Reserved Tax Deeds Sales Canada by lpz10580

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									     Oil & Gas Seminar
     Thursday, October 23, 2008

Sponsored by:
Energy Lending
Today vs. Tomorrow
             Today vs. Tomorrow

Today                 Tomorrow
 Energy Lending       The “Lending Tree”
  Practices             Model

 Competitiveness      Portfolio
 Industry
                       Regulation
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Energy Lending Practices

 Collateral Evaluation
     • The Reserve Report
     • Title

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Energy Lending Practices

 Collateral Evaluation - The Reserve Report
     •   Advance Policies
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     •   Upside
     •   Why different?

Energy Lending Practices

 Collateral Evaluation – Title
     • Bank Standards
     • How it is used?

Energy Lending Practices

 Risk Evaluation – How we do it?
    • It’s a Risky Business
       • The Big Six

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Energy Lending Practices

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Where we’re at and where we’re going
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            And Finally Tomorrow…

 The “Lending Tree” Model
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                  Contact Any Time

Christina Kitchens
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17950 Preston Road, Suite 500
Dallas, Texas 75252

P: 972.713.1110
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Thank you!
K&L Gates Oil and Gas Symposium

Avoiding the A&D Tax Bite and Enhancing Asset Performance

George Barlow, Esq.
Dallas, Texas – October 23, 2008
    Basic 1031 Exchange

Property Qualifications

•   HELD for productive use in trade or business or for
•   Exchanged for “Like Kind”
      • All real property is “Like Kind”
      • Many, but not all, mineral properties fit in.

Tax Deferral Requirements

•   Reinvest all cash
•   Trade = or > in value
•   For FULL Deferral, Replace
     QNRP with QNRP
Sale vs. Exchange
Pick the Winner:

    Sell Now, Pay Current Taxes, Reinvest


     Exchange Now, Defer Current Taxes, Reinvest
  Sale vs. Exchange $1,250,000 Value
Option          Value to Invest Annual Cash Flow   Discount   Present Value
                                                   rate       of Cash Flow

Exchange,       $1,250,000        $250,000         8%         $ 998,177
Defer Taxes

Sell, Pay 20% $1,000,000          $200,000         8%         $ 798,542

Benefit to Exchanger, after 5 years                           $ 199,635
    Basic 1031 Requirements
    Business or Investment Purpose

   There are six tax classes of property:
    1) property used in taxpayer’s trade or business;
    2) property held for investment
    3) property used for vacation purposes
    4) property which is used as your principal residence;
    5) property fixed and flipped.
    6) property held primarily for sale to customers.
   Mineral properties fall into 1 and 2, so Section 1031 applies
“Held” for investment

For conventional real estate, NOT
 held for personal use or resale.

For mineral properties, NOT held
 primarily for sale in a dealer
“Investor” or “Dealer”?
Reason, purpose and intent for acquisition?
Continuity of sales of leases over time?
Income from sale large in proportion to other income?
Sufficient assets to develop the lease, or dependent on
  selling the lease to make a gain?
How long was the property held?
What was the extent of development activity compared to
  solicitation of bids for the property?
- -From jury instructions in Bunnel v. U. S. (D.C.N.M. 1968)
  20 AFTR 2d 5696,68-1 USTC 86,054
    1031 “Like-Kind” Requirement

   We generally know that all US Real Estate is “Like-Kind”
     1) Improved Real Estate
     2) Unimproved Real Estate
     3) Long term leases
     4) Qualifying mineral properties, for example
           A.   Royalty property
           B.   Working interests
BUT: Not all Mineral properties are Real Estate!
Quiz Time

  Relinquished       Replacement        1031 Eligible?
    Property           Property
    Coal Lease     Fee simple in land   Ltr.Rul. 7906061
exceeding 30 years
Quiz Time

  Relinquished         Replacement             1031 Eligible?
    Property             Property
Overriding Royalty     TIC half interest   Chricton v. Commissioner
Interest in oil, gas    in unimproved       of Internal Revenue, 42
and mineral rights        real estate           BTA 490 (1940)
Quiz Time

 Relinquished         Replacement             1031 Eligible?
   Property             Property
Limited Oil Payment   Overriding Oil and    Midfield Oil Company v.
                        Gas Royalty        Commissioner of Internal
                                            Revenue, 39 BTA 1154
Quiz Time

 Relinquished       Replacement      1031 Eligible?
   Property           Property
  Oil and Gas        Overriding   Ltr.Rul. 8237017 (See
Working Interests    Royalties    Requirements therein)
Quiz Time

 Relinquished      Replacement             1031 Eligible?
   Property          Property
 Leasehold/Fixed    Leasehold/fixed     Bandini Petroleum Co. v
   Percentage      number of Barrels    Commissioner of Internal
                                       Revenue, 10 CCH TCM 999
Quiz Time

 Relinquished     Replacement            1031 Eligible?
   Property         Property
 Carved-out Oil   Fee interest in    Fleming v. Commissioner of
 Payment Rights       ranch         Internal Revenue, 24 TC 818
Quiz Time

  Relinquished         Replacement            1031 Eligible?
    Property             Property
    Interest in       Fee simple in land   Rev.Rul 68-331, 1968-1
 producing lease                                   CB 352
until exhaustion of
Quiz Time

 Relinquished        Replacement           1031 Eligible?
   Property            Property
Production payment   Real property   C.I.R. v. P. G. Lake, Inc., 356
  (Assignment of       interest             U.S. 260 (1958)
 Qualifying Mineral Properties
    Long Term Interests

   Relinquished           Replacement                 Reference
     Property               Property

    Coal Lease          Fee simple in land         Ltr.Rul. 7906061
exceeding 30 years
 Overriding Royalty     TIC half interest in   Chricton v. Commissioner
 Interest in oil, gas    unimproved real        of Internal Revenue, 42
 and mineral rights           estate                BTA 490 (1940)
Oil and Gas Working         Overriding           Ltr.Rul. 8237017 (See
      Interests             Royalties            Requirements therein)

Interest in producing   Fee simple in land     Rev.Rul 68-331, 1968-1 CB
     lease until                                          352
    exhaustion of
These Dogs Won’t Hunt…
   Short Term, Limited

 Relinquished           Replacement                   Reference
   Property               Property
Limited Oil Payment    Overriding Oil and        Midfield Oil Company v.
                         Gas Royalty            Commissioner of Internal
                                              Revenue, 39 BTA 1154 (1939)

 Leasehold/Fixed        Leasehold/fixed         Bandini Petroleum Co. v
   Percentage          number of Barrels        Commissioner of Internal
                                               Revenue, 10 CCH TCM 999
  Carved-out Oil      Fee interest in ranch    Fleming v. Commissioner of
  Payment Rights                              Internal Revenue, 24 TC 818
Production payment       Real property        C.I.R. v. P. G. Lake, Inc., 356
  (Assignment of           interest                  U.S. 260 (1958)
    Basic 1031 Exchange Requirements

     Some Tax Notes

•   Be careful. Get tax and legal advice from experts before you
•   Selling a working interest and retaining royalty or surface
    interests? 1031 trouble.
•   Production Payments? Not real estate. Sorry!
•   Equipment included in sale? If substantial, may require separate
    personal property exchange. (Valued over 15% = Substantial)
•   Depletion, Depreciation and IDC’s must be recaptured upon SALE
    unless 1031’ed into “qualified natural resource property”
1031 hang-ups…
   Selling a working interest and retaining royalty or surface
    interests spells 1031 trouble.
   You must sell to relinquish the entire “bundle of sticks.”
   Tax Court has ruled that a sale of WI and retention of RI
    is not a qualifying property for exchange --Crooks v.
    Commissioner, 92 TC 816 (1989).
       (Deemed a lease, not a sale, so 1031 not an option)
   ALSO, “Bonus Payment” to secure lease is ordinary
    income, not exchange-eligible.
1031 hang-ups…
Production Payments? Not real estate. Sorry!

   IRC Section 636 sees PP’s as loans.

   Some authorities call into question whether PP’s are ever
    like-kind with other mineral estates.
1031 hang-ups…

 Equipment included in sale? If
 substantial, may require separate
 personal property exchange. (Valued
 over 15% = Substantial)
 Valued over 15% - Must be replaced by
 “like-kind” personal property
 For personal property, like-kind means
 same SIC class or product category.
    Basic 1031 Exchange Requirements

    Recapture Treatment

•   You can exchange mineral property and defer tax on recapture
•   How? Select replacement property that is “Qualified Natural
    Resource Property.” (“QNRP”)
•   Get tax and legal advice from experts when you are planning an
•   Ordinary income treatment of depreciation recapture, depletion
    recapture, or recapture of IDC.
•   Capital Gain on the appreciated value of the property
    Basic 1031 Exchange Questions

    Sell or Exchange?

•   Does the property qualify for exchange?
•   How long was the property held before sale?
•   What type of replacement is in view?
•   Is the replacement QNRP?
•   How much IDC, depletion and depreciation is subject to
•   Is well equipment included in the sale?
•   Will I have like-kind equipment in my replacement asset?
    Basis and Gain

    Calculating Basis

•   Cost to Acquire is the Starting Point
•   Add improvements made to the asset
•   Subtract recapture items (depletion, depreciation, and IDC’s)
•   That is your Basis in the asset (never lower than Zero)

    Calculating Gain

•   Sales Price is reduced by cost of Sale

•   Net Sales Price – Basis = Gain
   Calculating Tax on Gain

Gain Calculation:                    Facts:
                                     $500,000 purchase price
Sale Price              $1,000,000
                                     $100,000 recapture items
(Adjusted Basis)        ($425,000)   $25,000 capital improvements
Gain                    $575,000     $1,000,000 sales price


                                     33% Recapture
Adjusted Basis                             $100,000 x 33% =         $33,000
Purchase Price           $500,000    15% Fed. Cap Gains
(Recapture Items)        $100,000          $475,000 x 15% =         $71,250
+Capital Improvements     $25,000    9.3% State Cap Gains
Adjusted Basis          $425,000           $575,000 x 9.3% =        $53,475
                                     Total Taxes Due:          $157,725
Total Tax Deferral

                        Example #1
Relinquished Property

Oil and Gas Property     $1,000,000
Potential Recapture        $400,000   Full Exchange

                                       Entirely Tax Deferred because
Replacement Property                   the Replacement Property is
Oil and Gas Property     $1,000,000    Qualified Natural Resource
                                       Property (QNRP)
  Partial Tax Deferral

                        Example #2
Relinquished Property

Oil and Gas Property     $1,000,000
Potential Recapture        $400,000
                                      Partial Exchange

                                      Tax deferred only to value of
Replacement Property
                                      QNRP – Ordinary income
Oil and Gas Property       $700,000   recapture to the value of the
Land                       $300,000   land which is Non-QNRP
Total                    $1,000,000
      Basic 1031 Timeline

      •    180 days to complete exchange
      •    45 day identification period
      •    COE after October 15th must file extension

 Day 0               Day 45                               Day 180
Close of          Identification                         Exchange
Escrow             Letter Due                           Completed
Basic Property ID Requirements

Identification Rules

   3 Property Rule
   200% Rule

   AND

   The 95% Exception
    First Identification Rule

   3 Property Rule
   You may identify not more than three
Another Way to Identify…

     200% Rule

    You may identify twice the
     value of your “Old” property

    Sell $2M, Identify $4M
The 95% Exception
   You can bust the three property rule

     OR

   You can bust the 200% rule

     IF

The Identification Problem in a

   1031-Eligible oil and gas royalty offering consisting of approximately 74,000
    acres with 1,450 producing wells, and 573 PUDs in Texas and Wyoming. 70%
    gas, 17% oil, reserves are estimated at 30 years. 179 new wells per year have
    been added over the past 5 years by major operators such as BP. Current CF of

 Say again, how many properties?
A Modest Proposal….

   ALWAYS use the 200% rule to identify replacement

   If the property is valued at more than 200% of the “Old”

     Acquiring it will be covered by the 95% exception

     Failing to acquire it, no exchange – (back to
       recognition of gain)
     Reverse Exchanges under Revenue
     Procedure 2000-37

 Provides a “Safe Harbor” for this procedure
 New Terms:
      Exchange Accommodation Titleholder (EAT)

      Qualified Exchange Accommodation Arrangement

 Park EITHER Relinquished or Replacement Property
 180-days To Complete
 Bona Fide Intent to do an Exchange
     Why Bother with a Reverse Exchange?

1.   Never be without income producing property

2.   Don’t miss out on investment because your
     property has not sold.

3.   Worst case: you own two properties but you
     don’t owe tax yet.
 Common Misconception

The Exchange Accommodation Titleholder
       (EAT) will fund your purchase.

Taxpayer must have WAYS and MEANS to
   handle the economics of the exchange.
    Why Reverse Exchanges Work…
  No requirement for arms-length terms under
  Rev. Proc. 2000-37 permitted agreement:

• TP can loan money or guarantee
• TP or a related party can manage property
• TP can oversee improvements
• Parked property can be triple-net leased to TP or related party

• Fixed or formula price Puts and Calls are permitted
• O.K. to adjust estimated values of relinquished property
Reverse Private Ruling 200836024

Service rules that Taxpayer may go “reverse”
    and “forward” with the same relinquished
   Basic Reverse 1031 Timeline

    •   First, park the replacement property “RP”.
    •   Identify relinquished property “RQ” - 45 day limit
    •   Sell RQ before 180 day limit

  Day 0       Before Day 45                            Day 180
RP Parked      Identify RQ                   Sell RQ, Exchange
I didn’t get enough…

                                    Property “Sold” is
                                    valued more than
                           = $RQ

                            = $RP

  Solution: Forward Exchange to
  get “More”
  Now, the Forward Exchange

   •   RQ valued MORE than RP, so…
   •   Identify additional RP before 45 day limit

 Day 0       Before Day 45                           Day 180
RQ Sold    Identify “More” RP               Buy RP, Exchange
Reverse Private Ruling 200836024
    Taxpayer MAY shift           Forward Exchange Blows Up!!
    tax on gain to
    next year.

0                          180                            360

Reverse                  Forward
Exchange                 Exchange    Unexchanged Gain
Starts                   Starts      Recognized under
                                     installment sale rules
                                     of Sec. 453 of IRC
All is not lost….

                          When $RQ is greater
                           than $RP….

        Exchange still works
        . . . to the value of $RP
Call Any Time
 George Barlow, Esq.
 Senior Account Executive
 LandAmerica Financial Group, Inc.
 2651 N. Harwood Street
 Suite 260
 Dallas, Texas 75201

 toll free: 866 377-1031
 direct dial: 214 855-8425
 mobile: 214 675-1031
 fax: 214 855 8411

The Paradigm Shift in the Domestic
          Crude Market

     Pricing Mechanisms
     Quality Differentials
     Regional Markets
                                                                                               NYMEX Monthly Average
                                                                                                           NYMEX Monthly Average



Price (U.S. $)


                                                                                                           $105.4200                                   $103.7638


                                               7          -07                         8                          8        8       8            8          8
                           p   -07         t-0        v            c   -07        n-0       b -0
                                                                                                        8    r-0      y-0     n -0      l- 0          g-0      p-0
                        Se            Oc           No           De           Ja           Fe      Ma      Ap       Ma       Ju        Ju           Au       Se

                                                                     Platts PPlus 13 Month Average (10/07 to 10/08)

                                                                                                                               PPlus Value


                                  $4.7893                           $4.6960
                                                                                                                     $4.3558                         $4.2987

Price (U.S. $)

                                                                $3.5828                                                                                                 $3.6928




                         0   07           0   07           0   07             008             008             008              008             008              008              008             008             008            0   08
                     1/2              1/2              1/2          1 /1
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                 10/              11/              12/                                                                                                                                                                  10/


     Transportation
          Pipelines
          Trucking
          Rail
Credit Requirements

    SemCrude Bankruptcy
    Cost of Credit
    Credit Instruments
         Standby Letters of Credit
         Corporate Guarantee
         Pre-payments
Spencer Falls
Founder & President
EnMark Services, Inc.
1700 Pacific, Suite 4500
Dallas, Texas 75201

Direct: 214.965.9581
     Oil & Gas Seminar
     Thursday, October 28, 2008

Sponsored by:
Mineral Lease Agreements –
Creative Solutions

Alignment of Interest – Enticing Parties Back to
the Table
About K&L Gates
 Over 1700 Lawyers located in 28 cities on three continents, U.S.,
  Europe and Asia
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      magazine and Flex-Time Lawyers LLC, in the first-ever 2007 Best Law
      Firms for Women list.

Three Interrelated Topics For Discussion
 Current law and history of “Dominant” and
  “Servient” Estates
 Basics of a Mineral Lease
 Creative Solutions to Encourage Production in
  Today’s Environment of:
    Harsh reductions in lease bonuses
    Downward spiral of hydrocarbon prices, and
    The fact that the major publicly traded players are at
     a standstill.

History of “Dominant” and
“Servient” Estates
 In Texas and a number of other jurisdictions, the
  Mineral Estate is dominant over the surface estate.

 Origin in Spanish law – the King held separate
  ownership of all minerals.

 In 1862, the Texas Supreme Court held that the State
  could use the land in any way it chose in order to get
  to the minerals.

 Texas Constitution of 1866 released all minerals to
  owners of the soil.

 Mineral Estate may be severed, creating separate

Accommodation Doctrine/Refinements–Fact-Driven
 Texas Supreme Court recognized that the interests of land and
  surface owners are not always compatible. The “recurring problem
  of adjusting correlative rights.”

 “Reasonable Accommodation Doctrine” -- Getty Oil
    Operator must conduct activities with due regard for surface estate
     owner’s existing use if there were reasonable means available.
    Only if a reasonable alternative is available consistent with industry
     standard, will the Operator be required to consider existing use by
     surface owner .
    The conduct of the Lessee may not destroy or substantially impair the
     surface owner’s use of the surface – more than slight interference.
    Very fact-driven, and involves questions to be resolved by a jury, with
     competing expert testimony.

Encouraging Production -- Resource Plays still offer
attractive risk/reward propositions
 Over the last several years, horizontal drilling in Shale Plays has
  had an incredible economic impact.
 The competition between Operators escalated signing bonuses and
  royalty percentages rapidly.
 Based on recent media hype, the boom is over and the Operators
  are not willing to pay the escalated lease bonuses, and most
  Operators are backing off on leasing activities all together.
 When energy prices stabilize, this change in the market place could
  have a positive impact on economic return on E&P companies
  operating in Resource Plays.
    lower cost of leasehold acreage;
    decreased drilling cost and rig availability; and
    Valuable Leasehold will most likely expire during the Primary Term.

 The Mineral Lease
 The “Mineral Lease” outlines the rights,
  privileges and obligations of the gas
  company, the “Lessee,” and the mineral
  owner, the “Lessor.”

 Regardless of what anyone may tell you,
  there’s no “standard” lease form being used
  today. All terms are negotiable. The term
  “Producer’s 88 form” is common, but there
  are hundreds of forms with “88” referenced.

The Mineral Lease - Conveyance and Contract
 The name “Mineral Lease” is somewhat misleading -- the “lease” is
  more like a transfer deed than a lease. It is both a conveyance
  and a contract.

 It conveys the mineral rights from the Lessor to the Lessee, and is
  also a contract between the Lessor and the Lessee for the
  development of the minerals. The Lessee’s interest is similar to a
  fee-simple determinable, rather than a term for years.

 The Lessor gives the Lessee the right to explore and produce oil
  and gas from the designated property, and in exchange the Lessee
  agrees to pay the Lessor a one-time cash lease bonus and
  allocates “royalty interests,” a percentage of oil and gas produced
  from the property.

Alignment of Interest – Enticing Parties Back to the
 Creative Solution must be established to resuscitate leasing
 An Oil and Gas Lease is a business transaction created to
  benefit both parties: the oil, gas, or mineral rich Lessor, and
  the Lessee who possesses both the knowledge, skill set, and
  resources to properly develop those minerals. New terms
  have developed to protect both Lessor and Lessee to insure
  that both parties achieve their goals.
 The parties are attempting to navigate these uncertain times
  by modifying the traditional terms of the Lease.

Creative Solutions – ORRI
 Overriding Royalty:
    Leverage Drillsite Tract Owners with additional overriding
     royalties – e.g. 1% overriding royalty on all natural gas produced
     from boreholes drilled on the leasehold premises on the first four
     wells, and 2% on all wells in excess of four.

        taking a percentage share of the natural gas produced by an
         Operator, is not the only means mineral owners have found
         to derive more income and encourage development of the

    Drillsite tracts – Operators have the ability to drill several
     horizontal wells from one padsite, and this gives added leverage
     to the owners of the pad site.

Creative Solutions – Minimum Royalty
 Minimum royalty clause.
 For owners of tracts within known producing areas.

 Regardless of actual production numbers, the lessor will receive a
  minimum royalty of a certain sum per month beginning
  approximately one to two years after the start of the lease through
  the end of the primary term.

     Generally available only to a Lessor of large tract, may now be used to
      encourage Lessor to lease and the development of the lease by the

     Because of the risks and uncertainties inherent in oil and gas
      exploration, such a penalty would only be negotiated with owners of
      tracts within known producing areas.

Creative Solutions – Most Favored Nation
   MFN -- Mineral owners do not want to leave money on the table, and it is
    hard to anticipate the market for lease bonus and royalty interest, due to
    their highly volatile nature. No Owner wants to sign a lease for several
    hundred dollars and suddenly see neighbors sign for several thousand.

   Lessee may be able to entice Lessor to accept a reduced bonus if the
    Lessor is able to protect themselves through the use of a Most Favored
    Nations Clause.

   The Clause will require an Operator to match any increase in bonus or
    royalty or both paid to other Lessors: (1) within a defined geographic area
    and (2) within a specified time period [1-yr vs. prior to a well being

   Because MFN Clauses are highly favorable to lessors, the Lessee will
    typically limited as much as possible the geographic area and time period.

Royalties - Free Royalty
   Stipulations of overriding royalty and minimum royalty or a Most Favored Nations Clause
    are not the limit to how lessors can retain more income from their royalty fraction. The net
    revenue interest due a landowner, based upon their royalty fraction, is highly dependent
    on the deductions and costs assessed against the lessor and the gas purchase agreement
    negotiated by the operator.

   Mineral and royalty owners can expect to always have some costs associated with
    production, from severance taxes to some costs of transportation. There is no cost free

   Many lessors, include clauses within the lease limiting the costs deducted from the royalty
    or stipulating arms-length gas purchase agreements.

   The Lease should specify if Lessor is responsible for transportation, compression,
    dehydration, marketing and other expenses.
        Lessee would like to calculate the value of the gas for royalty purposes as near the
         “wellhead” as possible.
        Lessor would like the royalty to be calculated further downstream in order to avoid paying
         post production expenses -- and reduce or prevent charges for producing, storing,
         separating, dehydrating, compressing, and transporting.
        “Marketable Condition Rule.”

Encouraging Production
 All of the foregoing lease terms are designed to protect the
  interests of the mineral owner, whether by:
    encouraging production through minimum royalty payments;
    protecting against the exclusion of the drillsite tract from a
     pooled unit through overriding royalties;
    rewarding those lessors who execute leases with the possibility
     of being compensated for rising bonus and royalty amounts in a
     Most Favored Nation Clause; and
    limiting costs and deduction to the royalty fraction.

Mineral Lease – Traditional Terms
 Habendum Clause

     This clause sets time periods, and provide for a primary term and a
      secondary term.

 The “primary term” is the fixed number of years during which the
  Lessee can maintain its rights without drilling. This term should be
  clearly stated (typically three (3) years).

     Extension Rights of Primary Term – similar economic terms.
     Mineral Leases will have no force and effect if the primary term has
      expired and there is no production from the property.

 The “secondary term” is the extended period of time for which rights
  are granted to the Lessee once production is obtained.

Mineral Lease -- Shut-In Royalty Clause
 The shut-in royalty allows the gas companies who have
  drilled a well to hold the lease without actually producing
  minerals past the primary term.

 From the Lessor’s prospective, this clause should have a
  maximum number of years, i.e., no more than two years past
  the primary term or two years in the aggregate -- Lessor
  wants to get the gas to market or have Lessee lose the lease.

 Lessee will want the ability to shut in well(s) based on market
  conditions, and maintain the Lease.

Shut-In Royalty Payments
 Well must be capable of producing in paying
   Shut-In for Operations
   Shut-In for Market conditions

Mineral Lease -- Mother Hubbard
   Mother Hubbard Clauses - Used when defining the Lease Property.

   Property descriptions found within oil and gas leases can often be vague,
    indefinite, or fail to adequately cover the entire property the lease was intended
    to cover. This often happens because the property description is based on the
    language found in old deeds, or omits small portions that were adjoined at a
    later date.

   These lot and block descriptions lack any definite metes and bounds
    description, but they are most often deficient because they do not take into
    account adjacent streets, alleys, and public rights of way.

   Strip-and-Gore. The mineral rights beneath public rights of way may belong to
    the individual lot owners under the doctrine of strip-and-gore. Under Texas law,
    when a deed conveys land abutting a street, public highway, or railroad right-of-
    way, title to the center of the street, public highway, or railroad right-of-way also
    passes by the deed These minerals, as part of a small adjacent piece of
    property, would also fall under the Mother Hubbard Clause.

    Contractual Pooling Rights -- there is widespread
     inclusion of pooling clauses in leases.

    The pooling language allows the Lessee to “pool” the
     lease premises with other land, and production from
     any part of the pooled acreage shall be deemed
     production to hold each mineral lease.

    Pooling language should allow the company to create
     the most efficient gas units, but not allow excess
     vertical or horizontal acreage to be held by a well.
       Anti-dilution – requires a percentage of acreage be
        pooled from the Lease – to ensure that Lessor’s share
        of royalties from production is not diluted by including
        only a small portion of their land in a large pooled unit.
       Pugh Clause – lease segregation when there is a partial

Pugh Clause
 The general rule is that a mineral lease is indivisible, and all
  the property under the lease will be held by production on any
  part of the lease premises.

 A Pugh Clause is intended to prevent the holding of non-
  producing acreages.

 In negotiated Leases, the release language not only include
  the undrilled acres but also depths below the producing
  formation. This is referred to as a vertical and horizontal
  Pugh Clause.

Warranty of Title to the Mineral Interest
 The warranty clause binds Lessor to defend interest in, or title
  to the lease premises, should a dispute ever arise over

 Underwriters are universally unwilling to issue title policies for
  specific mineral estates.

 Valuable mineral interests make title disputes much more
  likely. Many property owners will want the warranty language
  stricken or at least modified to cover only title defects caused
  by the Lessor, not those caused by Lessor’s predecessors in

Force Majeure/Extension of the Primary Term
 Due to the substantial lease bonuses recently paid to
  Lessors, Lessee are relying on claims of “Force Majeure” to
  extend the Primary Term.

 Force Majeure provides an excuse from non-performance
  caused by circumstances beyond the reasonable control of
  the Lessee.

 Acts of God to acts of government, may qualify for Force

 If “Force Majeure” is affective to extend the lease, it will only
  be affective as long as the force majeure event prevents
  production or operations.

Surface Use Implications
 Drilling and maintaining a well may involve water use,
  vehicular access, noise and other negative impacts.
    Building roads for transportation;
    Use of fresh water produced for the land; and
    Location of drill site may damage crops, timber etc.

 No duty to restore land, absent contractual agreement.

 Absent restrictions in the Lease, the Lessee has the implied
  right to use as much water that is reasonably necessary to
  produce the minerals from the Leased Premises.

Surface Use Restrictions
 If the Lessor doesn’t want a well drilled on its property, the
  Lease must clearly restrict surface rights or access.

 The Lessee will require a provision providing for directional
  drilling, to provide a subsurface easement for all purposes
  associated with such horizontal and/or directional wells.

 Operators are attempting to include provisions that provide
  for the continuing right to use and maintain such subsurface
  easement for so long as Lessee is utilizing a directional
  wellbore(s) traversing the leased premises either during or
  after the expiration of the lease.

Surface Use Allowed with Restrictions
 If you do want wells drilled on your property, then provisions
  need to be included in the lease or in a side agreement
  concerning the additional payment for the Pad site(s),
  damages to be paid for drill sites, roads, pipeline easements
  and the use of water.
 Title Insurance Considerations – T-19 possible coverage to
  surface owner for damage caused by mineral estate.
    Underwriters usually require full surface use waiver, designated
     drill sites or surface limitations.

Expiration of Primary Term
 What does the Lease require to extend to
  Secondary Term?
   Production in Paying Quantities
   Operations, Drilling Operations, continuous
   Pooling – with production in the pooled unit.

Production in paying quantities
 Objective Test
   Qualifying expenses exceed revenue for the lease
      Operating and marketing expenses; not capital expenditures
   For a reasonable, and not arbitrary, period of time;
    can range from 4 to 18 months or longer

 Subjective Test
   a “reasonably prudent operator” would, for the
    purposes of making a profit and not merely for
    speculation, continue to operate the well at issue.

Lease Provisions – ORRI Pad Site:
 Grantor hereby except from this grant and reserves unto itself, its
  successors and assigns, perpetually and cost free (except only for
  property taxes and severance taxes applicable solely to the
  reserved interest) a royalty of 1% of all (8/8ths) of the oil, gas and
  other minerals produced through the well bores of the first four
  wells, and 2% of all (8/8ths) of the oil, gas and other minerals
  produced through the wellbores of all wells in excess of four, that
  may be drilled and completed from a surface location or locations
  on the Property; provided, however, that no royalty shall be paid
  with respect to oil or gas that escapes and is not sold or used due
  to a blowout.

Minimum Royalty
   Notwithstanding anything contained herein to the contrary, Lessee shall
    pay to Lessor a minimum royalty during the first _______ months of this
    Lease equal to $50,000.00 payable as hereinafter provided. If at the end of
    the ____ month of this Lease, Lessor has not received at least $50,000.00
    from the royalties payable to Lessor pursuant to the above provisions of
    this Paragraph 3 then, commencing with the _________ month of this
    Lease, and continuing for each month thereafter until Lessor has received a
    total of $50,000 from sum of (i) all royalties paid to Lessor pursuant to the
    above provisions of this Paragraph 3 since inception of this Lease and (ii)
    the additional royalty provided for in this Subparagraph Lessee shall pay to
    Lessor an amount equal to the lesser of (x) the difference between
    $20,000.00 and the amount received by Lessor during that month as
    royalties pursuant to the above provisions of Paragraph 3 of this Lease,
    and (y) the difference between (a) $50,000.00 and (b) the sum of all of the
    royalties previously received by Lessor pursuant to this Paragraph 3. All
    minimum royalty payments shall be paid by the Lessee to the Lessor on or
    before the 25th of each month.

Most Favored Nations Clauses
   If within (Specify Time Period) from the date of this Lease, Lessee, its agents,
    partners, subsidiaries, affiliates, or assignees, shall enter into an oil and gas lease on
    lands in (Name) County, (State), located within (Specify Distance) from any
    boundary of the lands that are the subject of this Lease (the “Other Lease”),
    providing for a bonus, on a per-acre basis, greater than the per-acre bonus paid to
    Lessor for this Lease, and/or a royalty in an amount greater than is provided for
    in this Lease, then Lessee shall pay to Lessor, as additional bonus for this Lease,
    an amount equal to the difference, on a per-acre basis, between the amount paid
    Lessor for executing this Lease and the greater amount determined by the terms of
    the Other Lease, and/or amend this Lease to provide for Lessor to be paid the
    greater royalty interest provided for in the Other Lease. Lessees failure to perform
    the obligations provided for in this provision within (Specify Time Period) of the date
    on which a greater bonus is paid for or a greater royalty is provided for in the Other
    Lease, this Lease shall automatically terminate and Lessor shall have no obligation
    to return any bonus payments or other consideration paid by Lessee to Lessor. For
    the purposes of this provision, “bonus” shall be deemed to include any cash
    consideration paid to a lessor, however called or characterized, or any benefit
    provided the Lessor by Lessee, and “royalty” shall be deemed to include any and all
    interests in production, however called or characterized in the Other Lease.

Most Favored Nations Clauses
 FAVORED NATIONS: If at any time or times prior to a well being
  completed on the leased premises, or prior to a well being
  completed in any pooled or unitized units in which the leased
  premises are included, Lessee or its assigns shall obtain a lease
  from or make a contract with a mineral owner under the Leased
  Premises other than Lessor, then Lessor shall be entitled to any
  benefits paid for, granted or reserved in such lease or contract
  which are greater or more favorable than those paid for,
  granted or reserved in this lease. Lessee shall pay Lessor
  immediately Lessor’s prorate share of such benefit, including
  without limitation, bonus, royalty, rental or shut-in payment or any
  other benefit more favorable to such mineral owner than the
  payment for or the benefits of this lease. If necessary in the opinion
  of Lessor, then Lessee shall amend this lease to confer such
  benefits upon Lessor

Mother Hubbard Clause
 This lease also covers and includes, in addition to
  that above-described, all land, if any, contiguous
  or adjacent to or adjoining the land above
  described and (a) owned or claimed by lessor by
  limitation, prescription, possession, reversion, or
  unrecorded instrument or (b) as to which lessor has
  a preference right of acquisition.

K&L Gates
       Julie E. Lennon is a partner in the Dallas office of K&L Gates. Ms. Lennon’s
       practice is transactional in nature. She focuses on oil & gas transactions and
       commercial lending, and includes representing lenders and borrowers in oil &
       gas financing transactions, representing sellers and purchasers in acquisition
       and divestures of producing property, and representing both landowners and
       mineral owners in negotiation and drafting oil & gas leases. Ms. Lennon also
       represents and counsels lenders and borrowers in a variety of real estate
       financing transactions. Ms. Lennon is admitted to practice in and member of
       the Texas and Mississippi State Bars. She graduated from the University of
       Southern Mississippi and received her law degree from the Southern
       Methodist University, and her masters of law degree from the New York
       University School of Law. Ms. Lennon also clerked for the Mississippi
       Supreme Court.

       Contact Information:
       Phone: 214.939.4920

      Capital and Sponsorship for the Energy Industry
                       Since 1988

    Energy Private Equity: Choosing the Right Partner
                    October 23, 2008
NGP Energy Capital Management
   Founded in 1988, NGP Energy Capital Management is the
   Premier Investment Franchise in the Energy Industry
Strategic Advisory Council
     Robert W. Jordan
   James R. Schlesinger
   Charles R. Williamson
       Pat Wood, III





NGP Energy Capital Management
NGP has Created a Diverse Group of Energy-Focused
Investment Silos

 • Natural Gas Partners Funds – $6.9 billion North American private
   equity fund complex consisting of nine funds investing primarily
   within the oil and gas, midstream and oilfield services sectors

 • Co-Investment Funds – $100 million and $250 million co-
   investment funds are yield-oriented vehicles that invest
   alongside NGP’s private equity funds

 • NGP Capital Resources Company (“NGPC”) – Founded in 2004,
   NGPC is a $500 million publicly-traded business development
   company that focuses on providing senior debt and mezzanine
   capital to companies in the energy industry

NGP Energy Capital Management
NGP has Created a Diverse Group of Energy-Focused
Investment Silos

 • NGP Energy Technology Partners (“NGP ETP”) – Founded in
   2005, NGP ETP is a $148 million private equity fund created to
   provide growth capital and buyout funding for companies
   offering technology-related products and services to the oil and
   gas, power, and alternative energy sectors. NGP Energy
   Technology Partners II is currently raising a $300 million to
   $400 million follow-on fund that will execute the same strategy.

 • NGP Midstream & Resources, L.P. (“NGP MR”) – Founded in
   2007, NGP MR is a $1.4 billion private equity fund concentrating
   on the energy infrastructure (pipelines and related assets
   transporting natural gas, crude oil or refined products) and
   mining and mineral businesses

Overview of Natural Gas Partners
 Key Attributes

 • Private equity firm focused on the energy industry since 1988
 • Particular expertise in oil and gas production, midstream and
   oilfield service companies
 • Management has invested as a team for 20 years with no turnover
 • Over $6.9 billion of capital and undrawn commitments managed in
   nine private equity funds
 • $3.5 billion invested and committed – 163 transactions in 127
 • Gross IRR from inception to June 2008 of 33% using discounted
   market values
 • Premier investment franchise within the energy and limited partner

Overview of Natural Gas Partners
    NGP invests in a broad range of sectors within the energy

Oil and Gas                                                                                     End
 in Place                                                                                       User

              Upstream                Midstream                                    Downstream

  Upstream – Businesses      Midstream – Businesses that Downstream – Businesses
  that find, develop and     gather, process, store and  that refine, market and
  extract energy resources   transfer energy resources   distribute refined energy

Overview of Natural Gas Partners
 NGP has broad investment experience in the major North
 American oil and gas basins
                 Percent of Total Capital Invested by Region
                        November 1988 – June 2008


        Rocky Mountains



                            Gulf Coast                                       Gulf of Mexico
                               8%                                                  3%

Overview of Natural Gas Partners
The Governing Principles
  Own equity alongside “owner-managers” who:
     Invest a portion of their liquid net worth to the enterprise
     Lead a top-tier technical team able to effectively reinvest cash flows
     Have a proprietary source of transaction flow or other competitive
  Invest in companies with ongoing growth opportunities as
   opposed to project-oriented financings
  Fund the start-up of a company where significant opportunity
  Provide financial and strategic sponsorship to management and
   access to additional growth capital at the lowest possible cost
  Above all else, NGP believes that finding the right people is the
   most important ingredient for successful investing in the energy
   industry… NGP tries to align itself with the best managers in the
   business, and get out of their way

 Overview of Natural Gas Partners
     NGP’s Portfolio Company Structure Capitalizes on the
     Weakness of Traditional Corporate Structures
                                                                                          NGP Portfolio Company
               Traditional Company
                                                                                       Management Partnership Model
                Management Model
                                                                                            (flipped on its side)



 Seniority               Efficiency
  Level of
                Regional Asset Optimization

                  Area Asset Optimization

               Field Production & Optimization

                                                                                  Senior     NGP Portfolio Company Management Focus   Senior

                         NGP Assistance                   All Other Colors Represent Management Focus

                                        CONFIDENTIAL: NOT FOR REPRODUCTION OR DISTRIBUTION
Overview of Natural Gas Partners
          NGP Applies a “Build-Up” Strategy in the Oil and Gas
          Acquisition and Exploitation Market

                                                                             A Seller's Economics

                   1                                                         B Value Creation Through Lower Costs

                                                                             C Value Creation Through Production Enhancements

Production Rate

                  0.6                               C

                  0.4   Original Cost               A
                        Economic Limit

                        New Cost                    B
                  0.2   Economic Limit

                                           Time of
                                         Property Sale                           Time

                                                         CONFIDENTIAL: NOT FOR REPRODUCTION OR DISTRIBUTION
Overview of Natural Gas Partners
 Focus: People and Teams

 • Entrepreneurial

 • Strong Technical and Practical Experience

 • Sound Business Judgment

 • Confidence and Leadership Abilities

 • Creativity

 • Desirous of a Value-Added Partner

Overview of Natural Gas Partners
 Not Necessary

 • CEO Experience

 • Full Lineup of Technical and Financial

 • A Deal in Hand

 • Pretty PowerPoint Slides

Choosing the Right Partner

 • Incentives

 • Owner / Manager Contribution Requirements

 • Structure and Alignment of Interests

 • Ownership / Monitoring Dynamic

 • Resources Offered

 • Exit Dynamic

Choosing the Right Partner
 Always, Always, Always …

 •Check References:
   Good and Bad Deals

   Past and Present Partners

Choosing the Right Partner
 Capital Trends

 • Public Equity and Debt Markets are Closed

 • Many Commercial Banks are in Various States of

 • Hedge Fund and Other Generalist Money Likely Gone

 • Mezzanine Capital is Limited

 • Public Companies are Reducing Spending and
   Repairing Balance Sheets

 • Assets Coming Available, But Values Impacted by
   Lower Commodity Prices and Higher Costs of Capital

Choosing the Right Partner
 In Conclusion …

 • Private Equity Capital is Available

 • High Quality Entrepreneurs and Value-Added
   Partners Remain Scarce

 • Don’t Underestimate the Impact of a Bad or
   Inexperienced Partner

 • Go with Experience

Choosing the Right Partner
 Contact Info

          David Hayes
          Natural Gas Partners


Case Law Update

Clayton L. Falls
K&L Gates LLP
1717 Main Street, Suite 2800
Dallas, Texas 75201
Significant Texas Supreme Court Case

     Coastal Oil & Gas v. Garza Energy Trust
         2008 WL 3991029 (Tex. 2008)
            Decided August 29, 2008

Coastal Oil & Gas v. Garza Energy Trust
 Case Background
    Coastal located a Well as close to the Plaintiff’s adjoining
     property line;
    Well was within Railroad Commission spacing rules;
    Costal “fraced” this Well, with the fracing length designed to
     reach over 1,000 feet from the Well.
    Therefore the frac lines extended well into adjoining lease;
    Coastal proceeded to drain natural gas from neighboring land;
    Coastal held the Mineral Lease on the Plaintiff’s adjacent Land,
     as well.

Coastal Oil & Gas v. Garza Energy Trust
 Adjacent Property Owner’s Allegations:

    Subsurface trespass through hydraulic fracturing,
    Implied Mineral Lease Covenants:
       Breach of implied covenants to develop, market and protect
        against drainage
           Failure-to-Develop Damages – zero, interest was lost, but net
            income was increased.
       Breach of duty of good faith pooling.

Coastal Oil & Gas v. Garza Energy Trust
 Trial Court awarded Plaintiff:

      $1.75MM in lost royalties for failure to develop
      $1MM for bad faith pooling
      $1MM in lost royalties for subsurface trespass
      $1.4MM in reasonable attorneys’ fees

Coastal Oil & Gas v. Garza Energy Trust
 On Appeal

   Highly anticipated decision
   Tex. Sup. Ct. had never addressed subsurface
    trespass in regard to hydraulic well fracing
   Strong public policy implications

Coastal Oil & Gas v. Garza Energy Trust
 Rule of Capture

    Permits the owner of a tract to drill as many wells on
    his land as the Railroad Commission will allow and
    provides that he is not liable to adjacent landowners
    whose lands are drained as a result of his operations

Coastal Oil & Gas v. Garza Energy Trust
 Court’s Holding
   Any alleged damages for royalties lost due to
    subsurface trespass are precluded by the law of
      Justification:
          Start Drilling! - Operator required to drill to prevent drainage
          Better left to RRC rather than Juries
          Difficult to determine value of drained oil and gas
          No one wanted it.

Coastal Oil & Gas v. Garza Energy Trust
 Court’s Holding Cont.
    Royalty interest owners with reversionary interests
     have standing to sue
    Operators have a duty to protect the leasehold
     against drainage
       Royalty owner’s recourse could be against their Operator
       Could see additional litigation
    Damages valued at royalty lost to Lessor b/c of
     Lessee’s failure to develop.
       Could see increased litigation with drop of prices!

K&L Gates
       Clayton Falls concentrates his practice in the commercial litigation, product
       liability, and toxic tort areas. He has represented clients in a broad range of
       cases as plaintiffs and defendants in both state and federal courts. Mr.
       Falls handles a variety of cases including claims for breach of contract,
       breach of fiduciary duty, negligent misrepresentation, fraud, false
       advertising as well as numerous claims under the Deceptive Trade
       Practices Act. In addition to his general litigation experience, he has also
       assisted in the investigation and defense of two separate shareholder
       derivative suits brought against the companies prior to their highly
       publicized public sale.

       Contact Information:
       Phone: 214.939.4920

     Oil & Gas Seminar
     Thursday, October 28, 2008

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