If you lease your mineral rights, your contract with the drilling company will undoubtedly contain a royalty clause in which you are promised a certain percentage of the revenue from production. Calculating your expected oil and gas royalties can be a daunting task, but there are many royalty calculators that can assist. Type in some basic information, and the calculator spits out your anticipated royalty payment. If you’re looking to understand how this number is computed, here are the basic things you should know:
- Determine the Owner’s Share Interest. Chances are, the drilling company is drilling from a well present across multiple persons’ properties. In order to properly determine a single owner’s share interest, one must first consider the “spacing unit”. The spacing unit basically defines the boundaries of a particular drilling area and may include one or more wells. For example, a spacing unit for a given site might include 750 acres and encompass the interests of several mineral owners. An owner’s share interest would be calculated as their percent ownership of that acreage. So if Owner A owns 150 of the 750 acres, his ownership percentage would be approximately 20%. Calculating each owner’s share this way makes royalty distributions more equitable because owners each get a cut of the well production, no matter where their property is located in relation to the drill site.
- Determine the NRI. In this step, you would simply take the royalty percentage from the signed lease agreement and multiply it by the owner’s share interest from step 1. If owner A had a 1/8 royalty, his NRI would be 20% times 12.5% or 2.5% (.025). In case you’re wondering what the typical royalty rate is, 1/8 – 5/16 is pretty common for most private contracts. Companies drilling on federal lands pay a royalty at 1/8 or 12.5%, while royalties for drilling on state-owned public land varies. Texas charges oil companies a hefty 25% royalty.
- Calculate the Royalty. Taking the NRI calculated in Step 2, multiply by the well’s revenue. If the well produced $10,000 in revenue in a single month, then Owner A would stand to make $250 in royalties that month. If you aren’t certain of the well’s actual production in terms of dollar volume, you can also take the well production measured in thousands of cubic feet (MCF) or barrels (BBL) and multiply by the average price for MCF or BBL (depending on whether the well produces gas or oil, respectively). Multiplying the production volume by the average price per unit will yield the approximate total revenue.
Understanding how to calculate your oil and gas royalties is important, especially when considering pooling agreements. Most states have mandatory spacing laws, which require drilling companies to drill units of a certain size and place their wells at specific units. To comply with these spacing laws, drilling companies often have to lease the land of multiple owners to form one cohesive unit. Many times landowners agree to voluntary pooling, in which a group of owners reaches a mutual agreement with the oil company to collectively lease their land. On occasion, an owner who owns property in the middle of the pooling agreement refuses to lease their land, making it impossible for the drilling company to form one spacing unit and prohibiting any production. Since this impedes the interests of other owners, many states have mandatory pooling laws that compel owners to cooperate if the oil company has otherwise successfully negotiated leasing contracts with the rest of the parties in the unit. Whether you voluntarily pool your interests or were forced under mandatory pooling laws to lease your land, understanding how much your interest is worth is important.