Minerals and Royalty: Or, What Did I Just Sell to That Guy?

Now that NAPE has been over for a couple of weeks, and the hangover(s) and short week after Mardi Gras has come to an end, I figured I would address a topic that has come up on more than a few occasions in various discussions on GHS, and seems to have been revived again in the wake of the latest mass mailings from mineral and royalty brokers.

I should probably mention here that my area of discussion, and the state in which I predominantly work is Louisiana. No knocks to the Texas and Arkansas members, but Louisiana is the state I know, and the peculiarities of LA law and landwork are a daily part of my work as a landman (no, I'm not an attorney). Also, for the purposes of discussion, I assume that the landowner / mineral owner is not considered to be 'in the oil business'.

Minerals and royalty have long been a source of confusion and debate amongst the landowner / mineral owner and land professionals and attorneys alike for many years. The terms are often used interchangeably, sometimes even within the same document, and on more than a few occasions have landmen and lawyers had to have in-depth discussions as to whether a particular conveyance is a sale of minerals, or royalty. To boot, the Mineral Code further vexes the discussion by many citations of the term 'mineral royalty'. The term always flashed me back to a sendup of the old Reese's PB cup commercials:

"Hey, you got some of your minerals into my royalty!"
"No, you got some of your royalty into my minerals..."

But then I flash back to the reality that the terms and implications of a sale of minerals and a sale of royalty are quite different.

So, what is a mineral right? Unlike other states, mineral rights in LA are not a right to something tangible and permanent (particularly with respect to oil and gas). Unlike any other surrounding state, Grandpa couldn't take an acre of land in which he owned all rights, from heaven to hades, and sell the surface of that acre to Jim, and the minerals to Joe, and never have the rights in that acre (severed by sale) come back together again, unless Jim and Joe (or their successors in title) make a deal amongst themselves (like in TX). In LA, mineral rights are the right to capture minerals lying in, on, or under a particular tract of land. The mineral owner can lease this right in exchange for bonus, rentals, and royalty, subject to various provisions in the lease, or sell or donate this right, but the sale of mineral rights without the surface automatically creates a servitude of use for said rights. In general, the owner or lessee of mineral rights severed from the surface has a ten-year period with which to use these rights, or he loses them by prescription to the surface owner. If they are used, however (by the drilling of a well, or other qualifying operations, successful or not), the servitude is held by such productions or operations until such production or operations cease; thence, the running of prescription (and the ten-year clock) begins anew. This is one of the reasons that a oil, gas and mineral lease (OGML) cannot have a term of greater than ten years (if the lessee hasn't developed the OGML within the ten years, the lease is automatically terminated due to the rights prescribing to the surface owner). Also, only the mineral owner has the right to lease his right to capture minerals (although if the mineral owner does not possess any rights to the surface to develop his minerals, lessee may have to come to terms with the surface owner for a wellsite, or extract the minerals lying in or under the property from another tract of land).

In leasing his mineral rights, the mineral owner reserves the right to receive a portion of the product (or proceeds from its sale) produced and saved from his land (or a proportionate share thereof, if the minerals have been pooled into a unit), free and clear from all costs of exploring and producing said minerals; this right is called a royalty. Royalties can be paid in-kind, but generally they are paid as proceeds from the sale of product. Typically, a royalty right is deemed synonymous to "the right to receive money" from the production and sale of minerals.

So what does a sale of minerals do? If a mineral owner sells his minerals (all or portion), he has sold his rights (all or portion) to:

1) Lease his mineral rights for the purpose of exploration and/or production of same (the executive right)
2) (maybe 1a.) Receive future proceeds from said lease (bonus, rentals, or other payments)
3) (maybe 1b.) Receive royalty from production (saved or sold) under the terms of the lease
4) (Should his mineral rights not be subject to a lease) Receive his full proportionate share of production (saved or sold) after the direct well costs (actual reasonable expenditures incurred in drilling, testing, completing, equipping, and operating the unit well, including a charge for supervision) have been recovered, on a well-by-well basis. (Thus, if operations on a single well are not successful, the costs of that unsuccessful operation cannot be charged against production from any other well)

So what does a sale of royalty do? If a mineral owner sells his royalty right (all or portion), he has sold his rights (all or portion) to:

1) Receive royalty from production (saved or sold) under the terms of the lease (same as 1b above).

As to the terms 'mineral acre' and 'royalty acre': these terms do not have much direct translation or effect in Louisiana, as they would in other states, presumably because the mineral right is neither tangible or permanent; severed mineral rights exist as servitudes subject to prescription of non-use. The nearest approximation to these terms, as contemplated, is a right to undivided interest in the mineral rights or right(s) to receive royalty in a certain tract of land. Not that a sale of minerals or royalty that would refer only to mineral acres or royalty acres would be ineffective; the intent of the parties usually rules in the interpretation of a instrument which conveys title.

As such, it is generally recognized that a 'mineral acre' refers to a fractional interest in a tract of land which proportion or fraction is composed of the number 'one' in the numerator, and the gross acreage of the subject tract in the denominator. Thus, one mineral acre in an 40-acre tract would be equivalent to an undivided 1/40 mineral interest in the tract.

The term 'royalty acre' refers to a royalty interest equivalent to the first one-eighth of production attributable to a mineral acre. Thus, to follow the above example, the sale of one royalty acre in the same 40-acre tract above would be equivalent to a 1/8 X 1/40 interest in the production attributable to that 40-acre tract (saved or sold). Thus, if you were fortunate enough to sign an OGML at a 1/4 royalty, you would have up to 2 royalty acres to sell per net mineral acre (as 1/4 equals 2/8).

As stated above, since the terms 'mineral acre' and 'royalty acre' do not have much direct effect in Louisiana, most such sales that contain these terms are composed such that the interest conveyed is usually expressed in terms of both the fractional interest and the term 'royalty acre' or 'mineral acre'. For example, given the 40-acre tract contemplated here, a sale of '15 royalty acres' in said tract may be described as follows:

"... fifteen (15) royalty acres, being a proportional royalty interest (15 x 1/40 x 1/8 x 8/8) of production saved and sold, being attributable to, and payable out of, grantor's royalty interest and/or his proportionate share of production..."

Traditionally, the industry usually quotes their purchase prices for royalty in terms of royalty acres.

For jollies, I'll calculate how many royalty acres a 100% owner would have in a 40 acre tract if they had the following lease royalty:

40 acres, leased at 1/6: ((1/6) / (1/8)) x 40 = 53 1/3 royalty acres
40 acres, leased at 3/16: ((3/16) / (1/8)) x 40 = 60 royalty acres
40 acres, leased at 1/5: ((1/5) / (1/8)) x 40 = 64 royalty acres
40 acres, leased at 22.5%: ((.225) / (1/8)) x 40 = 72 royalty acres
40 acres, leased at 1/4: ((1/4) / (1/8)) x 40 = 80 royalty acres

Thus, selling 15 royalty acres out of each of these would leave a 100% mineral owner in 40 acres with the following:

40 acres, leased at 1/6: 53 1/3 - 15 = 38 1/3 royalty acres; you sold 28 1/8% of your royalty.
40 acres, leased at 3/16: 60 - 15 = 45 royalty acres; you sold 25% of your royalty.
40 acres, leased at 1/5: 64 - 15 = 49 royalty acres; you sold 23 7/16% of your royalty.
40 acres, leased at 22.5%: 72 - 15 = 57 royalty acres; you sold 20 5/6% of your royalty.
40 acres, leased at 1/4: 80 - 15 = 65 royalty acres; you sold 18 3/4% of your royalty.

Quite a difference, considering the effect of the lease terms and the royalty sale. Consider the sale of 40 royalty acres out of the same 40-acre tract:

40 acres, leased at 1/6: 53 1/3 - 40 = 13 1/3 royalty acres; you sold 75% of your royalty.
40 acres, leased at 3/16: 60 - 40 = 20 royalty acres; you sold 66 2/3% of your royalty.
40 acres, leased at 1/5: 64 - 40 = 24 royalty acres; you sold 62 1/2% of your royalty.
40 acres, leased at 22.5%: 72 - 40 = 32 royalty acres; you sold 55 5/9% of your royalty.
40 acres, leased at 1/4: 80 - 40 = 40 royalty acres; you sold 50% of your royalty.

So, to review:

Selling one's mineral rights means selling one's right to lease (and receive lease proceeds, such as bonus, rentals, or other payments), in addition to the right to receive royalty.

Selling one's royalty rights means selling one's right to receive royalty, payable from one's total royalty interest.

Mineral acres refer to an undivided fractional interest in one's total mineral rights.

Royalty acres refer to an undivided fractional interest in one's right to receive royalty, expressed as a fraction of one-eighth of the total production of each mineral acre attributable to your tract (and would be deducted out of the seller's share).

Hope this helps in furthering knowledge and discussion of the above terms and conveyances; or, in the vein of this blog:

They want me to sell WHAT for HOW MUCH?!?

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Tags: Louisiana, Minerals, Royalty, Sale

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Comment by Flip Phillips on March 4, 2011 at 8:59am

VERY nice explaination, Dion....but I'm still a little confused. I wonder if you could help me out.

Let's say I own 6.6% interest of 6000 mineral acres in the current Phillips/Burkley Well#1project. Can you show me how to calculate a monthly royalty $ if the well produces 20MMcf/d, gas (net after expenses) is $4Mcf, and the 640 acre unit is broken up 40% Phillips/60% Burkley . There is something in the contract (that I do not understand) that says we would get a 3/16 payout vs 1/8 payout on my royalty acres.

 

Also, if I sell say 25% of my royalty acres, what would my net mineral and royalty acres be after such sale

 

Thanks in advance

Flip Phillips

Also,

Comment by Chase on March 5, 2009 at 1:37pm
Mr. Warr,

Thanks for the great explanation.
Comment by intrepid on March 1, 2009 at 11:27am
Very enlightening. Even if I am in Texas.

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