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Oil and Gas Division Orders and Division Order Mathematics BASIC LAND MEASUREMENTS: 1 Section = 640 Acres = 5,230 Lineal Feet on a Side 1 Acre = 43,560 1 Quarter Section = Square Feet 160 Acres(Homestead) 1 Quarter-Quarter Section = 40 acres 1 Quarter-Quarter-Quarter Section = 10 acres 1 Quarter-Quarter-Quarter-Quarter Section = 2.5 acres 36 Sections = a Township LEGAL DESCRIPTIONS: (a gift of the genius of The Cadastral Survey System Thomas Jefferson) divides the surface of the Earth into a checkerboard of contiguous square-mile squares whose sides are aligned, as nearly as possible, along straight lines running true north-south and east-west. These "squares on the checkerboard," legally called Sections, are further arranged into larger squares, legally called Townships, which consist of 36 Sections arranged in a 6 Sections on a side and whose numbers square consisting of run in an "S"-shaped pattern from Section 1 in the upper 36 in the lower right-hand right-hand corner to Section corner. These Townships are arranged, on the surface of the Earth and in these United States (with the very notable exceptions of Texas and Louisiana), according to their distance from predetermined and landmarked boundaries established by the U.S. Geological Survey. Thus, Section 36 in Township 2N(orth) would be located 6 miles in the lower right-hand corner of the Township, North of a baseline running East-and-West determined by the U.S. Geological Survey. Note that Townships are sometimes called "Tiers" or are said to lie in "tiers" above or below the Baselines running through a particular County in a given State. But to complete the location of Section 36, it is necessary to establish an East-West co-ordinate on the map, and this is done by reference to Meridian Lines, which run North-and-South on the U.S.G.S. maps. Thus, Section 36-2N-4W 6th PM is located in the lower 6 miles North of the righthand corner of the Township, Baseline and 18 miles West of the 6th Principal Meridian on the U.S.G.S. maps. Note that the locations of the Baselines and Meridians are based on lines of Latitude (Baselines) and Longitude (Meridians) as established on nautical and aviation maps by celestial navigation with compass and sextant--tools used by the Surveyor as well as the Navigator. Also note that the distance between Baselines is denoted by the number of the Township as it lies North or South of a Baseline and the number of the Range as it lies East or West of a Meridian line. 10 36-2N-4w 6th PM Carter Thus, the Legal Description of 36, Township 2 County, Oklahoma would be read: "Section North, Range 4 West of the 6th Principal Meridian, Carter County, Oklahoma." The designation of the State and County establishes the numbers and locations of the Baselines and Meridians on the U.S.G.S. maps for that County, and the distances from them give the exact location coordinates of the Townships by position in the "tiers" North or South of the Baselines and Ranges East or West of the Meridians. Since, again, the Townships are 6 miles on a side (36 square miles) and can be conceived of as being 6 miles "tall". and the Ranges are 6 miles "wide"--i.e. a measurement of the "width" of the Township--then the three numbered designations in a Legal Description--Section, Township, unique coordinates necessary Section (and no other "Section and State in question. and Range--give the three to locate that particular 36") on maps of the County WELL LOCATIONS: As described above in this text, the spacing for an oil and gas well (that is, the minimum number of acres that a drillsite for a well to be drilled to a given depth and to a given geological formation must contain) is determined by the area of the DRAINAGE of oil and gas from that formation anticipated from that well without enchroachment on the drainage of adjacent wells in the same formation. Spacing is generally stated in terms of acres--running a scale from as little as 10 or even 2.5 acres for shallow oil wells up through 40 to 160 acres for deeper oil wells and from 160 acres to 320 acres for gas wells and up to 640 acres or more for deep gas wells. This determination of acreage in the "spacing unit" (sometimes called the "drilling and spacing unit") subdivides the Legal Description of the (160 acres), Section described above into quarter-sections quarter-quarter sections (40 acres), quarter-quarterquarter sections (10 acres), and quarter-quarter-quarter- quarter sections (2.5 acres). Note also the common division into halves (i.e. x 1/2) for of quarter-sections or quarter-quarter-sections establishing spacing units for oil and gas producing formations running in narrow bands north-south or eastwest. Thus, the N/2 SE/4 of Section 36 would contain 80 acres running east-west in a rectangle consisting of two 40-acre squares side-by-side; so, also, the W/2 SE/4 SE/4 of Section 36 would contain 20 acres running north-south in a rectangle consisting of two 10-acre squares arranged one atop the other. 11 Well locations often begin or end with numbers and letters such as "330' FSL, 220' FEL." These indicate that the well bore is 330 feet From the South Line (the Southern boundary line of the Section) and 220 feet From the East Line (the East boundary line of the Section). Spacing units and their determined acreage now leads examination of the concept of Net Mineral Acreage: to an NET MINERAL ACREAGE: Since the ownership of the surface of land and the minerals beneath it can be split apart--called "mineral severance" or just "severance"--it is important to determine the ownership of the minerals in a spacing unit in terms of Net Mineral Acres. Net Mineral Acres describes the number of mineral acres owned by each individual owner in a given spacing unit. These Net Mineral Acres will either be leased or force pooled into the spacing unit necessary to accommodate the drainage area of the well to be drilled. The leasing (or force pooling--which is a form of "forced" or governmentally sanctioned leasing) of these Net Mineral Acres creates the Leasehold Estate--which generally divides itself into Royalty Interests to be paid to the mineral acreage owners, the Working Interests leased by and to be paid to the Operator and Non-Operators,. and Overriding Royalty Interests said to be "carved out of" the Working Interest often for the benefit of intermediaries such as Lease Brokers, Geologists, or Landmen, who may have acquired the lease initially from the mineral acreage owners and then sold and assigned it to the Operator. The determination of the decimal portion of all production of oil and gas to be paid to each of the owners of a Royalty, Working Interest, or Override leads to an examination of Chaining the Leasehold Title to Derive the Fractional Interests: EXHIBIT "A" Chain: PAT. USA PAT. Tract Index 1-401 7-2-04 NW 11-33S-31W Bettie McLish 1-401 WD ......... 13-170 WD ........ . 72-13 WD ........ 101-32 WD 13-170 10-26-19 ALL NMR J. D. McWilliams WD 72-13 11-22-29 ALL NMR G. Ward Stone WD 90-181 6-12-52 ALL NMR Marvin W. Lepper & Oleta A. Lepper, Jt WRS u OGGL 270-43 WD 101-32 E/2 NW 11-33-31 4-15-62 Surface only Charles E. Lepper 0. R. Whittaker Whittaker Enterprises 13 1. Chaining the Title to Derive the Fractional interests: A. The title examiner "chains"--that is, physically draws a diagram much like an inverted tree--of both the leasehold and mineral title, with the fee simple title at inception—the PATENTS, abbreviated in the Tract Index kept by the County Clerk as “Pat.”—representing the roots of the tree, the subsequent conveyances of the fee simple to each of the 160-acre, Quarter-Sections intended as “Homestead,” or portions thereof listed in the PATENTS representing the "trunk" of the tree, and the surface and minerals constituting the major "branches" of the tree. The mineral title, whether leased or not, may further subdivide itself, by deeds, Oil and Gas Leases or other conveyances placed of record, into smaller branches which can be viewed as fractions of the mineral title or net mineral acres within the drilling and spacing unit. If these net mineral acres are leased, then, as to those acres so leased, there is created an oil and gas leasehold "estate" or title, divided into royalty, overriding royalty, and working interests. This final subdivision of the mineral title may be viewed as the smallest "branches" on the "tree", each one of which ends in a single owner who may be viewed as a single "leaf" on that same "tree". This "tree" of title is inverted because time runs on an axis down the page, and "branches" in the title run horizontally across the page. B. By making notations, at each branch of the "tree" described above, of the.fraction of mineral acreage or leasehold title being created or transferred, the title examiner derives a series of fractions which, when calculated together, yield a decimal component of 100% of the acreage contained in the drilling and spacing unit for the oil and gas well in question. These same decimals also constitute the net revenue decimal interests which determine the percentage of production proceeds to be paid to each owner of a portion of the leasehold estate--be it royalty, override, or working interest. This net revenue decimal interest will also appear on the division order for verification by the owner with his signature and his taxpayeridentification number. This process of drawing a diagram much like inverted “tree” described above, and making notes of the fraction, of surface or minerals under the surface—or both—of the Quarter-Section (160 acres—e.g. NE/4) or portions of that Quarter-Section (e.g. NE/4 NW/4 = 40 acres; NE/4 NW/4 SW/4= 10 acres) that are conveyed by deeds, to subsequent owners, is called “Chaining” the Title. C. The title examiner can "chain" these assignments together as a series of fractional divisions of the working interest and any royalties and overrides withheld. These fractional interests--when divided, multiplied, added and subtracted from each other in the proper sequence--constitute the "fractional interest calculation" which, when executed, results in the decimal of ownership on the division order. This 100% of production decimal expresses the portion of proceeds to which each owner of an interest in the well will be entitled. Setting up the fractional interest calculations of the decimal interests for the royalty, and working interest owners; overriding royalty (Peeling the onion apart one layer at a time.) SUGGESTION: Always calculate decimal interests in the same way and in the same order; that is, then calculate net mineral acreage first, leasehold (RI,ORI,WI) fractions, and calculate them in this order: STEP (1) : Royalty: For example, Farmer A owns all of the NW1/4 of a Section. He signs a lease covering this acreage that provides him a 1/8th royalty. A well is drilled by the lessee in the NW1/4 on a 160 acre drilling and spacing unit and completed as a producer. These facts tell you: (a) Farmer A's acreage position; expressed as 160 acres (the number of acres he owns in the NW1/4--i.e. all of it) of acres (i.e. divided by the number in the drilling and spacing unit 160 acres) or as the fraction: 160/160 = 1/1 = 100% of leasehold acreage (b) Farmer A's net revenue royalty interest is expressed as his fraction of acreage in the drilling and spacing unit (i.e. 160/160) multiplied by the fraction of royalty recited 1/8), in the lease (i.e. or as the calculation: 160/160 x 1/8 = .1250000 net revenue decimal royalty interest .1250000 OR NRRI 15 (c) The lessee's gross working interest--which will be important in calculating lessee's net revenue working interest--can now be calculated as follows: Total acreage leased from the owner divided by the total acreage in the drilling and spacing unit less the fraction of royalty recited in the lease, OR (160/160) STEP (2) : - 1/8 = 7/8 or .8750000 Gross-WI Overriding Royalties: For example, modify the situation with Farmer A above by having the lessee, Drillem, Inc., assign an overriding royalty of 1/8th of the 7/8ths working interest to Landman Larry, after lessee gets the lease from farmer A. Note that overriding royalty interests are often described as being "carved out of" the working interest. This means that the overriding royalties must be deducted out of the gross working interest (as calculated above at the end of Step (1) (c), above. In this Step 2, Landman Larry's net revenue overriding royalty is calculated as follows: (160/160) x (1/8 x 7/8) = 100% x 1/8 x 7/8 = 7/64 = .109375 net revenue overriding royalty OR .109375 NRORI STEP 3) Working interest: The net revenue working interest is calculated by determining the gross working interest, as in STEP (1) (c), above, and subtracting from it the amount of overriding royalty. In this case the calculations would be: 160/160 x 7/8 = .8750000 gross working interest; .875 - (1/8 x7/8) = .875 - .109375 NRORI = .765625 net revenue working interest OR .765625 NRWI 16 Recapitulation of Net Revenue Interest Calculations: Royalty: Farmer A: 160/160 x 1/8 = .1250000 NRRI Overriding Royalty: Landman Larry: 160/160 x (1/8 x 7/8) = .1093750 NRORRI Working Interest: Drillem, Inc.: (160/160 x 7/8)[160/160 x (1/8 x 7/8)] OR 7/8 - (1/8 x 7/8) OR .875 - .109375 = .7656250 NRWI TOTAL: 1.0000000 OR 100% of Production Payments TRACT CALCULATIONS: Starting with the example above, assume that Farmer A's 160 acre ownership of the NW/4 of the Section is now included in a 640 acre drilling and spacing unit encompassing the entire section. In order to calculate Farmer A's net acreage position in the drilling and spacing unit, follow the formula set out above, to wit: 160 acres owned --------------- = 640 acre drilling and spacing unit 1/4 x 640 acres = 160 net mineral acres 17 Also assume that each of the three other quarter-sections in the drilling and spacing unit are owned separately by Farmers B, C, and D, and are subject to three other leases-all of which provide for a 3/16ths royalty. How are the net revenue decimal interests in the NW/4 to be calculated? RI = 160/640 x 1/8 = 1/32 or .03125000 ORRI = 160/640 x ( 1/8 x7/8)= 1/4 NRRI x 7/64 WI = 160/640 x[7/8 -(1/8 x 7/8)] = 1/4 1/4 x ( .765625) = .19140625 NRWI =.02734375 x NRORRI ( .875 -.109375)= .03125000 .02734375 .19.140625 TOTAL: .25000000 = 1/4 = 160/640 If the same overriding royalty of 1/8 of 7/8 is retained by Landman Larry in all three of the remaining leases in the three other quarter-sections, how will the net revenue decimal interests be calculated in each of these quartersections? RI = 160/640 x 3/16 = ORRI = 160/640 x WI = 160/640 x .04687500 NRRI (1/8 x 7/8) [13/16 - = .02734375 NRORRI (1/8 x 7/8)] = .17578125 NRWI .04687500 .02734375 .17578125 TOTAL: .25000000 =1/4 = 160/640 18 FORMULAS FOR CALCULATING NET REVENUE INTERESTS: ROYALTY: Royalty owner's net mineral acres in drilling and spacing unit ----------------total number of fraction or x % of royalty = net revenue royalty interest acres in drilling and spacing unit OVERRIDING ROYALTY: net mineral acres subject to ORRI in drilling and spacing unit ----------------total number of acres in drilling fraction or x % of override = net revenue overriding royalty interest and spacing unit WORKING INTEREST: Working interest owner's net mineral acres in drilling and spacing unit ----------------- x [100%-royalty]-override total number of = net revenue acres in drilling working and spacing unit interest 19