Royalties vs Mineral Rights
Oil and gas royalties are not as complex as most people think. They are actually fairly simple, and I’ll explain clearly what they are and how they generate cash.
If you own a farm, then you own the land also known as the surface rights. Often, when you bought the farm, your deed conveyed the mineral rights under the farm along with the surface rights. Owning the mineral rights means you legally have the right to explore, extract, and sell any oil, gas , coal, uranium, helium or other mineral that rests beneath your land.
Most landowners, however, don’t have the geological knowledge or training to understand the potential minerals under their land. In fact, many landowners forget they own the mineral rights under their land. Further, the average landowner does not have the multi-million dollar budgets to explore for hydrocarbons, or the social networking skills to raise a multi-million dollar exploration fund.
Energy companies do have the knowledge and funding to explore for oil and gas . So when they identify a region that likely contains hydrocarbons, they negotiate with the landowners to lease their mineral rights for exploration. This lease gives the energy companies permission to explore for petroleum and to produce and sell it if they find petroleum in economic quantities.
The Bonus and the Royalty
The mineral owner receives two forms of compensation for leasing his mineral rights. The first is called a ‘Bonus Payment’ which is a signing bonus that is paid on a per acre basis. Typically $200-$500 per acre. The bonus will be paid once at the time of the signing of the lease, and it may be the only money the owner will get.
The second is the royalty which is the percent of the money generated by the oil and gas from his property. Traditionally 12.5%, but more recently around 18% – 25%. The percentage varies upon how well the mineral owner negotiated and how expensive the oil company expects the extraction of oil and gas to be.
However, if the oil company finds no oil or gas , or not any in economic quantities, then they abandon the prospect, and the lease expires which reverts the mineral rights back to the mineral owner. In this case, the Bonus was the only money the owner received.
In the event hydrocarbons are found and the wells produce, then the royalties kick in. So if the well produces 100 barrels a day, and the price of oil is $80 per barrel that month, then the cash flow is 100x$80 = $8,000/day The royalty owner, who agreed to 15% royalty, would receive $8,000 x 0.15 = $1,200/day. Over a month, that brings in $36,000 per month to the mineral owner, who in this case, is the landowner. Now you see why oil is a big business!
Royalties Dwindle Over Time
Royalties paid to the mineral rights owner will often last for decades. The wells will deplete, however, so over time the money received from royalties will drop considerably. The average well is thought to last 35 years. Eventually, the royalty dies, and all the owner has is the mineral rights. Which may get leased again in the future.
Finding Mineral Rights to Buy is Hard
Because of the reliable cash flow stream, oil and gas royalties make for a good investment. Finding mineral right owners who want to sell their royalties is the tough part. The only available data on royalty owners currently is Blackbeard Data Services, and they have all the owners in Texas and Kansas.