Surface Rights, Mineral Rights, Royalty Rights, and Working Interest.

These terms are becoming more prevalent in our day and age and starting to gain a lot more attention, especially by venture capitalists and institutional, private, and passive investors looking for a safe place to invest with a minimal amount of risk.

These terms are often used in a confusing way and the definitions tend to overlap on occasion and definitely require clarification.

I feel it prudent and most logical to start from the top, or surface, and venturing downward and out, so get ready and buckle your seatbelts!

But before we go, first a bit of intel that applies as we dig into all these various kinds of interests, conveyances, reservations, etc…

 

Mineral Right Ownership

A conveyance is simply the legal process of transferring certain property or interests from one person to another, or Grantor to Grantee.

During the conveyance of the property, oftentimes the person transferring the property, the Grantor, will reserve certain rights attached to the property being conveyed.

As to why someone or the Grantor, would do this, could matter greatly for a number of reasons; however, the top two in my opinion would be:

1. With ownership comes with responsibility

The recipient, or Grantee, to whom you, the Grantor, intend to deed specific property or interest to may not be as competent as you may be when it comes to matters of oil and gas exploration. There should be thoughtful and careful consideration of what can and/or will take place should there ever be exploration in your area and specifically, on your acreage.

Oil and gas leases can range anywhere from two to three pages up to 20-25 depending the attorney writing the lease. There are lots of things to consider and one better understand the ins and outs.

If you don’t know what to look for it could literally cost you millions in lost revenue.

YEP. MILLIONS.

 

2. You still want to retain some control

You, the Grantor, may wish to reserve certain rights, specifically the Executive Rights, should you wish to remain on the property.

The Executive Right is the right to grant or execute an oil and gas lease covering the mineral estate.

As the surface owner, you will certainly want to be the one deciding what takes place as far as operations are concerned on your property. If one raises any kind of livestock, wild game for hunting, or does a lot of farming, surface use can be a very big deal and you will want to retain your Executive Rights.

Intentions and/or specific reservations need to be very clearly spelled out during the transfer of specific property or interest. If certain rights need to be withheld from a Grantee for any reason, then during the transfer of specific property or interest is the time to do it.

It is very important to know that unless one or more of the various types of interests is not expressly RESERVED during the conveyance, or transfer of certain property or interest, ALL your RIGHT, TITLE, and INTEREST will pass through with the conveyance to the next party.

 

Surface Rights

If you own the surface rights to an area of land it does not necessarily mean you own the minerals below that land.

In areas of the country where drilling or mining occurs, the ownership between the surface of the land and the minerals beneath it are often severed.

As a sole surface rights owner, this means you have no rights to the minerals or the royalty rights attached to the minerals that are extracted from beneath your land. However, depending on the state, there are laws to help protect surface owners and make them feel more comfortable with oil companies drilling on their land.

Nowadays, oil and gas companies tend to play nice with the surface owner and pretty much always put what is called a Surface Use Agreement in place.

I guess they got tired of their employees and contractors getting shot at and having to place temporary restraining orders (TRO’s) against the owners of the surface!

I’m joking around, but also totally serious; ask almost any tenured Landman and they’ll confirm this really does happen and probably have a story of their own.

 

How the Rights of the Mineral Holder Differ from the Rights of Surface Owner

In certain states, the mineral estate carries more weight, or has greater rights, than that of the surface estate.

Texas, for example, is considered a “mineral dominant state”. Because of “an imperative rule of mineral law: a mineral owner’s estate would be worthless without the right to reach the minerals” (Moser vs. U.S. Steel Corp., Texas 1984).

The surface estate is subject to the rights of the owner of the mineral estate to use the land to extract certain minerals lying beneath so therefore, the mineral estate carries with it “superior” attributes or rights and that is why it is also referred to as the “dominant estate”.

The owner of the mineral estate must have the right to use the surface estate to be able to “go on the land” and drill wells or mine for certain types of minerals should they be present and be of value. This means the mineral owner may grant an oil and gas lease to an exploration company to drill wells on the land without the surface owner’s consent.

However, the amount of surface that may be used can only be what is minimally required or necessary to extract whatever minerals lie beneath.

IMPORTANT FACT: As the surface owner, whether you’re a mineral owner or not, you cannot keep any other mineral owners from exploring for the natural resources below the surface.

In Texas, an oil and gas lease is a conveyance by the mineral owner, the Lessor, to the oil and gas company, the Lessee, of the mineral estate for a specific time frame, or “term”, and thereby the oil company grants to the mineral owner, or the mineral owner reserves, a particular royalty rate or percentage, from what is produced and sold from the land.

There are several other conditions and clauses outlined in an oil and gas lease that carry weight and that one needs to pay attention to; we get into those in our upcoming blog, “Common Clauses Found in Leases”.

 

Mineral Rights

The mineral estate, similar to the surface estate, is considered an ownership interest in the minerals below the land surface of a particular section, parcel, or tract of land and containing boundaries.

In Texas, as well as many other states, the mineral estate can be separated (“severed”) from the surface estate and is very commonly done so. This is done during a conveyance or transfer by the Grantor to the Grantee and by way of a reservation specifically mentioned and outlined in the conveyance.

Multiple parties can own shares of the mineral interest in a tract of land, and in fact, much of the land in Texas, and many other states nowadays have more than one mineral owner.

The dividing of the mineral estate can take place by conveyances or reservations, or by inheritance.

The owners of the mineral estate in a tract of land are called co-tenants or tenants in common. Each mineral co-tenant has the right to explore for and develop the minerals and to execute oil and gas leases covering their undivided or individual percentage of mineral interest, also referred to as their “net mineral acres”.

Each co-tenant’s oil and gas lease can be different, reserving different royalties and providing for different terms.

Mineral co-tenants can, and often do, lease to different lessees. In some cases, this can be advantageous for individuals and sometimes it can prove more difficult in the long run (but that is a conversation/blog for another time).

They each have attached to them certain rights – the right to explore for and extract the minerals under the land being the main right.

 

Types of Mineral Interest and their Rights

As explained earlier, the Executive Right is the right to grant or execute an oil and gas lease covering the mineral estate. The Executive Rights can also be severed from the mineral estate; I explained a few reasons why this would be important earlier.

Due to conveyances and reservations of Executive Rights, one could end up with what is referred to as a Non-Executive Mineral Interest or “NEMI” or quite possibly even a Non-Participating Mineral Interest or “NPMI”.

It should be noted that these two types of mineral interests are fairly uncommon forms of mineral interest owned, but nonetheless are out there:

• Non-Executive Mineral Interest or NEMI

An NEMI may come about when one person reserves 100% of the Executive Rights therefore leaving the receiving party only the right to receive their proportionate share of bonus payments and royalties based on the net mineral acres they own under the tract of land.

• Non-Participating Mineral Interest or NPMI

An NPMI may come about when one person reserves 100% of the Executive Rights AND the right to receive bonus payments for the lease and therefore the receiving party is left with only the right to receive royalty payments, but is yet still a mineral owner.

Both of these interests are uncommon because the Grantee, person or entity receiving the conveyance, usually would prefer to:

• Have the right to negotiate their own oil and gas lease, and
• Want some of the lease bonus should there be an opportunity to negotiate and execute an oil and gas lease

 

Mineral Classified Interest

The Relinquishment Act of 1919, as interpreted by the courts, reserves all minerals in those lands the state sold with a mineral classification between September 1, 1895 and June 29, 1931.

Under the Relinquishment Act, Mineral Classified Interests, or Relinquishment Act Lands (RAL), are interests whereby the surface owner acts as agent of the lands for the state for the purposes of leasing.

The surface owner is responsible for negotiating and executing oil and gas leases on behalf of the state even though the state owns 100% of the minerals.

Moreover, the GLO, the General Land Office, must review and approve the terms and lease bonus payment being offered to lease the minerals and the leases are not effective until approved and filed in the GLO.

As payment for acting as agent for the state, the surface owner is able to receive half of all lease bonuses, delay rentals, and royalties, nothing more; this is given in lieu of any surface damages the surface owner might receive or be entitled to as a normal surface owner.

Above I stated that the surface owner negotiates the lease – this is true and it isn’t, because the GLO uses its own standard RAL lease form, which must be used for Relinquishment Act Lands.

The only thing the surface owner really negotiates is the lease bonus price of which still has to be approved by the state. See the GLO website for further clarification and more useful information.

 

Term Mineral Interest

Mineral interests can also be granted or reserved for a period of time, usually in years; this is called a “Term Mineral Interest.”

This generally has the same definition as Term Royalty Interest described in the next section, except that we are dealing with minerals and not royalties.

It should be noted that Term Mineral Interest conveyances are less common than Term Royalty because individuals generally want to hang onto their mineral interests.

These are just a few of the many “bundles of sticks”, as it’s commonly referred to, that make up mineral interests/estates.

(By the way, we have all this information set up for you visually with this infographic.)

 

Royalty Rights – NPRI, ORRI, and Term Royalty

 

A mineral interest may be divided in another way whereby a mineral owner grants, or conveys, or reserves, a royalty interest instead of a mineral interest as discussed above.

Owning a royalty interest is significantly different than that of owning a mineral interest and comes with fewer rights.

The royalty interest owner has the right to a share of royalties on production from the property, but has no right to lease the mineral interest or to receive a share of any bonus paid for granting a lease.

A royalty interest carved or reserved from the mineral estate is an interest in land, but has no right of use and possession and no right to explore for or produce the mineral estate.

Its sole right is to receive royalties once production is established, no more.

 

Types of Royalty Interest and Their Rights

 

• Non-Participating Royalty Interest or NPRI

When one is a royalty owner and receives royalties and nothing more, their interest is often called a Non-Participating Royalty Interest or NPRI.

I feel this term is kind of an odd term because all royalties are “non-participating” due to not being able to execute a lease or receive any bonus monies for leasing the land.

The royalty interest is created by a conveyance or a reservation in and to a particular parcel of land or mineral interest and is usually done prior to being leased.

This is a bona fide interest that one will own in perpetuity. An owner of a royalty interest of this nature will only receive revenue if an oil and gas well is drilled and produced.

Should a well be drilled and stop producing, the royalty owner will stop receiving revenue, but will still own the royalty interest for the next time an oil and gas lease is executed by the mineral owner that the NPRI is attached to.

This means that the royalty interest will remain in the family until it is sold or conveyed out to a new owner.

 

• Overriding Royalty Interests or ORRI (least amount of rights)

An ORRI is unique in that it can only come about after a mineral owner has executed a lease. It is also always bound to a specific lease or leases.

An ORRI is a portion of the royalty interest and is essentially “carved out” what the oil and gas company is to receive as their royalty, which is what is left over after paying the lessor, or mineral/royalty owner their agreed upon royalty rate.

ORRI’s can also be conveyed or granted to others just as other types of royalty interests.

Owners of an ORRI, like regular royalty interest owners, bear no cost of production, but own a portion of the revenues generated by the drilling and production process.

An ORRI will, no matter what, have a length of time associated with it in which the ORRI holder will be paid royalties. When the lease expires, or if there was ever a well drilled and production established and then ceases to produce and the well is plugged, the ORRI is extinguished and vanishes into thin air.

 

ORRI’s are often granted to professionals who help assemble a prospect, which could be Geologists, Landmen, Attorneys or executives in the company acquiring the leases within the prospect.

• Term Royalty Interest

A royalty interest may be granted in perpetuity or for a term, just like a mineral reservation described above.

It is common for a mineral owner to sell a term royalty interest to remain in effect for a specified number of years and/or “for so long thereafter as oil or gas is produced” from the land.

The benefit of doing this is one can sell and portion of something now and receive some sort of compensation and yet someday, if an oil and gas well is not drilled or even it is drilled and eventually stops producing, you or your heirs will receive this interest back.

NOTE: Nowadays, it is pretty standard that all royalties paid to royalty owners under the terms and conditions of their lease are free of production costs associated with drilling operations and free from any and all transportation and marketing costs associated with bringing the product to market.

With this said, royalty owners still have some deductions and expenses associated with bringing the product to market. Royalty owners are required to pay their share of severance and state taxes associated with owning and receiving royalty income.

 

Working Interest

When an oil and gas company, the Lessee, comes along and takes an oil and gas lease from a mineral owner it creates a new type of interest, the Lessee’s interest, or “working interest” as it is referred to.

When the lease expires and/or the production ceases, the Lessee or operator plugs the well and the working interest extinguishes.

The Lessee, or Working Interest owner in an oil and gas lease, bears all of the cost of drilling for and producing the minerals but receives only a portion of the production which is the difference between the royalty rate, or percentage, received by the mineral owner and 100%.

 

A very simple example:

An oil and gas company leases and drills 100 acres from Jim, the Lessor, and no other Lessors or acreage is included:

• Jim negotiates and gets a 25% royalty rate in his lease so he receives 25% of the royalty, or “revenue”, from the sale of the oil and gas produced. This means he now has a “net revenue interest” or NRI of .25%.
• The Lessee, or Working Interest owner, will receive 75% of the royalty, or “revenue” received from the sale of the oil and gas produced. This means he also has an NRI of .75%.

It is called “working interest,” because it does all the work of exploration and development.

The working interest can also be owned by multiple parties as well as any of the other aforementioned interests. The original Lessee may grant shares, or percentages, of his working interest to other parties who share the cost of drilling and production.

Or, in the event siblings or relatives leased their mineral interests to different oil and gas companies, those oil and gas companies, or working interest owners, may get together and agree to jointly develop the tract.

There can be only one operator of a tract under Texas rules; the company serving as the operator usually enters into a “joint operating agreement” or JOA, with the other working interest owners, which governs the rights and obligations of the collective working interest owners. The other working interest owners then become “non-op working interest” owners and simply pay their proportionate share of the costs.

Take a breather and check out our Working Interest infographic.

 

Tying it all together with a hypothetical example:

John is a single father who owns all right, title, and interest in 100 acres of land. He gets wind that oil and gas companies are sniffing around looking for acreage to lease.

John then decides to distribute his minerals to his children so he decides to:

• Convey ¼ of the minerals to each of his two children, Jimmy and Jane
• John, in that conveyance, reserves the remaining ½ of the mineral estate (no other reservations were mentioned)

Since no other rights were expressly reserved in this case, all other rights – surface, executive, and royalty, transfer through to his children. This means they now have full control of what they want to do with their new inheritance.

The new mineral and royalty ownership now owned is as follows:

• John owns an undivided ½ of the surface rights, executive rights, minerals rights, and royalty rights
• Jimmy owns ¼ of the surface rights, executive rights, minerals rights, and royalty rights
• Jane owns ¼ of the surface rights, executive rights, minerals rights, and royalty rights

John then decides he is feeling generous, so he is going to convey ½ (or 50%) of his ½ of the mineral AND royalty interest to his church for a term of 10 years. This is an example of a Term Mineral and Royalty conveyance. This is also an example of an NEMI and an NPRI simply because John reserved the executive rights during his conveyance to the church.

In this conveyance, John expressly reserves unto himself and his heirs, Jimmy and Jane, all surface rights and all the executive rights, thereby conveying only ½ of John’s ½ interest (or 25% or ¼) of the mineral and royalty interest for a period of 10 years to revert back to John’s children after the 10-year period is up or for so long thereafter as long as oil and gas is being produced from the land.

John decided to do it this way and make those certain reservations because:

• John still wanted control of negotiating any oil and gas leases and not the church because he is knowledgeable about how to negotiate leases, he didn’t want the church to get taken advantage of, and he still wanted control of decisions made pertaining to his and his children’s surface estate.
• John wanted himself and his children to be able to negotiate and receive any surface damage payments received by any would be Lessee, or operator
• John wanted the church to be able to receive a portion of the bonus being paid and the royalty income.

The new mineral and royalty ownership now owned is as follows:

1. John still owns an undivided ½ of the surface rights and ½ of the Executive Rights, but now he owns ¼ of the minerals and ¼ of the royalties
2. Jimmy still owns ¼ of the surface rights, executive rights, minerals rights, and royalty rights, nothing changes
3. Jane still owns ¼ of the surface rights, executive rights, minerals rights, and royalty rights, nothing changes
4. The church now owns ¼ of all the minerals and ¼ of all the royalties for a period of 10 years or for so long thereafter as oil and gas is produced from the land and NO surface or executive rights

XYZ Oil Co., POPS Oil Co., and Landman Bill, who is a broker, all are trying to acquire leases in John’s area. Should XYZ, POPS, or Landman Bill win the bid, or get the leases, then they would be considered the Working Interest Owners and are responsible for paying 100% of the costs associated with drilling any oil and gas wells.

John and his kids eventually lease with Landman Bill for $1,000 per net mineral acre and they negotiate a cost-free royalty rate of 25%.

John, Jimmy, and Jane all execute their leases (the church does not because John reserved the executive rights for himself) and all receive one-time bonus checks for $25,000.

Because John had the Executive Rights attached to the mineral and royalty interest he conveyed to the church, John negotiated the lease and the church now has to sign a ratification agreeing to the terms and conditions contained in John’s lease in order to receive their bonus monies and their eventual royalty income.

Because the church owns a Non-Executive Mineral Interest (NEMI) and not a Non-Participating Mineral Interest (NPMI), they are allowed to receive a portion of the bonus monies and royalties, so the church receives a check for $25,000 from Landman Bill once they sign their ratification of John’s oil and gas lease.

If John had reserved the minerals along with the Surface and Executive Rights, thereby creating an NPRI for the church, the church would not have been able to receive the bonus monies, only royalties.

With this royalty rate of 25%, John, Jimmy, Jane, and the church will eventually receive 25% of the royalty revenue generated from oil and gas production and Landman Bill will receive the other 75%.

Now that leases have been executed with Landman Bill, the mineral, royalty, and working interest ownership now owned is as follows:

1. John still owns an undivided ½ of the surface rights and ½ of the executive rights, ¼ of the minerals and ¼ of the royalties, nothing changes
2. Jimmy still owns ¼ of the surface rights, executive rights, minerals rights, and royalty rights, nothing changes
3. Jane still owns ¼ of the surface rights, executive rights, minerals rights, and royalty rights, nothing changes
4. The church owns ¼ of all the minerals and ¼ of all the royalties for a period of 10 years or for so long thereafter as oil and gas is produced from the land and NO surface or executive rights, nothing changes
5. Because John, his family, and the church each owned ¼ (25%) of the royalty under 100 acres of land and have now leased to Landman Bill and reserved ¼ (25%) in their leases, John, his family, and the church will each receive 25% of 25%, or .0625% royalty (25% divided by 4 = .0625%), or NRI, of the production from their 100 acres of land
6. Landman Bill now owns 100% of the Working Interest (WI) and 75% of the royalty interest or “Net Royalty Interest” or NRI, associated with those leases and so he will receive 75% should he end up drilling and producing the acreage

Six months after Landman Bill took the leases, he sells those leases to POPS Oil Co.

When Landman Bill assigns, or conveys, those leases to POPS he delivers 90% of the working interest and reserves unto himself 10% working interest and a 1% Over-Riding Royalty Interest (ORRI) thus leaving POPS to receive 74% of the royalty, or NRI, from the oil and gas produced.

Bill is now responsible for paying 10% of the costs associated with drilling and POPS is responsible for paying 90% of the costs.

The CEO of POPS then decides he is going assign, or convey, unto himself a 4% ORRI thus leaving his company an NRI of 70%.

Now that the leases have been sold to POPS Oil Co., the mineral, royalty, and working interest ownership now owned is as follows:

1. Everything with John, Jimmy, Jane and the church remains the same
2. POPS Oil Co. is now the operator of the leases and owns 90% of the working interest and 70% of the royalty or an NRI of .70%
3. Landman Bill now owns 10% of the working interest and 1% of the royalty interest (ORRI), an NRI of .01%
4. The CEO of POPS Oil Co. now owns a 4% ORRI or and NRI of .04%

If only the 100 acres were to be drilled and produced, the basic NRI for everyone would be as follows:

1. John and family have .25% NRI (.0625% x 4 = .25%)
2. POPS has .70% NRI
3. Landman Bill has .01% NRI
4. CEO of POPS has a .04% NRI

Total NRI = 1.00 or 100% of the revenue or royalty produced from the 100 acres of land

Now, should there ever be well drilled and there is additional acreage “pooled” or “unitized” with these 100 acres, these calculations will surely change, but that’s a blog for another time.

So, this is where we’ll end this hypothetical example and this is where the interest will remain until there is a well drilled or any one of the aforementioned parties decides to sell, transfer, assign, or convey their interest to another party.

 

Finito!