Mineral rights give the owner the right to exploit underlying resources. Most people do not have the means to extract these resources by themselves, so they instead choose to lease the rights to someone who does. These leases usually call for a royalty, along with an up-front bonus payment. Royalties entitle the lessor to a percentage of the revenue generated from the sale of the produced minerals. In oil and gas leases, royalties typically range between 12.5% and 20.0%.
Types of Oil & Gas Interests
Mineral ownership does not necessarily equal royalty ownership. The opposite is also true. Owning a royalty does not necessarily mean owning minerals. Let’s explore how this can be, along with the various types of ownership common to mineral rights.
Mineral Interest v. Royalty Interest
In this context, “interest” simply refers to a form of ownership. A mineral interest means you have ownership in minerals. The minerals may or may not be leased. A lease creates the royalty interest. Prior to the execution of an oil and gas lease, a royalty interest does not exist. No one has agreed to pay you a royalty for anything. The lessor only has a royalty interest after signing a lease that entitles him to as much.
A mineral owner could choose to sell his royalty interest, but keep his minerals. In this case, he maintains a mineral interest but no longer has a royalty interest, despite the existence of a lease. A royalty interest still exists, it’s just that someone else now owns it. A mineral owner might to do this if the lease that created the royalty only covered certain depths, for example. The mineral owner could sign another lease that covers these other depths, creating a new royalty interest in said depths.
Royalty Interest v. Working Interest
There are two types of owners in any oil and gas well:
- Working Interest Owners
- Royalty Interest Owners
Working Interest
Working interest owners participate in the cost of drilling a well. Royalty owners bear no expenses and only participate in the revenue. A helpful way to keep this straight is that working interest owners have put money “to work”, while royalty owners benefit from other peoples work, like a king or queen.
Working interest ownership can result in one of two ways:
- Owning un-leased mineral rights
- Being a lessee of mineral rights
Mineral rights owners that do not lease their minerals become working interest owners when drilling occurs by default. This does not mean they will have to come out of pocket for their share of drilling costs, however. Unleased owners can pay their share of the cost of drilling if they so choose. This entitles them to the same proportionate revenue. If they do not participate, they will be force-pooled.
Force-Pooling
Force-pooled minerals are pooled into a well without the owners consent. This is done in the name of conservation. Exact rules vary by state, but usually unleased owners are considered force-pooled and receive a statutory royalty until the cost of the well + a penalty are recovered. At this point they are treated as full, proportionate partners in the well. You can read more about force-pooling here.
If a lessee is not the well operator, he is considered a non-operating working interest partner (“non-op”). Like an unleased mineral owner, he has the option to not fund his share drilling costs. If he elects to not pay in his share, like unleased mineral owners, he is force-pooled. Force-pooled lessees are also subject to a non-participation penalty, but usually do not receive a statutory royalty prior to this penalty being recovered.
Note: Unleased mineral rights owners and lessees may also choose to go “non-consent”, but that is beyond the scope of this article.
Royalty Interest
There are three common types of royalty interests. By far the most common is a mineral owner who has executed a lease entitling them to a royalty. The next most common are non-participating (NPRI) and overriding royalty (ORRI).
Royalty Interest (RI)
The interest created when a mineral rights owner executes a lease calling for royalty payments. Prior to the execution of an oil and gas lease, a royalty interest does not exist. The lessor/owner of mineral rights only has a royalty interest after signing a lease that entitles him to as much. A leased mineral owner has both a mineral interest and a royalty interest (unless the owner sold the royalty interest at some point).
Non-Participating Royalty Interest (NPRI)
“Non-Participation” here means the owner of an NPRI has no say in decisions regarding the underlying minerals. An NPRI owner cannot negotiate or execute a lease and does not share in any lease bonus. It is strictly a share of production. NPRIs are “carved out” of the minerals (i.e. the existence of an NPRI reduces the mineral interests entitled share of production) and usually created when minerals are sold or transferred. Language like “…seller reserves 1/4 of 8/8ths production” creates an NPRI. If you own minerals that are subject to an NPRI, you will not receive 8/8ths (i.e. 100%) of the production attributable to your minerals.
For example, let’s say your father transfers his 40 mineral acres to you and includes “…seller reserves 1/4 of 8/8ths production” language. Additionally, the minerals are subject to an oil and gas lease with a stated royalty rate of 12.5%. The lessor drills a vertical well that pools 160 acres, including your 40. Your share of production in this case is*:
(40/160) * 12.5% * (1-(1/4)) = 2.344%
Without an NPRI, your share of production is: 40/160 (the proportion of acres you contributed to the well) x 12.5% (your lease royalty) = 3.125%. We see your share of the production is reduced by 25%, or the 1/4 NPRI.
Your father’s (i.e. the NPRI holder) share of production in this example is 0.7813%. The calculation is: (40/160) * 12.5% * (1/4)). This comes out of the mineral interest owner’s share (aka you).
Overriding Royalty Interest (ORRI)
Oil and gas professionals often receive an override as a form of payment for services rendered. An override gets carved out of the working interest (i.e. the existence of an ORRI reduces the working interests entitled share of production). Even though an ORRI is carved out of a working interest, because it is a royalty interest it bears no expense obligations. An ORRI is simply the lessor telling someone “I’ll give you X% of the revenue generated from this lease.” This amount comes out of the working interest owner’s share. Because it is tied to a specific lease, an ORRI will expire if the underlying lease expires.
In the example above, if the lessor owns the leases for all 160 acres and gives a 5% override to his geologist, the calculation for his share of production is as follows*:
(1-12.5%) – 5.0% = 82.5%
The geologist’s share of production is simply 5.0% of all production, with it coming out of the working interest owner’s share.
*These calculations assume there is no proportionate reduction happening. The actual calculation for NPRIs and ORRIs depends on the exact language to determine if they are subject to proportionate ownership reductions. This wades into heady territory and is beyond the score of this article
Summary
The most common types of mineral rights ownership are:
- Mineral Interest: The owner of mineral rights. Mineral interests do not by default carry a royalty interest with them.
- Royalty Interest: Created when a mineral owner signs an oil and gas lease, assuming leases calls for a royalty.
- Non-Participating Royalty Interest (NPRI): Entitles owner only to a share of production. Created from the mineral estate. Example language is “…reserve 1/4 of 8/8ths of all future oil and gas production.”
- Working Interest: A lessee or unleased mineral owner. Working interest owners can either fund their share of drilling costs or be force-pooled.
- Overriding Royalty Interest (ORRI): Entitles owner only to a share of production. Does not oblige owner to any costs. Created from working interest, often to compensate those who assist in a project. Tied to a lease, so once lease expires, so does ORRI. Effectively creates a higher royalty on the lease from the working interest owner’s perspective.
