Oil and Gas Handbook




Chapter 5:

Once an area has been determined to be viable for drilling, it is necessary to get a lease to drill on the property. The rights to the surface and the hydrocarbons beneath can be separate. An oil and gas lease is a contract between the person or corporation that owns the oil and gas rights to a property and a party who wants to drill a well on that property. If a lease is signed by both parties, the owner of the oil and gas rights is the "lessor" and the recipient of the rights is referred to as the "lessee."

The bonus, royalty, and the primary term of the lease are the three most important items considered during lease negotiations. The bonus is the amount of money required up front by the lessor and is paid whether or not a well is drilled or produces. The royalty is the interest the lessor is to receive if any oil and gas is pumped or taken from the well. The primary term is the time period that a company will be allowed to explore or drill. Most leases are taken on a standard form with additional negotiated terms added at the end.

It is important to note that there are costs associated with preparing oil and gas leases -expenses to evaluate the property before considering a lease, legal fees to establish ownership of a property to make the leases legally valid, and payments of bonuses to the owners of the oil and gas rights to secure the leases.


Landmen work for oil companies to research ownership of the surface and oil and gas rights and negotiate leases. The landmen also understand laws and rules concerning leasing in a certain area and how to file the proper paperwork with the local government. In addition, the landman works to resolve problems that may occur in disputed ownership rights, and they are generally knowledgeable about drilling that has taken place in a certain area.

Types of Legal Instruments Used for Oil and Gas

There are five main agreements an average surface or oil and gas rights owner could enter into with an oil and gas company. The first is the oil and gas lease described above. The second is a surface easement, which would be used to create a pipeline or road. Next is a seismic agreement which permits necessary seismic testing over a property. Fourth is a general damage agreement for use of roads and clearing a location to drill a well. On land, rigs need a minimum of one acre to work. The final type of agreement is a water rights agreement which allows access to surface or underground water to drill and complete a well.

Working Interest

Small exploration companies are known as "independents." Independents may not be able to take on the full financial risk of drilling a well. Instead, working interest in the well will be sold to individual investors or other independents. This allows everyone involved to spread their risk over more wells.

A working interest owner pays a percentage of the costs associated with a well. After royalties are paid, the working interest owner is entitled to his share in production revenues with other working interest owners based on the percentage of working interest owned.


Because of the high risk associated with drilling for oil and gas, the government provides tax incentives that allow individual investors to write off the entire cost of their investment regardless of the outcome of the well. Generally, only high income or high net worth investors can take advantage of these incentives. In fact, the government discourages those with limited financial resources from making direct investments in oil and gas drilling projects.