In recent years, the oil & gas industry has infused a great deal of money into many local municipalities. And while local leaders may be thrilled to have extra dollars on hand (or the promise of future revenue) to move forward with many long-delayed projects and economic development initiatives, it would be wise to take some time to prepare and become acquainted with oil & gas leases and what to expect after you sign one.
Welcoming the oil & gas industry into your neighborhood requires more than simply issuing a building permit and sending a welcome basket. Many companies come to town with complicated lease agreements in tow. Before you sign on the dotted line, make sure you have a clear understanding of the following points.
Understanding Your Lease Terms
- Primary term – Most leases are signed for a primary term of five years. Although lease language varies, if drilling does not occur during the primary term then the lessee may be able to enter into a new lease. Note: Most lease agreements provide for producing wells to have their rights extended into a secondary term. This term could be indefinite as long as wells are producing.
- Environmental concerns – As an elected official, you are responsible for your municipality and everything residing therein. Which is why, when reviewing the lease agreement, you should make sure it addresses safety measures that promote the overall wellbeing of your citizens. Make sure the lease outlines necessary limitations and restrictions to protect the public as well as the responsibility of clean-up costs if something were to go wrong?
- Royalties – You should be aware of how the royalties will be calculated and what costs are being factored into the royalty. It is advisable to have a professional review these terms to make sure you are getting the best deal.
Don’t Build A Budget Around A Lease Agreement
After speaking with your advisor and weighing the pros and cons, put pen to paper and make the agreement official. Just remember that there’s no guarantee that royalties will flow into your government coffers – there are many other factors involved. It could take years before you start to see any income from this source – if you receive any at all. Therefore, it is recommended that you budget this money very conservatively.
That said, even if royalties do trickle in be mindful that the revenue you gain today might be drastically different six months from now. Royalties may fluctuate significantly because they depend on various factors. If, for example, the agreement outlined in the lease was to pay royalties based on net profit, then declining gas prizes could adversely affect the amount paid to you. You should also mindful of any restrictions that may be in place with regard to how the royalties are maintained.
The oil & gas industry can help bolster your local economy, particularly if your lease agreement is well written and addresses all your questions and considerations. A financial advisor experienced these types of agreements can make the entire process smoother for all parties involved. Email Rea & Associates to learn more about working with oil and gas companies can benefit local municipalities.
By Derek Conrad, CPA (New Philadelphia office)