3100.0-5(c). Record title is the ownership in a federal lease as recognized by the BLM.  Therefore, it has no connection to the title or leasehold ownership reflected in the applicable county records.

[2] 43 CFR § 3100.0-5(d). The term “operating rights” should not be confused with the right to serve as operator on the ground. An operator is the person or entity that is responsible under the terms and conditions of the lease for operations being conducted on the leased lands; it can include, but is not limited to, the lessee record title interest owner or operating rights interest owner. See 43 CFR § 3160.0-5

[3] See 43 CFR §§ 3106.7-6(b), 3216.12.

[4] Id. § 3100.0-5(e).

[5] Not addressed herein are the qualifications to own an interest in a federal lease and the specific filing requirements.

[6] Id. § 3100.0-5(e).

[7] Most recent revision date is August 1, 2015.

[8] Id. § 3106.1(a). Note, the assignment of the entire interest in a portion of the leasehold will result in a segregation of the lease.

[9] Generally, requiring all of a governmental lot or quarter-quarter section under the Public Land Survey System.

[10] 30 USC § 1987a; 43 CFR § 3106.1. The 640 acre limitation was added to Section 30A of the MLA in 1987 pursuant to the Federal Oil and Gas Onshore Leasing Reform Act. Assignments of record title of less than 640 acres will be approved if the assignment constitutes the entire lease or is demonstrated to further the development of oil and gas.

[11] 43 CFR § 3106.1(b).

[12] Most recent revision date is August 1, 2015.

[13] 43 CFR § 3106.1. There is no written guidance defining “part of the acreage” or addressing this apparent acreage requirement. It appears that at least some minimal amount of acreage must be transferred to comply. Accordingly, although some BLM State offices will accept transfers of operating rights for less than 40 acres, they will not accept for approval, or even for filing purposes only, transfers of operating rights in a wellbore only.

[14] Id. § 3106.1(b).

[15] The term “assignment” is used generically in the IM applying to an assignment of either a record title interest or an operating rights interest.

[16] IM 1986-175.

[17] IM 2013-105 was issued in direct response to the 1996 amendment to Section 102(a) of the Federal Oil and Gas Royalty Management Act, 30 USC § 1712(a), providing that the owner of the operating rights shall be primarily liable for its pro rata share of payment obligations under the lease and the owner of the record title interest (if different from the owner of the operating rights interest) became secondarily liable. The federal regulations at 43 CFR Section 3016.7-6 and 3216.12, reflect these same principals. Furthermore, the BLM form Transfer of Operating Rights (Sublease) in a Lease for Oil and Gas or Geothermal Resources specifically provides that the transferee’s signature “constitutes acceptance of all applicable terms, conditions, stipulations, and restrictions pertaining to the lease… (Part B, paragraph 3) and “upon approval of a transfer of operating rights (sublease), the sublessee is responsible for all lease obligations under the lease rights transferred to the sublessee” (Part C, paragraph 8).

[18] See Jared A. Hembree and Uriah J. Price, Holding a Wolf by the Ears – A Look into BLM’s Policy on the Retroactive Adjudication of Operating Rights, 63 Rocky Mt. Min. L. Inst., Paper 11 (2017) (not yet published).

[19] The Montana State Office administers federal lands in Montana, North Dakota, and South Dakota. The Utah State Office administers federal lands in Utah only.

[20] The New Mexico State Office administers federal lands in New Mexico, Kansas, Oklahoma, and Texas.

[21] 43 CFR § 3106.1.

[22] 43 CFR § 3106.1(b).

[23] Both of the current BLM forms include a box that can be checked to indicate that it is for an overriding royalty interest assignment.

[24] 43 CFR § 3000.0-5(1).

[25] Id. § 3106.8-1.

[26] Id. § 3106.8-3.

Saving the Best for Last – What Is All That Stuff at the End of My Lease?

On this blog, we have posted our complete Fee Lease 101 Series covering many of the standard fee oil and gas lease provisions from the granting clause to the pooling clause. However, there is typically a group of clauses towards the end of the lease form that appear to be the left-over clauses. These clauses include the assignment clause, proportionate reduction clause, warranty clause, surrender or release clause, and preferential right to purchase or option clause. They can have important ramifications on the relationship of the lessor and lessee and status of the lease and, accordingly, are discussed below.

I.      Assignment Clause

The assignment clause governs how the lessor and lessee may assign their respective interests. It may contain a restraint on the lessee’s power to assign the lease in whole or in part without the lessor’s consent. It may also contain a restraint on the minimum acres or minimum interest that may be assigned, such as “no less than forty acres” or “no less than the lessee’s entire undivided interest.” This restraint on assigning/alienation by the lessee is generally allowed; however, it will be strictly construed.

To avoid a claim that the clause is an unreasonable restraint on alienation, contemporary leases typically authorize assignments by either the lessor or lessee, in whole or in part, but will often include conditions to the assignment. For instance, it may state that lessee will not recognize a change in the lessor’s ownership until it receives an original or authenticated copy of the assignment. It may allow a partial assignment by the lessor, but will require that the assignment cannot increase the lessee’s obligations under the lease, such as drilling offsetting wells, protection of drainage, requiring separate measuring, or installation of separate tanks.

Although often the intent of the assignor, it is important that the assignment clause provides that the lessor relieves the lessee of any further obligations concerning the interest assigned. 1 The assignor does not want to assign the interest and thereafter be stuck with the royalty payments if the assignee fails to pay the lessor. If a partial assignment of the lessee’s interest is allowed, a provision should be included that deals with the apportionment of rentals and royalties.

The following example assignment clause addresses all of the above requirements:

Ownership Changes. The interest of either Lessor or Lessee hereunder may be assigned, devised or otherwise transferred in whole or in part, by area and/or by depth or zone, and the rights and obligations of the parties hereunder shall extend to their respective heirs, devisees, executors, administrators, successor and assigns. No change in Lessor’s ownership shall have the effect of reducing the rights or enlarging the obligations of Lessee hereunder, and no change in ownership shall be binding on Lessee until 60 days after Lessee has been furnished the original or duly authenticated copies of the documents establishing such change of ownership to the satisfaction of Lessee or until Lessor has satisfied the notification requirements contained in Lessee’s usual form of division order. In the event of death of any person entitled to rentals or shut-in royalties hereunder, Lessee may pay or tender such rentals or shut-in royalties to such persons or to their credit in the depository, either jointly, or separately in proportion to the interest which each owns. If Lessee transfers its interest hereunder in whole or in part Lessee shall be relieved of all obligations thereafter arising with respect to the transferred interest, and failure of the transferee to satisfy such obligations with respect to the transferred interest shall not affect the rights of Lessee with respect to any interest not so transferred. If Lessee transfers a full or undivided interest in all or any portion of the area covered by this lease, the obligation to pay or tender rentals and shut-in royalties hereunder shall be divided between Lessee and the transferee in proportion to the net acreage interest in this lease then held by each. 2

II.       Proportionate Reduction 3

The proportionate reduction clause is also referred to as the lesser interest clause. It provides for reduction of rentals and royalties owed to the lessor in the event the lessor owns less than the full mineral estate. A typical proportionate reduction clause will provide:

In case said Lessor owns a lesser interest in the above described land than the entire and undivided fee simple estate therein, then the rentals and royalties herein provided shall be paid to Lessor only in the proportion that his interest bears to the whole and undivided fee.

However, the above example does not differentiate between the proportionate reduction of rentals and proportionate reduction of royalties. It focuses on the entire leased lands. What is the result if the lease covers a 640-acre section, the lessor owns 100% of the mineral estate in the W/2 of the section, 50% of the mineral estate in the E/2 of the section, and the well is located on the E/2? The lessor’s proportionate interest is 75% [(100% x 320/640) + (50% x 320/640)]. The lessor would not only receive 75% of the rental, but also 75% of the royalty even though the well is located on the lands in which the lessor only owns a 50% mineral interest.

The following example makes a distinction between rentals and royalties:

If Lessor owns less than the full mineral estate in all or any part of the leased premises, payment of rentals, royalties, and shut-in royalties hereunder shall be reduced as follows: (a) rentals shall be reduced to the proportion that Lessor’s interest in the entire leased premises bears to the full mineral estate in the leased premises, calculated on a net acreage basis; and (b) royalties and shut-in royalties for any well on any part of the leased premises or lands pooled therewith shall be reduced to the proportion that Lessor’s interest in such part of the leased premises bears to the full mineral estate in such part of the leased premises.

III.       Warranty Clause 4

The warranty clause provides a warranty of title by the lessor with respect to the interest described in the granting clause. Additionally, the warranty clause provides the basis for applying the doctrine of after-acquired title in the event the lessor acquires an interest in the leased premises after giving the lease. The following are two examples of warranty clauses:

• Lessor hereby warrants and agrees to defend the title to the land herein described and agrees that the Lessee, at its option may pay and discharge in whole or in part any taxes, mortgages, or other liens existing, levied, or assessed on or against the above described lands, and in the event it exercises such option, it shall be subrogated to the rights of any holder or holders thereof and may reimburse itself by applying the discharge of any such mortgage, tax, or other liens, to any royalty or rental accruing hereunder.
• Lessor hereby warrants and agrees to defend title conveyed to Lessee hereunder, and agrees that the Lessee at Lessee’s option may pay and discharge any taxes, mortgages or liens existing, levied or assessed on or against the leased premises. If Lessee exercises such option, Lessee shall be subrogated to the rights of the party to whom payment is made, and, in addition to its other rights, may reimburse itself out of any royalties or shut-in royalties otherwise payable to Lessor hereunder. In the event Lessee is made aware of any claim inconsistent with Lessor’s title, Lessee may suspend the payment of royalties and shut-in royalties hereunder, without interest, until Lessee has been furnished satisfactory evidence that such claim has been resolved. 5

The second warranty clause above allows the lessee to suspend payments to the lessor without interest in the event of a title dispute. However, a lessee should never suspend rental payments even if there is a title dispute. Failure to pay rentals could be fatal if the suspension is later determined to be unjustified.

As set forth in the above examples, the warranty clause often will contain a subrogation provision pertaining to a superior lien existing prior to the execution of the lease. To protect the lessee from the lease being extinguished if the superior lien is foreclosed, the clause authorizes the lessee to satisfy any liens and be subrogated to the rights of the lienor. The clause may vary in the types of claims or obligations the lessee is authorized to satisfy, including mortgages, deeds of trusts, taxes, assessment, charges, and encumbrances. Additionally, the clause may address whether the lessee may satisfy the claim or obligation prior to maturity thereof; and whether the lessee is authorized to withhold payments to the lessor for rentals, royalties, or other sums in satisfaction of the claim to reimbursement.

The warranty clause must be read in relationship to the granting clause and proportionate reduction clause. If the lessor owns less than 100% of the mineral interest, a granting clause that only describes the lands, but not the interest, is technically a breach of the warranty clause, but the proportionate reduction clause acts to proportionately reduce the lessor’s interest and the rental and royalties owed. If the granting clause describes the lessor’s percentage mineral interest in the lands, there is no breach of warranty, but there may be confusion as to the applicability of the proportionate reduction clause – is the lessor entitled to 100% of the rentals and royalties, i.e. not further proportionately reduced.

Cases have held that the warranty in the lease does not warrant the title of the lessor, it actually warrants title to the lessee. The warranty clause can be used to make a claim for a breach of warranty if the mineral interest covered by the lease is subject to an interest carved out of the mineral estate. For example, if prior to execution of the lease, the lessor’s mineral interest is subject to a non-participating royalty interest, it could be argued that the warranty clause, in some cases, results in the lessor’s royalty interest being reduced by the amount of the non-participating royalty interest. 6

Many lessors will strike out or delete the warranty clause. As discussed above, legitimate reasons exist for using this clause. If the lessor insists on deleting the warranty clause, the lessee should at least propose one of the options for protection: make it a special warranty (“by, through and under”); limit the damages for a breach of warranty to money paid for the bonus, rentals, and royalties; or have the lessor execute an indemnifying division order in the event of production attributable to the leased premises. 7 However, even if stricken, some courts have held that a warranty of marketable title is implied by law by use of the words “grant” or “convey” in the granting clause.

IV.       Surrender or Release Clause 8

The surrender or release clause was originally included in the “or” form lease to relieve the lessee of the obligations to either drill or pay rentals by allowing the lease to be surrendered back to the lessor. In contrast, the “unless” form lease permits a lessee to extinguish its obligations by merely failing to perform the obligation, i.e. lease will terminate unless rental is paid. However, a surrender clause is also useful in an “unless” form lease when the lessee desires to surrender only a portion of the lease. Following are two examples of a surrender clause:

• Lessee may, at any time and from time to time, deliver to Lessor or file of record a written release of this lease as to a full or undivided interest in all or any portion of the area covered by this lease or any depths or zones thereunder, and shall thereupon be relieved of all obligations thereunder arising with respect to the interest so released. If Lessee releases less than all of the interest or area covered hereby, Lessee’s obligation to pay or tender rentals and shut-in royalties shall be proportionately reduced in accordance with the net acreage interest retained hereunder.
• Lessee may at any time surrender or cancel this Lease in whole or in part by delivering or mailing such release to the Lessor, or by placing the release of record in the County where said land is situated. If this Lease is surrendered or cancelled as to only a portion of the acreage covered hereby, then all payments and liabilities thereafter accruing under the terms of this Lease as to the portion cancelled, shall cease and terminate, and any rentals thereafter paid may be apportioned on an acreage basis, but as to the portion of the acreage not released the terms and provisions of this Lease shall continue and remain in full force and effect for all purposes.

Of course, there are many variants of the surrender clause. As set forth in the above examples, a surrender clause may require that written notice be provided to the lessor and/or recording of the release. In some cases, the clause requires the notice be given at some particular date or after certain events have occurred (such as “after production is achieved”) or the surrender is not effective until some particular date after giving notice (such as “the surrender shall become effective 30 days after delivery of the release to Lessee”). The clause may also require a payment as a condition to the surrender.

As to partial surrenders, as provided in the examples above, if the lessee releases part of the lease, the lessee is relieved of all obligations concerning the released part, and rentals and shut-in royalties are proportionately reduced according to the amount of acreage released. However, some clauses specifically provide that certain obligations, including payment of rentals or royalties, will not be affected by a partial surrender. If a partial surrender is authorized, the size of the surrendered or retained lands may be addressed in the clause, i.e. “not less than ten (10) acres;” “contiguous;” or “any legal subdivisions thereof.” Including the phrases “at any time or times” or “may at any time, or from to time to time” clearly evidence that successive partial surrenders by the lessee are allowed. The lessee should include a provision that the partially surrendered lands shall remain subject to the easements and right-of-way provided in the lease for the lessee’s operations. Additionally, restrictions on the lessor’s or its subsequent lessee’s use of the surrendered land should be included stating that the lessor shall not interfere with the original lessee’s operations and requiring adequate set-backs from the exterior boundary of the lands retained or any well drilled by the original lessee.

V.       Preferential Rights to Purchase and Options 10

To protect the lessee, particularly with the advent of the short primary terms contained in contemporary leases, preferential rights to purchase and options to extend the primary term or renew the lease have been added to the lease. The following is a preferential right to purchase a new lease clause:

If during the term of this lease (but not more than 20 years after the date hereof) Lessor receives a bona fide offer from any party to purchase a new lease covering all or any part of the lands or substances covered hereby, and if Lessor is willing to accept such offer, then Lessor shall promptly notify Lessee in writing of the name and address of the offeror, and of all pertinent terms and conditions of the offer, including any lease bonus offered. Lessee shall have a period of 30 days after receipt of such notice to exercise a preferential right to purchase a new lease from Lessor in accordance with the terms and conditions of the offer, by giving Lessor written notice of such exercise. Promptly thereafter, Lessee shall furnish to Lessor the new lease for execution, along with a time draft for the lease bonus conditioned upon execution and delivery of the lease by Lessor and approval of the title by Lessee, all in accordance with the terms of said draft. Whether or not Lessee exercises its preferential right hereunder, then as long as this lease remains in effect any new lease from Lessor shall be subordinate to this lease and shall not be construed as replacing or adding to Lessee’s obligations hereunder. 11

The twenty year limitation is to avoid a violation of the rule against perpetuities in some states. This provision provides that the new lease is subordinate to the old lease to avoid any question about the status of the new lease while the old lease is still in effect.

An option to extend the primary term may provide for the lease to be extended for a specified period of time upon payment of a specified consideration. For instance, the following is an option to extend the primary term:

Lessee is hereby given the option to extend the primary term of this lease for an additional Two (2) year(s) from the expiration of the original primary term hereof. This option may be exercised by Lessee at any time during the original primary term by paying the sum of One Hundred and 00/100 Dollars ($100.00) per net mineral acre to Lessor or the credit of Lessor mailed to Lessor at the above address. This payment shall be based upon the number of net mineral acres then covered by this lease and not at such time being maintained by the other provisions hereof. If, at the time this payment is made, various parties are entitled to specific amounts according to Lessee’s records, this payment may be divided between said parties and paid in the same proportion. Should this option be exercised as herein provided, it shall be considered for all purposes as though this lease originally provided for a primary term of Five (5) years.

A lease may also contain an option to renew the lease. Courts have differed on whether there is a distinction between “renew” or “extend.” In an Ohio decision, the court held that the clause “Lessor grants Lessee an option to extend or renew under similar terms a like lease” provided the lessee with two options: (1) to extend the lease on the same terms as the existing lease; or (2) to renegotiate for a renewal “like lease” on similar terms. The court reasoned that the terms “renew” and “extend” are distinct terms. 12

In our Fee Lease 101 Series, we have covered most of the standard fee oil and gas lease clauses. As discussed above, these “left-over” provisions can affect the lessor’s and lessee’s, and their successor and assigns, rights, interests, and obligations and the status of the lease. A caveat for this article, and all our Fee Lease 101 Series articles, in interpreting any lease provision, care must be used in examining the specific language of the provision and the case law of the jurisdiction must be understood and applied. In order to avoid unintended consequences, the same caveat applies to drafting any lease provision.

1 See Pennaco Energy v. KD Co. LLC, 2015 WY 152, ¶ 19 (2015) (Finding, “Among the covenants [obligations] the original lessee-assignor retains after assignment of its interest are those requirement payments of rentals and/or royalties and restoration of the surface to its original condition once production activities have ceased.”). 2 Thomas W. Lynch, The “Perfect” Oil and Gas Lease (An Oxymoron), 40 Rocky Mtn. Min. L. Inst. 3-1, § 3.10 (1994). 3 See, generally, id. § 3.09. 4 See, generally, 4-6 Williams & Meyers, Oil and Gas Law § 685.1. 5 See, generally, Lynch at fn. 3, § 3.15. 6 Id. 7 Milam Randolph Pharo & Gregory R. Danielson, The Perfect Oil and Gas Lease: Why Bother!, 50 Rocky Mtn. Min. L. Inst. 19-29 (2004). 8 See, generally, 4-6 Williams & Meyers, Oil and Gas Law § 680. 9 The use of the terms “surrender” or “release” are used interchangeably to describe this clause. For purposes of this article, we will use the term “surrender”. 10 See, generally, 4-6 Williams & Meyers, Oil and Gas Law § 697.6. 11 See, generally, Lynch at fn. 3, § 3.17. 12 Kenney v. Chesapeake Appalachia, 2015 Ohio 1278 (Ohio Ct. App. 2015); Eastman v. Chesapeake Appalachia, 754 F.3d 356 (6th Cir. 2014).

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Oil and Gas Investment: Working Interest

Working interest refers to the financial responsibility an investor has for expenses related to the exploration, drilling, and production of natural resources. When someone holds a working interest, they are fully involved in the profits generated from the operation, reflecting their investment. Conversely, investors with royalty interests typically have limited potential for significant profits as they are usually restricted to their initial  oil and gas investment .

Having a working interest entitles investors to a percentage ownership of the profits derived from resource production. They also have the right to participate in drilling activities and benefit from the resources extracted. However, along with the income gained from resource production, investors also bear a proportionate share of the acquisition costs.

What is working interest in oil and gas?

A lease granting exploration, drilling, and production rights for oil and gas can be obtained by oil and gas developers through a  working interest .

Working interest owners are responsible for contributing a portion of the expenses associated with leasing, drilling, and operating oil or gas wells. In addition to the royalty payments received from royalty interests, working interest owners also receive a  corresponding percentage of the revenues  generated from production.

To illustrate, let’s consider a scenario where a property holds a 20 percent royalty interest. In this case, the owner who possesses a 100 percent working interest assumes the responsibility of financing the entire drilling expenses while retaining 80 percent of the generated profits from production. The remaining 20 percent is allocated to the holder of the royalty interest. In the event of multiple owners, they divide the 80 percent share of profits amongst themselves proportionate to the size of their respective investments.

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Notably, these divisions of net revenue are independent of the well’s productivity. While certain geographic areas may be more productive, it does not impact the allocation of revenue. The calculation remains the same.

In the world of oil and gas production, working interests can pertain to leases, wells, or drilling units. Acquiring and maintaining a working interest involves a substantial upfront investment.

Kinds of working interest

There are three primary kinds of working interest:

Operating working interest – This refers to the individuals or entities that are responsible for running the operations of an oil or gas investment. The owners of the operating working interest bear the costs associated with operations and make payments to holders of royalty interests.

Non-operating working interest – This type of working interest entails ownership rights in a well, lease, or other production areas, but without any obligation to operate or cover the operational costs of a producing unit. Non-operating working interest owners do not have direct involvement in the day-to-day operations.

Carried working interest – This kind of working interest involves a partnership between multiple parties who hold a working interest in a well. Through a joint venture or partnership arrangement, these parties pool their resources to finance the functioning of the well. Investors who hold a carried working interest are not required to participate in daily activities. Instead, they contribute upfront funds, and once production begins and profits are generated, they receive a share of the revenue.

Benefits of being a working interest owner

Just like any form of investment, investing in working interest offers several advantages:

Potential for substantial and lasting profits – If the well proves to be successful, the  profits can be significant  and last for an extended period of time.

Tax benefits and offsets – Tax benefits associated with working interest investments are treated as losses, which can be used to offset other income. This allows investors to potentially reduce their overall tax liability.

Active involvement in production decisions – Investing in working interest means actively participating in the decision-making process related to production activities. This provides investors with a sense of control and the opportunity to contribute to the success of the project.

Potential tax incentives – Working interest owners may qualify for tax incentives, which can amount to approximately 65 to 80 percent of the total investment cost. These incentives can further enhance the financial attractiveness of the investment.

The information provided above contains all the essential details you should be aware of if you are considering investing in a working interest in the oil and gas industry. Make an informed decision as an investor.

DW Energy Group, LLC is a non-operating oil and gas exploration company located in the Dallas, Texas metro area. Since 2008, DW has provided industry-leading  oil and gas investment  opportunities to qualified investors. DW is an expert at finding, developing, and managing the most lucrative domestic oil and gas investment opportunities for qualified and approved investors.

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“Working Interest: Meaning, Overview, Advantages and Disadvantages,” Investopedia, https://www.investopedia.com/terms/w/working-interests.asp “Oil and Gas Ownership Interests: Calculating Working Interest,” Legacy Exploration, LLC.,  https://legacyexploration.com/oil-gas-ownership-working-interest/ “How oil and gas working interest investments work,” Baker Tilly,  https://www.bakertilly.com/insights/how-oil-and-gas-working-interest-investments-work “Risk and Return: Working Interests and Royalty Interests,” Mercer Capital, https://mercercapital.com/energyvaluationinsights/risk-and-return/

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What is Working Interest in Oil and Gas and How to Calculate It

Working interest refers to an investor’s responsibility for costs related to exploration, drilling, and production of natural resources. A working interest owner participates fully in all profits from the well due to their investment. In contrast, an investor with royalty interests is usually limited to their initial investment, which leads to a lower potential for large profits.

A working interest provides investors with a percentage ownership of the production profits, a right to the drilling activities, and the resources produced. In addition to receiving income from resource production, investors also bear the responsibility for a percentage of the acquisition costs.

In this article, we will talk about different types of working interests, their benefits and disadvantages and how they are calculated and taxed.

What is a Working Interest in Oil and Gas?

With a working interest , oil and gas developers can obtain a lease allowing them to explore, drill and produce oil and gas from a piece of land.

Working interest owners have to contribute a portion of the costs for leasing, drilling, and operating the oil or gas wells. In addition to the royalty payments due on royalty interests , the owner of a working interest receives a corresponding percentage of the revenues from production.

So, if a property has a royalty interest of 20%, the owner of a 100% working interest would be expected to pay 100% of the drilling costs while retaining 80% of the production profits. The remaining 20% is due to the holder of the royalty interest. If there are multiple owners, they share 80% of the profit among themselves according to the size of their investments.

Note that none of the above depends on the productivity of the oil well. One geographic area may be more productive than another, but that will not affect the net revenue division. The calculation is still the same.

In oil and gas production , working interests may be a lease , well , or drilling unit . Purchasing and maintaining one costs thousands or hundreds of thousands of dollars at the outset. A working interest is a substantial upfront investment initially.

Working Interest vs. Mineral Ownership

Working interests and mineral interest ownership are two types of oil and gas rights. Let’s examine the difference between both.

Working interests are a lease agreement that grants oil and gas companies rights to explore, drill, and produce natural resources from a land. Mineral interest ownership is a recorded property document outlining the legal owner of natural resources below surface level.

The mineral owner and the holder of the working interest must adhere to the terms of the lease for it to be effective. An inactive well typically ends the agreement once the well no longer produces oil or gas, or when the lease with the oil and gas companies expires. Like any form of real estate, minerals can be owned forever. Despite this, states such as Louisiana enforce Napoleonic Law that reverts mineral rights to the original landowner. These are just a few of the differences between the two types of ownership rights.

Types of Working Interest

There are 3 main types of working interest:

• Operating working interest – Other working interest owners include the person who runs the operation as an oil or gas investment. The operating working interest owners handle the costs of operations and the payments to holders of royalty interests.
• Non-operating working interest – this type comprises an ownership interest in the well, lease, or other production areas with no responsibility to operate or pay the operation cost of a producing unit.
• Carried working interest – this type comprises a partnership between different parties who own a working interest in a well. Several parties can share their working interests through a joint venture, a partnership in which a group provides the required finance to keep a well functioning. Investors are not required to participate in daily activities. They pay upfront, and when the production starts making profits receive a share of the revenue generated.

How to Calculate Working Interest in Oil and Gas Investments?

To calculate the working interest owned, you have to know the Net Revenue Interest. This interest is the share of production revenue an investor receives after investing in the working interest. To calculate the net revenue interest , you deduct the royalty interests from the total amount generated from production.

To calculate the net revenue of the working interest, you subtract the RI share from the total percentage of the working interest. Then multiply the remaining shares by the sum of the subtraction.

So, for example, a group of people invests in a working interest investment in a well, with the following shares:

• Joe, royalty owner – 15%
• John, working interest – 10%
• Larry, overriding royalty – 5%
• Megan, working interest – 12.5%
• Moe, working interest – 12.5%
• Jack, working interest – 20%
• Joseph, working interest – 10%
• Mary, working interest – 15%

Among these working interests, the total royalty owners amount to 20% (15% + 5%).

Subtract the royalty owners’ percentage from the profits generated by the well.

So, 100% – 20% = 80% left from the 100% profits from the well.

Multiply each investment by the percentage of profit:

• Joe, royalty owner – 15% * 80% = 12% NRI
• John, working interest – 10% * 80% = 8% NRI
• Larry, overriding royalty – 5% * 80% = 4% NRI
• Megan, working interest – 12.5% * 80% = 10% NRI
• Moe, working interest – 12.5% * 80% = 10% NRI
• Jack, working interest – 20% * 80% = 16% NRI
• Joseph, working interest – 10% * 80% = 8% NRI
• Mary, working interest – 15% * 80 = 12% NRI

Aside from the royalty interest owners, the total NRI of the working interest owners is 80%. The formula is the same regardless of the quantity of interest or the number of decimals it contains.

What are the Benefits of Being a Working Interest Owner?

As with all types of investments, there are benefits. The benefits of investing in working interest include:

• If the well becomes a success, profits are likely to be substantial and can last for years.
• Since tax benefits are seen as a loss and losses are considered active income, they can be offset by other income.
• It is an active investment where you take part in production decisions.
• Working interest owners sometimes receive tax incentives. It can be worth around 65% – 80% of the cost of a working interest investment.

Are there any Disadvantages and Risks?

Apart from the benefits, there are also downsides to this type of investment. Here are some risks of taking part in this type of investment:

• Initially, the investment is high since you must pay for the cost of production.
• Due to the high cost of investment, there is a high chance of running at a loss.
• On-the-job calamities, such as employee injury or environmental damage, may place investors at risk.

How is Working Interest Taxed in the Oil and Gas Industry?

For tax purposes, most working interest income is treated as passive income because the investment is part of a partnership and, as such, will generally be taxed.

As a result, the investor has a taxpayer’s liability for investment income tax. Investors must pay the estimated tax based on Internal Revenue Service (IRS) tax rules and rates, as the tax on regular investment income is not automatically withheld. In the United States, the self-employment tax rate is 15.3%.

If an investor receives resources as a gift, such as lease rights to an oil well, these may qualify as taxable income. Working interest investors are eligible for tax benefits based on the operating costs of their investment. These may include tangible drilling costs or intangible drilling costs , such as equipment costs or utility payments.

How Do You Report Working Interest?

Schedule C is used to show the operating expenses, depletion, and gross receipts of working interest. As a working interest owner, you will see your gross receipts. Operating expenses, direct and indirect, should be noted in Schedule C. They include a dry hole, overheads, administrative and legal, taxes, and other operational costs related to oil and gas development.

Although a working interest is exempt from net investment income tax, it is subject to self-employment taxes, as reflected in Schedule SE.

The above is all the necessary information you need to know about investing in a working interest in oil and gas in case you want to become an investor. If you have no trusted broker to negotiate a working interest deal or ask for more information, count on Pheasant Energy. We are industry experts in oil and gas rights with more than 70 years of experience and a trustworthy broker for buyers and sellers of working interests. Get in touch with us today.

1. What is the difference between working interest and royalty interest?

Working interests are oil and gas investments that give owners the right to exploit the resources on a property. Royalty interests are the rights belonging to the landowner who leased out the property to the working interest owner.

2. Is a working interest real property?

No! A working interest is an agreement that grants its owner certain rights over a property.

3. Is working interest passive income?

Yes. Holding a working interest in the oil and gas industry may be a passive activity. Sometimes the investors are a group of people, and not all of them are actively involved with the production process.

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Assignment of Oil and Gas Lease

An oil or gas lease provides the lessee with many rights regarding the use of the land and the minerals buried underneath it. When that lease is signed, it creates a real estate, which can be further divided or assigned to other parties. That’s where the term assignment comes from in the oil and gas industry. 

But the assignment of oil and gas lease can include the transfer or conveyance of various things. So for anyone involved in an oil or gas lease in any capacity, it’s beneficial to understand the meaning of assignment and its implications for the lease itself. 

Assignment of Oil and Gas Lease Meaning

The definition of assignment in real estate is the sale, transfer, or conveyance of a whole property ownership/rights or part of it to another party. 

The term in the oil and gas industry is used for sale, transfer, or conveyance of working interest, lease, royalty, overriding royalty interest, or net profit interest. 

Since real estate property rights or mineral rights in the case of oil and gas are divisible, mineral rights owners or lessees often sell or convey parts of the mineral rights to other companies. The legal instrument used for this purpose is called an assignment. 

The party assigning the rights is called the assignor, and the party receiving the rights is called the assignee. 

Assignments are filed in the same way as an oil and gas lease or a title deed to a property. These legal documents need to be drafted in accordance with the state requirements and filled with the relevant county or municipality authorities. 

Of the different assignment transactions in the oil and gas industry, the assignment of rights in the oil and gas lease is the most common. While the lease itself is the negotiable instrument in the scenario, the assignment establishes the successful transfer of the rights. 

It may look like a simple document, but the rights and duties of the different parties can make it complex. As a result of the assignment, the property interests, rights, and obligations of the lessor, lessee, and assignee may alter. 

On top of this, any local laws governing such a transfer also need to be accommodated. Now, federal regulations also impact the transfer of oil and gas interests. 

What Can Be Assigned?

The lessee of an oil or gas lease can assign the entire lease or part of it. In other words, the lessee can sell or transfer part of the estate or the entire estate to which they have the working rights. 

The assignee is assigned the working interest and lease obligations, including override royalty. The assignment document will state the percentage of override royalty, which is the percentage of the mineral removed from the land under lease and the net profits received by the assignee by the sale of the minerals. 

An overriding royalty interest is an undivided interest that gives the holder the right to receive a certain percentage of the revenue from the sale of the mineral. This differs from royalty interest in that the overriding interest cannot be divided and doesn’t grant ownership of the mineral rights once the assignment expires. 

In other words, the original mineral owner (the lessor) retains a royalty interest, whereas the lessee assigning the lease to an assignee gets the overriding royalty interest. 

Multiple Lease Assignments

Normally, the assignment mentions and describes the lease assigned to an assignee. 

However, an oil or gas company often may have multiple lease agreements with different mineral owners from the same field or formation. On the other hand, the leases involving different lessees may have undergone unitization to increase production and reduce competition. 

In such cases, the assignment may include multiple leases. If multiple leases are in an assignment, they are typically described in an exhibit with the document. However, in cases of unitization, the assignment may not necessarily list or describe the leases. Instead, it will just mention all the lease agreements in a particular unit or tract of land. 

It all comes down to the document’s language, as sometimes the focus is on the rights and obligations rather than the actual lease or property. 

Assignment Limitations

Oil and gas leases are pretty flexible regarding how they can be further leased or assigned. An assignor may choose to assign the lease as is or set limitations that may not exist in the original lease. An assignor may set the following limitations for the assignee:

• Wellbore Limits: The assignment may set the production to the wellbore only. In other words, the assignee can only produce the mineral from the wellbore of a particular well, and all the interests outside of this wellbore are not assigned. In such a case, the assignee cannot produce from deeper formations. 
• Depth Limits: The assignment may set the interest to a certain depth or a particular formation by mentioning the formation’s depth or name. For instance, the assignee may only have a working interest up to a depth of 8,000 ft. from the surface. These are more common in assignments than wellbore limitations. Such limitation may also automatically apply if the oil or gas lease also had depth limitations. 
• Horizontal Limits: The assignment may set horizontal limitations or, in other words, include only a part of the land. The assignee would not be able to produce from outside these parts of the land as described in the assignment, even if they are part of the actual lease. 

Assignment of oil and gas lease is a common instrument in the oil and gas industry in the US, used to assign lease rights and obligations to other companies. The companies with the lease can assign multiple leases to the same party. Similarly, they can divide a lease and assign it to different parties. 

The assignment procedure and documentation may vary based on state laws and the individual case. However, it’s a detailed document that specifies what is covered under the assignment, what duties befall the assignee, and what they need to pay the assignor. 

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Texas Supreme Court Holds that Assignment Conveyed Entire Lease Interest, Not Merely A Wellbore Interest

Posted by: Jordan Mullins and Michael Szymanski in Case Law Update

Piranha Partners v. Neuhoff , No. 18-0581, 63 Tex. Sup. Ct. J. 474, 2020 Tex. LEXIS 136 (Tex. Feb. 21, 2020)

Where parties assign an interest in a lease with a single existing well, disputes can sometimes arise when the leasehold is further developed. Was the parties’ intent for the assignment to be limited to that single wellbore or did it also include production from later-drilled wells? The Texas Supreme Court reviewed a dispute as to whether an assignment of an overriding royalty interest conveyed an interest limited to an entire lease, a single well, or to the lands identified in the assignment.

In 1975, Neuhoff Oil & Gas (“Neuhoff”) purchased a two-thirds interest in the Puryear Lease, an existing lease covering all the minerals under a tract of land. Neuhoff later sold its two-thirds interest in the Puryear Lease but reserved a 3.75% overriding royalty interest on all production under the Puryear Lease. For twenty-four years, only one well was completed on the lands covered by the lease, the Puryear B #1-28. Then, in 1999, Neuhoff sold its overriding royalty interest at auction to Piranha Partners (“Piranha”). Neuhoff then went out of business, assigning its remaining assets to individual family members (the “Neuhoff Heirs”).

The operator under the Puryear Lease paid Piranha an overriding royalty on the Puryear B #1-28, but on additional wells it drilled on the lease, it paid an overriding royalty to the Nuehoff Heirs, believing Piranha had only been conveyed the overriding royalty interest in the specific well and not on all production under the Puryear Lease. The Piranha Assignment’s granting clause conveyed all of Neuhoff’s interest in properties described in an attached “Exhibit A” which described Neuhoff’s overriding royalty interest by reference to the Puryear #1-28, the land, and the Puryear Lease.

The Texas Supreme Court indicated Piranha erroneously relied upon numerous rules of construction that were not applicable. For instance, Piranha argued that the “greatest estate” canon applied since the assignment used the word “all.” The Court dismissed the canon’s applicability because the Assignment was unambiguous and the remainder of the sentence Piranha focused on included “all…right, title, and interest in and to the properties described in Exhibit ‘A’,” which, nevertheless, required analysis of Exhibit A.

Piranha also erroneously relied on construction rules regarding the clarity by which an instrument must describe a reservation or exception. The Court found those rules inapplicable because the issue was the scope of the grant to Piranha, not a reservation or exception. The Court also dismissed Piranha’s “construe against the grantor” argument, because the assignment was unambiguous.

The Neuhoff Heirs, on the other hand, primarily relied upon so-called “surrounding circumstances evidence,” including descriptions that appeared in the auction documentation and argued this information showed the interest offered was limited to the well. Arguing the flip side, Piranha contended those same documents did not describe the interest as “WBO,” an acronym sometimes used in auction materials to show an offered interest pertained to “wellbore only.” Piranha also pointed to the agreement Neuhoff signed with the auction house, indicating it was not selling a “fractionalized interest.” The Neuhoff Heirs, however, argued that the agreement applied to Neuhoff selling 100% of its interest in the Puryear B #1-28. The Court concluded the auction documents failed to support either side as the documents disclaimed the reliance placed on them by the parties, requiring that the parties instead look to the actual Assignment to Piranha.

The Court ultimately held that Piranha Assignment included all overriding royalty in the Puryear Lease, not just in the land or the wellbore. Rather than apply rules of construction or surrounding circumstances, the Court used a “holistic and harmonizing approach” in construing the language within the Assignment and its Exhibit A. Specifically, the Court focused on several provisions in the Assignment referencing the interest in the lease (as opposed to in a well or lands), and language describing the interest being conveyed as “all oil and gas leases…which shall include any… overriding royalty interests…held by [Neuhoff], as of the Effective Date,” to mean the Assignment to Piranha included all interest then owned by Neuhoff.

In addition, the Court noted the language “All presently existing contracts…to the extent they affect the Leases,” indicated “Neuhoff Oil conveyed its entire interest under the Puryear Lease,” further discrediting the assignment to Piranha was limited to the wellbore or land itself. Other provisions also referenced the lease, including a provision which indicated that the overriding royalty was payable out of oil produced under the lease and pursuant to the terms of the lease. The proportionate reduction clause also referenced the assignor’s interest in the lease.

As a result, the Court concluded that the Assignment to Piranha conveyed the overriding royalty interest as to all production under the Puryear Lease, not just in the Puryear #1-28.

Taken as a whole, the conclusion in this case is largely consistent with the body of case law emphasizing a holistic and harmonizing approach to deed interpretation. This case underscores the importance of ensuring that not only the body of an assignment, but also the exhibits, both carefully describe the intended scope of the conveyance. It also underscores that boilerplate “all right, title, and interest” language is not always merely expansive quitclaim language, but sometimes can have material meaning. It is important to evaluate the rights of either party in the event circumstances change in the future (i.e. drilling and production of an additional well).

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MRP 43: Overriding Royalty Interests

• Post author: Matt
• Post published: January 10, 2020
• Post category: Podcast

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In this episode, we talk about Overriding Royalty Interests, also sometimes called Overrides or ORRI’s.  We cover everything you need to know about Overrides if you have inherited them, are looking to invest in ORRI’s, or just want to know more. 

Using the embedded player above, you can download the episode to your computer or listen to it here!  Be sure to also subscribe on iTunes or wherever you get your podcasts and please leave us an honest rating and review.  We read every one of them and sincerely appreciate any feedback you have. To ask us a question to be featured on an upcoming episode, please leave a comment below or send an email to [email protected] .

What is an Overriding Royalty Interest?

• An Overriding Royalty Interest is a type of royalty interest that is carved out of the Working Interest in a property and does not affect the mineral owner.
• These are often used in the industry as a form of payment to geologists, landmen, engineers, or brokers who are involved in putting together an oil and gas prospect.
• It is also sometimes used when selling a lease, the seller may retain an override in the property
• An ORRI is an undivided interest in the proceeds from the sale of oil and gas, similar to a typical oil and gas royalty that a mineral owner receives.  Like other royalties, they are not burdened with drilling or operating costs 
• A unique element to an Override is that it is limited to a specific tract of land covered by an oil and gas lease and if that lease is allowed to expire, the ORRI expires with it.  Since they can expire when the lease is up, they aren’t perpetual in nature like mineral rights so while a mineral owner could lease their minerals again, the Override simply goes away.

Other Payments Carved Out of the Working Interest:

• Also, a notable difference vs. other types of Royalty Interests is the ownership is a percentage of production or production revenue produced by the acreage described in the lease, also that it is free of all costs of drilling and producing.
• There are also other similar forms of non-operated interests such as a production payments which is basically the same concept as an override but the production payment terminates when the specific amount of production or money has been received by the owner of the production payment. 
• Another type is a net profits interest which like it sounds pays the owner the net amount based on net production after specific costs have been deducted. 
• All 3 types are carved out of the Working Interest (the percentage ownership in an oil and gas lease that grants the owner the right to drill a well), but we are going to focus on Overrides today.
• If you are investing in Overriding royalties, this is potentially a more risky investment and you should value them accordingly.  In many cases, if investing in an override it may only make sense to pay based on existing production. In some cases where the lease is solidly held by production (say by vertical well) and there is a lot of horizontal drilling nearby then it may make sense to value based on potential future wells in addition to existing production.
• The scenario where there is only one well holding the lease, if operational issues come up or it is no longer economic to operate, the operator may plug & abandon the well and the ORRI could go away sooner than expected.
• Or, worst case scenario if you sell a lease and retain an override you have no control over the operator’s decisions whether or not to drill a well or to let the lease expire. This is unlike the scenario where the mineral owner can re-lease minerals to someone else if the lease expires.
• That said, some states have protections in place to protect non-operated interest owners from this situation if the operator lets the original lease expire and then leases the same tracts of land from the same lessor just so that it is free and clear of the original overriding royalty interest.  To protect yourself from this situation, (sometimes referred to as a “washout”) you might be able to include language in grants or assignment documents to protect you. Saying this for info purposes only…If you get into this situation, consult a qualified attorney in your jurisdiction.
• If you had a relative that worked in the oil & gas industry, you inherited mineral rights, it might be that your relative owned overrides as well

How to Find Out if You Own an Overriding Royalty Interest

• There are basically two ways to do this, 1st to hire a landman to search county records where you have inherited minerals to see if any grants or assignments were made to the person you inherited other property from.
• 2nd is to perform the title search yourself, either in person in the county courthouse or as is the case with many counties, you can often do this online.  We cover more about how to perform a title search in episode 10 ).
• Basically the steps would be to search the county grantor/grantee index for the name of your relative to see if there are Assignment documents that grant them an override.  Your relative may be either the grantor, as in the case where they owned the lease and assigned it to someone else but retained an override, or they might show up as the grantee if they received an override as a form of payment for some other type of work.
• Another thing to do is search by legal description.  In this case, you may need to look at any leases that might have been taken in the time of your relative to see if there is anything.

How to Interpret an Overriding Royalty Interest

• A caveat here is that since laws vary from state to state, it is best to consult with a qualified attorney to help interpret lease and assignment documents so that you can understand exactly what is covered and how big the override is.
• That said, will cover few scenarios to illustrate the point that overrides are very dependant on language.
• For example, Override may include proportionate reduction language.  To describe this means will talk about a mineral lease where language is included to proportionally reduce the landowner royalty interest in the ratio of  the mineral interests covered by the lease to the full mineral interest in the covered lands. In other words, if you own ½ of the minerals under a specific tract and have a 1/8th landowner royalty interest, your interest would be reduced to reflect the mineral interest covered by the oil and gas lease or in other words, you would get ½ of 1/8th and could also be further reduced based on the tract factor if the spacing unit for a covered well isn’t 100% on your lands.
• Similar to oil and gas lease, an override can be reduced proportionate to the mineral interest covered by the applicable oil and gas lease.
• In another scenario the override may only be reduced proportionate to the working interest being assigned (if it is not 100%).  So even if the lease covers minerals where the lessor owns less than 100% of the minerals under the specified tracts of land (called the “leased premises” in lease), if the language in the assignment document for the override says that “⅛ of 8/8ths Overriding Royalty Interest” is reserved without mentioning anything specific to the covered lands or the lease then the owner of the override would receive an undivided ⅛ of 8/8ths override that isn’t proportionately reduced, even if the covered lessor only owned ½ of the minerals like our earlier scenario.
• So, overriding royalty interests may be interpreted literally so language becomes very important and this is where it is critical to have an attorney review any assignment documents.
• Language in the lease (e.g. all the things we mention in the oil and gas leasing episode – Episode 6 ).  For example, if the lease only covered oil and gas and other minerals down to but not below a specific formation, any wells would need to be in the covered interval.  Any other wells producing from deeper formations might not apply to you.
• Proportionate reduction language in the assignment doc
• What expenses are to be borne by the override?
• What happens to the override if the covered il and gas lease is modified or renewed?
• Are there any drilling obligations other than those already covered by the oil and gas lease?  
• How is pooling or unitization covered and does it require consent from the owner of the override?
• When in doubt, get it in writing!

How to tell if the Oil and Gas Lease (and the Override) is Still Active:

• Look for release of oil and gas lease recorded with county, this will tell you definitively that lease has expired.
• In absence of this, look at state oil and gas commission website to identify if there are any producing wells on the leased land.
• Remember, you will need to check what depths and/or formations the producting wells were drilled into if there are any depth restrictions associated with the governing oil and gas lease. It could be that the producing wells are in a different formation and your lease may no longer be active.

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• Leave a comment or question below (we read each one and your question may be featured in a future episode)!
• Ask a question or leave us feedback via email or voicemail: (720) 580-2088.

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Subscribe and leave a review on iTunes or wherever you get your podcasts – we read each one and greatly appreciate it.  Plus, you can get a shout out on a future episode!

Thanks again – until next time!

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New Mexico State Land Office Oil and Gas Division Manual 2023

Web Version  

Why is it that no more than two persons are allowed to own a state lease?

By State Land Office rule, no more than two persons/legal entities may be named as the lessee of record on an oil and gas lease. If two persons/legal entities are the lessee of record on a particular lease, the lessees are joint tenants and the state views each lessee as having a 100% undivided interest in it.

What exactly are Miscellaneous Instruments?

Miscellaneous Instruments are other contracts and instruments entered into by the lessee that do not affect record title. Per 19.2.100.43 NMAC, The State Land Commissioner does not approve Miscellaneous Instruments. Currently the Commissioner is only accepting three types of Miscellaneous Instruments, these types are identified on the Miscellaneous Instrument Filing Form. Other instruments such as assignments of interest, undivided working interests, overrides, farm outs/rights to explore and produce below a certain depth, overriding royalty assignments, operating rights, financial statements, and powers of attorney, etc. should be filed with the applicable County Clerk’s Office.

What form is required when submitting a record title assignment?

NMSLO’s Assignment of Oil and Gas Lease (form 0-30-A) is required.  The 0-30-A form should NOT be altered; the language of the official form will bind all parties.  Attachments to the form are permissible, if necessary, in order to capture additional signatures. No reservations, percentages or depth restrictions are permissible in a record title assignment.  Please complete the mailing address of the assignee, as lease correspondence will be sent to this address.

• See  Oil and Gas Forms

What are the fees for submitting assignments?

A $100 filing fee is required on each lease for which an assignment of record title is filed. A late fee of an additional $150 per lease is required if the assignment is filed with our office more than 100 days from the assignor’s execution date on the form. The fee for filing miscellaneous instruments is $50 for each associated lease.   All filing fees are non-refundable.

Is the assignment 0-30-A form available on the Internet?

Why does the form 0-30-a require all signatures be notarized.

Any legal instrument that is a transfer of real property must be acknowledged before a notary, required by statute.  Record title transfers are considered transfers of real estate in New Mexico.

Is a transfer of record title on a portion of the lands accepted?

Yes, an assignment of partial acreage may be filed as a record assignment.  To indicate a partial acreage, Record Title Assignment please check the “Partial Assignment” box at the top of the 0-30-A form.  No less than a full quarter/quarter or a full lot of an Oil and Gas Lease will be approved as a 100% Record Title Assignment.

Why does my lease assignment have a suffix number attached to it?

Every time a transfer of record title is approved a suffix number, aka the assignment number, is systematically generated to distinctly identify that assignment.  The number of assignments within an entire lease determines the next assignment number, generated sequentially.

If I have a large number of assignments to make, do I have to complete the paperwork for each and every assignment?

No, Blanket Assignments/exhibits are accepted by NMSLO.  A Blanket Assignment must be completed in triplicate, notarized, original signatures are required on each, and an exhibit A must be attached.  Additionally, a copy of the signed assignment must be submitted for each lease listed on the exhibit.   Blanket assignments are limited to 25 lease assignments per exhibit and filing fees are due for each lease listed on said exhibit.  Please contact our staff for a template of the required exhibit format.

What is an OGRID?

It is an Oil and Gas Remittance Identifier. This is a number that is utilized by three agencies: the State Land Office (NMSLO); the Oil Conservation Division (OCD); and the Taxation and Revenue Department (TRD).  OGRID numbers are used by these agencies to identify each entity and track various transactions and data.

When do I need an OGRID?

When any business regarding Oil and Gas is conducted with the three state agencies, the entity must first obtain an OGRID number, i.e. in order to bid at our State Land Office monthly Oil and Gas Lease Sale, bidders must have an OGRID number.  To request an OGRID please contact NMSLO’s Oil and Gas Division.

If we do not remember our OGRID number, can we submit an assignment without it?

Yes, the Oil, Gas, and Minerals Division staff will research the OGRID number if it is left blank on the assignment form. The OGRID number will be documented on your returned copy of the approved assignment.

How do I notify the Land Office of an address change?

A formal request must be submitted either by letter or on the Change of Address Form, available online under  Oil and Gas Forms .  Please provide the new address as well as the previous address.  Please provide current contact information as well.

Do I need to procure and file a bond or a waiver when I acquire a state Oil and Gas Lease?

A Protect Surface Bond Waiver may be filed in lieu of a bond   if   there are no plans for development and no surface disturbance on lease.

Prior to the commencement of development/operations/surface disturbance on a lease, the NMSLO requires that a sufficient bond be filed with, and approved by the Commissioner.

What kind of bonds does the Land Office require from lessees?

• Single lease Surface Damage Bond (Provides Surety for one Oil and Gas Lease)
• Multi-lease blanket Surface Damage Bond (Provides Surety for two or more Oil and Gas Leases)
•  Megabond (Provides Surety for Oil and Gas Leases, etc.  Please see the Megabond form for coverage details)
• A Cash Collateral Assignment is an acceptable alternative to procuring a bond from a surety company.  This form must be submitted in conjunction with the applicable bond form, determined by the amount deposited.
•  Please refer to the  Bond instructions, law and rule document  for detailed information regarding bonds

How do I know when the oil and gas lease sales are held?

The sales are held the third Tuesday of every month. Lease sales are held online through the SLO auction contractor, EnergyNet.

Monthly Oil and Gas   Lease Sale Notices   are posted on the NMSLO website.

When would I need to pay a shut-in gas royalty?

Shut-in Royalty (SIR) payments are due per well, per year.  A completed Shut-In Royalty Payment form and the applicable payment may be submitted if:             

• The associated lease contract contains the shut-in provision.
• The well is capable of producing gas in paying quantities.
• The well is temporarily shut-in due to lack of market or lack of a pipeline connection.
• The lease(s) have not been extended in excess of the time allowed per the lease contract.

The SIR payment due is dependent upon the terms of your lease contract. The payment must be “timely paid,” which means on or before the next lease anniversary date after 90 days from the date of shut-in.  Each payment is reviewed according to the SIR requirements before acceptance or rejection.

What is a stipulation?

A stipulation is an amendment of the terms of an older oil and gas lease to the current lease terms.  Upon the Commissioner’s approval, the lease assignment stipulated to the current lease series terms now has access to the shut-in royalty payment and extension clauses, which were not offered in the older lease contracts.

The Stipulation fee is $150.00, the form and instructions are available on the Oil & Gas Forms page.

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General Oil and Gas Leasing Instructions 

The BLM issues competitive leases for oil and gas exploration and development on lands owned or controlled by the Federal government.

Congress passed the Inflation Reduction Act of 2022 which rescinded the BLM’s authority to issue noncompetitive leases.

Congress passed the Federal Onshore Oil and Gas Leasing Reform Act of 1987 requiring that all public lands eligible and available for oil and gas leasing be offered by competitive leasing.

The maximum competitive parcel size is 2,560 acres in the lower 48 states and 5,760 acres in Alaska outside of the National Petroleum Reserve-Alaska. The BLM issues a competitive lease for a 10-year period. 

BLM State Offices conduct lease sales quarterly when parcels are eligible and available for lease. Each State Office publishes a Notice of Competitive Lease Sale (Sale Notice), which lists parcels to be offered at the auction, usually 45 days before the auction. This notice is posted in the  National Fluids Lease Sale System  and by the State Office that administers the sale.  The Sale Notice specifies lease stipulations applicable to each parcel. The BLM may conduct lease sales in-person or through internet-based auctions.

Lands offered in the Sale Notice come from two sources:

• Lands identified by informal expressions of interest from the public; or,
• Bureau motion, or lands identified by the BLM.

The successful bidder must submit a properly executed 3000.002 lease bid form , which constitutes a legally binding lease offer. The bidder must also pay an administrative fee, the first year's advance rental ($3.00 per acre or fraction thereof), and not less than a $10-per-acre minimum bonus bid. The balance of the bonus bid must be paid within 10 working days from the last day of the auction.

Expenses associated with a lease 

Bonds:  Before an operator conducts any surface-disturbing activities related to drilling, a bond must be provided to the BLM to ensure compliance with all the lease terms, including environmental protection. Form 3000-004, Oil and Gas or Geothermal Lease Bond may be used for coverage of the principal on individual, statewide, or nationwide coverage with personal or surety bonds. The minimum required bond amount is $10,000 for an individual bond and will provide coverage for the principal on the single Federal lease. The minimum required bond amount is $25,000 for a statewide bond and will provide coverage for the principal on Federal leases in the state or states named on the bond form. A minimum of $25,000 for each state you name on the form is required. The minimum required bond amount is $150,000 for a nationwide bond and will provide coverage for the principal on Federal leases in the United States, except for the National Petroleum Reserve in Alaska. (Federal leases do not include Indian leases.)  The BLM will require an increase in the bond amount whenever conditions warrant.

Bonding can be secured by using a corporate surety bond, or a personal bond accompanied by negotiable Treasury securities, a cashier’s check, a certified check, a certificate of deposit, or an irrevocable letter of credit.

When a new person or company becomes the operator on a well, that new person or company must notify the appropriate BLM Field Office of the change in operator. The new operator must specify to the BLM what bond will cover its operations.

Rents:  Annual rental rates for a competitive lease is $3.00 per acre (or fraction thereof) in the first 2 years; $5.00 per acre for lease years 3 through 8; and $15.00 per acre each year thereafter. The first year’s rental payment is filed with a winning bid in the proper BLM office. Once a lease is issued, the second and all subsequent rental payments must be paid to the Department of the Office of Natural Resources Revenue (ONRR)  on or before the lease anniversary date. If the rental is not received by the anniversary date each year, the lease will automatically terminate through operation of law. A lessee will not receive advance notice of imminent rental due and lease termination. It is the responsibility of the lessee to pay timely rentals.

Royalties:   The ONRR collects a royalty on production for Federal onshore leases. The Federal onshore oil and gas rate is 16.67% for leases issued after August 16, 2022. However, there are a few exceptions, including different royalty rates on older leases, reduced royalty rates on certain oil leases with declining production, and increased royalty rates for reinstated leases.

Lease Terms

Terms and conditions: A lessee, may explore and drill for, extract, remove, and dispose of oil and gas deposits, except helium, for the lands covered under the lease. Before conducting any surface-disturbing activities, the operator must obtain BLM approval. Drilling proposals are subject to the lease terms and stipulations that are attached to the lease and necessary mitigation measures that are consistent with the lease rights. Please see due diligence requirements in the lease instrument. The BLM may cancel the lease if the lessee fails to comply with lease terms.

Transfer of interest: Interest in a lease can be transferred by assignment of the record title interest or by transfer of the operating rights interest. The assignment or transfer must be submitted to the appropriate BLM office within 90 days from the date the transferor signs it and an administrative fee. Until the BLM approves the transfer, the U.S. Government does not recognize the rights of the transferee, and the transferor remains fully responsible for the lease. The BLM will not approve any assignment of record title for a separate zone, deposit, depth, formation, a specific well, or part of a legal subdivision, nor will the BLM approve any assignment of record title for less than 640 acres outside Alaska, or less than 2,560 acres within Alaska. However, the BLM may approve an assignment of record title for less than this acreage, if it is for the entire leasehold or the parties can demonstrate that approval will increase the chances of development.

For more information on transferring oil and gas leases view the handout:  Information and Procedures - Transferring Oil and Gas Lease Interests .

Expiration: A lease will expire at the end of its primary term, which is usually 10 years. However, the BLM may extend the lease, or the lease may continue under its own terms, if:

Qualifying drilling operations are in progress; the lease contains a well capable of producing in paying quantities; or the lease is entitled to receive an allocation of production from an off-lease well.

Relinquishment: Lessee(s) may give up all or part of the lease by filing a written relinquishment with the appropriate BLM office. A relinquishment takes effect on the date it is filed. However, all wells and other work as may be required by the BLM must be performed so the lease is in proper condition for abandonment. The lease account must be in good standing with the ONRR.

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Energy bills intended to address Cook Inlet gas shortage in doubt as end of legislative session approaches

Hilcorp’s Alaska Platform A is visible with Platform C behind it. Photographed June 6, 2017. (Alex DeMarban /ADN)

JUNEAU — Several measures intended to address a looming shortfall of Cook Inlet gas are being rushed through committees as the end of the Alaska Legislature’s regular session fast approaches.

Lawmakers have broadly said that passing energy bills this year is a top priority. But the Legislature did not have an oil and gas consultant under contract until April, which could threaten some bills from passing into law.

Legislators say that Gov. Mike Dunleavy wants four energy measures to pass this year: Royalty reductions to incentivize new gas production in Cook Inlet; a state green bank to invest in renewable energy; a new organization to manage a modernized Railbelt electrical grid, and a framework so carbon dioxide can be stored deep underground.

Key senators, in particular, have said scant evidence has been presented to show that reducing state royalties paid by oil and gas companies will see more gas produced in Cook Inlet. There has also been some concern that carbon sequestration could end up costing the state treasury.

Rep. George Rauscher, a Sutton Republican and chair of the House Energy Committee, said House Republicans have been more closely aligned with Dunleavy. He said energy measures should pass now, or potentially in a special session in the summer. And he added that the four energy measures proposed are a priority for House Republicans and the governor.

“I think the House majority considers the governor — as a Republican — part of the caucus. So he carries a lot of weight, as far as the way we perceive things,” Rauscher said.

Dunleavy proposed last year to cut royalties paid to the state on new gas production. Department of Natural Resources Commissioner John Boyle said in April that could help “squeeze out” more gas from Cook Inlet to help avoid or delay importing natural gas.

Several royalty reduction proposals have advanced in the House, but it’s unclear if they have enough support to pass either legislative chamber.

“I would like to see something passed on royalty relief, because anything would help,” said Rep. Tom McKay, an Anchorage Republican and chair of the House Resources Committee. But he acknowledged there are no guarantees that would produce more gas.

“I think it would, you never know,” he said.

Since Hilcorp told utilities in 2022 that its contracts would not automatically be extended, utility managers have discussed importing natural gas as likely the best available alternative. Power and heating prices would be expected to increase substantially.

The House recently passed a bill to regulate gas storage that included a provision to block utilities from investing in a gas importation facility. Rauscher said the idea behind that provision was to force new natural gas to be produced from Cook Inlet, and not to be imported from Outside.

“Whether that was a good idea, we’re going to find out in the future when it gets over to the Senate side,” he said.

There has been skepticism that smaller independent gas producers will be able to fill a supply shortfall and that reducing royalties will substantially boost new production. A December royalty-free Cook Inlet lease sale on new fields drew a lackluster response from the industry. Producers can also already apply to the state to reduce their royalty payments.

A second set of proposals from Dunleavy would allow the state to lease depleted gas reservoirs in Cook Inlet for carbon sequestration. Once pitched as a revenue raising tool for the state, carbon storage has now been supported as a way to attract oil and gas investment.

The carbon storage bill was amended in the Senate Resources Committee on Friday, with the intention of preventing oil and gas companies from deducting carbon sequestration expenses from their oil production tax obligations. Sen. Bill Wielechowski, D-Anchorage, said Thursday that those deductions could “blow an enormous hole in our state budget.”

Another provision added Friday would require Hilcorp to pay more state tax revenue. The privately-owned operator of Prudhoe Bay does not pay corporate income tax . Wielechowski estimated that closing that “loophole” would net the state well over $100 million per year. But some in the Legislature say if that provision remains, the bill would be unlikely to pass.

Some legislators have expressed concern that there has not been independent modeling provided to the Legislature about the impacts of carbon storage and royalty relief. The Legislature did not have an oil and gas consultant under contract for almost eight months.

“I don’t think it’s worth just giving our state dollars away and not knowing if it’s going to have any impact at all,” said Wielechowski on Tuesday.

Members of Senate leadership spoke in opposition to approving a reduction of royalties for oil and gas producers without independent modeling. Sens. Loki Tobin, D-Anchorage, Cathy Giessel, R-Anchorage, Gary Stevens, R-Kodiak, Bill Wielechowski, D-Anchorage, Bert Stedman, R-Sitka, and Donny Olson, D-Golovin, speak to the media in Juneau on Tuesday, April 30, 2024. (Sean Maguire/ADN)

“What we would really like to have is some modeling,” said Anchorage Republican Sen. Cathy Giessel, chair of the Senate Resource Committee, on Tuesday. “It has economic implications. And normally we have consultants on board.”

Consultant delays

The Legislature usually hires GaffneyCline to work as its oil and gas consultant. The firm provides modeling about the financial impacts of amending the state’s oil and gas tax statutes. The firm could also give advice on what impacts those tax changes could realistically make to produce more gas.

GaffneyCline’s contract ended with the Legislature on June 30 last year. Legislators did not have an oil and gas consultant under contract until April 4.

Nikiski Republican Rep. Ben Carpenter, a first-time chair of the Legislative Budget and Audit Committee, was in charge of hiring an oil and gas consultant. But the process to hire one was long and protracted.

Kris Curtis, the Legislature’s auditor, has long managed those contracts. Carpenter said he found that dual role strange. He said the auditor could end up auditing contracts that they themselves wrote. Another concern was over a dispute with the governor.

The Legislature filed a lawsuit in 2022 against the Dunleavy administration over where billions of dollars of oil royalties should be deposited. Legislators agreed with Curtis’ interpretation that those funds should be placed into the state’s main savings account that requires approval from three-quarters of lawmakers to spend from. The Dunleavy administration said the funds should be deposited directly into the more-easily spendable general fund in the state treasury.

The Alaska Beacon reported last year that the Dunleavy administration prevailed in Superior Court, but the case had been appealed to the state Supreme Court. In light of the dispute last year, Carpenter said he was aware that Dunleavy considered Curtis to be “too political.”

“I need to be sensitive to that. I don’t think she is, but I’m going to be sensitive to that,” he said in an interview Thursday.

Instead of using Curtis, a state employee, Carpenter looked for outside help to write contracts for the committee. As chairman, Carpenter has the authority to issue contracts up to $40,000. The Nikiski Republican issued a contract of up to $40,000 to a retired state contract writer in November.

The contractor wrote out a request for proposals that was put out for bid in January. The only respondent was the Legislature’s normal oil and gas consultant, GaffneyCline. The Legislative Budget and Audit Committee approved a two-year, $200,000 contract with the firm on April 4.

But there was a problem. Since GaffneyCline’s contract ended with the Legislature last year, the governor’s office had hired the firm to work as its consultant on carbon sequestration policies. That means GaffneyCline has a conflict of interest on that issue and cannot provide the same independent guidance to the Legislature.

Carpenter said he didn’t want to be “pejorative” to Dunleavy, but he said the governor’s decision to hire GaffneyCline for carbon sequestration issues had “handcuffed” the Legislature.

There are few consultants available who are as well-versed in Alaska’s oil and gas structure as GaffneyCline, said Sitka Republican Sen. Bert Stedman. In retrospect, he said, “It would have been nice to have the contract extended.”

A ‘wrinkle’

Sen. Cathy Giessel said she filed a request with GaffneyCline for modeling on the impacts of reducing royalties earlier in the week. But it’s unclear if that modeling will be available before the end of the legislative session.

The House has advanced royalty reduction bills through the committee process without independent guidance.

“We didn’t realize that certain senators were going to demand modeling,” said McKay, a former petroleum engineer. He said that was “a wrinkle,” but also acknowledged that “it would have been better to have GaffneyCline on board way, way earlier.”

Longtime lawmakers said it was perhaps unprecedented for legislators to consider substantive changes to the state’s tax code without impartial advice. Rep. Zack Fields, D-Anchorage, said House members have effectively been “shooting blind.”

“It’s a huge deal. Are we representing the state’s interest in these things?” he said.

The carbon sequestration bill proposed by Dunleavy has advanced to the Senate Finance Committee for a first hearing next week. The committee will not have an independent consultant to offer guidance on its fiscal impacts. Stedman said the Senate Finance Committee would be very careful before making any adjustments to the state’s tax code.

“It’s more important to have it correct than have it fast,” he said. “If we make a mistake, it’s very hard to back up and fix it.”

For now, the Senate Finance Committee is waiting to see modeling from GaffneyCline on whether reducing royalties on Cook Inlet producers would see new gas produced for Southcentral and Interior Alaska. Stedman, a fiscal conservative, remains skeptical.

“My personal opinion? I’d be more surprised if the consultants tell us it’s going to make a difference,” he said.

In an interview Thursday, Carpenter suggested that it was “politics” that was causing senators to be wary of passing royalty reduction bills without modeling from an outside consultant.

“I guess the senators aren’t comfortable with it. And I would just ask, ‘Why?’” he said.

‘Not finished’

Another measure would create an integrated transmission system for the Railbelt electrical grid. The intention is allow for the lowest-cost energy to be distributed across the grid, and to better integrate renewable energy production.

The Senate Finance Committee hears a bill that would establish a new management organization for the Railbelt electric grid. The bill is part of a suite of energy measures being considered by lawmakers in Juneau on Friday, May 3, 2024. (Sean Maguire / ADN)

But one version of the bill has attracted concerns from the Alaska Public Interest Research Group of insufficient oversight from state regulators.

The one energy bill that is broadly expected to pass this year would establish a green bank to be administered by the Alaska Housing Finance Corp. The measure proposed by Dunleavy would allow the corporation to invest in renewable energy projects and give more opportunities to collect federal revenue for clean energy.

Some in the Legislature are skeptical that a substantial number of energy bills will pass this year. Other lawmakers think that unresolved concerns with the energy bills can be addressed now or potentially later in the year during a special session.

“We’re not there yet,” Rauscher said. “We’re not finished.”

The regular legislative session must end by midnight on May 15.

Sean Maguire

Sean Maguire is a politics and general assignment reporter for the Anchorage Daily News based in Juneau. He previously reported from Juneau for Alaska's News Source. Contact him at [email protected].