Oil and Gas Royalties: The Complete Guide

Oil and gas royalties can be one of the most rewarding – and most confusing – forms of income a property owner or investor ever encounters. Between mineral rights and royalty interests, leases, decimal interests, deductions, and taxes, it’s not always clear what you actually own or how your checks are being calculated.

This 2025 guide walks through the fundamentals of oil and gas royalties in plain language, from how you earn them and how payments are calculated to the key decisions around holding, selling, or exchanging your interests. Whether you’ve just received your first division order, inherited royalties from family, or are evaluating a new investment, this article is designed to help you understand your options and ask smarter questions of your advisors.

What Are Oil and Gas Royalties?

Oil and gas royalties are payments made to mineral rights owners and certain investors for the right to extract and sell oil and natural gas from a property. When an energy company produces and sells hydrocarbons from your land, you may receive a percentage of the value of that production as royalty income.

At a high level:

• Mineral rights owners typically receive royalties when they lease their subsurface rights to an operator.
• Royalty interest owners may receive income because they own a share of the mineral estate or have acquired a royalty interest from someone else.
• Overriding royalty interest (ORRI) holders receive a share of production without owning the underlying minerals. Their interest usually lasts only as long as the lease.

Common royalty rates in the United States range roughly from 12.5% (one-eighth) up to around 25% in highly competitive basins. The exact rate, deductions, and payment terms are defined in the oil and gas lease or other governing agreements.

Key Takeaways for Mineral Owners

• You must own or control mineral rights before you can earn oil and gas royalties. In a fee simple estate, surface and mineral rights often start together, but they can be separated and sold independently.
• Signing an oil and gas lease allows an operator to drill and produce in exchange for royalty payments and, in some cases, upfront bonus payments.
• Royalty income is usually calculated as a percentage of the revenue from oil and gas sold, minus any allowed post-production costs that the lease or division order specifies.
• Royalties are taxable income. Many owners may also be eligible to claim a percentage depletion deduction on qualifying royalty income, subject to IRS rules.
• Oil and gas royalties can be held, gifted, sold for a lump sum, or potentially exchanged into other property through a properly structured 1031 exchange. Each path has different risks and tax outcomes.

If you would like help reviewing an offer, understanding your royalty checks, or getting a sense of what your mineral rights might be worth, you can contact Ranger Land & Minerals for a confidential, no-obligation conversation.

How Do You Get Oil and Gas Royalties?

There are three primary steps to begin earning oil and gas royalties as an individual mineral owner:

1. Obtain or confirm mineral rights ownership. You may acquire mineral rights by purchasing a property in fee simple, inheriting them, buying them separately from the surface, or exchanging into them through a 1031 transaction. To understand the basics of mineral ownership, review the guide on what mineral rights are and how they work.
2. Enter into an oil and gas lease or similar agreement. Most mineral owners do not drill their own wells. Instead, they lease their minerals to an operator through a negotiated oil and gas lease. The lease will spell out your royalty rate, primary term, development obligations, and how costs are handled. It is wise to consult counsel before signing, especially when negotiating royalty percentage, deductions, and surface-use clauses.
3. Receive production and royalty payments. Once the operator drills and completes a well, oil and gas are sold into the market. After accounting for applicable deductions and tax withholding where required, the operator issues royalty checks to owners listed on the division order. Payments typically arrive monthly or quarterly, depending on the lease terms, state law, and minimum payment thresholds.

Types of Interests That Generate Oil and Gas Income

The term “mineral interests” is an umbrella that covers several different types of ownership and participation in a drilling project. Understanding the distinctions will help you read your documents and evaluate potential investments.

Royalty Interests

A royalty interest gives the owner a right to a share of production or revenue from a well without being responsible for drilling or operating costs. Mineral rights owners who sign a lease typically retain a royalty interest defined in the lease agreement. Royalty owners do not control day-to-day operations, but they must still pay taxes and track their income.

Overriding Royalty Interests (ORRIs)

An overriding royalty interest (often shortened to ORRI or “override”) is carved out of the working interest in a lease. It gives its holder a share of production or revenue, but it does not include mineral ownership and usually expires when the lease ends. To dive deeper into ORRIs, see the detailed guide on overriding royalty interests.

Working Interests (Non-Operated Working Interests)

A working interest owner participates directly in the costs and risks of exploration and production. Non-operated working interest owners do not manage the well, but they pay their proportionate share of drilling, completion, and operating costs and receive their share of production. Working interests can offer higher upside but also higher risk than pure royalty interests.

How Are Oil and Gas Royalties Calculated?

While every lease and state is different, most royalty payments follow a similar conceptual formula, which is the starting point if you are asking how are oil and gas royalties calculated for your specific wells:

Royalty payment = (Gross revenue from oil and gas sold − allowable post-production costs) × your royalty decimal interest

Key Factors in Royalty Calculations

• Royalty rate: The percentage of production or revenue that is payable as royalty. Many modern leases fall somewhere in the 18.75%–25% range in competitive areas, while older leases may be closer to 12.5%.
• Price received: The sales price per barrel of oil or per thousand cubic feet (Mcf) of gas at the point of sale.
• Production volume: The amount of oil and gas produced and sold during the payment period.
• Allowable deductions: Certain leases allow the operator to deduct post-production costs (such as gathering, compression, processing, and transportation) before calculating royalties. Others specify “no deductions” or limit the categories of costs that can be charged back.
• Your decimal interest: The exact fraction of the well you own, shown as a decimal on your division order (for example, 0.015625).

Simple Example Royalty Calculation

Here is a simplified example, assuming no post-production deductions:

• Production for the month: 10,000 barrels of oil
• Average sales price: $80 per barrel
• Gross revenue: 10,000 × $80 = $800,000
• Royalty rate: 20% (0.20)
• Your share of the royalty: 0.50% decimal interest in the lease (0.005)

Step 1: Calculate the total royalty pool: $800,000 × 0.20 = $160,000.

Step 2: Apply your decimal interest: $160,000 × 0.005 = $800 royalty payment for that month.

Real-world calculations often account for separate oil, gas, and natural gas liquids (NGL) streams, different prices, and specific deduction clauses, but the overall structure is similar and forms the foundation of how oil and gas royalties translate into monthly income.

When Are Oil and Gas Royalties Paid?

Many mineral owners are surprised by how long it takes to receive their first royalty check after a successful well is drilled. In practice, there are several steps before payments begin:

• Title work and division orders: The operator must confirm who owns what percentage of the production and issue division orders to each owner.
• First payment timeline: In many jurisdictions, operators are required to begin paying royalties within a certain number of months after first production, often in the 60–120 day range, subject to state law and minimum payment thresholds.
• Ongoing payments: Once set up, royalty payments are typically made monthly, although some operators pay quarterly or only when the amount due exceeds a stated minimum.

If you believe your payment is delayed or inaccurate, review your lease and division order and consider contacting the operator’s owner relations department or consulting with an attorney who focuses on oil and gas issues in your state.

How Long Do Mineral Rights and Royalties Last?

In the United States, mineral rights are usually a form of real property that can be owned indefinitely. They do not automatically expire when you pass away; instead, they can be transferred, gifted, or inherited according to your estate plan and state law.

However, your lease-based rights to royalties from a particular well depend on the terms of the oil and gas lease:

• Most leases have a defined primary term (for example, three to five years) during which the operator must drill or take other actions to hold the lease.
• Once production is established, the lease typically continues “so long as oil or gas is produced in paying quantities,” subject to specific shut-in or cessation-of-production clauses.
• Overriding royalty interests and working interests tied to a specific lease usually end when that lease terminates.

If mineral rights are left unattended for long periods, some states have dormant mineral statutes or abandonment rules that can affect ownership if notice and filings are not maintained. That is one reason it is important to keep your records current and discuss long-term planning with your advisors.

Taxes on Oil and Gas Royalties

Oil and gas royalties are generally taxable income. The exact treatment depends on your status as an individual, trust, or entity, as well as federal, state, and local tax rules. Key concepts include:

• Ordinary income: Most royalty checks are reported as ordinary income on your tax return for the year received.
• Self-employment status: Pure royalty income is usually not subject to self-employment tax, but working interests or actively operated interests may be.
• Federal and state income taxes: Many owners owe both federal income tax and, where applicable, state income tax on royalty income. A few states do not levy personal income tax but may impose other taxes on production.
• Percentage depletion deduction: Eligible royalty owners may claim a percentage depletion deduction, often equal to 15% of qualifying gross income from the property, subject to IRS limitations and income caps.
• Record-keeping: It is critical to keep check stubs, division orders, and year-end tax forms (such as 1099s) for your files and your tax preparer.

Because tax rules change and there are many oil- and gas-specific nuances, always work with a tax advisor who understands mineral and royalty income.

If you are unsure how your current royalty income, a potential sale, or a future 1031 exchange could affect your tax picture, reach out to Ranger Land & Minerals. Our team can collaborate with your CPA and advisors to help you model different scenarios before you make a decision.

Royalty Deductions and Your Net Check

One of the most confusing topics for mineral owners is why the amount on the royalty check is smaller than expected. Often the answer lies in post-production costs and other deductions listed on the check detail.

Common deduction categories include:

• Gathering and transportation
• Compression and processing
• Marketing fees
• Severance or production taxes (depending on the state)

Whether these deductions are allowed, and how they are calculated, depends heavily on the language in your lease and any applicable state law. Some leases are “gross proceeds” or “no deduction” leases, while others allow the operator to pass certain costs to royalty owners. If the statements and your lease do not seem to match, seek professional guidance.

Holding vs. Selling Oil and Gas Royalties

For many families, oil and gas royalties can provide long-term passive income. At the same time, there may be reasons to sell some or all of your interest—for example, to diversify your portfolio, reduce risk, or unlock a lump sum for other goals such as real estate or retirement planning. Evaluating selling oil and gas royalties vs holding them over time is ultimately a question of risk tolerance, time horizon, and liquidity needs.

Potential Advantages of Holding Your Royalties

• Ongoing monthly or quarterly income that may last for years, depending on the reservoir and drilling activity.
• Upside potential if additional wells are drilled or oil and gas prices rise.
• Ability to pass royalty interests to heirs as part of your estate plan.

Potential Advantages of Selling Your Royalties

• Immediate liquidity to pay down debt, invest in other assets, or fund large expenses.
• Reduction of commodity price risk and production decline risk.
• Opportunity to reposition into other properties or investments, sometimes using a 1031 exchange strategy where appropriate and allowed.

Where to Learn More About Selling Mineral Rights and Royalties

Deciding whether to hold or sell is complex. To explore detailed pros and cons, review the dedicated guide on selling mineral rights and the article outlining whether you should sell your mineral rights. These resources walk through different scenarios, from producing properties with stable checks to non-producing minerals with exploration potential.

Top States for Oil and Gas Production and Royalties

Royalty income opportunities tend to be concentrated in states with significant oil and gas production. While exact rankings change over time, states such as Texas, New Mexico, North Dakota, Colorado, Oklahoma, Alaska, Louisiana, Wyoming, and Pennsylvania are consistently among the most active producers. Production in these regions supports a large base of mineral and royalty owners, as well as investors seeking exposure to the energy sector.

If you own minerals or royalties in one of these states, it is especially important to understand your lease terms, the local regulatory environment, and how new drilling activity or pipeline infrastructure could impact your future income.

Frequently Asked Questions About Oil and Gas Royalties

Are oil and gas royalties truly passive income?

Royalties are often described as passive because you do not operate the well or manage day-to-day production. However, you still need to monitor your checks, keep tax records, respond to division order changes, and occasionally resolve title or payment issues. It is “hands-off” relative to operating a well but still requires some attention.

What is the difference between a royalty interest and a working interest?

A royalty interest entitles you to a share of production or revenue without paying for drilling or operating costs. A working interest requires you to pay your portion of costs but can offer a larger share of profits. Non-operated working interests, which Ranger also helps investors access, sit between purely passive royalties and fully operated projects.

Can I own surface rights without mineral rights?

Yes. In many areas, surface rights and mineral rights have been “severed,” meaning different parties own each estate. You might own the surface where a well pad or road is located while someone else owns the minerals and receives the royalties. To learn more, see the overview of fee simple ownership and separated estates.

How do I know if my royalty checks are correct?

Start by comparing your division order decimal interest to the interest listed on your check detail. Then verify that the volumes and prices look reasonable for wells in your area and that deductions match your lease terms. If you see persistent discrepancies, consider asking the operator’s owner relations team for clarification or consulting a professional experienced in royalty audits.

Can oil and gas royalties be part of a 1031 exchange?

Under the right circumstances and with proper structuring, certain mineral and royalty interests may be involved in a 1031 like-kind exchange. However, this is a highly technical area. Review Ranger’s 1031 exchange guides and speak with your qualified intermediary, CPA, and attorney before attempting any exchange.

How Ranger Land & Minerals Helps Mineral and Royalty Owners

Ranger Land and Minerals focuses on helping individuals and families unlock value from their mineral rights, royalties, overriding royalty interests, and non-operated working interests. Whether you are evaluating an offer to sell, considering a 1031 exchange, or simply trying to understand your existing royalty checks, our experienced team can help you navigate the process.

To explore your options, start with these resources:

• What Are Mineral Rights: Everything You Need to Know
• How to Calculate Oil and Gas Royalty Payments for a deeper look at how oil and gas royalties move from wellhead production to the amount on your check.
• 1031 Exchange Guides for Mineral Rights and Royalties
• Contact Ranger Land & Minerals for a confidential discussion about valuing, buying, or selling mineral rights and royalty interests that fit your long-term goals.

Next Steps for Mineral Owners

If you currently receive royalty checks, or think you may own mineral rights that are not yet producing, this is an ideal time to organize your records and clarify your goals. Gather your deeds, leases, division orders, and prior check stubs, and consider what matters most to you: ongoing income, risk reduction, estate planning, or repositioning into other assets.

When you are ready, reach out to a trusted advisor or connect with the Ranger Land and Minerals team to help you evaluate your options and chart a long-term strategy for your oil and gas royalties.