By David Closson, HindmanSanchez, P.C.
With continued advancement in fracking technology, oil and gas operations continue to spread across Colorado. As a result of this increased development, more and more community associations are being faced with a multitude of decisions regarding the minerals underlying the community’s common areas.
Oil and gas companies perform extensive title work to determine the owner of mineral rights. After ownership is determined, the company will send a “landman” to contact the owner of the mineral rights in an attempt to acquire rights to develop those minerals. For a typical community association being contacted by a landman is the likely first indication that the association may own mineral rights.
The owner of real property in Colorado may separate or sever ownership of the surface estate of the property from the mineral estate so that ownership to the surface vests in one owner while ownership of the minerals vests in a different owner. Such separation is commonly done long before a residential subdivision is developed. This results in situations where community associations with common area parks and open space parcels may, or may not, own the minerals underlying their property.
Options for Mineral Holders
Assuming an association owns mineral rights, the association has the following four options when approached by an oil and gas company interested in developing the underlying minerals: (i) sell the minerals; (ii) enter into a lease with the oil and gas company; (iii) become a partner in the drilling project; or (iv) do nothing and be subjected to Colorado’s “forced pooling” statute.
Sell the Minerals—As discussed above, the mineral and surface estate can be severed and separately owned. This would allow an association to sell the minerals under their common area parks, detention ponds, and open spaces while maintaining ownership of the surface estate of such property for its intended use.
Enter into a Lease—The association could enter into a lease with the oil and gas company allowing for development of the minerals. Under this option, the oil and gas company would pay a royalty to the association equal to a percentage (typically 15% - 19%) of the value of the oil and gas produced from the property.
Participate in the Drilling Project—A mineral owner is also entitled to participate in the drilling, thereby becoming a partner in the project. This option would allow the association to share in the profits from the project. However it would also require the association to pay its proportionate share of the drilling costs for the well. This option may be unappealing, as drilling and completion costs for a well today commonly exceed $5,000,000.
Do Nothing—If the association does not want to sell the minerals and refuses to enter into a lease or actively participate in the project, the association may elect to simply do nothing. The oil and gas company could seek a pooling order from the Colorado Oil and Gas Conservation Commission and the project could move forward under Colorado’s statutory pooling provisions. This option requires the other participants in the project to pay the association’s proportionate share of the drilling costs. The association will be entitled to share in the production revenue from the project, but only after the other participants recover 200% of their drilling costs. This is essentially a penalty for not sharing in the financial risk of the project.
Questions and Considerations
The issues and options above implicate a myriad of legal issues for a community association holding mineral rights. For example, an association will need to determine if a proposed course of action can simply be approved by the association’s Board of Directors, or if a community-wide vote is needed. Such approval requirements will depend upon the specific nature of the proposed transaction, as well as the contents of the association’s governing documents.
In the event a lease is desired, the association should ensure that provisions within the lease addressing issues such as royalty amounts, surface use rights, warranties of title, and indemnifications adequately protect the community. Finally, although documents such as oil and gas leases may be presented as “standard forms,” they are nevertheless subject to negotiation and revision as may be necessary to protect the community.
David Closson is a partner at HindmanSanchez, P.C.. HindmanSanchez has been dedicated to representing community associations in Colorado since 1988.