Oil & Gas Accounting 101 – Leases

 

LeaseA mineral lease is a contract between a mineral owner (lessor) and a second party (lessee). The lessor grants to the lessee the exclusive right to drill for and produce oil and gas, or other minerals on the property described in the lease. A lease usually provides for:
  • Cash (lease bonus) payable to the lessor upon the execution of the lease and approval of title
  • A specified term of years, usually from three to ten years
  • Delay rental for each expiring year during which the lessee has not commenced drilling operations
  • Lease cancellation if the lessee does not pay the delay rental by the due date
  • The basis for division of oil and gas produced between the lessor and the lessee
  • Continuation of the contract between the lessor and lessee as long as oil or gas is produced from the property

The lessor’s share of the production is known as the royalty or landowner’s royalty. It is common for the share to be stated as a fraction of the oil and gas produced, for example 1/8. The lessee acquires the right to the oil and gas produced less the landowner’s royalty.

The lessee does not take on a specific obligation to develop the property or to pay delay rentals, but does agree that the lease will expire if the property is not developed or rentals are not paid. Normally the lessee can abandon the lease without penalty.

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When the landowner signs the lease, the owner will be given a “Bonus.” The bonus is a sum of money, agreed upon both the Lessor and the Lessee to be given on signing of the oil and gas lease. If there are producing wells near the land, the bonus is usually higher than when there is no drilling yet or none of the existing wells are not producing.

The length of time established in the oil and gas lease is called the “term.” This is the primary length of the lease. The term is usually a fixed length of time, such as one to five years.

Another part of the oil and gas lease is royalty payments. It is an agreed on percentage of the profits of the oil and gas. The lease will specify what, if anything, can be deducted from the royalty payments such as, severance taxes and/or gathering or marketing charges.

If the term of the oil or gas lease extends beyond the time that the bonus was paid, and a well was not drilled, then the Lessee is required to pay the landowner an agreed on sum. This sum could be $1.00 or more per acre. This is called a delay rental. The payment is due on or around the anniversary of the lease. Occasionally oil and gas companies pay this fee up front when an oil lease is negotiated and signed. The company’s failure to pay a delay rental on time cancels the lease.

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Source: SherWare Blog

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