Article for Mineral Rights Owners - 2017
Technology Changed the Game
Advancements in horizontal well drilling and completion technology have changed the oil and gas industry forever - similar to the way the jet engine changed the aviation industry about sixty years ago. The jet engine was a game-changer that has allowed aircraft to fly higher, faster and more efficiently than the piston-driven propeller engine. Horizontal wells drilled into tight shale formations are a present day game-changer which has resulted in the discovery of massive volumes of oil and natural gas reserves in North America.
As a result of these huge discoveries, North Americans will be far less reliant on imported oil and more likely to use clean-burning natural gas as the fuel of the future. The development of these reserves will provide royalty income for owners of mineral rights in North America as natural gas prices improve and new wells are brought on production.
Oil and Gas Reservoirs - Simplified
It is widely believed that oil and natural gas (“hydrocarbons”) were formed from the degeneration of organic matter within sedimentary rock formations, often known as organic-rich shales. Over millions of years, hydrocarbons sourced from these dense shales tend to slowly migrate into the adjacent rock strata and often remain trapped in the overlying reservoir rocks, such as sandstone. To see an example of the properties of a sandstone reservoir, hold a sugar cube between your fingers and dip it in coffee. The sugar cube will immediately darken as it absorbs and retains the coffee between the sugar crystals. Think of the sugar cube as the sandstone reservoir with the crystals as the sand grains, the spaces between the crystals as porosity, the connections between the crystals as permeability and the coffee as the “oil”. What you now have between your fingers is a porous, permeable example of an excellent reservoir rock that is saturated with oil (coffee).
The Old Exploration Game - “Conventional”
In the past (think pistons and propellers), oil and gas Companies would start with a geological concept, lease the lands in prospective areas and then conduct a seismic program to image the subsurface formations in search of a structure and a potential reservoir. Structure is important, because over millions of years, oil and gas tends to migrate within the rock formations and accumulate on the structurally highest part of the reservoir. Why? Because natural gas is lighter than oil, oil is lighter than water and salt water often underlies hydrocarbons within a reservoir. To contain the hydrocarbons in a reservoir, an impermeable rock layer above the reservoir is required to create the hydrocarbon trap. Drilling an exploratory well into a seismically-defined structure will test the presence or absence of hydrocarbons and if this risky and expensive drilling operation is a success, the well will encounter a porous and permeable reservoir and economic amounts of hydrocarbons. When a well is drilled into a reservoir, which is subject to the pressure of one or two miles of overburden rock, hydrocarbons will tend to flow to the surface, a region of lower pressure. Not all reservoirs contain hydrocarbons however, and many contain only salt water. Statistically, a drilling venture like this will result in a dry hole with economic success being encountered only one or two times out of ten. Not for the faint of heart or for companies with limited funds. For an exploration Company to have a chance at long-term success, the Company requires the projects, land, money and expertise to drill eight or nine more times – seeking the one or two successes that will pay for the failures.
If the first exploratory well results in the discovery and production of oil, as the oil reserves are extracted the reservoir pressure depletes and each additional barrel is harder to extract. If an oil well can efficiently drain only 40 acres of the reservoir and the oil pool is much larger, less-risky development wells are drilled to ensure efficient drainage from the pool. Water or carbon dioxide may be injected into the reservoir which will maintain reservoir pressure and assist with the sweep of oil from the pool. For natural gas wells, drainage areas, reservoir pressure, reservoir porosity and permeability are also critical factors for the ultimate recovery of natural gas. Vertical oil and gas wells drilled into good reservoirs will often require a frac (more later on this) or similar wellbore stimulation to enhance the productivity of the well drainage area and improve the extraction of oil or gas from the reservoir. A conventional vertical well will always have its limitations – it is a very small hole into the target reservoir.
The New Exploration Game - “Unconventional Resource Projects”
The game-changer provided by horizontal drilling and fracking (think jet engines again) has provided industry with a new way to explore. Today, the oil and gas industry explores for hydrocarbons which are often referred to as “unconventional resource plays”. A resource play is one which has the characteristics of a mining project. The presence of hydrocarbons is well-known over a wide area and multiple horizontal wells can be drilled sequentially to develop the resource. To extract the hydrocarbon resource, ownership and control of large tracts of mineral rights and surface rights are critical factors for drilling and production operations.
With the application of modern well drilling and completion techniques, oil and gas operators are now drilling horizontally into known reservoirs or into the hydrocarbon-rich shales, where the oil or natural gas was actually formed, and producing directly from these shales. These unconventional shale reservoirs are dense (”tight”) hydrocarbon-filled rock formations which lack the porosity or permeability of the “sugar cube” reservoir. In unconventional reservoirs, the exploration Company knows that the hydrocarbons are present so the risk of encountering hydrocarbons is minimized. Using the sugar cube as an example of an excellent reservoir, this time think about spilling your coffee on your impermeable granite kitchen countertop – not much happens. If your countertop was made of shale however, your coffee would slowly seep into the shale and leave a stain. Shale reservoirs hold hydrocarbons because the hydrocarbons were formed there and have not yet migrated into conventional reservoir rocks. Shales and other relatively poor quality reservoirs may be so tight (lacking effective porosity or permeability) that the only way to extract hydrocarbons will be to horizontally drill a mile or so within this rock (think increased surface area) and then create mini-fractures (“frac”) to allow the horizontal well to produce. To get to the target formation, remember the well first has to be drilled a mile or so vertically and then it is horizontally steered into the target formation. Technically challenging, but done successfully every day, thanks again to technology. Interestingly, more often than not, the exploration Company knows that the hydrocarbons are in this tight rock - they just need some help from technology to get the horizontal well to produce. Quite different from the “old” way of exploring where the Company never knew if the reservoir was there or if the hydrocarbons were present until the exploratory well was drilled and tested. One of the key challenges for the industry will be managing horizontal well drilling and completion costs which are commonly three to five times the cost of a vertical well. Production rates from horizontal wells however, can be several times the rate of a vertical well which significantly accelerates the payout of a well.
Fracking a Well
A frac involves pumping a fluid and sand/proppant mixture under very high pressure down the wellbore, out the perforations in the well casing or frac assembly and into the surrounding rock formation. The intent of this down-hole operation is to enhance the productive capabilities of the rock near the wellbore so that the hydrocarbons can move through the fracture pathway, back to the well and flow to the surface. Fracs have been safely conducted on vertical wells for many years with great success. In a horizontal well, frac technology has advanced such that multiple frac operations are now conducted within horizontal wells at periodic intervals as close as 100 feet apart. Generally, fracs are conducted at a significant depth and well below the water table. That said, the surface casing of the well (the shallow pipe which is cemented to the shallow formations and isolates the vertical portion of the well from the surrounding shallow groundwater aquifer) is important to any well drilling operation. Much has been written about the technical benefits of fracking a well and the potential risks. A significant volume of fluids (water, oil, surfactants, chemicals) are used with each frac operation and once introduced into the formation and subsequently flowed back to surface, these products need to be contained and disposed. Previously believed to be a trade secret for many operators, the composition of frac fluids that are injected down-hole are now being disclosed by well operators in many jurisdictions. This disclosure trend will likely grow and become regulated in the interest of the landowner and the public. Public safety, protection of the environment and protection of the water table is the common goal of all concerned. It should be noted that large volumes of water are consumed during a frac operation and it is now becoming evident that frac water supply and post-frac water disposal are becoming significant issues for oil and gas well operators.
Firstly, to be clear - hydrocarbons do not care if the wellbore from which production is being obtained is a vertical or a horizontal well. Hydrocarbons want to move from areas of high pressure to areas of lower pressure. When you open the valve on a well, if oil or natural gas is entering the wellbore, it generally wants to flow to the surface. If you are the landowner who is fortunate enough to own the mineral rights overlying a reservoir or organic-rich shale, you could be sitting on buried treasure. Oil and gas operators will want to lease your mineral rights and potentially drill your lands. An oil and gas lease typically reserves the mineral rights owner a royalty share of production from the lands and if a successful well is drilled on these lands, significant financial rewards are possible.
Land is the Basis of All Wealth, Adam Smith, 1776 “The Wealth of Nations”
The “old” exploration game and the “new” exploration game have one very important common denominator - mineral rights ownership. Control of the land is the foundation for the development of an oil and gas prospect. The Company geologist or geophysicist who created the drilling prospect is powerless to test the concept without first having control of the mineral rights to the play. Without the legal right to drill, a drilling Company is trespassing. To acquire the right to drill, the Company must be able to demonstrate that it has contractually obtained the privilege to do so from the owner of the mineral rights. In North America, mineral rights are often owned by individuals but also by Corporations, States, Provinces or the Federal government. Worldwide it is estimated that approximately 80% of the “exploitable” oil and gas reserves are owned by the sovereign nations themselves, often by their National Oil Companies (“NOC’s”).
The Role of Mineral Landmen in Oil and Gas Leasing
In North America, the individual or Company that owns or has leased the mineral rights essentially controls the project and its pace of development. A mineral landman has the task of securing the right to drill either by leasing or purchasing the mineral rights from the owner or by committing to drill to earn an interest from the Company that holds the lease. Many US companies have committed large budgets to wide-area mineral leasing programs if they see the potential for repeatable oil or gas drilling targets. These companies will employ hundreds, even thousands of mineral landmen to scour the County Recorder’s offices in search of the owners of the mineral rights. After the owners are located, the landmen will make lease offers which, in many cases, are the first lease offers these owners have ever seen. This is due to two main reasons. Firstly, the new resource plays are in areas which may have been inactive for many years and secondly, the current owners of the mineral rights probably inherited the mineral rights and had no knowledge of their value.
Mineral Lease Terms
In oil and gas mineral leasing there are a few key issues for mineral landowners to consider. The mineral lease signing bonus (per net acre), the lessor royalty reserved to the landowner, the lease primary term (and lease renewal provisions) and the Lessee’s drilling plans are all important. It is worth noting that many mineral owners do not own full title to their mineral rights as a result of prior transactions by prior owners. Mineral landowners can only grant a lease on what they own. It is common that mineral landowners hold title to less than a 100% interest in the lands or that the prior owners may have retained royalty rights or lease bonus rights. As mineral rights owners convey ownership through the estate process, split mineral titles will become more common and increasingly complex. Due to these issues, it is highly recommended that mineral landowners consult with an oil and gas land professional or attorney in all leasing transactions.
Mineral Lease Signing Bonus
Lessor Royalty on Production
Lease Primary Term
Who Am I leasing to?
Surface Rights Ownership
In many jurisdictions mineral rights and surface rights are owned separately. This situation often leads to situations where the mineral rights owner wants to see drilling activity but the surface owner does not. Generally, mineral rights and the surface rights are distinct “bundles” of ownership and come with certain rights and privileges. A surface rights owner is generally compensated for any “adverse effect” and “loss of use” resulting from drilling and production operations. While it is recognized that surface rights owners are impacted by the drilling of an oil or gas well, it is also recognized that the mineral rights owner has the right to drill to the underlying mineral rights. In order to deal with the complex issues regarding surface rights ownership, surface landmen perform a key role in obtaining the right to conduct oil and gas drilling operations from the surface landowner. Many jurisdictions have provided legislation to ensure that the rights of surface owners and mineral owners are protected.
Summary for Owners of Mineral Rights
Leasing your oil and gas mineral rights.
- Leasing is a real estate transaction - get advice and do your homework.
- By leasing, you are granting the Company/Landman (lessee) the exclusive right to drill and produce your mineral rights for a period of time (primary term).
Tips for the landowner
Oil and Gas Lease Definitions
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