Compulsory Integration

Your Resource For Natural Gas Leasing And Exploration

COMPULSORY INTEGRATION

If a landowner chooses not to sign a gas lease, then New York State has a process called compulsory integration to account for unleased acreage. You can find information on the Public Hearing Process for Oil and Gas Well Spacing and Compulsory Integration here.

You can find notices on upcoming compulsory integration hearings in the Mineral Resources Environmental Notice Bulletin.

Before a gas company can be issued a permit to drill, they must either have 100% of the acreage within the proposed spacing unit under lease or at least 60% to proceed ahead with compulsory integration.

If you are compuslory integrated (do not sign a lease), then you will not receive a signing bonus from the gas company, but you will still collect royalties from gas pulled from under your property. The gas company does not have any surface rights on your property. Additionally, the gas company can only pull gas from the specificed formation (example the Marcellus Shale) and not from other gas bearing formations, unless specifically identified in the well permit. This could provide future leasing opportunities for you.

Typically when you sign a gas lease in New York (as it currently stands), you are signing a lease for all gas formations. In other states, landowners will sign gas leases for the specific gas bearing formation which allows landowners multiple opportunities for leasing their mineral rights.

Becoming compulsory integrated is not necessarily a bad thing, as a landowner you have a number of different options you can exercise depending on your goals and your tolerance to risk. With any option you choose, always consult with a qualified attorney who has experience with gas leasing.

If you are compulsory integrated, first, be aware that you will still have gas companies knocking on your door asking you to sign a lease - these companies may not necessarily be the same gas company who has applied for the drilling permit. These other gas companies (who do not have the permit) are interested in signing you up because they will be able to get valuable well data and other information once the well is drilled. The gas company who has applied for the well permit may also continue to try to get you to sign a lease - as it is in their interest in both time and money to get as much up the spacing unit under lease. During this time, you may be in a better position to negotiate a higher signing bonus and royalty rate with the gas company, as well as better lease terms, although this is not guaranteed.

If you still choose not to sign a lease and to go through the compulsory intergration process, then the following will happen.

At least 30 days before the scheduled compulsory integration hearing date, each landowner who has acreage within the spacing unit will be notified of the hearing date. The landowner will receive a compulsory integration election form which must be returned to NYS DEC within 21 calendar days. If the unleased landowner fails to return the compulsory integration election form within this timeframe, then the landowner will be integrated automatically as a Royalty Owner.

When you are compulsory integrated you will have three options to choose from:

Integration as a royalty owner - this can be thought of as the "do-nothing" approach. Essentially, you bear no risk, do not have to pay for any costs or fees associated with the drilling operation. You are gauranteed to received the lowest royalty rate given to all landowners within the spacing unit, but nothing less than the current state minimum of 12.5%. This royalty rate is determined by the amount (percent) of property you own within the spacing unit - your overall royalty = ([your acreage/total acreage in the unit times 12.5%] times the production value of the well). You will not receive signing bonus. The gas company does not have any surface rights to your property and an unsuccessful well ("a dry hole") does not cost you anything.

Integration as a non-participating owner - in this approach you bear some risk, but you do not have direct cash outlay, instead you are using the gas companies money to bear the upfront costs and then you are charged a 200% "risk penalty". The term "penalty" is somewhat deceiving, its not as much a "penalty" as it is the gas company recouping their money plus additional "interest" for the costs they incur. In this scenario you will not receive any royalty rate until a well has paid for itself three times (on total cost). While this sounds like a significant amount of money, a high producing well can recoup costs in a short amount of time (other factors come into play as well such as market price for gas, infrastructure costs, etc.). Essentially because you are not paying cash up front, the gas company gets to recoup its investment three times before you are paid any royalty. A BIG difference though, is once the "penalty" phase is over, then you will receive 100% royalty based on the amount of property you have with the spacing unit - your overall royalty = ([your acreage/total acreage in the unit times 100%] times the production value of the well). You do not receive a signing bonus and an unsuccessful well ("a dry hole") does not cost you anything. You will be responsible for additional completion and operating costs, and gathering line costs.

Integration as a participating owner - in this approach you bear the most risk and have direct cash outlay, but will receive royalties immediately if the well is successful. In this case, you need to pay your share of the estimated costs of the well (based on the percentage of your acreage within the spacing unit. This money does not get refunded if the well is a dry hole. You will also be responsible for additional completion and operating costs, and gathering line costs. In this case, once the well has been drilled and if successful, then you will receive 100% royalty based on the amount of property you have with the spacing unit - your overall royalty = ([your acreage/total acreage in the unit times 100%] times the production value of the well).

There is a fourth option that a qualified attorney who specializes in gas leasing can assist you with - which is forming an LLC and leasing your property to your LLC. In this case, you the landowner are considered to be acting as the non-participating owner. In this case, the LLC will receive a royatly payment over the "risk penalty" phase in the amount of 6.25% during the recovery phase of well costs, 9.38% during the first 100% of the risk penalty, then the lowest royalty (but not less than 12.5%) during the second 100% of the risk penalty. After the risk penalty phase is over, then the royalty rate will be 100% of your percentage of acreage within the spacing unit. Due to the legal complexity of such an arrangement, you must contact a qualified attorney who specializes in gas leasing to discuss this option further.

For more detailed information, see the NYS DEC Landowner Compulsory Integration Guide.