Oil and Gas Royalties: 2020 Guide
If you sign a mineral rights lease, then you are on your way to earning oil and gas royalties. As a mineral rights owner, you can receive royalty compensation on the sale of crude oil, natural gas, and other valuable resources found on your property.
Oil and gas royalties can only be earned in several countries around the world, and the United States is one of them. For over a century, oil and gas royalty and royalty interest payments have made companies and independent land owners a tremendous amount of money.
Naturally, questions on the subject arise as many Americans wonder how they themselves can earn oil and gas royalties. In this comprehensive guide, we will detail everything there is to know about oil and gas royalties in the United States.
How do I Get Oil and Gas Royalties?
To get oil and gas royalties, there are three simple steps
- Obtain mineral rights. If you purchase land in a fee simple estate, then you own your mineral rights. Mineral rights can also be inherited or purchased separately from the property’s surface.
- Extract valuable resources. Usually, the surveying, drilling, and extraction are performed by professionals. Most mineral rights owners sign an oil and gas lease, allowing companies to access and use the property.
- Wait for your paycheck. Once oil or gas is removed from your land, the resources are sold in the marketplace. In oil and gas leases, you will receive an oil and gas royalty as a fixed percentage of resource sales.
In this sense, some people view earning oil and gas royalties as a way to earn passive income. So long as the oil and gas lease is a success, royalty payments are a great way to financially benefit over a long period of time. Learn more about how to get these royalties.
Different Kinds of Mineral Interests
In the oil and gas industry, “mineral interests” is an umbrella term for what can be a few different types of royalty payments associated with a resource drilling operation. Although the language has evolved over the years, the three most common kinds of mineral interests are:
- Royalty Interests
- Overriding Royalty Interests
- Working Interests (aka Operating Interests)
Working interests, or operating interests, are ordinarily only earned by individuals and companies directly involved with the labor and equipment used to extract oil or gas.
Learn more about the different kinds of mineral interests.
What is the Difference Between an Oil Royalty and an Oil Royalty Interest?
In oil and gas leases, two of the most commonly used (and commonly confused) terms are oil royalties and oil royalty interests. Both royalties and royalty interests are great ways to earn income from the profit of a drilling operation, however, there is one major difference:
- Royalties are the landowner’s share of an oil or gas production.
- Royalty interests are earned by those involved in the actual production of oil or gas.
Royalty interests are usually reserved for contractors, financers, or other companies that are involved in the exploration, extraction, or sale of the resources. Oil royalty interests may also come as a fixed percentage of an operation, or as a one-time fixed payment for the party’s contribution.
Learn more about the difference between oil royalties and oil royalty interests.
When are Oil and Gas Royalties Paid?
For many landowners, it is nice to wish that oil and gas royalty payments were earned as soon as the oil is struck. Unfortunately, no matter how valuable the resources are below your property, you are going to have to wait for at least a small period of time before the check is sent in the mail.
By law, oil and gas companies must begin to send royalty payments within 120 days after the end of the first month of oil or gas production. Once the operation is up and running, royalty payments are due 90 days after each month of resource sales. Whereas this 3-month delay may be hard to wait for, many companies deliver oil and gas royalty payments within 60 days of extraction and sale.
Read more about when are they paid.
How Much Money Can You Make From an Oil Well?
Even though it’s below the ground, it’s safe to say that the sky’s the limit when it comes to how much money you can make from an oil well. If you own a large percentage share in a successful oil and gas lease, then you could be earning huge amounts of money each month in the form of oil and gas royalties.
Of course, if you only own 1/64 of the oil well, then it will not likely make you a millionaire. Likewise, the amount of money you make is directly related to the current market price of oil. In fact, there are many factors that influence how much money you can make from an oil well. These include:
- Property Size
- Property History
- Estimated Amount of Oil Reserves
- # of Existing Wells
- Percentage Ownership
- Price of Oil
- Oil and Gas Lease Terms
- & The Volume Sold
Read more about how much money you can make from an oil well.
How does the price of oil affect mineral rights owners?
Although there are clearly many factors that influence the amount that can be earned with oil and royalty payments, most of the variables largely stay fixed throughout an operation’s lifetime.
Originally, property size, lease terms, and percentage ownership will not change over an oil well’s lifetime. Instead, variances in the exact payment amount of mineral rights royalties are largely affected by the amount and price at which oil or gas is sold. From there, percentage share is calculated from exact transaction balances.
Read more about the factors affecting oil prices.
How Long do Mineral Rights Last?
Here’s the short answer: Mineral rights last as long as you do. If you own your mineral rights outright (perhaps as a part of your entire property estate), then you will be the owner of your mineral rights so long as you are alive.
Mineral rights are required to earn oil and gas royalties, so they can be very valuable. Mineral rights can be gifted, sold, or bequeathed to another individual or entity. Only the true owner of mineral rights can enter in an oil and gas lease in an effort to receive royalty payments.
If mineral rights are abandoned, then they may revert back to the surface rights owner of a property. This comes after a predetermined amount of time after abandonment, which varies state to state.
Learn more about how long mineral rights last.
Taxes on Oil and Gas Royalties: What is Paid?
In a sense, oil royalties are not going to be exempt to what many consider two of the only guarantees in life: death and taxes. That’s right, oil and gas royalty payments are made, but only after current tax rates are applied and paid.
Depending on the location and nature of the transaction, an oil and gas royalty payment may be subject to a few different taxations. These include:
- Federal Income Tax
- State Income Tax
- Bonus Income Tax (when applicable)
Bonus income tax rates are only applicable to oil or gas “bonus” royalty payments above $600. These usually come at the beginning of an oil and gas lease, as a sort of “signing bonus.”
State income taxes may come in the form of a flat rate or fixed percentage. Of course, some states, like Texas, Wyoming, and Nevada do not enforce a state income tax. Conveniently, these are great states for oil and gas production.
Read more about the taxes that are paid.
Oil And Gas Royalty Deductions Guide for Tax Season
As a part of a mineral rights lease, those who receive oil and gas royalties can be essentially viewed as small (or large) business owners. Every piece of income that is generated from the well’s royalty payments are subject to income tax. However, applying oil and gas royalty directions during tax season can help mineral rights owners save more on their operating costs.
By far, the most common deduction for oil and gas royalties comes in the form of a depletion alliance. Aptly named, a depletion allowance allows taxpayers to write off the loss of a property’s value as the natural resources are depleted. Depletion allowances come at a standard 15% of gross income, however more exact amounts of oil reserve depletion can be calculated.
Learn more about tax deductions.
Who Buys Oil Royalties?
Like a stock yields dividends, owning a percentage share of mineral rights yield oil royalties. Whereas these payments are variable, but steady bits of income, there may come a time where oil royalty owners want to cash out.
The exciting thing about the mineral rights industry is that there are essentially no rules. No two contracts are alike, so be sure to check the associated clauses when considering selling your mineral rights and transferring your oil royalties to an individual or company.
Anyone can buy royalties, but it is highly advised to not sell to the first interested buyer. Consider your options and speak to a professional before renegotiating your oil and gas lease.
Explore more about who buys oil royalties.
The Rights of an Oil Royalty Owner
Oil and gas leases can be extremely complicated, full of industry jargon and fine print that may leave some property owners wondering exactly what they are signing up for. Most commonly, all of the legal information and rights of oil royalty owners are outlined in one of several documents. These include:
- A copy of the deed
- A copy of the mineral lease
- A division order
- And any communications with the oil and gas company
In order to fully retain and enforce your rights as an oil royalty owner, it is important to keep these documents on hand, in a safe place. Whereas most oil and gas operations go smoothly, company shutdowns and other external forces may cause a contract to go sour. Being able to show all of the necessary paperwork (and understanding it in the first place) is the best way to ensure your basic rights are met and enforced.
American States that Earn the Most Oil and Gas Royalties
Whether you are an experienced investor or simply looking for some market data, it is pretty interesting to see which American states earn the most oil and gas royalties. Although each state earns a different amount each year, in general, many of the highest-earning states remain in the top 10 annually.
In general, the following ten states earn the most oil and gas royalties:
- North Dakota
- New Mexico
If you own mineral rights in any of the states above, then you may want to consider signing a mineral rights lease. In doing so, you will be able to earn oil and gas royalties for anything extracted from your property.
Learn more about the states that earn the most royalties.