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Embed code for: Title Opinion Analysis - Jan. 2014 NADOA Presentation
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Discussion of analyzing oil and gas land title opinions, a routine task required of a Landman, Division Order Analyst and Lease Analyst in the oil and gas industry.
Title Opinion Analysis By Marsha Breazeale, CDOA, CPLTA Types of Title Opinions The three basic types of title opinions used by lease analysts and/or division order analysts are: Lease/Leasehold Title Opinion Drilling Title Opinion Unit Tract Title Opinion Limited Acquisition Title Opinion Division Order Title Opinion Supplemental/Corrected Opinions Depending on the circumstances, either supplemental or corrected opinions are issued. This become additions to the original opinion, and should never replace the original opinion, only adjust it. All types of opinions should be imaged and filed. Lease/Leasehold Title Opinion This type of opinion is rendered when the validity of the lease could be questioned (“is the lessor the bona fide owner of the mineral interest purported to be leased?”) or the amount of mineral interest covered by the lease could be questioned. It covers only the lease itself in its non-producing status. Drilling Title Opinion A DTO is rendered when an owner of significant leasehold in the targeted drilling unit intends to drill a well on its leasehold but needs to know three important facts first: 1. Are there any unleased minerals interests within the targeted drilling unit? 2. What valid leases exist within the target unit area and who owns their leasehold? 3. What title requirements need resolution before drilling can proceed at an acceptable financial liability level? The answer to Question 1 allows the landman to seek oil and gas leases from unleased owners, or to identify which interests will need to be force pooled or carried. The answer to Question 2 allows the landman to seek a farmin of the other lessee’s interest, or to create a JOA. A DTO must contain the specific override burdens and lease royalty of the other leases to facilitate negotiation of the farmin and/or JOA, but it will not contain a list of all royalty owners or other parties entitled to a share of production or production revenues. The answer to Question 3 allows the Company to assess the additional cost and viability of reducing financial exposure to title failure and proceeding with the project. 2 A DTO might cover only the drill site tract or the entire area for an eventual pooled unit. A DTO should always include legal opinion of surface ownership and permissions in the drill site tract. Unit Tract Title Opinion A Tract Title Opinion is utilized commonly when a unit has been formed and complexities of unleased interests and depth restrictions apply. This type of opinion is found often for South Louisiana sand units, and also for communitized or fieldwide units in all states. Limited Acquisition Title Opinion Often as part of the due diligence for a very valuable acquisition the Buyer will commission a limited acquisition title opinion covering the most valuable properties. These can be the “PV10” assets on a prospect basis or a well basis, depending on the needs of the Buyer for assurance that title is reliable and to learn of any obscure liabilities that could affect the agreed price for the asset. A limited acquisition title opinion will contain only the elements requested by the Buyer. There is no standard format for such an opinion, but standard elements include affirmation or disagreement with the purported entitlement or vested interest of the Seller in the property. It generally will include a discussion of liabilities and possible liabilities indicated by the records, as well as specific requirements and legal advice for minimizing risks where possible. This type of opinion is highly beneficial in negotiating final settlement per the terms of the purchase and sale agreement (PSA). Also, such an opinion routinely is required by a lender for financing the acquisition. Division Order Title Opinion Generally, a division order title opinion is a written statement listing all of the owners entitled to a share of production from the unit, or entitled to revenues from the sale of that production. This means it should include in the statement not only leased interests but unleased interests also, because all active oil and gas producing states have statutes protecting unleased interests when production is obtained. Division of Production When an oil or gas well produces, the production or the revenues from the sale must be distributed among all those people and/or companies who are legally entitled to receive their share. To reduce an operator’s financial liability for wrong payments, a division order title opinion is prepared by a competent title attorney who is an expert not only in mineral and leasehold ownerships but also an expert in the oil and gas laws of the State in which the well is located. The title attorney reads and analyzes copies of actual courthouse documents to write a legal statement of who owns every type of land right on or under the land within the boundaries of the producing unit. A division order title opinion is certified by the attorney to the cut-off 3 date specified, which serves as a warranty as to its completeness and correctness. For this reason, it is certified only for the party(ies) to whom the opinion is specifically addressed. Types Of Ownership Interests Once the right to explore, drill and produce oil and gas has temporarily passed from the landowner to the lessee in the form of an oil and gas lease, additional specific ownership rights are created by the lease. Working Interest The first ownership right created by an oil and gas lease is the “leasehold working interest.” This is the temporary right to explore, drill and produce the oil and gas under the land covered by a lease and every lease states that language in its granting clause. The Lessee receives 100% of this right, unless the lease states otherwise, which is rare. The word “working” refers to the money invested in the process of exploring, drilling and producing from the lease. The oil company does all the “work” (spends the money) and the mineral owner is “cost free” as to all costs of exploring, drilling and producing from his lease. Once the lease begins to produce and the production is sold, the WI owner is obligated by the terms of the lease to pay to the royalty owner(s) the fraction or percent of royalty stated in it. In other words, the working interest in a lease is “burdened” by the lease royalty and must pay the royalty owner out of the sale of production. Lease Royalty The right to receive royalty is inherent to a “mineral” interest. That means that anyone who owns a mineral interest also owns the right to receive a royalty from the production and sale of the minerals found beneath the surface. When the mineral owner signs the oil and gas lease, he transfers to the Lessee the temporary (for the duration of the life of the lease) right to explore, drill and produce the land covered by that lease but reserves the right to receive a quantified amount of lease royalty. The royalty right is a separate type of interest ownership inherent to the mineral rights. Almost all of the time, the mineral owner will also own all of the royalty rights, but it is possible for the mineral owner to sell or gift all or part of his royalty right to someone else even if there is no oil and gas lease covering the land at the time of the transfer. This is how it is possible for a mineral owner to convey to another person all or part of his royalty right only (NPRI), in the form of a “Royalty Deed” and still retain the right to receive all of the lease bonus and rental payments. A royalty right by itself (NPRI) does not have with it any right to explore, drill or produce the land to which the royalty right is attached, so any person who owns an unleased royalty right by virtue of a Royalty Deed does not have the right to sign an oil and gas lease or to receive part of the bonus or rental payments. A royalty interest owned by one other than the mineral interest owner is called a “non-participating royalty interest” because it does not participate in the payment of lease bonus or rentals. 4 Overriding Royalties An overriding royalty is not a true royalty but rather, is carved from a working interest but never pays any part of the costs. The working interest from which it was carved will always pay (“carry”) the bills on behalf of the overriding royalty owner. This is an important concept to understand fully, because the oil and gas “deals” today are extremely complex and correct payment of revenues only to the entitled parties depends upon the Analyst’s understanding of the various types of ownerships and their flexibility. There are many different types of overriding royalties as defined by their purpose and rights attached to them. The Convertible Overriding Royalty A convertible overriding royalty is one that can be converted, in whole or in part (depending on the terms stated in the assignment) to a working interest at some agreed point in time, usually at a point of “payout”. A Company usually tracks only those convertible-ORRI payouts affecting the Company’s interest (“will the Company’s interest increase or decrease after payout?”). All other override payouts between third parties are tracked by the parties involved and processed by the Company as operator in the form of a recorded assignment received. The conversion of a convertible override can be automatic on the payout effective date if the agreement states that, or at the option of the holder. If it is an option, an election letter must be mailed to the override owner allowing him a set number of days to elect to convert his override and typically will default automatically to remain a perpetual override if no response is received by the deadline. The division order title opinion should include all of this information in its body and should set out the decimal interest of all of the owners of production and revenues both before and after each payout, if applicable. The complexity of modern mineral and leasehold ownerships and their application to certain depths in relation to certain points in time make today’s division order title opinions some of the most challenging statements of ownership. Very often, the complexities cause ambiguity and sometimes can cause actual breaks in the chain of title, or gaps in time or acreage for which ownership cannot be determined with certainty. For this any many other reasons, the division order title opinion Objections and Title Requirements section is important, to insure distribution of production and revenues to the correct owners in the correct amounts. Title Objections and Requirements Every complete and correct division order title opinion should have a section in which the title attorney states all of the irregularities, ambiguities and title errors found of record and further states what he recommends the oil company should receive in the form of documentation to “cure” the title defect. Any drilling opinion will contain the initial objections and title requirements that should have been satisfied or waived prior to drilling the well 5 based on a business decision to assume the risk rather than pursue the curative. An analyst must determine with analytical skill which objections and requirements should result in the owner(s) interest affected being placed in suspense until a resolution to the title problem is determined. Two Basic Rules of Thumb There are two circumstances which the Analyst should always place the interest in the appropriate type of suspense and seek the curative documentation as recommended by the title attorney: (1) “This is the correct owner, but what is the correct decimal he owns?” If the attorney states the records leave any doubt as to how much interest in production to credit to an owner, but the identity of the owner is not at issue, the documentation to resolve the issue should be secured by the analyst prior to release. The analyst’s remarks in division order records should state with clarity the title requirement at issue and documentation required prior to release. A complete set of instructions is being formulated by CLA regarding suspense codes and their appropriate use and will be forthcoming in the near future. (2) “Who is the correct owner of this decimal interest?” If the attorney states that the record is ambiguous as to who owns the true, current record title to the interest but the amount of interest is not at issue, the analyst should request the documentation as outlined by the attorney in the Requirement prior to release. Remember, unless contact with the owner or anyone claiming to be an owner is not made at least once during the applicable “look-back period”, this interest will become escheatable. Note: if “lease jeopardy” is present in the objection, always bring such a title requirement to the attention of your mentor, supervisor or manager immediately so that a business decision many be made quickly whether to pay regardless of the objection even if it means paying two people at the same time until the issue is resolved. It is the analyst’s responsibility to make certain the Company is aware of any critical objection, and that proper steps are taken to fully protect the Company’s assets. Division Order Checklist The matrix in the back sets out each of the components found in the “ideal” division order title opinion. “Ideal” is a relative term, so no DOTO is ideal according to every analyst. Important Components of the Ideal Division Order Title Opinion Date: The opinion must be dated in order for this opinion to be properly identified in future opinions, including supplemental opinions that might be necessary. Use of any of the information from this opinion in future opinions requires that this opinion must be correctly identified by date. Opinion Title: This is no small thing. The title “Original Division Order Title Opinion” is universally assumed to mean that all of the title information in it is 6 comprehensive from sovereignty of the soil to date of first production. It should cover all forms of ownership of whatever nature, for all periods of time and all depths, for distribution of production and revenues effective the date of first production from the well. It should also set out all changes in ownership to be triggered by events identified in contracts known of record at the time the opinion was written. A Supplemental opinion is just that: an addition to the original. In this regard, having the correct title is very important for avoiding current and future mistakes. Legal Description: The title attorney certifies title to the lands from the date so specified in the opinion through to the cut- off date also specified in the opinion, as to the lands covered by the opinion. If the legal description stated on the first page of the opinion is not correct, it calls into doubt immediately the correctness of the entire opinion for the purpose of distributing revenues from the correct lands. The correct legal description is a required component of an effective division order title opinion. Owners Identified With Leases: This information is critical to the Division Order Analyst when analyzing the Opinion to verify the decimal interests attributable to each owner stated. It is also needed to create ownership spreadsheets to satisfy statutory requirements such as the PPI Schedule required for Oklahoma gas units. Fractional Text: When a DOTO fails to give the fractional text (spells out each of the components in the calculation) that results in the decimal that the attorney has attributed to an owner, it makes it difficult at best or impossible at worst, for the Analyst to prepare an ownership spreadsheet. Each number used in an interest calculation derives from a title document and the equation built from the documents must yield the decimal credited to the owner. Liens, Lis Pendens and Judgments: An adequate Original Division Order Title Opinion should include a sections specifically for each of these. A “lien” is a legal notice placed of record by one party announcing the public (including the oil company) placing them on notice that the lienholder potentially has a superior right to any revenues or payments that might be made to the person against whom the lien has been filed. “Lis Pendens” is Latin for “lawsuits pending”. These are always a serious red flag, and a business decision must be made whether to hold the revenue payments or to interplead them into the open lawsuit, or other curative action as decided by company management or legal counsel. A “judgment” is a court order issued establishing a debt and directed to a party (“non-prevailing party”) to pay another party (“prevailing party”) a certain sum of money. When filed of record as a judgment it becomes an order enforceable against all payors current or future requiring them to turn over payments to the judgement-holder and not the person against whom the judgment is directed. That means the oil company is placed on notice that the prevailing party might be entitled to the revenue payments, and not the record title owner. Curative documentation or a business decision is required before payments are released. So if any of these areas have not been researched and analyzed by the title attorney, the Company may be left vulnerable to demands for duplicate payment to those who could be entitled to it. 7 Title Certification Date: Correct title ownership information in effect on the day of first production is essential for making certain the right people get paid the right amounts at the right time. If the Opinion certifies title through a date BEFORE the date of first production, there is a chance that someone filed a Deed, or Assignment or other document of record after that date and time that could have changed title ownership after the date of certification. The wrong people could get paid revenues from production as a result. Spacing Order: This is a requirement very important in Oklahoma, because a Spacing Order issued by the Oklahoma Corporation Commission effectively forces all mineral owners within the acreage included in the order to allow pooling of their minerals into the producing unit. It acts to proportionately reduce all royalties in the spaced unit to the proportion their net acreage bears against the total acreage in the spaced unit. A spacing order also establishes the minimum number of acres which must be allocated to the producing unit and thus they are utilized in every producing State for that purpose primarily. All additional wells that an operator determines should be drilled (“development wells”) must receive permission from the state agency (“increased density order”) first, based upon the applicant’s reason for the request. Forced Pooling Orders: When a landowner is being unreasonable, not willing to accept a bonus or royalty reasonably similar to those accepted by the landowners around him, or is a working interest owner unwilling either to participate or farmout, most oil and gas producing states grant the statutory power to force the pooling of these interests. The state may issue a formal Force Pooling Order that orders these owners to accept one of several options outlined in the order. Non- cooperation is not an option. A signed lease is not required if a Force Pooling Order is issued, nor is execution of the JOA by a force-pooled leasehold owner. Force Pooling Orders are issued routinely in Oklahoma. Other states, such as Texas, have much more restrictive force pooling statutes such that operators do not usually pursue them, instead opting to “carry” these interests. State statutes are characterized as “free ride” (Texas), “risk penalty” (New Mexico), “option” (Oklahoma) or “silent”. The only oil and gas producing state with no compulsory pooling statutes is Kansas. Another peculiarity is found in Louisiana, where the consenting working interest owners are allowed to recover 100% of their costs, but only if the operator provides a detailed itemized statement of the cost of drilling operations if requested in writing from the non- consenting owner. If the operator fails to furnish the information, all consenting owners lose the right to recover the non- consenting owner’s share of costs. Materials Examined By Attorney: A complete and correct DOTO should contain a comprehensive list of materials examined by the attorney to render the opinion, to make certain that the attorney considered this or that farmout, joint venture agreement, or pending Assignment of ORRI, as just a few examples. These types of documents can have significant impact on the accuracy of the DOTO issued by that attorney. 8 Tabulation of Leases and Assignments: This information is often necessary for creation of an accurate revenue division of interest in that the tabulation should include information relative to term interests or marketing/transportation-free provisions in a lease or Assignment. This is usually Exhibit “A” to the opinion. It lists each lease by identifying number or alphabet letter and gives the key data from each lease, including royalty rate and amount of interest covered by the lease. Assignments may be intertwined in chronological order in the tabulation of leases, or might be set out as Exhibit “B”. Leases Held Beyond Primary Term: If this is the Original Division Order Title Opinion for the Operator’s first well in the Unit, even though it will be an increased density well it is necessary for the Opinion to state that the production history of the Unit has been carefully reviewed by the attorney to determine that continuous production in fact has perpetuated all of the leases beyond their primary terms. Inclusion Of “a/k/a” Names: This item is important for the Division Order Analyst for two primary reasons. First, to determine if an owner listed in this Opinion is the same owner the Company is already paying in another well and therefore, a BA is already set up. Second, to establish in a permanent record all of the names appearing for an owner in public records in support of future Opinions in which the owner may appear. Unsatisfied Title Requirements Carried Forward: The Original Drilling Title Opinion generally sets out all of the most critical objections and title requirements for the purpose of drilling the well. It is safe to assume that all of the requirements were carefully reviewed by the landman and/or in-house counsel prior to spud and those that are not now cured probably have been waived. When the analyst secures the documentation to cure the title objection set out in an opinion written for the Company, it is an excellent practice to submit a copy of that documentation to the attorney only for his/her files. The analyst should not request any further work on the matter by the attorney, to avoid additional costs. This is the analyst’s opportunity to clarify and complete the attorney’s records for any future opinions that will be written by that attorney, clearly a “best practices” policy. Special DOI Revenue Distribution Considerations By State Oklahoma: Production Revenue Standards Act (“PRSA”, a/k/a “SB-168) generally requires the operator to distribute 100% of the total unit royalties (“TUR”) to all of the owners. Affects gas royalties only. Partners marketing their share of gas under a separate contract (“Take-in-Kind” a/k/a “TIK”) must remit their share of TUR back to the Operator for distribution. Their share is based on their Proportionate Production Interest (“PPI”), not their billable gross working interest. The Operator distributes 100% of the revenues for any condensate produced. Arkansas: Still operates under that State’s version of the Blanchard court ruling that requires the Operator to distribute the first 1/8th of all gas Unit royalties to the respective owners, so partners taking in kind must remit 1/8th of their gas sales revenues to the Operator for distribution. They must distribute directly to the 9 owners any lease royalties in excess of the basic 1/8th. The Operator distributes 100% of the revenues for any condensate. Louisiana: Northern Louisiana operates under the same Township grid land description (Jeffersonian) system as Oklahoma and most other producing States except Texas. Southern Louisiana uses a combination of metes & bounds and Township system, since most of Southern Louisiana was settled by grants from France, Spain and others prior to the Louisiana Purchase in 1803. Southern Louisiana gas units are most often produced from “sand units” which tend to initially produce in large quantities but then quickly deplete. When depleted, recompletion “behind the pipe” is usually done until all encountered producing zones have been depleted. Each zone is a different Sand Unit, named and numbered by the Louisiana Department of Natural Resources, Office of Minerals Conservation. Each Unit contains tracts which are numbered and assigned a tract participation factor calculated by acre-feet and approved by the OMC. The Sand Units for these reasons are often “layered” with the possibility that many of the same tracts of land are situated in more than one Sand Unit and producing at the same time but with different tract participation factors. Title opinions are generally done on a tract-by-tract basis, and often no comprehensive DOTO for the entire Sand Unit is done. The tract division order title opinions must be combined to bring together all of the title information for a given Sand Unit. Federal Units (Rocky Mountain): If an oil or gas unit is less than 10% Federal acreage, the unit is typically treated like any other pooled Unit because communitization is not required. These units may, or may not, have a comprehensive DOTO prepared for them. At a minimum there will be an Original Drilling Title Opinion covering at least the drill-site tract, then individual lease opinions or runsheets approved by the landman covering the remainder of the unit acreage should be available for division of interest creation. If the oil or gas unit is comprised of more than 10% Federal acreage, communitization is required by the Office of Natural Resources Revenue (ONRR), formerly the Minerals Management Service, in the form of a Communitization Agreement. Documents affecting leasehold title to Federal leases are not filed for record in the County courthouse, they are filed only with the ONRR. Individual private lease opinions or runsheets, together with the Original Drilling Title Opinion if the drillsite is on a private lease, and the “Approval of Participating Area” issued by the ONRR commonly form the basis of the revenue division of interest for a federal unit. Spreadsheets are an indispensable tool for Rocky Mountain federal units because of the complexities in farmouts, joint ventures and convertible or escalating overrides. DOTO Calculations The decimal credited to any owner must be supported by the calculation producing that decimal. Each number used in an interest calculation derives from a title document or set of documents and the equation built from the documents must yield the decimal credited to the owner. 10 Standard Formats WI Owner: (Gross WI) x (Mineral Interest) x (Net Lease) x (Gross Acs / Pooled Acs) ORRI Owner: (Gross WI) x (Mineral Interest) x (Gross ORRI) x (Gross Acs / Pooled Acs) RI/BL Owner: (Mineral Interest) x (Lease Royalty Rate) x (Gross Acs / Pooled Acs) Example 1: 50% x 14/144 x 13/16 x 80/640 Lse A less 50% x 14/144 x 2% x 80/640 or WI Example 2: 0.019820 x (0.0390625 x 0.0625) plus 0.019820 x (0.0171875 x 0.0500) or ORRI Example 3: 0.1875 x 9.97/641.92 or RI Example 4: BPO 100% Lease Acme 100% x 4/10 x 5/6 x 80/320 1 + 100% x 3/10 x 7/8 x 80/320 4 + 100% x 8/8 x 13/16 x 120/320 5 + 100% x 4/5 x 120/320 6,7 - 5% x 50% x 7/10 x 80/320 1,4 - 5% x 100% x 1/2 x 120/320 7 or 0.7398958 WI Example 5: BPO 100%, BPO N/C Lease Acme 100% x 4/10 x 5/6 x 80/320 1 + 100% x 3/10 x 7/8 x 80/320 4 + 100% x 8/8 x 13/16 x 120/320 5 + 100% x 4/5 x 120/320 6,7 - 5% x 50% x 7/10 x 80/320 1,4 - 5% x 100% x 1/2 x 120/320 7 + (92.5%/95%) x 2/10 x 4/5 x 80/320 (N/C) or 0.7788432 WI nce most of Southern Louisiana was settled by grants from Fr