When a Texas mineral owner asks me to review or negotiate an oil and gas lease offer they have received, one of the first things I do is to determine who the proposed operator, or lessee, will be. Many people do not realize how important it is to know just who you are leasing to. If you do not investigate the proposed lessee before you sign, you may be throwing away the royalties you could have received had you leased to a competent oil and gas company.
First, I determine whether the potential lessee is a licensed oil and gas operator. I strongly urge my clients not to sign a lease with a middleman. Instead, I insist that the actual oil company who will be operating the lease be disclosed so we can do a background check on them. There can be many potential problems if you sign a lease with a middleman. These include, (but are certainly not limited to), the following problems:
1) The company who contacted you may be a broker or a “lease hound”, that is, a person or company who tries to sign up leases cheaply and then sell them to a real oil company for a huge markup. I prefer to see my client be paid that markup, rather than the middleman.
2) They may be an agent for a “boiler-room” operation, who make their money by selling interests in a lease or “drilling program” as an investment. They make their money on the sale of these interests, and could care less about drilling a good well, or treating your minerals or the surface of the property competently. In some cases, they don’t care if a well is drilled or not, because they have already made their money.
3) You can end up with the drilling being done by an inexperienced or even unscrupulous operator, who can destroy the surface of your land, leave toxic chemicals, and either refuse to clean up, or go out of business or file bankruptcy to avoid the cost of cleanup.
4) An inexperienced or unscrupulous operator can do an inept job of developing your minerals, damage the reservoir and possibly leave the minerals unrecoverable. In either case, this type of operator can either go out of business or file bankruptcy to avoid the payment of damages.
5) Many reputable oil and gas operators refuse to buy leases from these middlemen. Instead, they wait until the initial term of the lease has expired, and then contact the mineral owner to lease from them directly. An oil and gas lease is almost always “exclusive”, that is, you are prohibited from leasing to anyone else during the initial, or primary, term. Thus, while your minerals are tied up in a lease to a middleman, you may miss out on a good lease with a competent oil and gas company, and lose the royalties you would have been paid during this time. It’s also possible that you will miss your window of opportunity more permanently: by the time your initial term is up, a competent operator may have leased what they need in surrounding areas, and not be interested in leasing from you any longer.
Once we determine who the actual lessee will be, if the proposed lessee is not well known, I strongly recommend that I do a background check on the proposed lessee. While there are many good oil companies and well operators, there are a number that you do not want to lease to for any price. As I indicated above, allowing an inexperienced or unscrupulous operator to drill on your land can result in serious financial consequences for you. A background check is not a guarantee that these things will not occur, but it gives us some idea of whether the operator is legitimately incorporated, how long they have been in business, how many other wells they operate and where, and whether there are or have been any lawsuits or regulatory proceedings against them.
Way too many mineral owners do not investigate who the proposed lessee will be. When they contact me, after the damage is done, it is usually too late.
These lease hounds and brokers and middlemen come out of the woodwork when the price of oil goes up. Please don’t waste your mineral assets and the potential royalties those assets can produce for you by leasing to someone without checking them out first! In addition, please be patient. In an area of the state where the brokers and lease hounds are busy, the competent oil companies often follow!