Royalty interest in the oil and gas industry demonstrates a crucial facet of property rights. It offers the holder a strong share of the profit generated from mineral extraction without actually engaging in operational and extraction expenses. This informatory piece will explain all the fundamental aspects of entering into royalty interest in oil and gas. Let’s dive deeper.
About Royalty Interest
In the oil and gas industry, the royalty interest refers to an interest that offers the legal rights to receive a share of the production from the leased mineral surface to the royalty interest owner. Even though the royalty interest owner has legal rights to receive the share of production, they need not engage in the drilling or operating expenses of the wells that exist on leased land; basically it’s a passive income. Royalty interest in oil and gas is also known as Net Revenue Interest (NRI).
Royalty interest holders must understand that they are only eligible to benefit from the profits received from the hydrocarbon production, and not responsible for any kind of operational or drilling expenditures at all. However determining the appropriate value of the royalty interest is often a challenging task as they are generally privately held.
Moreover, once the hydrocarbons are extracted from the reservoirs, the well undergoes declining production results instead of growing one. The owners must go through all the legal aspects before investing in royalty interest. They can also engage in various types of royalty interest.
Types of Royalty Interest
Below are three major types of Royalty Interest.
- Ownership Interest
Ownership interest is the most common and highly preferred amongst investors. Holding the ownership interest grants its owner the possession of land and legal rights to explore the hydrocarbons beneath the land. If the leasing companies decide to drill for the minerals on the land, they must lease the mineral rights from the landowner to avoid any legal disputes. Lease terms, including bonuses and royalties, are negotiated individually.
Generally, such leasing companies offer the landowner a substantial amount of royalty income. It may involve sign-on bonus and current royalty payments. The amount of lease usually depends on a myriad of factors such as long-term well profitability, rivalry for the leases in the market, the risk belonging to the mineral area, and fluctuations in oil prices.
The landowner can also sell some portion or all the ownership interest to the mineral firms if he finds any future risk.
- Non-Participating Royalty Interest
As the name indicates a non participating royalty interest (NPRI) does not include any participation in sharing of expenses. The NPRI is the share in the mineral profits received by the owner that does not include any kind of sharing the expenditures.
If the landowner decides to sell the property they possess but wants to retain a stake in the mineral profits, they might become eligible to reserve an NPRI.
This represents that NPRI holders have a legal allowance to receive a share of profit without actually participating in lease bonuses and negotiations. Landowners can also sell their NPRI for quick finance, such as huge purchases or medical bills.
- Overriding Royalty Interest
Overriding royalty interest refers to the additional payments made by a lessor (working interest owner) when they decide to sell their lease to another oil and gas company. Let us understand it better from the following situation.
You are a mineral owner and leased your land to a landman for oil and gas exploration.
If the landman leases your land with an 18.75% royalty, they may sell this lease to other leasing entities but retain 1.25% ORRI for themselves. This ORRI the landman owns doesn’t minimize the payment to you; instead, it adds the expenses the leasing firm needs to pay. So, the leasing entity pays 18.75% of profits to you and an additional 1.25% to the landman who leased your land.
ORRI only depends upon the leases. They can last only till the lease stays active. Once the lease expires, the ORRI also expires. While investing in ORRI you must engage in high potential leases only and understand the value of royalty interest.
Value of the Royalty Interest in Oil and Gas
Valuing of royalty interest refers to the legal process of calculating its appropriate market worth. This essentially means figuring out the correct prices the buyer and seller who lack prior acquaintance would agree on. You can analyze mineral owner data, and oil & gas well data in order to get a better valuation of your royalty interest.
The value of royalty interest in oil and gas strongly depends upon anticipated future revenue generated from leasing or production. However, the following factors may also influence the value of royalty interest.
- Ongoing Oil and gas market prices
- Drilling environment and risks
- Financial and political variables
- The market demand for oil and gas
- Neighboring drilling undertakings
- Technological innovations
This comprehensive draft has covered all the essential information associated with royalty interest in oil and gas. However, you should go through all the legal formalities in detail and consult with mineral experts before investing in royalty interest.
