Understanding Royalty Checks
Understanding royalty checks can be a nightmare for many oil and gas owners. A key component to fully understanding royalty checks is comprehending the risks and expectations for future value.
A Royalty Check Is Based on Several Factors
1. The oil and gas production from the wells on an owner’s property.
2. Current commodity prices for oil and natural gas.
3. The decimal interest (also known as percentage interest), which is a factor of the owner’s share of the drilling unit multiplied by the royalty percentage agreed upon in the lease.
While the oil and gas production and commodity prices are out of an owner’s control, it is still important to know where these numbers can be found on the royalty checks. The royalty check of several operators have columns called “Volume,” which show the quantity of oil or natural gas produced during the payment month. Other operators name this volume column “BBL/MCF” which stands for barrels of liquids and million cubic feet. Barrels of liquids are usually oil measurements and million cubic feet is a measurement of natural gas. The volume column shows how much the well(s) produced during that payment month.
Understanding Commodity Prices
On the royalty checks there is also a column labeled “Price,” which is where the operator lists the actual selling price for the oil or natural gas.
Decimal interests can be confusing. Decimal interests are calculated by multiplying each owner’s share in the drilling unit by the royalty percentage agreed upon in the lease.
Share in the Drilling Unit
Drilling unit sizes vary by state, reservoir and target formation. Many horizontal wells are unitized based on sections which are 640 acres. Each owner’s share in the drilling unit is that owner’s Net Mineral Acres divided by the total size of the drilling unit. For example, if an owner had 64 acres in a 640-acre drilling unit, that owner’s share of the drilling unit would be 10% (64/640). Remember to use Net Mineral Acres when calculating share in the drilling unit.
Net Mineral Acre
One Net Mineral Acre is one that is wholly owned by only one entity (person, company, organization, etc). If a father owned 100 Net Mineral Acres, and he gave his entire ownership in the 100 NMA to his four children in equal proportions, each child would own 25 NMA.
When a lease is signed, the owner is agreeing that the oil and gas company will pay that owner a certain percentage of the revenue from the well. This is called “royalty.” Common royalty percentages include ¼, 1/5, 3/16, 1/6 and 1/8.
Bringing It All Together With A Formula
Mineral and royalty owners receive a share of gross revenue less allowable deductions like transportation, dehydration, gathering costs, and taxes. The value of a royalty check can be calculated using the following formula:
A = Net Mineral Acres Owned in Unit
U = Number of Gross Acres in the Oil and Gas Unit
R = Net Royalty Owed to Mineral or Royalty Owner, including all prior reservations
P = Product price (oil, gas, natural gas liquids)
V = Volume of Certain Product (oil, gas, natural gas liquids)
D = Deductions including Severance Taxes, Transportation, Marketing, Dehydration, etc…
Royalty Revenue = (A / U) x R x ( P x V – D)
Solving for “R” can be difficult, especially in areas where oil and gas have been produced for a long time. Various types of reservations of mineral and royalty interests have been carved out for hundreds of years and these reservations impact the division of interest in a variety of ways.
To solve for “R”, the following calculation is used:
L = Lease Royalty Burden
V = Variable Royalty Reservation
F = Fixed Royalty Reservation
There are two scenarios where “R” can be less than “L”:
1. Fixed Royalty Reservation – Where a prior owner reserved a fixed non-participating royalty. Such language would resemble the following: “Grantor reserves an undivided 1/6 interest in and to all oil and gas produced from said Lands…” If there is a Fixed Royalty Reservation, calculate “R” with this equation –
R = L – F
2. Variable Royalty Reservation – Where a prior owner reserved a share of the future royalty. Such language would resemble the following: “Grantor reserves one half (1/2) of all the future oil royalty, gas royalty and casinghead gas royalty from said Lands…” If there is a Variable Royalty Reservation, calculate “R” with this equation –
R = L x V