“Here is the lesson. Forget what you learned from watching Beverly Hillbillies. ... Mr. Mineral Owner will not advance his cause by overplaying his hand in lease negotiations. ... He should remember this reality check: Not long ago one could have bought his whole farm, surface, minerals and all, for less, per acre, than the bonus offer on his kitchen table.” governing “ownership” of wild game.8 Since molecules of gas can migrate through porosity channels in reservoir rock, they are “owned” by no one, in their “wild” state.9 Thus, the owner of a well, legally drilled upon lands where he “owns” mineral rights, may keep all the gas molecules captured by his well, without liability to those “owners” of the land off which those molecules might have migrated in response to pressure relief afforded by the well. Neighboring owners’ sole common law remedy is to “go and do likewise” – drill their own wells and capture molecules of their own. That unregulated “free market,” common law approach is dangerously flawed. Oil and gas deposits are precious natural resources in which the state has a vital interest. Reservoirs are best developed by scientists who are primarily driven to maximize the ultimate commercial recovery of a reservoir’s molecules. Wells drilled for competitive reasons are not likely to accomplish that. Rather, leaving things to the Rule of Capture has historically led to the drilling of far too many wells than needed to efficiently produce the resource. That wastes money and can damage the very reservoir containing the target molecules. Obviously, it is not really good for the environment either. Consequently, virtually every American jurisdiction with significant oil and/or gas production has enacted statutory limitations upon the Rule of Capture.10 These statutes typically create state administrative agencies with mandates to regulate exploration and production, prevent waste of money and molecules, and insure for each owner a fair share of the reservoir’s bounty, without having to “go and do likewise.” Each owner’s fair share is termed his “correlative right” to oil 12
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and/or gas within the common reservoir. Please remember though, correlative rights are not common law rights; they are one hundred percent statutory. Arkansas’ regulatory agency is the Arkansas Oil and Gas Commission.11 We will need to understand how that agency regulates gas exploration and production from the Fayetteville Shale.12 While shale gas regulation is similar to the agency’s regulation of the Arkoma Basin, some is unique to the Shale Play. That is because of the unique “tight rock” nature of the Shale and the inherent differences of a shale drilling and production process which employs horizontal wells. Now, let us consider the mineral owner whose land is underlain by this shale-full of gas. Just visualize the typical owner. That owner is not an oil and gas professional, nor is he wealthy enough to hire a bunch of scientists and front the high cost of horizontal gas wells. Rather, he is Mr. Ordinary Arkansas Citizen, a hard-working (or retired) chicken rancher or truck driver or hair trimmer or whatever else makes him uniquely unqualified to be drilling gas wells. Still, he is the one owning the legal right to explore and produce. Luckily, help is near. Our mineral owner can make a deal with a gas production company to get wells drilled, produced and administered for their mutual benefit. The company comes to the table with scientific expertise, specialized business knowledge and, importantly, the capital and risk-taking mentality necessary to make it all happen. So, mineral owner and gas company need one another about equally and, most of the time, they will make a deal. That “deal” takes the form of an Oil and Gas Lease. Its form has become pretty stan-
dardized in Arkansas.13 The Lease transfers the mineral owner’s right to drill and produce to the gas producer, for an initial term (the primary term), and then for as long thereafter as there is commercial production from within the unit. Typically, the mineral owner is paid upfront money (“bonus”), but the real consideration is a right to a fractional portion of the proceeds of future production (“royalty”). The amounts of bonus and royalty paid, in any given deal, are dependent almost entirely upon one thing, competition. Oil and gas production is a competitive business. If Company A wants the lease, it better outbid Company B for bonus, royalty or both. If there is no Company B to worry about, Company A may be able to name its price. Fortunately for mineral owners, in most of the shale play, these days you can find Companies B, C and D. Now is the time to make something clear. The oil and gas business is just that, a business. It is undertaken only with expectation of making a profit. “Profit” means profit in the traditional sense. It is revenue, adjusted for time value, which exceeds expenses, and fairly compensates for the use of capital and the attendant risk of losing part or all of it. Expenses, which must be exceeded, are high, as is required capital investment and risk.14 Costs include, of course, the abovediscussed bonus and royalty, but also include the costs of drilling, completing, periodically recompleting and equipping the wells, the cost of transporting and marketing the produced gas, plus the direct and indirect expense of labor and other overhead associated with all of that. Any increase in any cost requires either an offsetting decrease in other costs or an appropriate increase in revenue. The only revenue is money from the sale of the gas. Gas is a publicly traded commodity. Its price fluctuates violently, influenced, somewhat, by the market fundamentals, supply and demand, but also by less predictable forces, like market psychology. Here is the lesson. Forget what you learned from watching Beverly Hillbillies. This is a tough business. The current cost of drilling and producing shale wells can only be justified by high gas prices. Every dollar spent must be returned, plus profit. Mr. Mineral Owner will not advance his cause by overplaying his hand in lease negotiations. If he Daily continued on page 41