In this episode, we discuss the concept of not signing an oil and gas lease when you are force pooled and deciding to not participate in the drilling of a well and this may mean for future royalty payments. This is also referred to as going non-consent to the drilling of a well. There is a lot to consider when becoming a non-consenting mineral owner.
When you go non-consent, what happens next depends on the state where the minerals are located. In general, you become subject to a risk penalty to compensate the consenting working-interest owners who have to carry your proportional share of the cost of drilling the well.
This topic is in response to a question from Beth who wrote in with the following question:
I own minerals in North Dakota. I found your site while looking for information about forced pooling/non-consent. I’m looking to understand some basic things about a) what it is we have done those years ago when agreeing to go non-consent (thanks for episodes 7 and 8), b) how risk penalties are calculated when secondary wells are drilled on the same pad as the original well…
Thanks again for your show.
Beth
This is an important topic to be aware of if you are considering not signing an oil and gas lease and an operator has filed a pooling order to potentially force pool your interests.
As a reminder, this should not be construed as legal advice, we are not attorneys, consult with a qualified attorney licensed to practice law in the state where you own minerals if you have questions.
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A Refresher on Pooling
Before we dive into the details around deciding to stay an unleased mineral owner and going non-consent when a well is drilled, it is helpful to talk about how this all relates to pooling.
To summarize:
Pooling is the concept of combining small tracts or fractional interests in mineral rights into a single unit for the purposes of drilling a well.
- Statutory pooling or forced pooling is the process by which the interests of unleased mineral owners are pooled to allow for oil and gas development to occur.
- An operator will try to lease all mineral owners within a unit and the terms of the lease will grant the operator the right to pool their interests into a unit so that they can drill a well.
- Sometimes they can’t lease 100% of mineral owners in the unit because some mineral owners will not agree to the terms of the lease, some may simply refuse to lease their minerals, or the operator simply cannot locate all mineral owners (they may be deceased, mail gets returned to sender, etc.).
- Forced pooling occurs when the operator can’t voluntarily pool all mineral interests in a unit so that a well can be drilled. They utilize statutory law to obtain consent to pool these unleased tracts. The company will apply to the respective state agency that governs oil and gas to obtain what is called a “pooling order”. Forced pooling is also sometimes called statutory pooling.
Some states have a minimum percentage of mineral interest owners that must be leased before they will grant a pooling order to an operator. In Beth’s case, North Dakota does not have a minimum percentage (at lease at the time of recording this episode).
We cover Forced Pooling / Statutory Pooling in more detail in MRP 8: Forced Pooling – What are Your Options?.
Working Interest Refresher
If you acquire a leasehold interest in a well or if you elect to not lease your minerals and you are force pooled, you become what is called a “Non-Operated Working Interest Owner.” We talk about these concepts in more detail in MRP 7: Working Interests for Mineral Owners but here are a few key concepts to remember:
- Participating in a Well – When you participate in the drilling of a well, you are electing to financially contribute to the direct costs of drilling & completing a well or wells in exchange for a percentage of the production. By participating in the well you become a non-operated cotenant (also known as holding a “non-operated working interest”).
- Non-Consent – If the operator proposes to drill a new well or perform work on an existing well, they will provide a cost estimate for the proposed work (called an Authority for Expenditure or AFE) and an election letter asking the other working interest owners whether or not they want to participate. Parties that elect to participate would owe their portion of the costs for the work. Those who don’t consent to the work (going “non-consent”) would be subject to a penalty of some multiplier of cost (also called a “risk penalty”) before they are allowed to receive their proportional share of the working interest revenue (based on their % ownership in that well). In other words, the cost for that work would need to be recovered along with a “penalty” (in many states a total of 200% to 300% of the cost of the work would need to be recovered before you get paid your portion of the working interest revenue (and charged your share of the operating costs).
But I Thought I was Just a Mineral Owner, Not a Working Interest Owner?
By not signing an oil and gas lease and electing to not participate in the cost of drilling a well, you become a non-operated working interest owner that is subject to a risk penalty before you earn the working interest for that well or group of wells. This may come as a surprise to many mineral owners so it is a decision that should not be taken lightly.
We cover this in more detail in this and the episodes listed below. Many mineral interest owners who elect to not lease their minerals when presented with the opportunity end up getting “forced pooled”. The way this is handled varies from state to state but we’ll give a couple of examples of this might apply to you if you own minerals in these states and you opt out of signing an oil and gas lease.
Again, I can’t stress enough how much it depends on the state where the mineral interests are located as to what happens to you when you elect to go non-consent. Most states will still pay you the statutory minimum cost-free royalty rate when you go non-consent as a mineral interest owner but you are then subject to the risk penalty previously mentioned before you would earn your non-operated working interest in the wells you did not participate in paying your share of the drilling and completions costs.
If I haven’t said it enough, each state takes a slightly different approach as to how unleased mineral interests are handled so check with your state’s oil and gas commission and any statutes covering this issue.
“Risk-Penalty” Approach
Most oil and gas producing states take this approach including Colorado, North Dakota, and Texas [side note: Texas does not have forced pooling, instead they follow the concept of unleased co-tenancy which we cover in MRP 111: What Every Mineral Cotenant Should Know (Hint, You Probably Are One).
What is a Risk Penalty and How is it Determined?
A risk penalty is the penalty that you are charged out of the proceeds from producing from the drilling spacing unit when you decide to not participate in the cost and risk of drilling and completing a new well. Before being charged this risk penalty, most states require that the operator make a good faith effort to try to lease your minerals and provide proper notice that you will be charged this risk penalty.
The amount of the risk penalty is determined by each state’s oil and gas commission or by statute. Here are a few examples:
North Dakota:
Per the North Dakota Industrial Commission (NDIC), “there is no specific percent required for an operator to pursue “force pooling” or “Recovery of a Risk Penalty” as it’s defined by the [NDIC]. The NDIC has authority to approve such an action pursuant to statute 43-02-03-16.3. An operator does, however, need to have an interest in the drilling unit of the proposed well, whether it is by lease or mineral, in order to propose the forced action. Obtaining NDIC approval requires the operator to provide a written invitation to participate in the risk and cost of a well. If the party receiving the invitation to participate is not subject to a lease or other contract for development (mineral interest), the operator seeking such recovery action must make a good-faith attempt to lease said party. The risk penalty for this interest owner is 50% of their share of the costs of drilling and completing a well, while an owner with an interest derived by lease or contract realizes a 200% penalty.”
Colorado: Colorado uses a risk-penalty approach, where any non-consenting mineral owner must pay for 100 percent of their share of equipment and operating costs for the well as well as 200 percent of their share of costs incurred in drilling and completing the well (or wells) (this is the risk penalty).
Multiple Choice Approach
States like Oklahoma have yet another approach when you are forced pooled where they provide the mineral owner with the best lease offers based on existing leases (lease bonus vs. royalty rate combinations) or option to participate in the well. I believe Pennsylvania and West Virginia also follow this approach. This approach incentivizes the mineral interest owner to hold out until they are force pooled in order to get the best lease terms available within that drilling spacing unit.
How Risk Penalties are Determined With Additional Wells
This is where it can get tricky. In my experience, the operator will usually present you with an offer to participate in the drilling of future wells in that drilling spacing unit but it may vary from state to state. Some states my have a minimum number of wells within a unit (e.g. the first 8 wells) that would be subject to the risk penalty incurred due to the original decision to go non-consent.
If you are faced with this potential situation or would like more specific advice to your unique case, contact a qualified attorney licensed to practice law in the state where your minerals are located.
Final Thoughts
It is a big decision to remain unleased when a well is drilled on your mineral interests. In the words of the band Rush in their song “Freewill”:
“If you choose not to decide, you still have made a choice. . .”
Neil Peart
In most cases, by choosing to not sign an oil and gas lease, you are deciding to become a non-operated working interest owner. Once the well reaches payout and you earn your working interest, you may be expected to sign a Joint Operating Agreement with the oil and gas company. You may also be required to provide proof of insurance for your proportional share of the liability associated with that well. To learn more about Working Interests and some of the pros and cons, check out MRP 7: Working Interests for Mineral Owners. Becoming a non-operated working interest owner is very different from leasing your minerals and receiving a cost-free royalty. Be sure you know what you are getting into before making this decision.
Resources Mentioned in This Episode
- MRP 7: Working Interests for Mineral Owners
- MRP 8: Forced Pooling – What are Your Options?
- MRP 111: What Every Mineral Cotenant Should Know (Hint, You Probably Are One)
- North Dakota Administrative Code 43-02-03-16.3 – Recovery of a risk penalty
- North Dakota Oil and Gas Frequently Asked Questions
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