Oil and Gas Lawyer Blog
I’ve been asked what is a “net royalty acre.”
The term “net royalty acre” is used by mineral and royalty buyers to price a mineral or royalty interest that is subject to an oil and gas lease. It is related to, but different from, a “net mineral acre.”
To illustrate, consider the following hypothetical: I own a 1/4 mineral interest in Blackacre, containing 640 acres. My mineral interest is subject to an oil and gas lease reserving 1/4 royalty. There is one producing well on the tract and there are prospects for additional drilling.
To calculate the number of net mineral acres owned by a mineral owner, we multiply the mineral owner’s undivided interest in the tract by the number of acres in the tract. If I own a 1/4 mineral interest in Blackacre and Blackacre contains 640 acres, I own 1/4 X 640 = 160 net mineral acres.
A net royalty acre is sometimes defined as the right to a 1/8th royalty in one acre of land. In my hypothetical, I have the right to a 1/4th royalty on 160 net mineral acres, so I own 320 net royalty acres in Blackacre. This seems counter-intuitive – how can I own more royalty acres than mineral acres in the same property?
For many years, the “standard” landowner’s royalty in oil and gas leases was 1/8th. The “landowner’s royalty” and the “1/8th royalty” were considered synonymous. So for leased minerals owners began to speak of “royalty acres” in transactions for purchase and sale of royalty interests. If I own 1/4 mineral interest in 640 acres subject to a lease providing for 1/8th royalty, then I own 160 net mineral acres and 160 net royalty acres. I can sell 1/2 of my royalty interest, which would be 80 net royalty acres.
Mineral and royalty buyers value their proposed purchase of minerals and royalties that are subject to an oil and gas lease based on the projected income from the property. Suppose that Blackacre, in my hypothetical, has one well whose projected future production value is $1 million, present value $750,000, and the buyer projects that three more wells will be drilled, whose projected future value will be $2.25 million. So the value of $3 million must be applied to the royalty interest the buyer wants to purchase. The minerals are subject to a lease providing for 1/4th royalty. The buyer estimates the value of a 1/4th royalty interest in the 640 acres is $1 million. I own a 1/4 mineral interest in the tract and I’m interested in selling 1/2 of my royalty.
To calculate the number of net royalty acres I’m selling, I use this formula:
[acres in tract] X [% of minerals owned] X 8 X [royalty interest reserved in lease] X [fraction of royalty interest being sold].
640 acres X 25% X 8 X 1/4 X 1/2 = 160 net royalty acres.
The price per net royalty acre is $125,000 / 160 = $781.25 per net royalty acre.
So the buyer offers me $781.25 per net royalty acre. This works out to 1/4 of 1/2 of $1 million, or $125,000 for 1/2 of my royalty. It makes sense for a mineral buyer to value royalties in terms of $/net royalty acre because they are in effect buying a future cash flow from the royalty interest.
If the seller does not own a mineral interest but only a right to receive royalty, determining the number of net royalty acres owned may be more difficult. Some royalty interests are a fractional royalty and some are a fraction of royalty. I may own a 1/16 royalty interest in Blackacre, or I may own a royalty interest equal to 1/2 of the royalty. In the latter case, my royalty depends on the royalty reserved in the lease of the mineral interest burdened by my royalty interest. If the lease reserves 1/4th royalty and I own 1/2 of the royalty, then my royalty is 1/2 of 1/4, or 1/8th. If my royalty interest in Blackacre is 1/16th, that fraction of production is all I own regardless of what royalty is reserved in the lease.
So, if I own a 1/16th royalty interest in Blackacre, I own 320 net royalty acres (1/16 X 8 X 640). But if I own 1/2 of the royalty in Blackacre, I own 640 net royalty acres (1/2 X 1/4 X 8 X 640).
Mineral buyers often make offers in terms of dollars per net royalty acre. If the recipient of the offer does not know for sure what she owns, it can be difficult to evaluate the offer. My advice is for the owner interested in selling to first determine what she owns before entering into any agreement to sell. If that is not possible, and if the price to be paid in the purchase and sale agreement is based on net royalty acres, the term should be defined in the purchase and sale agreement. The conveyance of the royalty interest should not use term net royalty acres, but should clearly describe the fractional interest in royalties being conveyed.