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Things for the Landowner to Consider Before Executing an Oil and Gas Lease

03.24.15 written by

As a result of oil companies’ expectations of significant oil and gas production from the Utica shale formation in Ohio, area landowners have been taking advantage of the opportunity to sign an oil and gas lease with these companies.  As a result of the recent favorable drilling efforts, the current amount of signing bonus payments and royalty rates have been significantly increasing as well.  However, despite all of these significant benefits, landowners still need to take an interest in the terms of the lease before signing the lease.  This lease could be in existence for a great number of years and landowners should make sure that they understand the terms of the lease or, at the very least, obtain the services of an attorney who works in the oil and gas area.

Thanks to a college, Attorney Nathan Vaughan who has significant experience in the oil and gas area, the following are a number of things that landowners need to consider before they enter into an oil and gas lease:

  1. Tax Issues.  Lease signing bonuses are generally taxed as ordinary income and therefore before signing a lease, landowners should sit down with their accountant to discuss this tax liability.
  2. CAUV Issues.  Landowners need to consider that drilling operations could have a significant impact on their CAUV status.  Therefore, landowners must be aware of the potential recoupment of real estate taxes that could occur and negotiate a “spud fee” which is a one-time fee to compensate the landowner for potential CAUV recoupment.
  3. Request a Gross Royalty.  Be aware that many of the leases currently being circulated provide for a net royalty which allows the lessee to deduct various costs associated with the production of oil and gas before the landowner’s royalty.  Negotiate a gross royalty if possible.
  4. Free Gas.  A landowner would certainly like to obtain free gas; however, if the lessee is unable to provide the free gas, the landowner should make sure that they receive an annual payment in lieu of the right to free gas.
  5. Location Issues.  Landowners should try to include provisions requiring them to approve the location of any wells or other items needed in the drilling process.
  6. Water Rights.  Please be aware that a number of leases provide that the landowners will need to supply water for the drilling efforts, and therefore, landowners should prohibit any right to use water from their property because it could affect their water supply.
  7. Title Issues.  In a significant amount of cases, landowners may not be able to take advantage of the leasing boom because they do not have the ability to lease the oil and gas under their property.  However, even if a landowner has an oil and gas lease, they may be able to reacquire their oil and gas rights under Ohio’s Marketable Title Act, Ohio’s Dormant Mineral Act, or Lease Forfeiture statutes.  Please contact an attorney for assistance with this matter.
  8. Held by Production / Pugh Clause.  Landowners should negotiate a “Pugh Clause” in their lease.  This Pugh Clause requires that unproductive acreage could be released from the lease after the primary term thereby allowing the landowner to lease acreage to another party.
  9. Indemnification / Insurance.  Landowners should always require the lessee to maintain general liability and environmental insurance covering all operations under the lease and also to indemnify and hold the landowner harmless from any damages arising from operations under the lease.

These are only a few of the issues which the landowner should consider when determining whether to enter into an oil and gas lease involving the Utica shale.  Whether joining a group or negotiating your individual lease, consulting an experienced oil and gas attorney is a must before signing any lease document.

NOTE: This general summary of the law should not be used to solve individual problems since slight changes in the fact situation may require a material variance in the applicable legal advice.

James F. Contini II, Esq.
Certified Specialist in Estate Planning,
Trust & Probate Law by the OSBA
Krugliak, Wilkins, Griffiths & Dougherty Co., LPA
158 North Broadway
New Philadelphia, Ohio 44663
Phone:  330-364-3472
Fax:  330-602-3187