oil & gas underpayments · payout is the break-even point when well expenses equal production...

OIL & GAS UNDERPAYMENTS Finding Lost Mineral Income: 5 Things You Need to Know

Learn more at drillinginfo.com

Introduction

In a crowded room of mineral owners, if someone mentions the word “underpayment” everyone is likely to turn to the only operator in the room. It’s easy to assume that oil & gas operating companies are the culprit when it comes to incorrect and non-payment on mineral interests, however, such situations are almost always an oversight and symptomatic of the business environment. The oil & gas industry is complex with labyrinthine ownership structures and cumbersome production accounting. Operators are obliged to not only manage the tough tasks of finding and extracting oil and gas, they must also manage payments and expectations of thousands of interest owners. Things fall through the cracks and with a few exceptional cases of misconduct, underpayments are a result of a complicated system stressed to the max. And it’s important to note that most operators are also non-op interest owners, putting them in the same boat with oil & gas investors.

In this report, we’re going to take a deep dive into the top 5 underpayments oil & gas investors struggle with every day. What’s more, non-ops and operating companies alike can both benefit from the risk assessments and solutions offered in the following sections.

of 7

OIL & GAS UNDERPAYMENTS

MissingWells

MiscalculatedOwnership

IncorrectDeductions

PayoutMistakes

UnderreportedProduction

LostIncome



Underpayment #1: Funds in Suspense

Right now, there is a chance you are not in-pay on wells you didn’t know existed. You have a right to receive income from such wells but for many reasons the operating company isn’t sending the check.

Funds that are held in suspense can occur through title defects or change in purchaser. In some states, operators are not obligated to pay royalties without a signed division order. The operator might also be holding funds in suspense due to simple record keeping errors, such as a missing W9 form. And the checks may have been in the mail but sent to an incorrect address.

Let’s assume a new well produced 100,000 barrels of oil in the first six months at $60/bbl. You have a 1% interest in the well that is not being paid on. During this period $60,000 is held in suspense by the operator.

While this money could eventually make its way to your bank account through an audit on either side, significant risks of a total loss exist. Funds might revert to the state after a statutory waiting period. Many states don’t require producers to hold suspended funds in an escrow account, so there is also a chance that funds could be locked-up or lost if the operator files bankruptcy.

Avoiding the risk of losing or delaying payments from missing wells is all about staying tuned-in to what’s happening around your properties. Key to this is the ability to quickly map and monitor nearby permitting and rig activity. If you spot a new well going in on one of your tracts, you can be proactive rather than relying on the operator to track you down.

Underpayment #2: Incorrect Decimal Calculation

A chain of title is a good way to understand mineral ownership complexity. These instruments document mineral ownership from the original owner (almost always the state) who had 100% interest to the current owners. Over time mineral interests are divided and divided again as land is sold, inherited, or otherwise exchanged hands over decades. The result is that mineral interest is tracked to the eighth decimal place, so even a small miscalculation or dropped decimal place can impact your bottom line.

The biggest reason decimals are calculated incorrectly is simply human error. Landmen and title attorneys still rely on manual Excel calculations. And leases and other title documents can be misinterpreted. The situation is complicated further when an owner has multiple interests in the same well, which might be the same types of interest or a mix, such as owning both an overriding royalty interest and royalty interest. In the case of multiple interests, operators often miscalculate the ownership or miss an interest altogether.

of 7


Using the same scenario from our previous section on funds in suspense (in which a new well produced 100,000 barrels of oil in six months at $60) let’s assume you have an incorrect interest decimal in this well of 0.009 and an actual decimal of 0.01. That’s $6,000 you were underpaid.

Of equal concern is that investors can also receive overpayment on their wells. So, if the decimals were reversed in this scenario, you would owe the operator cash, who would have every right to claw it back.

Don’t assume your interest decimals are correct. Fortunately, there are purpose-built tools and online courthouse records that will empower you to maintain accurate land information and fill in gaps in your title documents so you can spot decimal problems faster. Then take action to correct and recover missing revenue.

of 7


Don’t assume your interest decimals are correct. Fortunately, there are purpose-built tools and online courthouse records that will empower you to maintain accurate land information and fill in gaps in your title documents so you can spot decimal problems faster.”

Underpayment #3: Improper Deductions

Investors often share the revenue as well as the costs of operating a well through post-production deductions and a variety of tax obligations. In some states, royalty calculation is subject to mandatory deductions from marketable product rules that burden lease holders with multiple postproduction costs. But depending on the type of interest you own and the terms of a lease, you might be exempt from paying such fees, but the operator charges you anyway through revenue deductions or even adjusting realized prices.

While there are multiple causes behind improper deductions, most occur because a lease is misinterpreted or because the revenue deck was created using a standard, one-size-fits-all lease.

When a producer unintentionally deducts post-production expenses on a no-cost lease, investors can lose as much as 25% of their revenue. In some rare cases improper deductions can result in negative royalties.

Mistakes like this can hit the bottom line especially hard where marketable product rules apply and for wet gas wells, where ethane and other NGLs are subject to “market enhancement” deductions, i.e., those costs associated with bringing unusable raw products to market. These can add up and include compression, separation, dehydration, storage, marketing, CO2 reduction, and transportation fees.

Learn more at drillinginfo.com of 7


To nip improper deductions in the bud, ensure you are linking each of your revenue statements to the lease records that govern your post-production expense obligations. Purpose-built mineral management solutions can greatly simplify the tasks of putting your land and accounting data in context with each other.

Secondly, post-production fees may not always be itemized as direct revenue deductions on check stubs, instead manifesting as adjustments to realized pricing. To spot these deductions, be sure to compare realized pricing to local benchmark pricing for oil, gas, and NGL.

Underpayment #4: Payout and Interest Conversion

Payout is the break-even point when well expenses equal production revenue. Before payout, an owner has either a reduced or zero ownership. After payout, ownership can dramatically increase and/or convert to a different ownership type. This all depends on type of interest and provisions set out in farmout and joint operating agreements. For example, in the case of a “back-in after payout” scenario, overriding royalty interest converts to a working interest.Your interest conversions may not be applied post-payout as a result of change in purchaser, inaccurate or incomplete records. Operators should issue payout statements quarterly, but legal complexity and bandwidth to stay on top of payouts can cause delays. Asset acquisitions and bankruptcies frequently create a massive document management challenge where vital records are simply lost or misplaced, in which case an operator might not even be aware a well is subject to payout.

Preventing this type of underpayment is especially tough because payout on a new well can take years with multiple factors determining the timing, including daily commodity price changes. And for investors with thousands of mineral interests, it can be a land data management nightmare to sift land records for the provisions that govern interest conversion.

Tackling the payout and interest conversion problem is a matter of being proactive. To determine whether or not a claim is required, ensure you are using a land records management system that allows for easy data mining of agreements involving payout provisions.”



Missing a payout conversion can have huge implications especially if there is an unleased interest in a drill tract that is not subject to forced pooling. In such a case, payout converts the interest to an NRI without being reduced by the tract participation factor since no agreement was signed. Be sure to spot these types of payouts since the difference in decimals can be an order of magnitude bigger.

Like funds in suspense due to a missing well, tackling the payout and interest conversion problem is a matter of being proactive. To determine whether or not a claim is required, ensure you are using a land records management system that allows for easy data mining of agreements involving payout provisions. Then match those agreements with relevant wells and reconcile payout status and revenue to address any issues.

Underpayment #5: Underreported Volumes

Oil & gas operating companies are driven by two monthly production reporting cycles. First, operators must account for production sales in order to calculate and issue payments to interest owners. Second, producers must adhere to strict state regulatory reporting requirements for individual wells and lease-level production.

It’s not uncommon to be underpaid on mineral interests because the production volume reported on your check stub is less than the final number reported to the state. This can happen for a variety of reasons, not least of which is production allocation complexity or even gas flaring that results in a discrepancy.

Spotting inconsistencies between volumes reported on your check stubs and publicly reported volumes is extremely difficult given the amount of data points involved. Oil, gas, and NGL volumes are often multiplied by thousands of wells in a portfolio, making it a data management problem more than anything.

Given the poorly organized state of most government regulatory websites and datasets, comparing production reported to you with state data can be overwhelming for most investors. Even worse, reporting standards vary widely from state to state, with some states, including Texas, only reporting lease level production.


Drillinginfo delivers business-critical insights to the energy, power, and commodities markets. Its state-of-the-art SaaS platform offers sophisticated technology, powerful analytics, and industry-leading data. Drillinginfo’s solutions deliver value across upstream, midstream and downstream markets, empowering exploration and production (E&P), oilfield services, midstream, utilities, trading and risk, and capital markets companies to be more collaborative, efficient, and competitive. Drillinginfo delivers actionable intelligence over mobile, web, and desktop to analyze and reduce risk, conduct competitive benchmarking, and uncover market insights. Drillinginfo serves over 5,000 companies globally from its Austin, Texas, headquarters and has more than 1,000 employees. For more information visit drillinginfo.com.


Unlike the other types of underpayments examined in this report, which involve a lot of due diligence and manual fact checking to prevent, production verification can be completely automated.

MineralSoft combines data from the Oildex check stub exchange and Drillinginfo’s quality public data with purpose-built production verification tools. As a result, investors can verify check stub production volumes with data reported to the state in real-time, enabling faster identification and recovery of funds.

oil & gas underpayments · payout is the break-even point when well expenses equal production...

Documents