Oil And Gas Basics For The Mineral Owner

Basic oil and gas industry framework and knowledge for the mineral owner

Basic Mineral Rights

In America, we enjoy a broad range of property rights. One such right is mineral ownership on and under the land we own, ASSUMING someone before us has not severed the mineral estate from the surface estate. A legally binding title opinion is typically the only document that substantiates mineral ownership (at least with regard to earning income from the minerals, which is usually what matters). The complexity of such a title opinion can vary dramatically. In the 18th and 19th century, when land was originally deeded to individuals, the mineral estate naturally came with the land, and if it had not been severed since, remains with the land.

Learn the Basics of Oil and Gas

The majority of landowners are relatively disinterested in minerals, mineral estates, etc. until they open the mail and find a letter from an oil company proposing to lease their mineral rights. Then everything changes. Now they’re quite interested in learning a few things… which is the reason Oil and Gas Mineral Services Co. exists, to educate and serve America’s mineral owners. An oil company is interested in leasing your minerals because they have reason to believe that they can find oil or gas there.

The Oil Company (a.k.a. the Operator) Relationship with the Mineral Owner

To bring oil and gas reserves to market, minerals are leased by oil companies through a legally binding contract known as an Oil and Gas Lease. This arrangement between individual mineral owners and oil companies began prior to 1900 and still thrives today. Although there are numerous other important details, the basic economic structure of the Lease is this: in exchange for an “up-front” cash bonus payment, plus a percentage of the value of any production, the mineral owner grants the oil company the right to drill and produce. In some cases, no activity follows and the lease simply expires. However, a well may in fact be drilled. We’ll assume here that drilling is viewed as a good thing by all involved. After all, nobody will enjoy economic gain if nothing is done.

Drilling and Completion Activities

Assuming the oil company decides to drill, they may drill on your tract of mineral (and quite possibly surface) ownership. If you are a surface owner, the oil company will likely propose a drill site, notify you, and offer to pay for damages related to the surface use. Obviously, all parties should be guided by reasoned thinking as to the compensation for damages, road usage, pipelines etc. Both parties should remember that realizing economic gain from mineral production is accomplished by partnership between the mineral owner and the Operator. Drilling operations can vary from 10 days to 90 days, or even more in some cases. Completing the well (perforating, hydraulic fracturing, installing production equipment etc.) can take a similar period. Now, let’s say that we’ve made a well…

Producing Characteristics of Oil and Gas Wells

Oil and gas production is produced from what are commonly known as reservoirs. Production rates generally decline more rapidly in the early stages of a wells producing life. There are typically three types of natural drive mechanisms from which hydrocarbons flow through reservoirs: water drive, depletion drive, and solution drive.

One of the primary determinants of value for a producing well is its decline curve. A decline curve illustrates the production history of a particular well, and is also used to predict future performance. Now, the hydrocarbon must be sold.

Oil and Gas Marketing

In the majority of cases, a royalty owner’s (a mineral owner whose land has been drilled upon and hydrocarbons found, is now a producing mineral owner, commonly called a royalty owner) share of production is marketed and sold along with the working interest owner’s (working interest owners are those owners obligated to pay for the expenses of drilling and operating a well) portion.

The quality of produced hydrocarbons varies and has direct impact on its value. Oil gravity and sulphur content are the two most important characteristics affecting crude oil pricing. With natural gas, the MMBTU content and the amount of impurities have the most impact on the value per MCF.

Oil and Gas Measurement

Produced oil and gas is measured prior to leaving the well site, as required by law. The gross volume from which your royalty share is calculated is based on this measurement. Customary industry standard requires that the Operator verifies the measurements of the First Purchaser through a “check” meter for gas, or by rechecking (behind the First Purchaser) the levels in the oil storage tanks. With respect to the risk of you being “shorted” your properly due production, it is important to keep in mind that it is in your Operator’s best interest to insure proper product measurement.

Marketing Expenses (a.k.a. Deductions)

You may notice a column on your royalty check stub that contains deductions for making production ready for sale. Common charges are for compression, dehydration, and removing impurities from gas. Debate, often in court, has gone on for years as to the applicability of these charges.

Oil and Gas Pricing

Crude oil and natural gas are commodities, and subject to daily swings in their value in the marketplace. The New York Mercantile Exchange (NYMEX) is the primary market maker for pricing these commodities. The actual cash (or physical) price which royalty owners and oil companies receive is usually based upon a contracted price set each month.

The Tax Man cometh – Oil and Gas Severance Taxes and Ad Valorem Taxes

State governments levy a severance tax monthly when natural resources such as oil and gas are “severed” from the earth. Generally, the First Purchaser is responsible for collecting and accounting for this tax. This should be easily calculable, and match the deduction shown on your royalty check stub. County governments render and collect a yearly ad valorem tax on producing minerals in most states. Owners are usually billed annually.