The Math of Marcellus Shale Leases

How much will you earn from your gas and oil lease? There seems to be a lot of confusion surrounding this issue so I’ll try to clear it up.

Web-Math.jpgThere are two primary ways you can receive income from a gas & oil lease- Lease Payments and Royalties.

LEASE PAYMENTS- Most leases are “Paid Up” leases meaning there are no monthly payments. Instead, all payments are paid up front for the entire term of the lease.

The amount is based on the net mineral acres you own. You’d simply take the amount being offered and multiply it by the number of acres. So, if you owned 50 acres and were offered $3000 per acre your upfront payment would $150,000.

$3000 X 50 = $150,000

This would be considered payment in full for the term of the lease.
ROYALTIES- Royalties are far more complicated to calculate and you’ll only be able to speculate as to what the amounts will be until you actually have a producing gas well. Here’s some info that should help with an estimate, though.

You’ll need to know the following in order to calculate:

• Number of acres you have within the drilling unit
• Wellhead Price of gas (Avg. $4.43 in 2010/ Avg. $5.34 over last 10 years)
• Actual Wellhead Production (measured in MCF- thousand cubic feet)
• Royalty Rate (what you negotiate)

The typical drilling unit consists of 640 acres. You would receive royalties based on the proportionate amount of acres you have in the drilling unit and the percentage of your royalties. So, if you have 50 acres in the 640 acre unit you would divide 50 by 640 giving you a 0.078125 interest. Then you would multiply your royalty rate by that figure. Assuming a 12% royalty rate:

12% X 0.078125 = 0.009375

Natural gas is measured in cubic feet and priced by dollars per thousand cubic feet (MCF). If the well produces 2,000 MCF per day, or 60,000 MCF per month, and the price of gas is $4. 25 you’d receive approximately $2,391 per month in royalties.

(60,000 MCF x $4.25 = $255,000(total drilling unit gross)) ($255,000 x 0.009375 = $2,391)

That’s OVER $28,000 a year for just 50 acres. In July of 2008 the price of gas peaked at $11.32. This would increase the monthly royalty in the above example to over $6,300 per month, or $76,410 per year.

Alternatively, if the royalty rate was 18% the royalty would be $3,586 per month if the wellhead price of gas $4.24/MCF and just over $9,500 per month at $11.32/MCF. That’s a 50% increase in revenue with just a 6% change in royalty rate.

The take away? Royalty rates are EXTREMELY important!

There are some great calculators online that can make this a lot easier. One that I like can be found here.

Remember, just because they put a hole in the ground doesn’t mean you’ll have a productive well. And, the level of production from well to well can vary.

One other thing to take into consideration before you go shopping for a yacht is that horizontal drilling is relatively new technology and there’s no historical data for wellhead production. Although the number of wells has tripled since 1971 according to the American Gas Association, the production per well has declined. And a study published by the Oil and Gas Journal suggests that the expected life of newer wells will be much shorter than vintage wells.