Sliding scale royalty?

I have heard that some mineral owners in N.D. are adding a clause that would increase their royalty if their minerals are pooled, and the pool is larger than a single well can drain, unless more wells are drilled in a specified time. For example, if your royalty is 20%, such a clause would automatically raise the mineral owners royalty (for example) to 22.5% if the operator fails to drill another well within 2 years. I think this is in response to, and may help the mineral owner with the dilution of interest in too large a pool. I would insist such a clause is in any next lease I sign. It won’t hurt the operator a bit if he actually makes the effort he says he wants to do, to produce your minerals, the clause would never kick in. It would be unpalatable to operators just seeking to hold by production a 1280 acre spacing with 1 well. I’d like to hear more if anyone has experience with such a clause. I haven’t actually run across an example to examine, just the description of what it does.


That would be a good solution. We have also used sliding scale royalties based on other factors, such as 1x payout, 2x payout, increased royalty in the second year (which increases the incentive to drill in the first year).

Another option would be to require continuous drilling and development in the lease itself. I am not sure how effective it would be in a forced unit, but if all mineral owners in their section and all adjoining sections added a continuous drilling clause, it would dramatically increase the pace of development.

A "Continious Drilling" clause, as Buddy suggests would be a more effective protection against being dilluted and held by production by just one well in a larger pooled unit.

The larger royalty percentage would be nice to shoot for, but that extra 2.5% does not protect you from a situation where you could be waiting for decades on end for any 2nd well or in-fill production if you don't have that continous operations clause.

The NDIC order establishing spacing units in my township provide for only ONE allowable well. Even though the spacing unit is not being fully developed, the lessee can avoid the “continuous drilling clause” in the lease by simply stating that the only well allowed has been drilled. How will the unsophisticated lessor handle that situation?

Just to make sure that I understand, is the law there that one allowable well per section? No densifying?

Mr. Cotten:

No, the law does not limit drilling to one well per section. What I've observed is the following. The Operator applies with the N.D. Industrial Commission for approval to pool acres into a drilling unit. The request may be for 640, 1280, or even 2560 acres within the unit. In their request, the operator specifies a number of wells which it might drill in the unit (the law doesn't mandate a specific number). Then if the spacing request is approved, that number of wells becomes the MAXIMUM number of wells an operator may drill. Though an operator can go back to the NDIC later to increase it.

In short, the NDIC issues blanket approval for these spacing requests. The few exceptions I've seen were when competing operators had a controling interest in the different sections. As an example say... Continental has 70% of Sec 6, and EOG has 60% of Sec 7, the NDIC may deny Continental's request to pool Sections 6 & 7 unless they get EOG's prior approval for creation of that pool.

Buddy Cotten said:

Just to make sure that I understand, is the law there that one allowable well per section? No densifying?

Buddy Cotten

Has any attorney written a lease clause that prohibits the lessee from forming a drilling unit any greater than 640 acres?

Eastern MT: Pooling of interests and spacing of wells are two separate topics. Among other things, the law requires uniformity with respect to establishing spacing units. The law requires that the spacing order establish the location of the permitted well in each spacing unit. What purpose does a spacing order establishing spacing units serve if nothing is being spaced? There is no uniform well spacing happening in this state when operating companies are given discretion to determine well density within a spacing unit. It makes no sense and the current well spacing practices are not in conformity with the requirements of ND law. Correlative rights are not being protected and mineral owners are not afforded an opportunity to obtain their fair and equitable share of the oil in the common reservoir.

DG, I am not trying to defend the practices, only trying to describe what I have observed. I understand why they are pooling these tracts. The sheer size of this Bakken play make it a little different than other ones. There is no doubt the operators are the ones who primarily benefit from the pooling of the tracts. Though a study shows that on average there may be greater Ultimate Oil Recovery by drilling a 1280 vs two 640 wells. If so, in the end we too (mineral owners) may also benefit from them.

Mr. Cotten, Yes it can be done up here. In the past I have inserted language into a lease to limit the maximum size of pooling allowed. However that was with the old vertical wells and I haven't done so on any of these ND minerals. With the growing prevalence of drilling horizontal 1280's I suspect the Lessee would almost certainly insist you strike it from a Bakken lease. I can live with their 1,280 acre pools if they provide better ultimate recovery. Though if they were requesting to include any of my small interests into 2,560 acre pools I would drive to Bismarck and protest it at the hearing.

Great points, Eastern MT.

I wonder how many small acre holders have prevailed by protesting being swallowd by a 1280 for a Bakken well. None I would think. To let even one small mineral owner escape would open the door to continuous protests if word got around.