Oil and Gas Interests: Part One
Mineral interests and royalty interests and non-participating royalty interests, oh my! In this post, we’ll be discussing each of these interest types. Read on to learn more!
Oil and gas law can be overwhelming, especially when it comes to its terminology. Terms are often used interchangeably and sometimes their meanings overlap. For example, we’ll use the terms “rights” and “interests” interchangeably throughout this post. Once you understand these different terms, however, oil and gas law doesn’t feel so confusing. In this post, we’ll go over mineral interests, royalty interests, and non-participating royalty interests.
Before we begin, it’s important to first understand the rights to land ownership. Land ownership includes both the surface rights and mineral rights, also called the surface estate and mineral estate. These mineral rights include all the oil, gas, and other natural resources that lie below the surface of the earth. The surface estate and mineral estate can be separated from each other. When that happens, the surface estate and mineral estate are said to be “severed.” Let’s look at an example: Oliver owns all of the rights to a tract of land. He transfers only his mineral rights to Michael, thereby severing the surface estate from the mineral estate. Michael is now the owner of all mineral rights under the tract of land, and Oliver owns only the surface rights to the tract of land.
Mineral Interest:
Let’s take a closer look at mineral interests. As stated above, mineral interests include all the oil, gas, and other natural resources (sometimes collectively called “hydrocarbons”) that lie below the surface of the earth. Mineral interests are made up of five separate rights. These rights are:
The right to develop and produce the minerals
The right to sell and lease the minerals, also called “executive rights”
The right to receive bonus payments
The right to receive delay rental payments
The right to receive royalty payments (including shut-in royalty payments)
You can think of these elements as a bundle of sticks, where each stick represents a separate right. The mineral interest owner collectively owns all of these rights, but can also sell each individual right to other people. You can visualize such a transfer as the mineral interest owner taking a stick out of the bundle and giving it to someone else.
Although the mineral interest owner has the right to develop and produce the minerals himself, most mineral interest owners will lease this right to an oil and gas company instead by an Oil and Gas Lease. Upon executing an Oil and Gas Lease, this right to develop and produce the minerals is transferred to the oil and gas company for as long as the term of the Oil and Gas Lease, and the mineral interest owner will retain the four remaining sticks, or rights, listed above. In exchange for the execution of the Oil and Gas Lease, the mineral interest owner will receive bonus payments, delay rental payments, and royalty payments.
Royalty Interest:
A royalty interest is an interest in the Oil and Gas Lease that gives the royalty interest owner the right to receive a portion of the total production profits from a producing well. This portion of production is made in the form of a royalty payment. Royalty payments are calculated after production costs have been accounted for from the total production. The costs to maintain the operate the well, for example, are considered production costs. The exact portion of production covered by the royalty payment is negotiated in the Oil and Gas Lease. The most common percentage seen today is typically 3/16 of production, being 18.75%.
Assuming that the mineral interest owner still owns the four remaining rights listed above, then the royalty payments would be made to the mineral interest owner. This is because the mineral interest owner still has the fifth stick in his bundle, the right to receive royalty payments. However, the mineral interest owner can take this fifth stick out of his bundle and give it to someone else. He can decide whether he wants to transfer the entire stick to someone else, or he can break the stick into pieces and only transfer a portion of it. When the mineral interest owner transfers any part of his right to receive royalty payments, he creates what is called a non-participating royalty interest.
Non-Participating Royalty Interest:
A non-participating royalty interest is an ownership in the share of the total production profits in a well, but it is paid to an owner who only has the right to receive royalty payments. Non-participating royalty interest owners do not have any other rights, so they do not have the right to develop and produce the minerals or the right to sell or lease the minerals, though they can sell their non-participating royalty interest. They also do not have the right to receive bonus payments or the right to receive delay rental payments, since these payments are made upon the execution of the lease.
A mineral interest owner may wish to create from their own royalty interest a non-participating royalty interest for a number of reasons. For example, let’s say that Mary executed an Oil and Gas Lease with a 1/5 royalty that has successfully been producing oil and gas for a number of years. Mary wants her two children to share in the wealth she receives from her royalty payments, but doesn’t want her children to have to worry about negotiating leases down the line. Instead of giving them a share of her mineral interest, she decides to just transfer a portion of her royalty interest to each child, thereby creating non-participating royalty interests for her two children.
Have more questions? Check out our Frequently Asked Questions on our Mineral Rights page HERE or contact us HERE.