"Mineral" can be used in various contexts and can vary from state to state. The term can include a wide variety of valued natural resources, from fossil fuels to gemstones. Within the Barnett Shale area, when discussing mineral rights or the leasing of minerals, natural gas is generally the mineral of interest.
Mineral rights are the rights entitling a mineral owner to extract a mineral from the earth or to receive payment, in the form of royalties, for the extraction of minerals. Mineral rights are an integral part of property ownership. Mineral property is considered a real property much like surface property — it can be retained, transferred and leased in whole or in part. In the state of Texas, it is possible to own the mineral rights of a property without owning the surface rights.
Now is the perfect opportunity to have your minerals produced. Many drilling rigs in the Barnett are being sent to the Haynesville or Marcellus shales. The price of gas will rebound and if you’re in a producing unit, you will reap the benefit when it does. The initial bonus offer is actually irrelevant over the life of the well; the important factor is getting the royalties for decades to come.
Owning a piece of property does not automatically mean you own the mineral rights. There are many cases where the original owner sold the surface rights, but retained the mineral rights. A search of your deed or property title can disclose whether you own your minerals. If your current deed doesn’t specifically discuss minerals, you may need to look back through deeds of previous owners. This is why title searches are necessary to confirm mineral ownership.
Surface ownership of a property and mineral ownership are two different issues in the state of Texas. As a result, it is possible to own surface rights to a property and not own the minerals. Property can be sold to another individual while still maintaining the ownership of the minerals under that property. Often, a property’s value or selling price can increase when the minerals are included.
A mineral lease is a legally binding contract that gives an energy company the right to extract and produce the mineral owner’s natural gas. Typically, the owner of the mineral rights is paid a sum of money (the “bonus”) when such a lease is signed. Then, the mineral owner will receive a recurring payment based on the percentage of a well’s production and on the amount the operating company is paid for the natural gas (the “royalty”).
The basic lease agreement involves an initial bonus payment for signing the lease, royalty percentages to be paid if natural gas minerals are found and extracted from the property, and a time frame within which the energy company has to begin operations. If natural gas production does occur, the lease is in effect for the life of the well, which could be 30 years or more.
Commonly, the term bonus refers to the “up-front” money paid to the owner of the mineral rights in consideration for signing an oil and natural gas lease. It is generally calculated on a per-acre basis.
Bonuses are generally calculated on a per-acre basis, so your lot size may be a factor. Other factors may include availability and cost of a wellsite, proximity to existing pipelines, access to seismic testing, geology of the area, offset production and existing competition.
A royalty is a percentage of production on the proceeds of the sale of the gas. Royalty payments start after natural gas is produced and these payments continue for the life of the well — which could be 30 years or more.
Many factors determine the proposed royalty and bonus amounts, including size of your lot, competitive offers in your neighborhood, anticipated geological risks in your area, availability and accessibility of drilling sites, proximity of pipelines and production results in your area.
Bonus checks are typically paid within 45 business days of signing the lease agreement. Royalty payments begin only if your property is placed in a producing unit — meaning when and if natural gas is actually produced and sold. The time from lease-signing to mineral production can vary from months to years, and is determined by many factors. While the bonus money is attractive because it’s immediate and tangible, generally the royalty income is more substantial because it can last for decades.
There are many factors to consider before and during the leasing process. The main consideration is to discover who will ultimately be producing your minerals, regardless of which company offers you the lease. The operating company is the one that will actually drill and produce your minerals; possibly but not necessarily the same one that offers you the lease. Also consider the reputation and stability of the leasing company, the volume of leases they have generated in this market, the company’s relationship to the mineral producer, and their commitment to the community as demonstrated through corporate contributions or civic service.
Well-established companies with proven track records and drilling success rates will generally produce a better well, which means more royalty income for you. It’s also important to choose an operator with the financial strength to hire the best people and provide the best equipment, with the durability to maintain the well for the next several decades. There are several excellent operators in the Barnett Shale, but there are also young start-up companies with little expertise or capitalization.
Typically, lease brokers are individuals who work independently or for a lease acquisition company (or lease brokerage firm) on behalf of certain operators. Their job is to acquire mineral leases in a specific geographic area for an E&P company to produce. Brokers may or may not be trained as landmen and may possibly represent more than one E&P company. Be sure to find out which one they represent in your area.
Though you may receive letters from several different brokers claiming to represent the same operating company (such as Chesapeake), the best way to find a legitimate broker connection is to call or visit the operating company’s website for a list of approved brokers.
Getting started is easy. If you own property in the Barnett Shale, send us an email at BarnettShale@AskChesapeake.com with your property address. A representative will contact you within 48 hours. Or, if you prefer, you may use one of the Chesapeake Energy authorized leasing agents.
Chesapeake properly reports lease bonus payments as Rents in Box 1 of Form 1099–MISC. Lease bonuses are a form of rental payments (paid in advance of drilling) that give operators the right to explore for minerals and are received upon the execution of an oil and gas lease.
Payments to landowners are considered royalties only after the well begins producing. A lease bonus is not considered a royalty because the payment is made before natural gas production commences and is determined without regard to any possible production. A royalty represents the cash value paid based on a percentage of gross oil and gas production from the property. Royalty payments are reported in Box 2 of Form 1099–MISC.
Most land owners are concerned with the classification of lease bonus payments as royalties, because of the ability to deduct depletion expense on royalty payments. According to the Internal Revenue Code §613A(d)(5), percentage depletion is not allowed on lease bonuses, and the term “gross income from the property” (for the purposes of the depletion calculation) shall not include any lease bonus, advance royalty, or other amount payable without regard to production from the property. Since lease bonus payments are not subject to depletion, it is inappropriate to classify this income as Royalty Income in Box 2 of Form 1099–MISC.
You can get more information about reporting bonus and royalty payments from the CHK Contact Center.
You can download a free copy in PDF format of the Chesapeake Energy leasing brochure. It details the leasing process and other important questions you might have.