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PROCESS OF OIL AND GAS EXPLORATION AND PRODUCTION

Many residents in western North Dakota are familiar with the process of petroleum (oil and gas) exploration and production. However, the nation's use of energy and advancing production technologies have produced an upsurge in exploration into new areas of North Dakota where residents are not familiar with the process. Being aware of the steps involved in exploring for, finding, and eventually producing oil and/or gas will aid in understanding the need for some of the provisions mineral owners may wish to include in a mineral lease for their benefit or protection.

The process followed by oil and gas companies to explore for and produce petroleum can be described as five basic steps:  1) initial interest, 2) leasing, 3) geophysical survey, 4) drilling, and 5) production.

1) INITIAL INTEREST

Before a petroleum field can either be explored or brought into production, someone (usually someone in the oil and gas industry) must take an initial interest in doing so. Establishing this interest can be done in several ways.

1. Research methods such as stratigraphic analysis, geophysical techniques, review of geological maps and literature, and photogeographical mapping coupled with on-site examination of rock strata out-croppings, may indicate if petroleum deposits exist in a particular area.
2. Exploration activity in a particular area is another indication that a company not previously involved may want to explore whether other petroleum deposits may have been overlooked.
3. Initial interest also may be established on a hunch. The hunch is still based on research, but the decision to drill an exploratory well is based on less detailed research information than the other two methods.

2) LEASING

After establishing an initial interest in a particular area, the next step for the company is to determine who owns the land -- especially the mineral rights -- and, if possible, acquire (purchase or lease) the rights to allow further exploration. The common practice is a mineral lease, rather than a purchase of the mineral rights. 

A landman is usually involved in searching the public record in the county's Register of Deeds office to determine mineral ownership as well as land ownership.  The landman also has the duty of negotiating and securing a lease agreement with the mineral owners.

A mineral lease is a contract that temporarily conveys a property right to the company, not unlike any other lease.  In this case, the company that leases the mineral rights acquires the right to explore for and extract oil and gas. Each lease is negotiated and agreed upon individually.  The negotiating process usually begins with the landman offering the company's standard lease.

Initial compensation to the mineral owner for leasing the mineral rights is a bonus payment and perhaps a delay rental payment. These payments are explained as part of the discussion about the royalty clause in a mineral lease.

Competition for Leases

The basic geological potential for oil and gas deposits exists throughout most of North Dakota. However, it is unlikely that payments for leases will become competitive until the potential exists for production that can be integrated into established transportation systems (i.e., trucks or pipeline). Thus, access to transportation imposes a pattern of leasing activity that spreads outward from discoveries of significant quantities of oil and gas.

Even so, large areas in North Dakota quite distant from existing wells may be leased if they have production potential. Some companies are prepared to invest in the cost of holding large lease acreages, hoping that successful exploration by themselves or other companies will cause a portion of their holdings to become valuable.

When a successful wildcat well is drilled a significant distance from previous production, there is likely to be an increase in leasing activity. This also may occur when new information from geophysical testing gives a favorable indication of deposits.  Even though drilling information is readily available in local oil industry journals or on the Industrial Commission web site, the results of geophysical tests are seldom made known to the public.

Neither distance from existing production wells nor lack of recent exploratory activity is a reliable indicator of production potential. Interest in developing a particular area is best determined by consulting as many sources as possible including neighboring mineral owners, oil industry journals, and county and state officials charged with issuing permits for various phases of the exploration and production process.

Issues mineral owners will want to consider in negotiating a mineral lease are discussed on another page.

3) GEOPHYSICAL SURVEY

With initial exploration and lease acquisition completed, the company can begin more advanced phases of exploration. The company can begin immediately, or may postpone additional exploration to check additional information and data, or wait in "frontier areas” to see what oil and gas activity develops. In some situations, on-going activities within the company may take priority over new exploration projects.

Once the time is right, the company will begin further geophysical exploration to obtain more reliable information. Substructures of the earth are studied to localize areas where accumulations of oil and gas might occur.

Seismic Exploration

The seismograph provides the only direct way of acquiring subsurface structural information without drilling a well. Shock waves, generated at or near the earth's surface, penetrate the earth's crust and reflect back to the surface from the subsurface rock layers. The reflected signals are recorded and a record obtained from which the depth of various underground formations can be measured. Ideally, such information will reveal patterns of rock formations such as faults, anticlines, and folds where oil and gas deposits have a good chance of being found. Sophisticated 3-D seismic, which requires a more intensive use of the surface, can even identify the possible presence of hydrocarbons.

Seismic shock waves may be generated by 1) detonating explosives at the bottom of shot holes 4 to 5 inches wide and drilled 25 to 200 feet in depth depending on conditions or 2) “thumper” trucks that create sound waves by pounding a steel plate against the land surface. For conventional seismic surveys, a single line of shot points and a parallel or perpendicular line of geophones (listening and recording devices) are used. The number of shot points and geophones used per mile varies with the type of geophysical information desired. In 3-D seismic surveys, a grid of shot points and a perpendicular grid of geophones are used to gather more detailed geophysical information. After the information is gathered, a holeplugging and cleanup crew finishes the operation.

Permit man

Each geophysical crew has a permit man who contacts the surface owner and negotiates an agreement about entering on the land to explore for oil and gas. This person also informs the exploring company of the location of streams, wells, buildings, and other improvements designated by the surface owner as being sensitive to geophysical testing (N.D.C.C. §38-11.1-04.1).

As discussed on another page, a surface owner cannot stop a mineral owner or a company that has leased the mineral rights from entering onto the land to explore for minerals.

Surface Owners' Notice and Compensation

Prior to exploration, the company also needs a permit from the Industrial Commission; see N.D.C.C. §38-08.1-04.1(1).  Perhaps more important for individuals, North Dakota statutory law requires that the company 1) notify the surface owner before exploration and 2) compensate surface owner for any damages caused by the exploration process.

The “mineral developer shall give the surface owner written notice of [exploration activities] contemplated at least twenty days prior to the commencement of the operations” (see N.D.C.C. §38-11.1-03(2) and -05).  "This notice must sufficiently disclose the plan of work and operations to enable the surface owner to evaluate the effect of drilling operations on the surface owner's use of the property. Included with this notice must be a form prepared by the director of the oil and gas division advising the surface owner of the surface owner's rights and options under the chapter…”

As an outcome of these statutory requirements, surface owners in North Dakota have an opportunity to communicate with the company even if the mineral rights are severed. In addition, surface owners and tenants should be aware of specific North Dakota regulations pertaining to geophysical exploration.  If these regulations fail to cover concerns that apply to specific situations, provisions pertaining to these situations should be agreed upon in writing (as part of the "Surface Owners' Notice and Compensation").

The legislature hopes this communication between the company and surface owner culminates in an agreement as to the compensation the company will pay the surface owner.  In addition, there is an expectation that the surface owner will take steps to assure a tenant of the surface owner also is compensated for disruptions to the tenant’s surface activities, such as crop and livestock production.

After the Testing

State statutes require the company notify the Industrial Commission when exploration has been completed (N.D.C.C. §38-08.1-05) and that any holes have been plugged (N.D.C.C. §38-08.1-06; N.D.A.C. §§43-02-12-06 and -07).  This requirement also offers some protection to the surface owner against the risk of holes remaining open as the result of exploration.

4) DRILLING

Even though leases have been transacted and geophysical studies have been analyzed, other factors will be considered by the oil company in deciding whether to drill in search of oil. First, it may cost several million of dollars to drill even a dry hole. Second, if timing is not right or drilling equipment is not available, the venture may be postponed or even cancelled. Finally, there are non-financial considerations such as potential impact on the environment.

As with the exploration process, state law requires the company, before drilling is started, to notify the surface owner in writing that drilling is about to start.. This requirement is identical to what is required before the company explored the land, that is, the notice must outline the plan of work and include the Industrial Commission's form advising the surface owners of their legal rights and options.

A survey team is an essential part of the pre-drilling preparation stage. They survey the site and stake out where the drilling will take place. They also map out the location of routes to insure access to drilling locations for all necessary heavy equipment, supplies, and power.

Once the surveyors have completed their assignments and the surface owner has been notified, work-crews come in with earth-moving equipment to build access roads, level the location, and dig pits, trenches, and "the cellar" for the rig which will house some of the drilling equipment. When completed, the drilling rig and related equipment and supplies can be moved onto the drilling location so drilling operations may begin.

Water Use

Water is essential to the drilling process, especially in the preparation of drilling mud. The mud consists of water, special chemicals, and clays. It is used to clean and cool the drill bit, lift rock cuttings to the surface, and maintain a constant pressure in the hole to keep the walls from caving in.

Because of the large demands for water, mineral owners who also own the surface rights should pay close attention to any lease provision regarding the use of water for operations (see Additional Considerations).  Surface owners who do not own mineral rights will need to rely on state statutory law and the opportunity to negotiate with the oil company based on the mandatory notice to discuss water usage (see Surface Owner Considerations).  State law attempts to protect surface users from adverse consequences to water resources, see N.D.C.C. §38-11.1-06. Issues relating to water use is discussed more fully in Considerations for Surface Owners.

Dry Hole

If drilling does not result in the discovery of a petroleum deposit, the well is plugged with cement and abandoned. Should a well prove to be productive, the well is completed (which may include hydraulic fracturing), and production equipment is installed. In either case, the drilling rig is “demobilized” and removed -- possibly to another well site,

5) WELL PRODUCTION

A decision on whether a well is productive or non-productive is made when drilling reaches the pre-calculated producing zones. If oil or gas does not come to the surface in the drilling mud, tests can be taken to pinpoint the petroleum containing-formations. Two types of tests normally used are the drill stem test and well logging.

A mineral lease obligates the oil company to operate the well and produce the oil if a sufficient quantity is found.  The issue becomes whether a well is producing a sufficient quantity to warrant operation. If the exploration yields a dry-hole or if it yields considerable oil, the answer is clear as to whether or not the well will be operated.  It is the marginal producing well where this becomes an issue.  The price of oil also can impact the decision; a marginal well may not warrant operation if the price of oil is low, but it may be economical to operate if the price is high.  Thus the determination of whether a well warrants production can change with a rise or fall in the market price of oil.  It is not just a matter of the quantity produced; it also is a matter of the cost of operating relative to the value of the oil produced. Mineral owners will want to address this issue of operation as part of mineral lease.

Many wells flow naturally because of subsurface pressures. In these cases, a production device with gauges and control valves, known as a "Christmas tree", is installed on the well head. On nonflowing wells, pumps must be installed.

Once production has begun, the well's productivity is gauged, which allows hourly and daily readings on the volumes of oil and gas being produced. These readings are not only important in calculating royalties, they also are important in calculating the life of a well and in prescribing what maintenance must be done to assure optimal productivity.

Multiple Mineral Owners

In the past, oil wells were drilled vertically; but advances in technology now make it possible to drill wells horizontally thereby allowing the process to capture more of the oil and gas resources.  Horizontal drilling reduces the number of well sites necessary to develop the oil and gas resources, thereby reducing the impact on surface activities, such as livestock and crop production. 

For a discussion of horizontal drilling, see Energy Information Administration. Drilling Sideways -- A Review of Horizontal Well Technology and Its Domestic Application. Office of Oil and Gas, U.S. Department of Energy, Washington, DC 20585, April 1993, < http://tonto.eia.doe.gov/ftproot/petroleum/tr0565.pdf>, July 12, 2010.

But this technology increases the number of situations where one well is producing oil for several mineral owners.

Nature does not follow property boundaries as defined by humans, so a well may be tapping into an oil deposit that underlies several tracts of land where the mineral rights are owned by different individuals.  Each mineral owner is entitled to their "share" of the production, so a procedure was created by which oil produced from a well that is drawing from tracts owned by different mineral owners is equitably divided among the mineral owners based on their correlative rights. The concepts of pooling and unitization are discussed on other pages.

Pooling -- dividing the oil production from a well that is drawing from a deposit owned by more than one mineral owner.

Unitization -- allocating oil production and costs associated with wells that are drawing from a deposit with more than one well and most likely more than one mineral owner ( N.D.C.C. §§38-08-09 through -10 and N.D.A.C. §43-02-03-77).

Mineral owners, in their mineral lease, can grant an oil company considerable flexibility in how the company wants to pool, as well as unitize production.  Alternatively, mineral owners can grant the oil company no discretion to pool or unitize, in which case the oil company will petition the Industrial Commission to establish the pool or units.  As discussed on another web page, mineral owners may want to decide to not grant the oil company this authority in the mineral lease, but instead rely on the administrative process of the Industrial Commission.

Another question is whether the mineral owner will be expected to pay a portion of the cost of developing and operating a well.  If this is agreed to in the mineral lease, the oil company is authorized to reduce the royalty payment to the mineral owner by the cost the mineral owner agreed to bear.  This point also is discussed on another web page.  That discussion introduces the concept of a risk penalty for mineral owners who do not enter into a mineral lease (see N.D.C.C. §38-08-09.4(3) and N.D.A.C. §43-02-03-16.3).

Surface Use During Production

Storage tanks may have to be built at the well site, and pipelines or tank trucks will be used to get the crude oil to market. Both methods have advantages and concerns. Truck transportation increases traffic on rural roads and bridges which in turn increases local government maintenance costs. Some of these costs are subsidized by oil and gas production taxes, although, in new areas of development, there may be a time lag between when these funds are needed and when they are available.  Gathering lines and pipelines require rights-of-way and additional surface disruption.  Pipelines, which must be used to transport natural gas, are usually cheaper in the long run, but the size and the life of an oil field usually determines whether the oil company will use truck or pipeline transport.

Surface owners will be interested knowing how production might impact use of the surface.  An understanding of the regulation of surface use by an oil company also may be helpful.  The following list identifies some North Dakota regulations and the topic it addresses.

N.D.A.C. §43-02-03-18:  well spacing (for example, depending depth and type of well, no more than one well per 40 acres, 160 acres, 320 acres or 640 acres)

N.D.A.C. §43-02-03-19: construction of a drilling site (for example, stockpile topsoil, slope drill site to divert surface drainage, construct a reserve pit, locate a reserve pit so not to block natural drainage, possibly fence the reserve pit, reclaim the site)

N.D.A.C. §43-02-03-19.1:  fencing (for example, fence around pits and ponds containing saltwater or oil)

N.D.A.C. §43-02-03-19.2:  disposal of waste (properly dispose of waste)

N.D.A.C. §43-02-03-19.3:  storing of waste (something more than an earthen pit is needed to store saltwater, drilling mud, crude oil, or waste oil)

N.D.A.C. §43-02-03-49: positioning oil storage tanks (oil may not be stored in underground or partially buried tanks; dikes must be erected around oil tanks)

N.D.A.C. §43-02-03-53:  handling saltwater (saltwater liquids must be processed, stored, and disposed of without pollution of freshwater; at no time shall saltwater liquids be allowed to ow over or pool on the surface or inltrate the soil; dikes must be erected and maintained around saltwater tanks at saltwater handling facility).

Even though these regulations are directed toward the oil company, their application can impact the surface owner, e.g., how many wells, roads, tanks, pipelines and other facilities will the surface owner have to farm around, where they will be located, how much land will be used as the well site, and other concerns.

Keeping the Well Productive

Periodically, “reworking” operations are performed to insure efficient operation of the well. Work-over crews clean the well by getting rid of fluids and sands which may have gathered in the hole. They also may refracture the well to open cracks in the formation to allow the oil or gas to flow more freely.

Enormous quantities of water also may be needed for injection into oil-bearing strata during production to push oil out a second nearby well, especially during any secondary recovery operations.  Again, surface owners need to understand the potential impact on water resources.

Clean-up After Production

For various reasons, wells stop producing.  State law requires that the site be reclaimed and directs the Industrial Commission to oversee that process. 

"A well in abandoned-well status must be ... plugged and reclaimed within six months."  N.D.C.C. §§38-08-04(1)(l) and -04.4; also see N.D.A.C. §43-02-03-55.

Plugging the well and reclaiming the site certainly are of interest to the surface owner.  In addition, N.D.C.C. §38-08-23 requires that information about the location of a reserve pit be filed when a site is reclaimed after drilling is completed and N.D.A.C. §43-02-03-34 requires that the well plugging process protect groundwater.

With respect to the mineral owner, shutting down a well means no more royalty income, so a question for the mineral owner often is whether the company appropriately decided to cease production; similar to the question of whether there is enough production when the well was initially drilled to commence production or declare it a dry hole.  Discussed in another section.

Observation and Recommendation

The variety of topics discussed throughout this web site illustrates many factors that should be considered when negotiating a mineral lease. The list is by no means complete nor will all factors pertain to every mineral owner. However, the need for knowledgeable legal advice in negotiating a lease should be evident.

Before making a final decision, the mineral owner and attorney should work through the possible outcome of each leasing situation. They need to select those lease provisions that will adequately protect BOTH the mineral owner's interest and the company's ability to carry out an effective development program.

Likewise, surface owners want to consider issues that impact them when when negotiating compensation for surface use.

Next Page

The next page discusses how mineral rights and surface rights become severed and how this can impact mineral leasing.

Last Updated August 29, 2010

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