Severing Your Mineral Estate - A Basic Example of Mineral vs. Royalty Ownership posted by Matt Bodley

As the fee owner to 3,000 mineral acres, your options are pretty wide open as to how
you wish to handle your estate. If you wish to convey a portion of your mineral interest,
royalty interest, working interest, or any portion of each, you can. Let’s compare mineral
vs. royalty. Mineral ownership is mainly defined by, oil and gas on, in or under, while
Royalty ownership is mainly defined by, oil and gas produced & saved, or oil and gas
produced, saved and marketed.

In general, mineral owners have executive rights and receive bonus and rental payments.
So as the owner of 3,000 mineral acres, you get an offer from someone looking to buy
50% of your mineral estate. You strike a deal and convey an undivided 50% mineral
interest on, in or under the 3000 acre ranch. Because there were no further stipulations in
the agreement, you and the new owner each own 1500 undivided mineral acres. If an oil
and gas company is interested in leasing the property, they will need two leases signed to
get 100% of the leasehold, one from each mineral owner.

In most cases, a royalty interest will be reserved or conveyed as a way to share in the
production of a well, free of production costs, with no rights of participation. This is
often called a non-participating royalty. While mineral owners have executive rights
and receive bonus and rental payments, non-participating royalty owners do not. The
most a non-participating royalty owner will be asked to do in regards to any leasing
efforts is to sign a ratification acknowledging that an oil and gas lease has been executed.
The royalty owner benefits from actual production so in order to benefit from being
a non-participating royalty owner, the well has to pay out. Non-participating royalty
owners may have the easiest route to income from a well because other than signing
the ratification, cashing the royalty check is all that needs to be done. While mineral
owners invest time and money to negotiate lease bonus amounts and provisions, non-
participating royalty owners sit back and hope the well is a monster.

Suppose you are interested in selling the Southern 1/3 portion (Southern 1000 acres) of
your 3000 acre ranch and you find a buyer. Within the conveying deed you reserve a 25%
non-participating royalty interest.

So now, with all examples of conveyances shown, you own 50% of all oil and gas in
and under and that may be produced (mineral and royalty estates) to the 2000 acres that
weren’t conveyed (the Northern 2/3 of the original 3000 acres ranch) and a 25% non-
participating royalty interest to the 1000 acres that were conveyed (Southern 1/3 of
original 3000 acre ranch). So how are your payments determined?

First, let’s focus on what you can control; your 50% mineral interest in and to 2000 acres.
Here you are able to negotiate all facets of the lease. Let’s say an oil and gas company is
interested in obtaining 100% leasehold to the original 3000 acres. You own 1000 mineral
acres, First buyer owns 1500 mineral acres and Second Buyer owns 500 mineral acres.
The oil and gas company, depending on the situation, will negotiate 3 separate leases:
One from you that covers 50% of the Northern 2/3, or Northern 2000 acres (1000 net
mineral acres); one from the First Buyer covering 50% of the entire 3000 acres (1500
net mineral acres); and one from Second Buyer covering 50% of the Southern 1/3, or
Southern 1000 acres (500 net mineral acres). Let’s focus on what you can control with
your executive rights to 1000 net mineral acres. If you and oil and gas company come
to an agreement of $500/acre and 25% royalty, you will be paid a bonus amount of
$500,000 ($500 x 2000 gross acres divided by 50% mineral ownership) and receive 25%
(less 50% of) royalties on the production of the well (subject to the agreed royalty terms).

So what value does that 25% non-participating royalty interest hold? The negotiations
for this lease are out of your control. What you are entitled to is 25% of whatever royalty
percentage is signed for on the lease. For instance, if the owner of the Southern 500 net
mineral acres signs an oil and gas lease with a 25% royalty provision, you will get 25%
of their 25% and they will be less 25% out of the 25% they signed for. In other words,
your 25% non-participating royalty interest is carved out of the percentage amount that
the executive rights owner signs off on. Say the gross royalty check at 25% for 500 net
mineral acres is $10,000. As a 25% non-participating royalty owner you will be cut a
check for 25% of that $10,000. So, while you have no worries in negotiating the lease,
you are subject to the royalty amount the lease is agreed upon.

These examples are in the most basic form. In long time producing parts of Texas like
West and East Texas, it is not uncommon to find a tract with several non-participating
royalty owners and several mineral owners. Severing your mineral estate is a great way to
profit from what you own, especially if timed right.

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