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A Second Look at Royalty Interests

Posted on: February 26th, 2014
by David Ganje

All That’s Royal Aint Royalty—A Second Look at Mineral Interests

                                                By David Ganje

 

            Let’s start at the beginning.   Production is not the starting point in the oil patch.   The genesis of all operations goes back to the basics, Mineral Rights Law.  In the Bakken and elsewhere, the basics require a look at oil and gas interests’ law also known by some as “real property law on steroids.”  In what other field of law can efforts to retain one’s property rights result in the loss of those same rights? 

The mineral interest has a first cousin, the royalty interest.  One needs to scrutinize the four corners of the legal document on which they are described.   Legal phrases were perhaps not meant to confuse, but they sure do.   If the document uses words describing a particular percentage of a mineral that will be “produced,” “saved” or that it is “nonparticipating,” this often refers to royalty interests.  Documents using phrases such as “in and under” usually grant mineral interests.

       Mineral interest versus royalty interest—what do you get?   A “grant” made by deed or other legal document can convey either a “mineral interest” or a “royalty interest”.   Both appear to offer the grantee the same thing:  a percentage of the value of minerals on a described plot of land.  However, a mineral interest includes an interest in the land itself.  It is a real estate interest “with benefits” as they say and that is pretty powerful.  A royalty interest, on the other hand, only offers an interest in a percentage of the minerals’ value after they have been extracted from the ground.  If processing is required in order to make their sale possible, the cost of doing so is deducted from the sales price when calculating royalties.

A mineral interest contains several rights for the holder.  These rights are usually described in a deed as “the minerals in and under and that may be produced from” a given area of land and grants the holder rights concerning the land.  In North Dakota, a holder of a mineral interest has the right to explore and develop the area (including the right to enter).  In addition to the profits from the minerals themselves, he may also receive bonuses, delay rentals, and royalties.  Because a mineral interest holder also possesses an interest in the land from which the minerals are extracted, he can enter into leases with regard to the resources contained in the ground (oil, gas, minerals, etc.) with third parties. 

The holder of a royalty interest, on the other hand, has no right of entry or exploration of the land, no right to receive bonuses or delay rentals, and may not grant leases to third parties.  A royalty deed is usually written in reference to minerals “produced and saved.”  Interestingly, a royalty interest holder has a cost-free interest in the resources that are produced.  He is like a teenager.  He gets the car, but doesn’t have to pay for the gas or insurance.  He gets the profit of the oil and gas production, but does not have to deal with management or production issues.

When negotiating or determining mineral rights one should always be on the lookout for these two categories.  When dealing just with the basics, this may not be too difficult.  But, mineral interest or royalty interest contracts are rarely limited to the basics.  There are too many moving parts.  Even the very language used may prove improper.   In other words; read the fine print.

In North Dakota, this may not always be an easy picture to read.  Many deeds contain the phrase “other minerals” regarding the interest that is being conveyed or reserved.  The meaning of that term has not been consistent over the history of North Dakota law.  From 1955 to 1983, the definition differed.  Under a 1955 statute, a lease or conveyance of “minerals” did not include interests in gravel, coal, clay, or uranium, unless the intent to convey those materials was separately stated.  Oddly, a reservation of a mineral interest still included coal.  A 1975 amendment to the statute fixed this unusual distinction.  Since July 1983, North Dakota law has defined the use of the word “mineral” to mean the same thing, regardless of whether it is the subject of a deed or a reservation: “all minerals, and their byproducts and compounds, except those specifically excluded by name.”  Also, the language used to define interests is also treated differently depending on whether it might be a deed or an oil and gas lease.

In the end production is what we’re all shooting for, but don’t ignore the basics.  Be aware of mineral rights law.  The wording in your legal document determines your interest which in effect determines your profit.

 

Author:   David Ganje.  David Ganje of Ganje Law Offices practices in the areas of natural resources law, environmental law, and commercial law in North and South Dakota.