What are Royalties

Understanding royalties
What they are

Royalties

Royalties are a form of real property ownership as defined by the IRS.  As property owners, royalty investments could provide a complement to existing real estate portfolios offering similar benefits to REIT’s – including passive-cash flow and upside participation from any recovery in energy prices.  

 

What is a

Real Estate Provider to the Energy Sector

When a company, such as Exxon looks, to drill on a particular property they rarely buy the land outright. Purchasing the land would require a large upfront-capital commitment in addition to the costs to drill and complete the wells.  Instead, the company will lease the rights to explore for oil and gas with the landowner. In return for granting access to their property, landowners will receive a set royalty rate based on production from on-site wells.  The oil and gas company provides the technical know-how and capital, while deferring land costs through paying the royalty rate only if the wells are successful and productive.  

 

Overview of 3

COMMON ROYALTY STRUCTURES

Mineral

Mineral owners have the right to negotiate and sign leases on their minerals, as well as the right to receive bonus consideration and annual rental payments. They also have the right to receive royalty payments as outlined in the lease.  Like any other real property, mineral owners can also sell oil and gas royalties.

Royalty

Royalty owners have the right to receive royalty payments for the oil and gas produced from the lands under which they own royalty.  However, they do not have the right to lease and receive bonus and rental payments from the lease. Both mineral and royalties, however, are considered real property for tax purposes.

Override

An override is carved out of the actual oil and gas lease as, opposed to the minerals under the ground. An overriding royalty interest shares on a pro-rata basis in the production, but once the lease has ceased producing and expired by virtue of its own terms, the overriding royalty expires as well. Whereas, the mineral and royalty owners maintain ownership after production ceases.