- Pancaked layers of oil-soaked rocks forcing lease updates
- Market downturn provides an opportunity to renegotiate terms
The University of Texas is looking for new ways to cash in on 2.1 million acres of prime oil assets obtained through land grants more than a century ago.
What is now viewed as some of the richest oil land in the world was initially seen as a money maker from cattle grazing. After 1923, when petroleum was discovered in the Permian Basin, a wave of wildcatters descended on the state university seeking leases. By 2014, the annual royalties from about 200 drillers had exploded past $1 billion.
Now, the school is taking steps to change the equation again. It’s beefed up its geological expertise and wants to adjust how payments are figured, based on cheaper ways to tap into multiple pancaked layers of oil-soaked rock underground. Success could mean as much as a tripling in land value and a new leasing model that might extend to other shale regions across the U.S.
"In the new scheme of things, not only do we have 2 million acres of land, but if there are two to four plays based on various depths in the shale formations, we might have the equivalent of 6 to 8 million acres of land," said Scott Kelley, who oversees the University Lands office as executive vice chancellor for business affairs.
The shale oil boom and crash brought home how much more the school could be getting from its acreage, propelling it to the vanguard of an effort to redefine the rules for how landowners get paid by U.S. oil companies.
Negotiations hang on the unique nature of the region’s geology. Before the shale boom, most wells were drilled straight down until they punctured pools of crude deep underground. When a company leased drilling rights, those rights basically extended all the way to the center of the earth.
Shale is different. Oil is locked into layers of rock like water in a sponge. Getting it out requires drilling sideways through those levels and cracking the rock with hydraulic fracturing to let the oil flow. In some shale fields -- and most notably in the Permian Basin -- there can be many distinct layers of oil-soaked rock pancaked together.
Those stacks multiply the value of each acre and landowners should be allowed to lease them separately, says Mark Houser, a longtime industry executive who took over a year ago as chief executive officer of University Lands, which manages UT’s oil assets. His strategy: Renegotiate leases for zones that haven’t yet been drilled.
"We’ve got to know our assets better," said Houser. "We need to understand what the potential is." With drilling activity way down and the crude market in the doldrums, "it’s even more critical now," he said.
The eye-popping growth in oil revenues during the boom inspired university regents to take a more sophisticated approach to managing the assets. Over the past year, University Lands hired Houser, moved its main office to Houston from Midland to be closer to oil company headquarters, and hired a team of geologists and an attorney to assess its prospects.
Many of the 9,000 wells on university lands are governed by leases signed decades ago. Consultants identified at least a further 21,000 potential well sites. All of the revenue from the oil lands goes into a large pot known as the Permanent University Fund, which today stands at about $17 billion. Each year, roughly 5 percent of that fund is withdrawn, with two-thirds going to UT, and the remainder going to the Texas A&M System. UT has the largest endowment of any U.S. public university.
The current oil-market bust may have hammered home to the school the inadequacy of its old leases, but convincing companies to change the terms won’t be easy, said Bret Wells, who teaches oil and gas law at the University of Houston.
"The problem now is you’re wanting new clauses in leases, and you’re not executing many new leases at this point," Wells said.
Houser sees an opportunity during the downturn to strengthen the university’s position. The drilling slowdown gives him leverage to renegotiate some terms when strapped producers come to him for help, such as to swap out leases to bundle acreage closer together.
UT isn’t alone in trying to force change. Landowners are waging similar battles in Ohio and Pennsylvania’s Utica and Marcellus shale fields to break down drilling rights based on depth. “It’s difficult because the oil and gas companies didn’t want to give it up,” said Scott Kurkowski, an attorney at Levene Gouldin & Thompson LLP who specializes in oil leases.
If UT succeeds in setting new terms, it could help set a precedent that would be quickly copied, Kurkowski said. “Then we’ll see a greater push to that for all oil and gas leases, hopefully for our region and throughout the country.”