Presentation on theme: "INCLUDING ESSENTIAL UPDATES FOR SHALE OIL AND GAS"— Presentation transcript:
1 INCLUDING ESSENTIAL UPDATES FOR SHALE OIL AND GAS MODERN DAY OIL AND GAS LEASE FORM WRITTEN TO PROTECT THE LAND, MINERAL AND ROYALTY OWNERSINCLUDING ESSENTIAL UPDATES FOR SHALE OIL AND GASAND TIGHT SAND LEASES
2 JUSTIFICATIONRead on if a 40% Oil or 35% Gas Royalty Rate is appealing…Also, while the suggested extensive Modern Oil and Gas Form seems long…ask yourself…Is it really?...Given the Oil and Gas Lease is the essential and fundamental agreement that secures the vital oil and gas mineral resources, without it all of the oil and gas business fails…And given the Oil Companies regularly negotiate 100 plus page documents associated with each of their …Joint Operating Agreements among their partners;purchase and sale agreements of oil and gas;drilling contracts;Seismic geophysical contract, andConstruction and Management and FEED (Front End Engineering and Design) agreements…A comprehensive Oil and Gas Lease is as a minimum equally important…
3 ‘BUYER BEWARE”!Oil and Gas Leases are written by Oil Companies and their lawyers…Such leases are not very favorable to land, mineral and royalty owners…Beware of the ‘Producers 88’ Lease form – not your most friendly lease for land and royalty owners…especially for shale…Now there is an alternative…PROTECT YOUR RIGHTS AND ROYALTY PAYMENTS!!!
4 A PICTURE IS WORTH A THOUSAND WORDS OIL COMPANIES HAVE DONE ALL RIGHT
9 ROYALTY RIGHTS – AN ALTERNATIVE TO AGREEING TO TOO LOW ROYALTY RATES! 10 IMPORTANT MESSAGES..Oil Companies objective: Sign up a Lease with the lowest possible cost ...Lease is the most important asset : No Lease – No access to oil or gas resources…Leasing has been successful: Executive pay checks are in the $millions – Share price & profits are double digit rates of return (>16%) - compared to <2% mutual funds for the rest of us…Oil service companies have added profit take: Halliburton, Schlumberger, others…‘Government Take’ in the low risk USA business environment is much lower than Government Take in higher risk foreign oil and gas leases. So what happened to higher risk - lower reward business formula?‘Unconventional Shale’ is now the lesser risk of Conventional way of doing business.Shale operation protection against: Ground water pollution; Excessive destruction of the land and restoration; Excessive use of water and other resources (sand); Earthquake concerns; Drainage by horizontal drillingGas price sensitivity to supply, demand, location, export rightsGas price influenced by exploration/production costs; transmission costs; storage and the market consumer of gas (fuel or feed stock to make other materials)Why should Royalty be high?...without the lease, no access to oil and gas resource and the entire value chain collapses…because of lower business risk in the US, higher Royalty should go to the land owner – lower risk to Oil Company means lower reward…yet Oil Companies accept a lower reward in higher risk foreign investments—why not do the same in lower risk USA?
10 WHAT IS ‘GOVERNMENT TAKE’ Government Take means all the payments that Oil Companies pay to third parties that reduces profits (other than capital costs – such as drilling wells or building facilities, and day to day operating investment costs)Government Take Payments include: Taxes; Royalty; Bonuses; Rentals; Right of Way FeesGovernment Take is typically reported as the percentage of Government Take payments compared to Gross RevenuesExample:If 100 barrels of Oil is sold for $100 per barrel, Gross Revenue = 100 x $100 = $10,000Assuming the sum of Government Take payments equal $7,000, the Government Take = $7000/$10,000 = 70%Typical Government Take calculations for a low business risk environment in the USA ranges from 35% to 45% (varies by State and Federal leases)Typical Government Take calculations for higher risk oil and gas business risk environment in foreign countries ranges from 55% to over 90%.CONSEQUENTLY…WHY SHOULD USA ROYALTY OWNERS CONTINUE TO TAKE A LOWER ROYALTY WHICH MEANS A LOWER GOVERNMENT TAKE BY THE OIL COMPANIES, WHEN THE SAME OIL COMPANIES ARE WILLING TO ACCEPT A HIGHER GOVERNMENT TAKE IN HIGHER RISK FOREIGN COUNTRIES?...
11 SO WHAT SHOULD THAT ROYALTY RATE BE? Depends…How ‘hot’ the area is for oil and gas exploration success; Desperation of Oil Company to buy ‘protection’ acreage around an area; Developing area; New technology (such as Shale plays); Price of oil and gas; Size of the acres in a lease; How sophisticated the oil company or landowners are; and many other factors…Two factors that MUST be factored in the decision…Royalty owners securing a much higher Government Take right (and thus a higher Royalty right) since the same leasing Oil Companies are willing to do that with higher risk foreign countries…Establish a sliding scale Royalty that allows the Royalty owner to share in the upside in regard to oil and gas commodity price increases…Fixed Royalty RatesFor Oil: Minimum of 35%; For Gas: Minimum of 30%Variable Royalty RatesFor Oil: Sliding scale Royalty ranging from 20% (if WTI Spot price is below $50) to 40% (if WTI Spot Price exceeds $125) [Note: A modification to this sliding scale is to use Brent Spot pricing]For Gas: Sliding scale Royalty ranging from 15% (if Henry Hub Spot price is below $2.00 per MMBTU) to 36% (if Henry Hub Spot price is over $5.50 per MMBTU).
12 WHAT IS A FAIR BONUS PAYMENT OR $ PER ACRE LEASING COST? How are lease bonus payments determined?...Two ways…Formal Way…Oil company estimates the success of exploration and determines, by cash flow economic analysis, what they think a successful exploration project will look like (future after tax cash flow and net present value – using the companies discount rate factors – typically their weighted cost of capital between the interest rate to borrow money and dividend rate to pay stock investors). Assumptions are made about how much oil and gas is found, its production rate over time, the future price of oil and gas (and their escalation factors), capital and operating cost estimates (and their inflation rates), as well as payment of taxes, royalty, rentals and other costs. A probability of success factor is applied to the net present value to determine a risked successful net present value or Risked Success NPV. Needless to say, much speculation…Oil company estimates the ‘dry hole’ cost of an exploration project. These are costs expended that do not result in successful exploration. (Typically these costs include up front cash payments to the land owner, cost of acquire seismic and drill one or more wells). Likewise, a probability of failure factor is applied to the total failure cost to determine a Risked Failure NPV.Adding the Risked Success and Failure NPV values results in what is called a risk adjusted ‘Expected Monetary Value’ or ‘Expected Net Present Value’ or ENPV. Theoretically by comparing different project ENPV’s the one with the highest ENPV is the preferred investment.Oil companies can take the ENPV and divide it by the number of acres in the leased property and come up with a $ per acre leasing cost that it should target to pay to the land owner. The Oil company will try and offer a lower payment.Example: Unrisked NPV of a successful project is assumed to be + $50,000,000; there is a 10% chance if success, so the NPV of success is 10% x $50,000,000 or $5,000,000; Unrisked NPV of failure is (-$10,000,000 )and has a 90% chance of happening (100% minus the success probability) or risked NPV of 10% x $-$10,000,000 or -$1,000,000; Adding NPVs gives an ENPV of +$4,000,000. Assuming 1000 acres are to be leased, the lease bonus is $4,000,000/1000 or $4,000 per acre.Informal Way..What the market will bear or what historically and currently Oil companies are paying other land owners in the area for lease bonuses. That payment may or not be based on a formal calculation and often times reflects what it takes to secure a lease. It might be lower or higher than the ENPV calculation.OIL COMPANIES DESIRE TO PAY THE LOWEST BONUS AND LAND OWNERS DESIRE THE HIGHEST AND THE ANSWER DEPENDS ON HOW ‘HOT’ THE AREA IS IN REGARD TO POTENTIAL SUCCESS. NEARBY DRILLING SUCCESSES DRIVE UP THE BONUS.
13 WHAT DO THE OIL COMPANIES NEED TO MAKE MONEY? Other than signing up a Lease from the land and royalty owner at the lowest price possible, Oil Company economics are sensitive to costs and prices…So what about prices?...populations world-wide continue to grow and demand more and more oil and gas…so the demand side of economics is a given…the challenge is to provide the supply…another reason the land and royalty owner lease is so valuable…US Energy Information Agency (2013 Annual Report) projects real growth in both oil and gas prices
14 WHAT DO THE OIL COMPANIES NEED TO MAKE MONEY?...cont’d What about costs…2012 indicative costs for oil and gas exploration and production operations have been reported by various agencies as follows:Typical (2012) Unit Capital Costs and Operating Costs (Dollars per Barrel for Oil or Dollars per thousand cubic feet for Gas)Capital + Operating Costs Oil Projects ($/barrel) Gas Projects ($/mcf)Onshore $4-$27 $0.75-$2.00Shallow water $10-$30 $1.20-$4.00Deep water $16-$75 $1.25-$4.10
15 WHAT DO THE OIL COMPANIES NEED TO MAKE MONEY?...cont’d CONSEQUENTLY…COMPARING PROJECTED PRICE INCREASES…AGAINST INDICATIVE UNIT CAPITAL AND OPERATING COSTS…ILLUSTRATES A SUBSTANTIAL MARGIN FROM WHICH ‘GOVERNMENT TAKE’ – TAXES AND ROYALTY CAN BE PAID…ILLUSTRATING OIL AND GAS COMPANIES CAN MAINTAIN A BALANCED RISK AND REWARD INVESTMENT OBJECTIVE AND STILL INCREASE HISTORICAL LAND OWNER AND ROYALTY OWNER ROYALTY PAYMENTS!
16 WHAT DO THE OIL COMPANIES NEED TO MAKE MONEY?...cont’d For 2013, the oil price is represented by spot prices for light, sweet Intercontinental Exchange Brent crude oil instead of WTI crude oil traded on NYMEX. This change was made to better reflect the price refineries pay for imported light, sweet crude oil and takes into account the divergence of WTI prices from those of globally traded benchmark crudes such as Brent. WTI prices have diverged from other benchmark crude prices because of insufficient pipeline capacity to move crude oil to and from Cushing, Oklahoma (the location at which WTI prices are quoted), and the growth of midcontinent and Canadian oil production that has overwhelmed the transportation infrastructure needed to move crude from Cushing to the U.S. Gulf of Mexico.For AEO2013, the Henry Hub spot price is projected using a new methodology. Previously, the Henry Hub prices were based on the average national wellhead price and its historical relationship with the Henry Hub price. Given historical correlations, the projected difference between the Henry Hub price and the national average wellhead price increased as the wellhead price rose over the projection period. The Henry Hub spot prices in the AEO2013 Reference case are based on natural gas prices that balance the supply and demand for Gulf Coast natural gas, which contributes to a lower Henry Hub price projection in AEO2013 than in AEO2012.With increasing natural gas production, reflecting continued success in tapping the nation's extensive shale gas resource, Henry Hub spot natural gas prices remain below $4 per million Btu (2011 dollars) through 2018 in the AEO2013 Reference case. The resilience of drilling activity, despite low natural gas prices, is in part a result of high crude oil prices, which significantly improve the economics of natural gas plays that have relatively high liquids content (crude oil, lease condensates, and natural gas liquids). Also contributing to growing production volumes are improved drilling efficiencies, which result in a greater number of wells being drilled more quickly, with fewer rigs and higher initial production rates.After 2018, natural gas prices increase steadily as tight gas and shale gas drilling activity expands to meet growing domestic demand for natural gas and offsets declines in natural gas production from other sources. Natural gas prices rise as lower cost resources are depleted and production gradually shifts to less productive and more expensive resources. Henry Hub spot natural gas prices (in 2011 dollars) reach $5.40 per million Btu in 2030 and $7.83 per million Btu in 2040.
17 OTHER LEASE ISSUESBecause of the many unique operating issues associated with Shale Leases, the new modern Oil and Gas Lease Form takes into account many important features the land and royalty owner should manage. These issues include:Extensive Definition section…avoids misunderstandings and addresses many lawsuit case concerns.Added Definitions peculiar to Shale operations and Horizontal Well DrillingExtensive Definition of Leased Hydrocarbons (Oil, Gas, condensate, sulfur)…what is and not included in the Lease as oil and gas minerals…and confines any such ‘mineral’ to only those that can be produced through a well bore…Clearer description of how the Primary Term can be extended
18 OTHER LEASE ISSUES, cont’d Clear description how Gas operations can be extended by payment of Shut-In payments, and limitations of that extension as well as continuing obligation of the Oil Company to secure a market for GasClearer description of Oil Companies obligation to prevent drainage, especially from adjacent Horizontal Drilling activitiesClearer explanation of pooling and Pugh Clause obligationsProvision for use of Free Gas to the Royalty OwnerConfirms no warranty of title by LessorDefines clearly what are conditions of the Lease (which can cause Lease termination) vs. covenants (no right to terminate the Lease but rights to damages for non-performance)Clear description of Lessor and Lessee mutual indemnification rights and tax obligations of each
19 OTHER LEASE ISSUES, cont’d Obligations of Oil Company to comply with relevant laws especially environmental and safety.Obligation of Oil Company to restore the land to its original condition after operations cease.Obligation for Oil Company to provide financial performance guarantees or security, acceptable to Lessor.Obligation for Oil Company to pay damages to Leased Premises (to Lessor or Lessor’s assignee).Restriction for Oil Company to obtain permission (and pay a fee) for use of any non-minerals on the Leased Premises (such as fresh water, sand, caliche, etc.)Restriction for Oil Company to build pipelines only for transporting minerals produced from the Leased Premises and not third party production.
20 OTHER LEASE ISSUES, cont’d Restrictions on Oil Company how it can dispose of salt water and other drilling fluids on or in the Leased Premises; and restriction against disposing of such from other leases on the Leased Premises.Detail description of Royalty payments based on fixed percentages or a sliding scale, whereby the Royalty Owner shares in price upside movements.Obligation for Oil Company to conduct recurring tests such as ground and surface water quality, for potential contamination by Oil Company, and obligation to clean up any contamination.Obligation for Oil Company at Lessor’s request to provide abandonment security.Obligation for Oil Company to provide free of charge to Lessor various items such as land survey, title opinions, operating records from which Lessor can confirm Royalty payments, environmental tests, audits, etc..
21 OTHER LEASE ISSUES, cont’d Obligation for Oil Company to agree and pay for certain uses of the Leased Premises (mud pits, roads, drilling pads, frac laydown areas, etc..)
22 GENERALThe new Lease Form and supporting discussions papers have been provided free of charge to most all of the USA oil and gas royalty owner associations, government leasing agencies and various oil and gas law firms.Discussion papers include the detail of:Cash flow and ENPV risk analysisRoyalty CalculationsLease Bonus determinationReturn on investment data and compensation packages of Oil CompaniesOil and gas price and capital/operating cost discussionAnatomy of oil and gas leases and what their terms mean and the difference between a condition (subjects Lease to termination) and a covenant (non-performance results in damage claims but not Lease termination) in a leaseUnderstanding the difference between the Mineral (dominant) Estate and the Surface (subservient) Estate and rights of eachDiscussion of the unique characteristics between ‘unconventional’ shale operations versus ‘conventional’ oil and gas operations and unique Lease terms (to protect the royalty and land owner) required for either.‘Lease-o-meter’…quick and easy way to test your lease and give it a report card (Excellent, Average, Poor, Failure) to determine how friendly it is toward the land and royalty owner versus the Oil Company.Protect your rights and receive your fair share of value from oil and gas leases.