The Gas Royalty Clause

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The Gas Royalty Clause

 

 A typical industry lease gas royalty clause looks like:

To pay lessor on gas and causing gas produced from said land (1) when sold by lessee, one-eighth of the amount realized by lessee, computed at the mouth of the well, or (2) when used by lessee off said land or in the manufacture of gasoline or other products, the market value, at the mouth of the well of one-eighth of such gas and casinghead gas;

 

 Some of the issues presented by the typical oil industry gas royalty clause include:

 •        whether the lessor can take its gas production in-kind;

 •        whether the value of the gas is computed at the “mouth of the well” or otherwise;

 •        whether the oil company can deduct costs.

A lessor-friendly gas royalty clause that addresses these issues (except take-in-kind) and that has been accepted by oil companies is set out below:

 (2)        Gas. On all hydrocarbons, including casinghead gas and all other hydrocarbon gaseous substance and hydrogen sulfide, as follows:

 

 [a]   The “value” (as determined hereafter) of Twenty Five percent (25%) of all liquid or gaseous hydrocarbons extracted or obtained from such gas by any method, on or off the Leased Premises;

 

 [b]  The “value” (as determined hereafter) of Twenty Five percent (25%) of all other minerals, including sulphur, that are (a) produced in gaseous or liquid form incidental to or in conjunction with the production or processing for sale of hydrogen sulphide or any liquid or gaseous hydrocarbons produced from the Leased Premises and/or (b) extracted or obtained therefrom by any method, either on or off the Leased Premises; and

 

 [c]  The “value” (as determined hereafter) of Twenty Five percent (25%) of all gas, including gas remaining after the extraction therefrom of sulphur and/or any hydrocarbon content, produced from and either sold on or off the Leased Premises or used off the Leased Premises.

 

 Other Valuable Components. On all other valuable components, including but not limited to sulfur, (together “Valuable Components”) produced in conjunction with oil or gas and extracted or separated therefrom, Lessee shall pay Lessor Twenty Five percent (25%) of the market value thereof less a proportionate share of the cost of extracting the Valuable Components. In no event shall the costs that the Lessee may deduct from the “value” of a Valuable Component exceed the “value” of the Valuable Component.

 

Determination of Value, Deductions, and Reductions.

 

 (3.1).   Third Person.  The term “Third Person” as used herein shall mean a person, firm, corporation or other entity not a subsidiary or affiliate of Lessee, with whom the Lessee deals at arms length.

 

 (3.2).   Determination of “Value” for Gas. The “value” of the Production Royalty under Section (2) on gas and gaseous substance and products therefrom produced from the Leased Premises shall be determined as follows:

 

 (3.2.1)   “Value” for Purposes of §§ (2) [a] and [b]. The “Value” of all liquid and gaseous hydrocarbons and other minerals on which the Production Royalty is determined under Section (2) [a] and [b] shall be:

 

 [i]  Their selling price, if sold under bona fide contracts of sale with Third Persons, with no deduction for any cost of transportation from the Leased Premises to the point of delivery, and no deduction for any costs of saving, storing, gathering, dehydrating, extracting, separating, compressing, piping, or marketing such liquid and gaseous hydrocarbons and other minerals, or

 

[ii]  If they are not so sold to Third Persons, the fair and reasonable value thereof at the place where sold or used, with no deduction for any cost of transportation from the Leased Premises to the point of delivery, and no deduction for any costs of saving, storing, gathering, dehydrating, extracting, separating, compressing, piping, or marketing such liquid and gaseous hydrocarbons and other minerals.

 

 (3.2.2) “Value” for Purposes of (3.2.2) [c]. With reference to the Production Royalty to be paid by Lessee on gas under Section (3.2.2)[c] above, the “Value” of such gas shall be determined as follows:

 

 [i]  If the gas is sold by Lessee to a Third Person under a bona fide contract of sale entered into after the discovery of gas in paying quantities on the Leased Premises or lands unitized therewith, the “value” shall be the selling price thereof including any premiums or allowances received by Lessee, with no deduction for any cost of transportation from the Leased Premises to the point of delivery, and no deduction for any costs of saving, storing, gathering, dehydrating, extracting, separating, compressing, piping, or marketing such gas. If Lessee shall sell such gas to a Third Person and deliver it off the Leased Premises, the “value” shall be the selling price thereof with no deduction for any cost of transportation from the Leased Premises to the point of delivery, and no deduction for any costs of saving, storing, gathering, dehydrating, extracting, separating, compressing, piping, or marketing such gas.

 

 [ii]  If the gas is not sold to a Third Person, its “value” shall be the fair and reasonable value thereof at the place where sold or used, with no deduction for any cost of transportation from the Leased Premises to the point of delivery, and no deduction for any costs of saving, storing, gathering, dehydrating, extracting, separating, compressing, piping, or marketing such gas; provided, however, that the fair and reasonable value of gas used or sold off the Leased Premises shall be the value at the place sold or used (but not less than the highest price obtainable for an annual contract which is freely and currently offered for products of like kind, quality and characteristics in similar quantities produced and sold from any field located within two hundred (200) miles of the Leased Premises).

 

 As with the oil royalty clause, timing, location, and the size of the leasehold tract will determine whether or not you can negotiate the oil company away from its standard gas royalty language.  If you do not have a large tract that is strategic to the oil company and if timing and location are not favorable, you cannot expect to negotiate any concessions on the gas royalty language.

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