Derek Fletcher

Understanding the Oil & Gas world – Part II

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Here is Part II of the Oil & Gas Outline provided by the author Derek Fletcher a Managing Director and Wealth Strategist at U.S. Trust, Bank of America Private Wealth Management. I have not altered the context of Mr. Fletcher’s work, however, I have reduced it down to include only the basic information and broken the outline into two separate blogs.

As is the case with many industries, the oil and gas business has adopted a specialized, unique and, in some instances, humorous vocabulary. Below are some of common terms utilized in the oil and gas business:

1. The Players.

a. Landman. A person in the oil and gas industry whose responsibilities include acquiring oil and gas leases, examining and curing titles and managing an oil company’s leases. This term applies to both men and women and it is not advisable to use the terms ‘Landwoman” or “Landperson” !

b. Lessee. The person entitled under a lease to drill and operate oil and gas wells. The lessee will pay the lessor a royalty and retain the balance of the production. The lessee is commonly referred to as the “operator” or “working interest owner.”

c. Mineral interest Owner. The owner of the minerals under a tract of land. The mineral interest owner has the right to extract the minerals or lease that right to another party. The mineral interest owner has a right to bonus payments, delay rentals and royalties.

d. Operator. The working interest owner who is responsible for the daily operations after production has commenced.

e. Purchaser. The company that remits payment to the various interest owners, including the royalty owners and working interest owners.

f. Surface Owner. The owner of the surface estate. While a party can own both the surface and the minerals, the term “surface owner” generally means a person who owns only the surface and none of the minerals.

2. The Economics.

a. Bonus. The consideration paid by the lessee for the execution of an oil and gas lease by a landowner. If the bonus is to be paid out in installments over a number of years, it is referred to as a “deferred bonus.”

b. Carried interest. A fractional interest in oil and gas (usually in the form of a lease) where the owner of such interest has no obligation for the operating costs. Instead, the owners of the remaining fractional interest in the property bear the costs and reimburse themselves out of the production proceeds, if any.

c. Carved Out Interest. An interest created out of a greater interest (e.g., the creation of an overriding royalty interest out of a working interest).

d. Delay Rental. Consideration paid by the lessee to the lessor for the right to delay drilling operations or production during the primary term of the lease.

e. Depletion. The exhaustion of a reservoir (or the reduction in value of the reservoir) caused by the extraction of minerals.

f. Nonparticipating Royalty Interest. A royalty interest which does not “participate” in (i) bonus or rental payments, (ii) the right to execute leases or (iii) the exploration and development. Instead, it entitles the owner to an expense-free interest in any oil and gas if and when produced.

g. Overriding Royalty Interest. This is an interest that is similar to a royalty interest but which is carved out of the working interest of an existing lease. It is commonly expressed as a fraction of production from the lease but is free of exploration and development costs.

h. Production Payment. A production payment is a right to minerals in place that entitles its owner to a specified fraction of production for a limited period of time, or until a specified sum of money or a specific number of units of mineral has been received.

i. Royalty Interest. The interest in production reserved by a mineral interest owner upon entering an oil and gas lease. The royalty is commonly referred to as a fraction of the total production of oil and gas (or the proceeds) and is free of exploration and development costs. Historically, a standard oil and gas royalty was 1/8 – although it now has a range of 1/8 to 1/4.

j. Shut-in Royalty. A payment made when a well that is capable of producing in paying quantities is shut-in due to the lack of an available market. The payments are generally expressed as a particular amount per acre. These payments enable the lessee to keep the lease alive without actual production for a reasonable period of time.

k. Working Interest. Interest under a lease which gives the lessee the exclusive right to explore and develop the property. In exchange for this exclusive right, the lessee must bear all costs associated with such exploration and development.

3. Miscellaneous Terms.

a. Barrel of Oil. 42 U.S. gallons of oil at 60 degrees Fahrenheit weighing approximately 306 pounds. A barrel is the most common unit used for measuring crude oil.

b. Casing. Round steel tubes of varying sizes, weights and grades that can be interconnected into a string. Casing is run into an open borehole and cemented into place. It is the outermost tube in a wellbore and prevents the borehole from caving in.

c. Casinghead Gas. Is basically the gas produced from an oil well. It is a gaseous hydrocarbon which is found in liquid form prior to production but which converts to a gaseous form upon production.

d. Condensate. Liquid hydrocarbon which is found in gaseous form in the formation prior to production but which converts to liquid form upon production. Generally speaking, this is the oil produced from a gas well.

e. Crude Oil. Hydrocarbons found in liquid form in the formation prior to production and remaining in liquid form upon production.

f. Directional Drilling. The drilling of a well that materially departs from vertical drilling (e.g., horizontal drilling).

g. Division Order. A contractual agreement between the party distributing production proceeds and the various interest owners setting out the proportions of production that each owner is entitled to receive. The division order generally requires the payee to stipulate as to the size of the interest involved, warrant title to the same, agree to prove title to the payor’s satisfaction if a dispute arises, indemnify the payor for payments made in accordance with the terms of the division order and other related matters.

h. Dry Hole. A well determined to be incapable of producing in paying quantities.

i. Farmout. An agreement between operators whereby the owner of a lease transfers the development rights (or some portion of it) to another operator in exchange for consideration (often a payment per acre, an overriding royalty interest or a reversionary working interest).

j. Executive Right. The power to make executive decisions regarding the mineral estate, including the power to lease. The executive right can be severed from other incidents of mineral ownership.

k. MCF. Abbreviation for 1,000 cubic feet of gas. MCF is the most common unit used for measuring natural gas.

l. Mud. Drilling fluid which is pumped down the drill pipe through the drill bit and circulated back to the surface. The purpose of this process includes maintaining hydrostatic pressure, lubricating the drill bit, carrying rock cuttings to the surface and preventing the pipe from getting stuck in the borehole.

m. Natural Gas. Hydrocarbon found in gaseous form in the formation prior to production and remaining in gaseous form upon production.

n. Permeability. A measure of the ease (or difficulty) with which a fluid can move through a porous formation (such as shale, sandstone or limestone).

o. Pooling. The joinder of several small tracts for purposes of securing a drilling permit.

p. Porosity. The ratio between the volume of pores within a formation to its total volume. In general terms this is the space in a formation where oil can be held.

q. Primary Term. The period of time during which a lease can be kept alive even though there is no production in paying quantities.

r. Secondary Recovery. Application of various liquids, gasses, heat, etc. at a time in which a reservoir has reached the exhaustion of the natural energy needed to extract the oil.

s. Secondary Term. The period of time during which a lease can be kept alive by virtue of production in paying quantities.

t. Section. An area of one square mile – which equals 640 acres. Sections are divided into quarters – each representing 160 acres.

u. Tertiary Recovery. Use of chemicals or energy to enhance recovery methods for the production of oil or natural gas.

v. Transfer Order. If an interest subject to a division order is transferred, the party distributing production proceeds will require a transfer order to be executed by the transferor and transferee. The transfer order will describe the interest being transferred, the date of the transfer as well as making the transfer subject to the original division order.

w. Tubing. Like casing, tubing is round steel tubes of varying sizes, weights and grades that can be interconnected into a string. Tubing runs inside the casing and is the path through which oil and gas is brought to the surface.

x. Unitization. The joint operation of all or a portion of a producing reservoir often to make secondary recovery operations more economically feasible.

y. Wildcat. An exploratory well that is drilled in an unproven area.


Understanding the Oil & Gas world – Part I

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Do you own oil & gas interest?  Many people in Texas have some sort of mineral interest.  When you deal with the landman or operator, do you understand all the nuances of the oil & gas world?  Many people have a basic understanding, but do  not usually have enough information to feel truly knowledgeable.  Therefore, I am providing a great outline in two separate blogs for your reading pleasure.

The author of this outline is Derek Fletcher a Managing Director and Wealth Strategist at U.S. Trust, Bank of America Private Wealth Management.  I have not altered the context of Mr. Fletcher’s work, however, I have reduced it down to include only the basic information and broken the outline into two separate blogs.

The mineral estate is a tract of land that is distinct from the surface. It includes five primary attributes: (i) the right to explore (ingress & egress), (ii) the right to develop (executive right), (iii) the right to receive bonus payments, (iv) the right to receive delay rentals and (v) the right to receive royalty payments. Accordingly, in the estate planning context, a client may own or be willing to transfer one or more of these various “sticks.”

Steps in the Exploration and Production Process. In order to appreciate oil and gas as an asset, it is important to understand the general activities involved in the exploration and production process.

Step One: The Survey

a. Geological Maps – identifies sedimentary basins and favorable geological locations.

b. Aerial Photography – identifies promising land formations such as faults or anticlines.

c. Magnetic, Gravimetric or Seismic Studies – provides information regarding the various rock strata below the surface.

 (1) Magnetic Survey – measures the intensity of the magnetic character of the rock strata.

(2) Gravimetric Survey – measures the variations in gravitational fields.

(3) Seismic Survey – measures the various reflective properties of the rock strata as sound waves are transmitted below the surface. The seismic survey is the most common assessment method.

 2. Step Two: Exploratory Drilling

a. Exploratory boreholes are drilled on a promising geological area in order to determine whether, in fact, hydrocarbons exist.

b. Once drilling begins, “mud” is circulated down the borehole and back to the surface. Casing is run into the completed sections of the borehole and cemented into place.

c. When a hydrocarbon formation is found, initial testing is performed to determine the rate flow rates, thickness and internal pressure of the reservoir.

3. Step Three: Appraisal

a. If exploratory drilling produces favorable results, additional wells will be drilled in order to ascertain the size and extent of the field.

b. The economic feasibility of development and production IS determined during the appraisal process.

4. Step Four: Development and Production

a. If commercial quantities of hydrocarbon are discovered, the next step involves development and production from the reservoir.

b. If the field is small, the appraisal wells may simply be used to develop the field.

c. If the field is large, additional production wells may be drilled.

5. Step Five: Enhanced Recovery

a. Many wells are free-flowing – meaning that the underground pressures are sufficient to carry hydrocarbons up the wellbore to the surface.

b. If the underground pressures are insufficient, some fonn of additional lift may be required – such as a pumping mechanism or the injection of gas, water or steam to maintain the necessary pressure.

c. It may also be necessary to stimulate production by fracturing the formation referred to as “fracking.”

6. Step Six: Processing

a. This is the process whereby the fluids produced (oil, gas and water) are separated.

b. Oil must generally be free of dissolved gas.

c. Gas must be stabilized and free of liquids and other elements such as hydrogen sulphide and carbon dioxide.

d. Water must be treated before disposal.