Prior to a more detailed discussion of Whiting's position in the Bakken, I thought I'd do a post on the concept of unitization and also discuss land leasing practices in the US.
Private Oil Leases:
Unlike almost any other country, in the USA the landowner also owns the mineral rights below his land, and can generally authorize an oil company to drill on his land. There may be exceptions to this where local laws might prohibit drilling. In offshore regions like the Gulf of Mexico, the state owns land up to a certain distance from shore, and the federal government owns the land beyond that up until international waters are reached.
An oil and gas lease is generally a fairly simple document, and it is usually shorter than the lease you might sign for an apartment. The general structure is that the leasing company pays the landowner a "bonus" which is an upfront payment for the lease. Often the bonus is discussed in terms of dollars per acre. $1,000 or $2,000 per acre might be typical, although it can vary considerably. Then the landowner will also receive a royalty, which is a percentage of the gross value of oil and gas produced by the well. In some periods an eighth was fairly standard (12.5%), though in many of the current plays, 15-20% is more common, and royalty rates can even be higher than that. 25% would be considered a very high royalty rate.
Most states also have a production tax on gross revenue. In the case of North Dakota, a C-Corp (such as an oil company) would pay 4.53% of gross revenue as a production tax to the state. The individual landowner pays a 3.22% tax on revenues he receives from his royalty.. Oil and gas production taxes now make up over 50% of North Dakota's state government revenues. For the individual landowner these royalties (after paying the production tax) are also taxed as personal income by the federal government and state government just like earned income would be. In financial reports, the oil companies will be reporting in net numbers, after subtracting the royalty amount, unless they specifically note that the number they are talking about is gross production. Canadian companies producing in Canada, where royalties are paid to the government, report production in gross terms before royalty, making them a bit tricky to compare to US companies using some valuation metrics.
Now as long as a lease is producing oil, the oil company will retain its ownership of the lease. This period might extend for many decades down the road. But if the lease is not drilled within a pre-determined expiration date, or the lease is drilled but it is not found to produce a commercial amount of oil, then the lease agreement will expire. In some cases the expiration might be in two years. In others it might be in as much as 5 years. Many recent leases also offer a renewal clause, allowing the oil company to have an option to renew upon expiration for a second term, but they must pay another bonus to the land owner.
In some states, the oil company only holds the mineral rights that are closer to the surface than the depth they have drilled. In other words, if they drill a well to 4,000 feet and are producing oil, then they only retain the rights to all the oil at that depth or closer to the surface after the original expiration of their lease.
Unitization:
Private Oil Leases:
Unlike almost any other country, in the USA the landowner also owns the mineral rights below his land, and can generally authorize an oil company to drill on his land. There may be exceptions to this where local laws might prohibit drilling. In offshore regions like the Gulf of Mexico, the state owns land up to a certain distance from shore, and the federal government owns the land beyond that up until international waters are reached.
An oil and gas lease is generally a fairly simple document, and it is usually shorter than the lease you might sign for an apartment. The general structure is that the leasing company pays the landowner a "bonus" which is an upfront payment for the lease. Often the bonus is discussed in terms of dollars per acre. $1,000 or $2,000 per acre might be typical, although it can vary considerably. Then the landowner will also receive a royalty, which is a percentage of the gross value of oil and gas produced by the well. In some periods an eighth was fairly standard (12.5%), though in many of the current plays, 15-20% is more common, and royalty rates can even be higher than that. 25% would be considered a very high royalty rate.
Most states also have a production tax on gross revenue. In the case of North Dakota, a C-Corp (such as an oil company) would pay 4.53% of gross revenue as a production tax to the state. The individual landowner pays a 3.22% tax on revenues he receives from his royalty.. Oil and gas production taxes now make up over 50% of North Dakota's state government revenues. For the individual landowner these royalties (after paying the production tax) are also taxed as personal income by the federal government and state government just like earned income would be. In financial reports, the oil companies will be reporting in net numbers, after subtracting the royalty amount, unless they specifically note that the number they are talking about is gross production. Canadian companies producing in Canada, where royalties are paid to the government, report production in gross terms before royalty, making them a bit tricky to compare to US companies using some valuation metrics.
Now as long as a lease is producing oil, the oil company will retain its ownership of the lease. This period might extend for many decades down the road. But if the lease is not drilled within a pre-determined expiration date, or the lease is drilled but it is not found to produce a commercial amount of oil, then the lease agreement will expire. In some cases the expiration might be in two years. In others it might be in as much as 5 years. Many recent leases also offer a renewal clause, allowing the oil company to have an option to renew upon expiration for a second term, but they must pay another bonus to the land owner.
In some states, the oil company only holds the mineral rights that are closer to the surface than the depth they have drilled. In other words, if they drill a well to 4,000 feet and are producing oil, then they only retain the rights to all the oil at that depth or closer to the surface after the original expiration of their lease.
Unitization:
Originally
oil reservoirs were governed by the “rule of capture”, where anyone could
extract oil as long as they had the permission of the landowner at the location
where they were drilling. This led to
extremely wasteful practices where hundreds of oil derricks might be set up
around the site of a discovery, with wild drilling on every patch of land big
enough to fit a derrick. Inevitably this
would damage the reservoir, since all the wells were rushed. The fields would typically run dry very fast,
since water ingression and inefficient production would damage the reservoirs
and leave most of the oil trapped underground.
Huntington Beach oil field in California during the "rule of capture" period.
The concept of unitization was born out of a need to stop the chaotic rush to be the first to drill into the reservoir. In unitization, every landowner in the designated area shares equally in the production according to their share of the land. The unit size is established by a state commission that sets out to determine the most geologically efficient size to drill. Gas wells in Oklahoma were typically 1 mile by 1 mile sections (640 acres).
My sense is that the drilling unit today has been more standardized and doesn't really relate to the area of land that can support a single well. In many of these shale gas or tight oil regions they end up drilling a number of wells on a unit. But the concept of unitization is still important, because it is an equitable method of sharing out the revenues among the landowners, and ensures more efficient development. In North Dakota, these units tend to be one mile by two miles, because a Bakken well tends to extend underground for a distance of two miles in the horizontal direction.
Unitization
also allows the companies to have an amount of space sufficient to drill a
series of horizontal wells from a single site, known as a well pad. Ussually there is an optimal direction for drilling into shale or tight oil to maximize the effect of the hydraulic fracturing. A similar analogy would be how it is much easier to chop wood with the grain than against it.
Above you can see the drilling units in the Colorado Redtail oil play. The vertical lines within each square represent wells. When one of these wells starts to produce, all the landowners in the unit share the royalty income according to their ownership percentage of the land in the unit. When the second well starts producing they all will share equally in that as well.
Besides the operator and the landowner there may well be other royalty owners as well. In some cases an oil company might sell an ownership stake in a well to a financial partner, who would then be obligated to put up money for the initial capital expenses in proportion to their stake (unlike the landowner), but would also receive royalties in proportion to their stake. The company Northern Oil and Gas, exclusively does investments like this as their entire business, and they do not directly operate any drilling rigs. Oil companies might also sell a "royalty interest" in a property that is already producing, in exchange for an up-front cash payment from a financial partner. Investors in the oil company may rightly look upon complex transactions like this with some skepticism, since creative financing is often a sign of trouble. But theoretically transactions like this can make sense if an oil company can achieve a much higher return on capital than the investor can when the oil company uses that money to drill another well.
No comments:
Post a Comment