Are You Better Off Being Forced Into a Unit than to Lease?

by Andrew R. Thomas, Esq

There are two good news items for forced unit landowners in Ohio.

First, House Bill 8, which was unanimously passed by the State House, stalled in the Senate. So the penalty (set at 200% in the bill) charged to the forced landowner for his working interest in the production remains discretionary for the Oil and Gas Commission.

Second, the Oil and Gas Commission has shown that it does not necessarily rubber stamp penalty and royalty rates. In its recent Teeter decision, the Oil and Gas Commission changed the standard 12.5% royalty rate to 20%.

Unfortunately, there is also bad news for forced landowners. With depressed commodity prices, it is unlikely that a forced unit owner who endures the usual 200% penalty will ever see a penny for his working interest in the production.   Increasing the royalty only makes the problem worse – royalty payments are deducted from the working interest before calculating the penalty.

So if you do get forced into a unit, you should object to the 200% penalty.   While producers do not usually share their drilling and completing costs, they do reveal their anticipated ultimate recovery in the unitization application. You can estimate drilling, completing and post-production costs (they can’t include lease acquisition costs) from public sources. If you then assume that 90% of the estimated production will be recovered in the first three years, you can calculate payout based upon current prices.   Just compare the net revenue (i.e. subtract the royalty payments) to the total costs.

What you will likely find is that without some dramatic improvements in commodity prices, producers simply won’t get to a 200% payout ever.   You will be drained, and get nothing more than a 12.5% royalty on historically low prices.

Unfortunately, this also means that producers can use the threat of forced unitization in lease negotiations. If you don’t lease under the operator’s proposed terms, you may be forced into the unit. Many of you have already had to deal with this, and it could get worse.

So when a landowner does get a call from a leasing agent, he may find that the terms offered are not particularly attractive.   Landowners may have reason to turn down such offers – and not just because of poor bonuses or royalty shares. Most landowners are better off not getting royalties with current commodity prices. Who wants to see their production drained during a time when prices are historically low?

Some landowners, however, will be faced with a decision to either lease or face being force unitized.   If this happens to you, it can hard to know what to do. In negotiations classes, they teach you to remember your “BATNA” – the best alternative to a negotiated agreement. Your BATNA might be taking a working interest through forced unitization. If you go this route, you should be prepared to challenge the 200% penalty.   The Oil and Gas commission should be sympathetic to an argument that any penalty that leaves the landowner with no value from his working interest is excessive.