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Herein of mineral interests, royalty interests, working interests and overriding royalty interests

Like most subjects, understanding oil and gas law is often a matter of knowing the terminology – WI, RI, ORRI, NPRI. These terms are often used in a confusing way and the definitions sometimes overlap. So I’m going to try to clear things up.

It all starts with the mineral estate. In Texas, the mineral estate can be separated (“severed”) from the surface estate. This can be done either by a conveyance or a reservation. I grant Blackacre to John Doe, reserving the mineral estate; or I convey the mineral estate in Blackacre to John Doe.  The mineral estate is considered an ownership interest in land, just like the surface estate. It carries with it certain rights – the right to explore for and extract the minerals under the land. To make that right effective, the owner of the mineral estate must have the right to use the surface estate – to go on the land and drill wells. So the mineral estate is called the “dominant estate,” because the surface estate is subject to the rights of the owner of the mineral estate to use the land to extract minerals.

The mineral owner may grant an oil and gas lease to an exploration company to drill wells on the land. In Texas, an oil and gas lease is a conveyance to the lessee of the mineral estate for the term of the lease, reserving a royalty interest.  An oil and gas lease severs the mineral estate into two interests – the lessee’s interest, often called the “working interest,” and the reserved royalty interest. When the lease expires, those two estates merge back together into the mineral estate.

The lessee’s interest in an oil and gas lease bears all of the cost of drilling for and producing minerals but receives only a portion of the production. It is the “working interest,” because it does all the work of exploration and development. If I lease Blackacre to ABC Oil Company and reserve a 1/4th royalty, ABC Oil Company bears all of the cost of drilling and production and receives 75% of production, and I, the royalty owner, receive 25% of production, free of all production costs. So the lessee’s “net revenue interest,” or NRI, is 75%, and its working interest, or WI, is 100%.

Multiple parties can own shares of the mineral interest in a tract of land. Most lands in Texas have more than one mineral owner. The dividing of the mineral estate can take place by conveyances or reservations, or by inheritance, as when John Doe’s five children inherit his mineral estate. The owners of the mineral estate in a tract of land are called co-tenants. Each mineral co-tenant has the right to explore for and develop the minerals and to sign oil and gas leases covering their undivided interest. Each co-tenant’s oil and gas lease can be different, reserving different royalties or providing for different terms. Mineral co-tenants can and often do lease to different lessees.

The working interest can also be owned by multiple parties. The original lessee may grant shares of his working interest to other parties who share the cost of drilling and production. Or multiple lessees of a tract may get together and agree to jointly develop the tract. There can be only one operator of a tract under Texas rules; the company serving as the operator usually enters into an “operating agreement” with the other working interest owners which governs the rights and obligations of the working interest owners.

A mineral interest may be divided in other ways. A mineral owner may grant a royalty interest in her land. The grantee receives the right to a share of royalties on production from the property but has no right to lease the mineral interest or to receive a share of any bonus paid for granting a lease. A royalty interest carved from the mineral estate is an interest in land but has no right of possession or use – just the right to receive a royalty. It is often called a “non-participating royalty interest” or “NPRI” – an odd term because all royalties are “non-participating” in that the owner has no right to lease and receives no bonus when the land is leased.  The royalty interest may be created by a grant or by a reservation in a conveyance of the land. A royalty interest may also be granted in perpetuity or for a term. It is common for a mineral owner to sell a term royalty interest, to remain in effect for a specified number of years and “for so long thereafter as oil or gas is produced” from the land. This is commonly called a “term royalty interest.”

If a royalty interest is granted or reserved in a tract of land, then when the mineral owner leases the tract the owner of the royalty interest receives his share of royalty out of the royalty reserved in the lease. If I grant a 5% royalty interest to John Doe and then lease the land to ABC Oil Company reserving a 25% royalty, John Doe receives a 5% royalty and I get a 20% royalty.

Mineral interests can also be granted or reserved for a term of years – a “term mineral interest.”

The “executive right” can also be severed from the mineral estate. The executive right is the right to grant oil and gas leases covering the mineral estate. It is one of the “bundle of sticks” that make up the mineral estate. So I can grant to Jane Doe a one-half interest in the minerals in Blackacre but reserve the exclusive right to lease Blackacre. If I lease Blackacre, Jane receives half of the bonus and half of the royalty I reserved in the lease.

Finally, overriding royalty. An overriding royalty is “carved out of” the working interest. If ABC Oil Company acquires an oil and gas lease covering Blackacre that reserves a 25% royalty, ABC has a 75% net revenue interest. ABC can convey a share of that net revenue interest as a royalty. Suppose ABC conveys to its CEO a 5% overriding royalty in the lease: the CEO receives 5% of production, free of drilling and production costs; ABC’s share of production is now 70% and it bears all drilling and production costs; and the lessor receives 25% of production, free of all drilling and production costs. All three interests add to 100% of production. An overriding royalty necessarily has a term limited to the term of the oil and gas lease. When the lease expires, the overriding royalty is extinguished. Overriding royalties are often granted to professionals who help assemble a prospect – geologists, landmen, attorneys, executives in the company acquiring leases within the prospect.

Early in the development of oil and gas leases the “standard” landowner’s royalty was almost always 1/8th. In old leases, one sometimes sees the landowner reserving an additional royalty interest described in the lease as an “overriding royalty.” That is an antiquated use of the term and is not really an overriding royalty as the term is currently used; any royalty reserved in an oil and gas lease is simply the landowner’s royalty.

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