Michael A. Dolezal, CPA • 440.225.7680

Leasing your Mineral RightsThings You Should Know Before You Sign...

Considering Leasing your oil and gas rights? Contained in this brochure, we’re providing some basic information. Before signing any of your rights away, we strongly suggest you seek our professional advice to avoid any complications in the future regarding the important choices you are about to make. Once you sign, it’s too late, so let’s do this right the first time!

1. Determine if you are being presented with a proposed lease or something else: Recently, many “marketing agreements,” “lease option agreements,” and other documents have appeared that look like oil and gas leases but are instead agreements to market your oil and gas rights to third parties. Often these cost you far more than hiring an attorney and negotiating directly with the gas company. If you sign such an agreement without negotiating the terms of the underlying lease, you cannot do so in the future.

2. Learn what resource is of primary interest: Do they propose to produce oil from your property? From what formations? Will these be conventional (vertical) or unconventional (horizontal) wells?

3. Lease only that part of your property which permits currently anticipated production activity: This preserves your right to negotiate future leases for the development of other formations if and when they are developed (for example, the Rhinestreet Shale which lies at shallower depths than both the Marcellus and Utica Shales).

4. Determine if the lease is in your favor: Many oil and gas leases

contain a “Mother Hubbard” clause, which may not be favorable to you, the landowner. Under some variants of this clause, you agree to lease all your land – not just the property specifically described in the lease. This could have significant impact if you intend to lease only a portion of your property.

5. Receiving Payments: Bonus payments are usually made upon signing the lease or within a short, well-defined period of time thereafter. When and how payments should be made may depend upon your personal tax situation, the time of year, and the drilling company’s production timeline. There may be tax advantages to you in splitting the payment of bonus money over two or more tax years. Be sure to consult with your tax advisor as well as your attorney.

6. To Be, or Not To Be... If the lease proposes a bonus payment via “draft,” be aware that this is not a check and may or may not be funded by the oil or gas company: If it is not funded, they have effectively unilaterally canceled your lease and you will not receive the contemplated bonus payment or other economic benefits of your lease. The gas company may have months before

it must choose to fund the draft or surrender the lease.

7. Determine the length of the primary term of the lease: Many oil and gas companies are leasing at a pace that exceeds their ability to produce within a standard two-year primary term, so your lease may include a longer primary term. The longer they have to begin production, the longer it may be before you earn “the real money” — royalty income. Worse, if no production ever occurs, you’ll get only the bonus payment (and delay rentals, if any) for executing the lease and making it unavailable to other interested companies during this time.

8. Determine the royalty percentage to be paid, and how it is to be calculated under the proposed lease.Is it a gross or net royalty? If net, what costs are being deducted? A gross royalty is better for you, the landowner. Pennsylvania’s statutory minimum is a 1/8 (12.5%) royalty interest. It is not a “standard,” but a minimum, and is negotiable. Gross royalties of 18% are becoming more and more common.

9. The lease should specify the manner and time frame for royalty payments: Payments should begin within 90 days after the well is completed and every month thereafter. However, many leases for accompanying documents called “orders of payment” will give the gas company much longer than that.

10. Determine whether the lease is a “paid-up” lease, on which no payments are made beyond the initial bonus payment during the primary term of the lease: An alternative to a paid-up lease is one which provides for “delay rental payments” for each year in which drilling has not yet commenced.

11. Determine whether or not the lease permits the storage of gas under your property, and whether this extends the term of the lease: Gas storage rights can and should be the subject of separate negotiations and agreements. Generally, landowners should be reluctant to sign a lease with gas storage providers on it.

12. Not all leased parcels from which gas is produced require a well to be situated on them: If you do not want the well site located on your property, you should inquire about a “surface non-disturbance clause,” which makes it clear that the gas company will have no right to use the surface. Depending on a variety of factors, including the size of your parcel, you may or may not be able to obtain such a clause. The larger your parcel, the less likely it is that the gas company will agree.

13. Use of the Land: Many leases give the oil or gas company the right to build large interstate gas pipelines over and across the property, together with compressor stations and other related facilities. These “transmission line easements” can

and should be negotiated separately from the underlying oil and gas lease.

14. Consider including an “industry best practices” provision. Vertical wells are fine for the development and production of shallow gas fields, but are inefficient and undesirable for unconventional gas formations, such as the Marcellus shale, where horizontal drilling is more appropriate. Insist on horizontal drilling in unconventional shale formations.

15. Understand the unitization provisions of the proposed lease: They need to be flexible enough to permit the company to efficiently produce the resource, but not so large as to allow excessive acreage to be held by any single well in production. Typically, vertical wells should be allowed to hold 40 acres; horizontal wells must hold much more. 640 acres is a commonly accepted maximum unit size for horizontal wells.

16. Notice provisions are very helpful.You should be given notice in the event of an assignment of the oil or gas company’s interest in the lease. The oil or gas company should also notify you if it terminates operations on the lease and document a termination of the lease in your favor, which you may then record at the courthouse to give notice to others.

17. The more the merrier? Leases for larger parcels should include a “Pugh Clause,” allowing leased

acreage that is not produced or held by production to be leased to other oil or gas companies. A vertical Pugh Clause extends this release to include all other formations not produced under the original lease.

18. After all, it is your land: You should be paid an additional compensation if they put a well site, roads, water retention ponds, or other surface disturbance on your property. Additionally, language addressing the company’s liability for damages to standing crops, field drainage tiles, and timber should be included in the lease to avoid any future misunderstanding.

19. Insist on the right to audit the company’s production records.This is especially important in the liquids-rich portions of the Marcellus, Utica, and Rhinestreet Shales.

These are just a few points to consider before engaging in any agreement regarding your oil and gas rights.

Please call us today to discuss your individual situation so that together we can achieve your financial goals and reduce your tax liability.

Michael Dolezal, CPA1667 E. 40th Street, Suite 1G- 3Cleveland, Ohio 44103

216-485-2028 (office)440-225-7680 (mobile)mdolezal@cpaneeds.com