After-Payout Option to Escalate Royalty or Convert to Working Interest

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After-Payout Option to Escalate Royalty or Convert to Working Interest

 

 In the very rare circumstance where you or your client is negotiating a lease  on lands offsetting a very productive well, you may be able to get the lessee to agree to an after-payout option to escalate the royalty or to convert some of the royalty interest to a working interest.  (Some of the lessors in the Big Escambia Creek Field negotiated these types of clauses.)    An example of this type of clause is:

 

0.        After Payout Conversion Option or Royalty Escalation.

 

0.1        Definitions.  For the purposes of this Paragraph:

 

0.1.1        “Net Proceeds”  means the proceeds from the sale or other disposal of all Minerals produced from any well on the Leased Premises or Lands Unitized therewith (including products extracted therefrom) which are attributable to the Leased Premises (“Leased Minerals”), and such Net Proceeds shall be calculated as follows:

 

(i)        Either (a) the price of such Leased Minerals if sold under a bona fide contract to Third Persons or (b) if not so sold, the fair and reasonable value thereof at the place sold or used (or in the case of Leased Minerals processed or treated in a Service Facility, the fair and reasonable value thereof at the outlet of the last Service Facility involved);

 

(ii)        Less the aggregate of (a) all royalties payable on such Leased Minerals which in the aggregate do not exceed one-fourth (¼) of such Leased Minerals and (b) all severance and/or production taxes applicable to such Leased Minerals.

 

In the case of Leased Minerals which are treated or processed in a Service Facility, the price or fair and reasonable value thereof (whichever is applicable under Paragraph 0.1.1(i), above) may be reduced on a current basis by that proportionate share of the current direct costs and overhead of such Service Facility, which is attributable to the processing or treatment of  such Minerals. The charge for the operating costs of such Service Facility shall be a proportionate share of the current direct costs for such month of labor (including employee benefits but not to exceed twenty-five percent (25%) of total labor costs), supplies, utilities, taxes, repairs and similar items, plus overhead; provided, however, that overhead in no case may exceed ten percent (10%) of such current direct costs. Such price or value, as the case may be, shall not be reduced by any share of the capital costs of such Service Facility.

 

0.1.2        “DC&E Costs” means all of the costs which are attributable to the Leased Premises of drilling, completing and equipping a well on the Leased Premises or Lands Unitized therewith, excluding however any part of the capital costs and operating expenses of any Service Facility attributable to or serving such well.

 

0.1.3        “Payout” means the date on which the Net Proceeds from any well on the Leased Premises or Lands Unitized therewith shall equal (i) the DC&E Costs for such well, plus (ii) 100% of the costs of operating such well which are attributable to the Leased Premises during the period when the DC&E Costs are being recovered (“Payout Period”).

 

0.2        Monthly Statements.  Prior to Payout with respect to such well, Lessee shall furnish to Lessor a monthly statement showing (i) current direct costs of operating  the well, (ii) Net Proceeds for the month and to date from production and the calculations used in determining such Net Proceeds, and (iii) a statement of the unrecovered balance to date of DC&E Costs. Accounting for all related costs and expenditures with respect to such well shall be made in accordance with customary accounting procedures.

 

0.3        After Payout Option.  When Payout occurs with respect to any well on the Leased Premises or Lands Unitized therewith (which well after Payout shall be termed “Payout Well”), Lessee shall notify (“Notice of Payout”) Lessor of such fact by certified mail within no more than ten (10) days after Payout, and Lessor shall have the right to elect to convert one-fourth (1/4) of the Base Royalty of one-fourth (¼) provided for in Paragraph 4.1 (that is, 1/16 of 8/8) to a thirty-three and one-third percent (33 1/3%) working interest (i) in Lessee’s Mineral rights covered by this Lease insofar as the Lease affects the Well Tract on which the Payout Well is located and (ii) in the Payout Well as completed and equipped for production and all equipment used or obtained in connection therewith, to the extent that Lessee’s working interest in the Payout Well is attributable to Lessee's working interest in the Lease. Lessor shall make such election to convert by giving written notice thereof (“Notice of Election”) to Lessee by certified mail within ten (10) days following receipt of Lessee's Notice of Payout. As to each Payout Well located on the Leased Premises or on Lands Unitized therewith, if Lessor fails to give notice of an election to convert or elects not to convert, its Base Royalty shall automatically escalate according to Paragraph 0.4, below.

 

0.4        Royalty Escalation at Payout.  If the Base Royalty automatically escalates by virtue of Lessor's election not to convert or Lessor's failure to give Notice of Election, with respect to any producing well on the Leased Premises or Lands Unitized therewith, when Payout occurs with respect to such well, then the Base Royalty provided for in Paragraph 4.1 on production from such well (which after Payout well shall be named “Payout Well”) shall escalate from one-fourth (¼) to thirty percent (30%).  Such escalation shall become effective as of 7:00 A.M. on the first day of the month next following Payout.

 

0.5        Conversion to Working Interest at Payout.

 

0.5.1        Date Of Conversion And Effect.  If Lessor elects to convert part of the Base Royalty upon Payout to a working interest, such conversion shall become effective as to each such Payout Well as of 7:00 A.M. on the first day of the month next following the date of Payout (“Conversion Date”). Lessor shall thereafter receive, on account of Lessor's working interest, thirty-three and one-third percent (33 1/3%) of 13/16 of 8/8 (that is, 13/48 of 100% or 27.083%) of all production from the Payout Well which is attributable to the Leased Premises and pursuant to the Operating Agreement provided for in Paragraph 0.8.   Lessor shall thereafter be obligated to pay or to bear 13/48 (27.083%) of one hundred percent (100%) of: (i) such amount of the cost of operating the Payout Well as is attributable to this Lease; and (ii) the Base Royalty provided in Paragraph 4.1. Lessor's 13/48 (27.083%) working interest in that portion of the production from the Payout Well which is attributable to the Leased Premises shall be in addition to and apart from the unconverted Base Royalty of three-sixteenths (3/16) of 8/8 (that is, 18.750% of 100%).

 

0.5.2        Ownership Of Well.  It is understood that if this Lease affects only a portion of the lands in any Unit around a well in which Lessor has elected to convert a portion of its Base Royalty to a working interest, then the ownership of Lessor in the well and well equipment shall be reduced to that proportion of 100% which the acreage affected by this Lease and included within the Unit bears to the total acreage included in the Unit. If Lessor owns less than the full mineral estate in the Leased Premises included in such well unit, then the ownership of Lessor in the well and well equipment shall be further reduced in the same proportion which Lessor's mineral interest in such Premises bears to the whole mineral interest in the well.

 

 

0.6        Election to Acquire Interest in Service Facility.  In the event that Lessor makes the election hereunder to convert to a working interest in any Payout Well, and the oil and/or gas produced from the Payout Well is treated or processed in a Service Facility as defined in Paragraph 1.1, and Lessee is a participant in the ownership of such Service Facility, then:

 

0.6.1        Service Facility Option.  Lessor shall have the option to become an owner of the Service Facility with Lessee, effective on Conversion Date as defined in Paragraph 23.5(a), to the extent that Lessor's working interest (13/48 (23.083%) in that portion of the production from the Payout Well attributable to the Leased Premises) entitles it to an ownership interest. Lessor shall exercise its option to acquire an interest in the Service Facility by written notice given to Lessee at any time after Payout and no later than sixty (60) days following Conversion Date.

 

0.6.2        Capital Cost Reimbursement.  If Lessor elects to acquire an interest in the Service Facility, then Lessor shall reimburse Lessee for that share of the capital cost of such Service Facility which is attributable to the working interest acquired by Lessor in the Payout Well. For the purpose of such reimbursement the capital cost of the Service Facility shall be the book value thereof on Conversion Date and the capital cost of the Service Facility which is attributable to Lessor's working interest in the Payout Well shall be that portion of such cost which is in the same proportion that the quantity of oil and/or gas produced from the Payout Well which is attributable to Lessor's working interest in the Payout Well and which is processed in the Service Facility bears to the total quantity of oil and/or gas processed through such Service Facility, all as determined on a cumulative basis to Conversion Date.

 

0.6.3        Facility Agreements.  The interest acquired by Lessor in the Service Facility shall be subject to the Facility Construction and Operating Agreement for the Service Facility, which shall govern the rights and obligations of Lessor with respect to its interest in the Service Facility; provided, however, that the operating costs shall not exceed those set out in Paragraph 03.6.4 (ii), below; and provided further that if the Service Facility processes production from other property as well as from the Leased Premises, then the Service Facility operating and capital costs shall be prorated between the Leased Premises and such other properties in the following manner:

 

(i)        Costs of operations shall be prorated to the Leased Premises in the same ratio that the quantity of production attributable to the Leased Premises that is processed or treated in such Service Facility bears to the total production processed or treated in such Service Facility.

 

(ii)        Capital costs shall be prorated such that the cumulative amount of the capital costs charged to the Leased Premises shall be in the same proportion to the total cumulative capital costs as the cumulative production from the Leased Premises processed or treated in such Service Facility bears to the total cumulative production processed or treated in such Service Facility.

 

0.6.4        Processing Charge.  If Lessor does not elect to acquire an ownership interest in such Service Facility, then the charge for processing its working interest share of production from the Payout Well treated or processed in such Service Facility shall be a “proportionate share” (as determined below) of the operating and capital costs of such Service Facility in which the production was treated or processed, computed on a monthly basis in the following manner:

 

(i)        Costs shall be computed monthly, either on an actual basis or (if the Service Facility operator so computes costs) on the basis of a monthly figure derived from an estimate based on actual costs of a prior period of twelve months (12) or less (“Estimated Basis”). When the monthly costs are computed on an Estimated Basis, Lessee shall notify Lessor, within sixty (60) days after the end of each calendar year, of all adjustments for actual costs with respect to such year, and if such actual costs are less than the costs charged on an Estimated Basis shall reimburse Lessor for the difference within such sixty (60) day period. If such actual costs are higher than the estimated costs, Lessor shall pay Lessee the difference within thirty (30) days after receiving such notice of adjustments.

 

(ii)        The monthly charge for the operating costs of such Service Facility shall be a proportionate share of the current direct costs for such month of labor (including employee benefits but not to exceed one-fourth (¼) of total labor costs), supplies, utilities, taxes, repairs and similar items, plus overhead; provided, however, that overhead in no case may exceed ten percent (10%) of such current direct costs. Such costs may be computed on an actual basis or on an Estimated Basis with adjustment after year-end as provided in (i) above.

 

(iii)        The monthly charge for a proportionate share of aggregate capital costs of the Service Facility as fixed by the Construction and Operating Agreement for the Service Facility, except that such charge shall be an amount no greater than:

 

(A)        An amount equal to one-twelfth (1/12) of annual charges for depreciation on the Service Facility at an annual rate of (1) no more than fifteen percent (15%) of the “book value” of the Service Facility on Conversion Date and (2) no more than fifteen percent (15%) of the cost of any new capital investment in the Service Facility after Conversion Date which charges shall cease when such book value and new capital costs have been fully depreciated at such rate; and

 

(B)        A monthly charge for return on investment of one-twelfth (1/12) of no more than fifteen percent (15%) of an amount equal to the book value of the Service Facility as determined monthly, on a declining basis, by monthly deduction of (1) the depreciation factor provided for in paragraph (A) above from (2) the book value on Conversion Date as defined in Paragraph 23.2(c) as reduced by all previous monthly deductions under this Paragraph (B). Such charge shall cease when such book value has been reduced to zero by such process.

 

(iv)        The “proportionate share” of operating and capital costs of a Service Facility to be charged for processing a given quantity of Lessor's working interest share of production (whether such charges are accounted for on a Mineral-by-Mineral of full-well-stream basis) in each calendar year (or fraction thereof) from and after Conversion Date within the term of this Lease, shall be in the same proportion as such quantity bears to the total quantity of oil, gas or other Minerals (whether on a Mineral-by-Mineral or full-well-stream basis) treated or processed in the Service Facility during such calendar year (or fraction thereof), as determined retroactively at the end of such year pursuant to the Construction and Operating Agreement for the Service Facility. For the purpose of calculating current monthly charges under (A) and (B) above, a reasonable estimate of the “proportionate share” for the then current calendar year may be used. Any over- or under-charge made on account of inaccurate estimates of “proportionate share” during such calendar year or fraction thereof shall be adjusted within sixty (60) days after year-end.

 

0.7        No Double Deductions.  Notwithstanding anything contained herein to the contrary, there shall be no duplication of expense deductions for any purpose under this Lease, and if the proceeds from the sale of oil and gas (including the products extracted therefrom), or the fair and reasonable value thereof, represents the sales price or the value of such products after processing, treating, transportation or other charges have been deducted, then the deduction of such charges shall not again be made for any purpose under this Lease.

 

0.8        Operating Agreement.  If Lessor elects to convert to a working interest in accordance with this Paragraph 0, then any well unit in which Lessor so elects to convert to a working interest shall, after conversion, be operated pursuant to the terms of the AAPL 610 Model Form (1982) Operating Agreement, which shall:

 

(1)        Designate Lessee herein as Operator.

 

(2)        Use customary accounting procedures.

 

(3)        Provide for non consent penalties of one hundred percent (100%) for operating costs and three hundred percent (300%) for drilling costs.

(4)        Provide for a $25,000 limitation on expenditures and for furnishing copies of AFE’s in excess of ($5,000).

 

(5)        Provide for a mutually acceptable gas balancing agreement and such other special provisions and modifications as Lessor and Lessee may agree upon. The following special provision shall be added as Article 1A:

 

“This agreement is entered into by <Lessor>  pursuant to Paragraph 0 of an Oil and Gas Lease between <Lessor> as Lessor and Operator as Lessee, which provides for operation pursuant to this form of agreement of a well unit in which Lessor has a working interest. Insofar as there is any conflict between such Lease and this agreement, the Lease shall govern, and nothing in this agreement shall be interpreted as being in derogation of the rights of either party under such Lease.”

 

(6)        Provide minimum insurance coverage as set forth in Exhibit B.

 

Such Operating Agreement shall be executed by and between Lessor and Lease immediately after Lessor first exercises its right under this Paragraph 0 to convert to a working interest on any well unit, and the provisions of such Operating Agreement shall thereafter apply equally to any additional wells completed on the Leased Premises or Lands Unitized therewith in which Lessor subsequently elects to convert to a working interest.

Copyright 2011 by Edward G, Hawkins. All rights reserved.