NEED TO KNOW TERMINOLOGY AND VALUE METRICS

By Skip Peel, Independent Landman

In order to make informed decisions concerning leasing and selling minerals it is helpful to understand what you own and how you own it.  It may seem strange but a large percentage of mineral owners do not know what they own.  The legal concept of severing the mineral estate from the surface estate did not come into practice until the early twentieth century when the exploration and production of oil spread across the nation.  Some areas of the country did not experience exploration and production until the mid to late twentieth century  and some areas long thought to be non-commercial are proving otherwise in the twenty-first century.  The ownership of both estates is said to be ownership in fee.  Once the potential value of minerals became clear the sale and trading of mineral and royalty rights became relatively common in areas of successful production or sheer speculation.  Thereafter mineral rights were often severed and no longer owned in fee.

It is common for ownership of minerals to be shared by multiple owners.  When an individual owns a fraction of the whole they are said to own an undivided interest.  For example, four owners with equal interests in a 40 acre tract are said to own an undivided interest in one quarter of each acre.  Another common way to express this is that each owner owns 10 net mineral acres.  It is common practice for lease forms to contain the gross acreage of a master tract, (e.g. 40 acres) instead of the net mineral acre total for each undivided ownership interest (10 acres).  For that reason if the four owners were to all lease their interest in the 40 gross acre tract they would execute lease forms giving a legal description of the tract as 40 acres even though their individual interest was one quarter or 10 net mineral acres.  The simplest way to calculate what the company offering the lease thinks you own is to find out the dollar amount of the bonus per acre and then to divide the bonus payment by the per acre amount.  If the bonus per acre was $200 and your bonus check was for $400 then the land company would have calculated that you own two net mineral acres of the 40 gross acre tract.  An owner of an undivided interest may act independently of the other owners to lease and receive a bonus or to sell their mineral right or a royalty interest.

In states that allow severance of the mineral estate from the surface estate in perpetuity it is quite common for gross tracts to have many owners due to the handing down of family ownership over generations.  In many cases those heirs are unaware that they own the mineral interest owing to the fact that it may never have been leased and that no taxes are levied on non-producing minerals (how minerals are taxed varies by state).  Their first recognition of that ownership interest is often when they are contacted by a landman offering a lease.  Undivided ownership may also come about by the sale of a portion of the mineral right as opposed to ownership handed down within a family.  Between sales of mineral interests and the passing of ownership by will or forced heirship laws a 40 acre tract of land could have many owners each having a small fraction of the whole and it is not unusual for the surface owner to have no ownership in the mineral estate.  

Louisiana mineral law is different from most other states in that the severance of the two estates in perpetuity is not allowed.  The sale of Louisiana minerals results in the creation of a mineral servitude (the right to explore for and produce minerals) that is governed by a ten year prescription period.  The ten year period begins the day a mineral servitude is created.  At the end of the ten years the mineral right would return to the current surface owner if there is no good faith effort to produce (drill a well meeting state standards).  If a productive well is completed the prescription period is suspended and begins anew from day one on the date that the production ceases.  If a well meeting the standards is drilled and is not productive that act resets the ten year period which begins again from day one that the well is plugged and abandoned.  A mineral servitude may be created with an effective period of less than ten years but cannot be greater than ten.  This is a simplified definition and mineral servitudes can be quite complex and subject to a number of exceptions and conditions.  Servitude owners should seek counsel from professionals with extensive experience in servitude statutes and legal precedents.   

Researching mineral title is complicated and requires experience.  In states where the two estates may be severed in perpetuity running title is especially time consuming and costly.  For this reason a client company dictates the level of due diligence that a land company will employ in order to offer a lease.  It is common practice in the industry to perform a limited amount of due diligence during the leasing process.  This is because it is a considerable expense that is wasted if a well drilled under those leases is dry or sub-economic and not produced.  If the well is economic then the client will conduct a full blown title review in preparation for paying out royalties.  That review will result in a Division Order that specifies who will be paid and calculates the net mineral interest for each royalty recipient.  Division Order reviews may include new surveys of each tract in a unit and those surveys may not correspond exactly with older or original surveys.  For example a tract surveyed in the early twentieth century may be found to be of a different size with the more modern technology/methods used in a new survey.  Once a Division Order is completed each royalty interest will receive a document stating their specific decimal interest and requesting personal information for tax purposes.  When mineral owners approve their decimal interest and provide that personal information they are said to be "in pay" and will begin to receive monthly checks and statements. Mineral lessors should keep originals or copies of all documents pertinent to their lease, division order and royalty payments in a permanent file along with the contact information for their operator and/or lessee.

There is an additional term and concept that should be mentioned although it will not come up in lease negotiations nor in the payment of royalty.  Those in the business of buying, selling and brokering minerals often use the term, royalty acre.  In addition to mineral ownership having a net mineral interest, leased minerals will have a royalty acre total based on the royalty fraction contained in the lease agreement.  Early leases commonly carried a one eighth royalty.  Royalty fractions now are quite varied generally ranging from one eighth to one quarter with leases in unconventional plays normally commanding one fifth to one quarter.  All else being equal, a lease with a higher royalty has greater value to a buyer.  A royalty acre is one net mineral acre at a one eighth royalty fraction.  Therefore our 40 acre tract leased at one eighth is 40 royalty acres.  64 royalty acres if leased at one fifth.  And 80 royalty acres if leased at one quarter.  To calculate royalty acres divide the royalty fraction in the lease by 0.125 (one eighth).  The calculation for a one fifth royalty would be:  0.20 divided by 0.125 = 1.6.   Each net mineral acre under that lease would equal 1.6 royalty acres.  The concept of mineral value based upon royalty acre should be an important consideration when negotiating a lease and deciding which lease terms are most important.

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