The ongoing revolution in oil and natural gas exploration has created a wellspring of interest in the formerly sleepy subject of mineral lease agreements. From Texas to North Dakota and Pennsylvania to California, landowners who enter into mineral leases with mining and exploration firms must juggle a range of competing interests and ensure that they protect their interests to the best of their abilities. Likewise, drillers and exploration firms must work to maximize their returns and control the growth of their production costs.
Brief Background on Mineral Leases
For drilling firms, royalty payments comprise a significant slice of ongoing production costs. While customs vary from place to place, it's not uncommon for lessors to demand royalties of 10 to 20 percent on the minerals that their clients produce. Mineral leases also make allowances for other forms of compensation or land use, including bonus payments, rental payments, access, use of services and more. These documents can be complex affairs: In addition to a "granting clause" that outlines the terms and limits of the lease, various stipulations like the retained acreage clause, the warranty clause and the proportionate reduction clause inform the nature of the agreement and may affect the earnings of all involved parties.
Granting Clause
The granting clause is the first and arguably most important provision of any mineral lease. This clause outlines the purpose of the lease and the land area to which the lease applies. It may also contain stipulations and restrictions about the ways in which the leased land may be used for non-mineral purposes. In many jurisdictions, exploration companies may not drill for minerals that aren't explicitly mentioned in the granting clause. Since small variations in wording can have major impacts on the intent and effect of a granting clause, landowners who wish to lease their land would do well to hire a trained attorney to evaluate their leases.
Warranty Clause
The warranty clause is often inserted into a mineral lease at the behest of a lessee. This stipulation allows a lessee to take the initiative to settle any outstanding encumbrances on the leased properties at the expense of the property's owner. This could affect royalty payments over a long period of time and significantly alter the lessor's financial calculus. Most impartial legal experts advise landowners to remove this clause before signing a contract. Further, careful landowners often take the additional step of disclaiming any implied warranties.
When Does the Proportionate Reduction Clause Come into Play?
Although this clause is often tucked into the depths of a mineral lease, it's no less important than any other provision. Also known as the lesser interest clause, the proportionate reduction clause can play an important role in the construction and enforcement of mineral leases. While it doesn't always come into play, it has the potential to dramatically change the cost-benefit analysis for mineral owners and lessees.
Under certain circumstances, the proportionate reduction clause permits lessees to reduce the royalty payments that they make to the owners of the minerals that they exploit. This is because the granting clause often makes no provision for multiple owners of mineral interests. Even if he or she maintains full ownership of the parcel's surface rights, a lessor who owns just a fraction of the underlying mineral rights must accept a proportionate reduction clause that curtails the lessee's royalty, bonus or rent obligations by the appropriate amount.
For instance, a landowner with a "quarter interest" in the minerals that underlie his or her parcel would multiply the agreed-upon royalty rate by .25 to arrive at the proper royalty arrangement. If the drilling unit for a given well extends into another property, the royalty would be further reduced to account for this. Again, it's crucial for landowners who wish to maximize their returns to understand the implications of all mineral lease clauses.
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