In the oil and gas industry, royalties play a major role in the costs and revenue of a well. So who has the royalty interest? What does it even mean? What should you know about it?
This article aims to answer all your questions about the topic of royalties oil and gas. As you would know, royalties aren’t distinct to a specific industry as other industries like music, entertainment, and publication industries also use royalties as compensation for talent.
Royalty Interest Definition
Royalty interest refers to the entitlement or ownership of a portion (percentage) of the mineral or the revenue for the mineral one or more wells produce.
The individual or company with the royalty interest in an oil or gas well does not bear any costs for the drilling of the well or the production of the resource. Royalty interest usually derives from the well or mineral ownership, as the party of the royalty interest sells or leases the mineral interest to another party.
However, they may bear some of the initial costs but not any operational or production costs in the later stages of the well.
Variations of Royalty Interest
Royalty interest is a broad term per se because the nature and level of royalty interest can vary by situation. Here are some of the common variations of royalty interests:
Non-Participating Royalty Interest (NPRI)
The NRPI refers to the royalty interest the original royalty interest owner leases to a third party to receive a certain percentage of the royalty payments. However, this royalty interest does not grant executory rights and may not involve bonuses either that comes from extra production.
Overriding Royalty Interest (ORRI)
ORRI refers to the share of a working interest leased to another party. The party with the working interest can lease an undivided, non-processionary share of the revenue. Unlike royalty interest owners, this party does bear some of the costs.
Royalty Interest vs. Working Interest
Working interest should not be confused with royalty interest, as the former gives a company the right to explore, drill, and extract minerals from the depth of a land. The mineral owner usually sells or leases the working interest to a company in the oil and gas industry to explore, extract, and produce hydrocarbons.
Those with a working interest bear 100 percent of the costs associated with these operations.
In terms of payment hierarchy, royalty interest is above working interest. The party with the working interest must pay the royalties from the revenue from production before taking any for itself. Therefore, for such a party, the costs also include royalties in addition to the actual costs of the operation.
Who Can Own Royalty Interest?
In the US and some other countries, land ownership is usually divided into two: land ownership and mineral ownership.
Land ownership or surface ownership defines ownership to the land or surface. On the other hand, mineral ownership defines the ownership of what’s beneath the surface. This is called split property, as the rights are split into two.
Mineral ownership basically gives the person, group of persons, or a company the mineral interest or mineral rights. What this means is that they own any minerals found under the land.
So mineral owners or mineral interest owners can sell or lease mineral rights or working interests to another party in exchange for royalties. Technically, they are still the owners of the mineral interest, but they allow the other party to extract the minerals and sell them in exchange for royalty payments.
Often, families and companies receive royalty interest when they lease mineral rights for the depth of the land they own.
Many companies also offer working interest in exchange for royalty interest because they simply don’t have the money to extract and produce the minerals themselves. So to earn some kind of profit from those minerals, they lease the land to a bigger company that has the initial investment needed to drill a well and complete it.
In most cases, multiple parties receive royalties, be it a family or a company (multiple owners and investors).
How Are Royalties Calculated?
Royalty calculation depends on several factors that vary by field, its potential, and the conditions. Before two parties go into an agreement for royalty interest, there are estimations of the cost and revenue of the well.
Based on estimates, a royalty rate is set, which may be fixed or depend on production.
The following factors affect royalty interest percentage:
- Acreage of the total land
- Acreage of the oil field within the land
- The oil or gas reserves in the field
- The estimates of the monthly or yearly production of the mineral
- Production costs
- Oil or gas commodity prices
For such complex calculations, experts in the oil and gas industry, as well as, lawyers are involved that ensure that the right percentage is included in the agreement. Also, the terms and conditions of the agreement vary widely.
What Are Average Royalties Oil and Gas?
After all considerations, royalty interest comes down to a percentage of the revenue. While the percentage may be fixed, the actual payments month on month can vary, especially when tied to the market price of crude oil or natural gas.
The average royalty on a federal level is 12.5 percent. However, the percentage can vary greatly state by state, even field by field.
Texas has the highest percentage of royalty share in an oil or gas well revenue, coming in at 20 to 25 percent. For most other oil and gas producing states, it ranges between 15 to 20 percent.
There can be many reasons why mineral owners may want to sell mineral rights for royalties. This basically indicates a percentage in the revenue of the oil or gas-producing, often adjusted for production costs.
It can range from thousands to hundreds of thousands of dollars depending on land area and production levels. The royalty interest usually lasts for as long as the field is operational and producing.
All conditions are set in the agreement, which the royalty interest owner must review very carefully in the presence of their lawyer.