Let's Talk About Your Options: Hidden Terms in Your Oil and Gas Contract

Let’s Talk About Your Options: Hidden Terms in Your Oil and Gas Contract

Having options in life is a great thing. Having options in your oil and gas contracts is not. In fact, you might be worse off if you sign an option contract rather than signing nothing at all. Exercise your right to read further about options in the oil and gas industry.

What is an option?

An option simply gives the holder of the option the right to do a certain activity at an agreed upon price. On the other hand, it also allows the holder of the option to do nothing, and the contract will expire after a certain period of time.

In the oil and gas industry, options are present in nearly all contracts involving surface use. That would include pipeline rights-of-ways, access roads, and well pad agreements. The way it typically works is that the oil and gas company pays an extremely small amount (or nothing at all) in exchange for an option to install a pipeline, a well pad, etc. sometime in the future.

The option period can last for a few years, 5 years, or even 20 years—sometimes even indefinitely. However long the period, the effect is still the same. The landowner only receives payment when (and only when) the oil and gas company commences activities to install the pipeline, well pad, etc., (i.e. it “exercises” the option).

Why options?

The answer is simple: options are extremely valuable to the oil and gas companies. Options allow companies the flexibility to make the best use of their time and money. It also allows them to limit their risks.

For instance, assume Acme Pipeline Co. is seeking to install a pipeline across 50 different landowners’ properties. Acme doesn’t take options and is paying landowners in full at signing. Acme signs 49 landowners to agreements (and pays them), but the 50th landowner refuses to sign at any cost. Now, Acme has to reroute the entire line and cannot receive a refund of the money it has already paid to the other 49 landowners.

Therefore, while options are a necessary part of oil and gas development, they don’t offer any benefits to the landowner. Not only that, but they could be downright harmful. An option ties up your land and what you can do with it for the entire option period—which could be 20 years or more or indefinite. For example, you wouldn’t be able to build upon any impacted portions of the land or come to an agreement with another company. Moreover, if you ever seek to sell your property, a buyer may refuse to buy because of the option.

Protect Yourself!

If options are a necessary part of oil and gas development, what can landowners do to protect themselves? While the answer for each individual will depend on the unique circumstances of each negotiation, the easy answer is two-fold.

Limit the option period!

Oil and gas companies typically have some flexibility during the option period. Oftentimes, companies will agree to option periods as short as 1 or 2 years. That not only limits the amount of time a landowner’s land is tied up, but it also incentivizes the company to “use it or lose it.” The end result is that the landowner is paid sooner rather than later.

Get compensation at signing!

While oil and gas companies don’t want to offer much of anything as compensation at signing, most companies in most cases will pay something. Insist upon some form of upfront payment due upon signing, whether it’s $2,000 or 25% of the compensation ultimately due. Otherwise, the oil and gas company is getting “something for nothing.” What you may be entitled to is obviously a function of each unique circumstance.

Don’t be fooled!

The agreement that you are presented with by an oil and gas representative may not use the term “option,” but if you will only be paid upon commencement of construction and installation activities, know that you have an option in your agreement. Options aren’t always easy to spot. Sometimes even oil and gas leases have options built into them—look for the “subject to management approval” or some similar language to find the hidden option.

If you have been presented with an agreement that may contain an option and want to learn what YOUR options are, give GKT a call or fill out the form to the right. We’d be happy to set up a no-cost, no-obligation consultation at your convenience.

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