How to Calculate Oil and Gas Royalty Payments?

The oil and gas industry is still far from being tapped to its maximum, and vast wealth is waiting to be explored.

However, knowing how to calculate royalty interest oil and gas is needed to determine the financial reward for both operators and resource owners.

In this article, we’ll focus on the complexity of royalty payment calculations, so even as a property owner, you won’t get cheated when you lease out your property for oil and gas production.

What Is An Oil and Gas Royalty?

Oil and gas royalty is the payment made to mineral owners for the use of their property from which the minerals are extracted. By accepting the compensation, the mineral owner acknowledges the use of their property and gains financial interest in the production operations.

What Do You Need to Know When Calculating Oil and Gas Royalties Payments?

When calculating oil and gas royalties, there are several factors to put into consideration.

Important elements to keep in mind include;

• Sales Price: The current market price of oil and gas will determine the sales price. This price is the foundation for revenue calculation, as it directly affects the gas royalties.
• Deductions: Depending on the content of the lease agreement, certain deductions will be made. Deductions can include production costs, transportation costs, and other expenses; all of these will be subtracted from the gross revenue before calculating the royalty payment.
• Production Volume: Knowing the exact volume of oil and gas produced by the production unit during the relevant period is important, and you can get this information from either the lessee or the operator.
• Lease Agreement: Properly review the conditions in the lease agreement to have a full understanding of what you are agreeing to. The lease clearly outlines specific terms, royalty interest, and rates, plus any deductions and adjustments that may apply.
• Royalty Rates: The royalty agreement or rate is a percentage of total revenue gotten from the sale of oil and gas, and it’s always outlined in the lease agreement. The royalty percentage is usually 12.5% to 15% but can change based on regional regulations or negotiations.
• Types of Leases: There are different types of oil and gas leases, and they affect royalty calculations differently. Common types of leases include net royalty leases, paid-up leases, gross royalty leases, and delay rental leases.
• Fractional Interest: Fractional interest applies when there are several mineral owners of a particular property. In this case, you’ll need to know the ownership percentage of each party, to calculate royalty payment accurately.
• Royalty Calculation Method: Ideally, in the lease agreement, a specific calculation method will be listed. Most times, it might involve multiplying the royalty rate by production volume; whatever the method may be, familiarize yourself with it.

Main Factors When Calculating Oil and Gas Royalty Payments

Oil and gas royalties are calculated based on the percentage of the value generated from the sale of the extracted minerals.

Most landowners don’t know to calculate royalty interests, while it’s true that there are calculators that might help, it’s still advisable to understand the process.

The three major factors that should be considered by both landowners and oil and gas companies include;

Unit Size

The unit size refers to the portion of land included in the production unit. And it’s determined by pooling or combining multiple leases. This is essential for the management of resources, plus a larger unit size means a higher potential for oil and gas production.

Net Acres Owned

Net acres are the mineral rights owned by the royalty owner within the production unit. It’s an important factor as it determines the share of oil and gas royalty interest allocated to the owner.

For instance, if a royalty owner owns 100 net acres out of a total acreage of 1000 acres, they would have 10% of the production volume and royalty payment.

Lease Royalty Rate

The lease royalty interest is the specified percentage that determines the share of revenue allocated to the royalty owner, and it’s usually mentioned in the lease agreement.

There is no fixed rate, as the lease royalty rate is subject to change based on negotiation between the operators and resource owners.

What is the Most Basic Way to Calculate Oil and Gas Royalty Payments?

Calculating oil and gas royalties is fundamental in the gas industry, to ensure fair compensation.

Without complicating things, here’s the least complex way to calculate oil royalties.

Example

Royalty payment = Production volume x Royalty Rate x Price per Unit

In this formula;

• Production Volume: It represents the quantity of oil produced from the leased property during a certain period. Accurate measurement is important, so you don’t have any problems when calculating the royalty payment. And it’s usually measured in standard units; barrels (bbl) for oil and cubic feet (cf) for gas.
• Royalty Rate: This rate is the percentage stated on the lease agreement as revenue allocation. It represents the amount the resource owner is expected to receive from the sale of the oil and gas. Royalty rates are between 12.5% to 15%.
• Price per Unit: This is the current market price of oil and gas at a particular period.

Let’s take give an example, so you understand better;

Question: An oil company produces 20,000 barrels of oil in one month, and the current market price of a barrel in that month is $80. If the royalty rate is stipulated as 15% in the lease, what’s the royalty payment?

Answer: Using the formula mentioned above, and inserting the terms;

Production Volume x Royalty Rate x Price per Unit

20,000 x 15 % (0.15) x 80 = 240,000

So, the royalty payment is $240,000.

Note: Some oil and gas leases might include things like deductions (i.e., production costs, transportation costs, etc) and it may affect the final calculation. So, it’s important to go through your oil and gas agreement and royalty clause, because it varies for every oil company.

Specific Cases

The formula listed above applies to most scenarios, however, there are a few exceptions where additional factors come into play.

Non-Participating Royalty Interest

Just like the basic “royalty interest” the NPRI owner doesn’t take part in production costs, unlike a mineral rights owner who’ll get to receive royalties and still bear costs and expenses associated with production.

Calculation of the NPRI is by multiplying the NPRI interest percentage rate by gross production revenue; where

Gross Production Revenue = Production Volume x Price per Unit

Overriding Royalty Interests

This is a type of royalty interest that’s carved out from the mineral interest royalty. It’s the percentage of gross production that’s void of expenses and costs (i.e., cost of exploration, developing and operating gas wells), making it similar to NPRI.

To calculate the ORRI, multiply the gross production revenue by the ORRI interest percentage, and the figure gotten is what the ORRI owner is entitled to.

Different Royalty Rates for Different Resources

If the lease agreement covers different resources like oil and gas, then the royalty rates will differ as well. So, separate calculations and separate payments will be made for each resource, and this will be based on their production volumes and rates.

Working Interest Royalties

This is a type of royalty where the investor is involved in the drilling operations and is directly liable for a section of production costs. So, the investor shares in both the revenue and cost of production.

To determine the owner’s net revenue interest, you need to subtract the proportionate cost from the revenue.

The formula for calculating working interest royalty;

Working Interest Royalty = Gross Production Revenue x Working Interest Percentage

Mineral Interest Royalties

This is the portion of revenue gotten from the production and sale of oil and gas that’s paid to the mineral owner.

You can use the basic formula to calculate the mineral interest royalty, but the royalty rate will be 100% or 1.

Complex Deduction Structures

Depending on your oil and gas lease contract, specific deductions might be outlined to be considered. The calculation needs to put all the factors into consideration to arrive at the actual revenue.

Shale Gas Royalties

This type of royalty is peculiar to the extraction of natural gas from shale formations. It’s net royalty interest given to the mineral rights owner for production and extraction.

Shale formation involves hydraulic fracturing techniques to access the natural gas trapped under the dense shale rock layers.

The formula for calculating the shale gas royalties is the same as the basic royalty formula, but some changes in figures might be made in relation to gas production.

Shut-In Royalties

A shut-in royalty is a payment stipulated in the oil and gas lease which royalty owners are entitled to when a gas field or well is shut-in as a result of market conditions, equipment failure, or regulatory constraints. In essence, the payment is not based on oil and gas production.

Minimum Royalty Provision

This is a form of a safe bet for most mineral owners, so they don’t lose out completely even if things go south. Some oil and gas lease includes a minimum payout regardless of the production volume or prevailing price of oil at the moment.

Calculation of the minimum royalty provision is based on the higher of the minimum royalty rate, or the figure gotten using the basic formula.

How to Estimate Royalty Payment in a Pooled Unit?

It’s no news that oil and gas companies include a pooling clause in their lease agreement with most landowners.

The clause allows the oil company to pool minerals from your property as well as other surrounding properties. The major reason why companies do this is that sometimes a particular amount of acres is needed to obtain a drilling permit, and if yours doesn’t meet the acreage requirement, then the company pools your property and that of your neighbors in one production unit.

You may be wondering how your royalty payment will be calculated since oil and gas are produced for the unit as a whole. However, every landowner’s royalty payment will be made based on how many acres they contributed. Ideally, there’ll be a pooling agreement between all property owners.

The formula for calculating net royalty interest in a pooled unit is as follows;

Net Acres ÷ Total Unit Acres × Royalty Rate

Let’s do a quick practical example

Question: If you have 150 acres of minerals in a pooling unit that has 700 acres total, and you lease it for a 15% royalty rate, what will be the net royalty interest percentage?

Answer: Using the formula and inputting the figures;

Net Acres ÷ Total Unit Acres × Royalty Rate

150 ÷ 700 × 15 (0.15) = 0.032 or 3.2%

What Are The Steps When Calculating Oil and Gas Royalty Payments?

It can be tricky and hard to calculate oil and gas royalties if you don’t know the right way to go about it. Every step requires full understanding, or else you might end up with the wrong figures.

For mineral owners, it’s non-negotiable learning the steps involved in oil and gas royalties, plus familiarizing yourself with every piece of information in the royalty clauses and even mandatory pooling laws will help you more than you think.

Moving on, to calculate oil and gas royalties, here’s what to do;

Review the Lease Agreement

This is the first and most important thing to do, before calculating royalties. The oil and gas industry has different clauses, and it’s best you are aware of the terms of your agreement, so you know whether it’s favorable to you or not.

You can also get an attorney to go through the agreement as well, and also make sure you understand the royalty calculation method outlined.

Get Production Data

Production data is subject to change with time, and you cannot base your calculations on previous market prices or values. Production data you’ll need include production volume and all the necessary production reports.

Calculate Gross Production Revenue

To determine gross production revenue, multiply the production volume by the sales price per unit. Whatever figure you get is the total revenue gotten from the sale of the oil and gas, with no deductions.

Apply Royalty Rate

The royalty rate is stated in the lease and is usually written in percentage. Multiply the gross production revenue by the royalty rate to determine what the mineral rights owner is entitled to.

Consider Adjustments and Deductions

Sometimes the lease may contain deductions such as transportation fees and other expenses that need to be subtracted before calculating the net revenue interest.

Apply Fractional Interest

If there is more than one mineral owner, multiply the net revenue by the fractional interest of each owner to determine their respective royalty interest.

Consider Minimum Royalty

If the lease contains a minimum royalty provision, then the mineral owner is entitled to the minimum royalty even when the final calculated royalty payment is less than the royalty amount.

For your advantage, make sure your royalty clause has a minimum royalty provision, so you can still receive substantial proceeds from your oil property no matter the situation.

What Should You Be Aware of When Calculating Oil and Gas Royalty Payments?

To ensure fair and accurate calculation, consider the following;

Lease Agreement Terms

The agreement should carefully be studied so you learn about all the terms and provisions concerning the mineral rights.

It needs to contain the royalty rate and any other adjustment that might impact the oil and gas royalties.

Price Determination

Determine the right price per unit based on the current market situation. The factors you’ll have to consider include pricing indices, quality differentials, and other pricing adjustments as indicated in the lease.

Deductions and Adjustments

Take into account deductions that need to be subtracted from the gross production revenue before arriving at the net royalty interest.

Severance Taxes

Severance taxes are peculiar to states, so you may need to talk to your attorney if you are unsure of how to interpret this. And yes, the taxes can affect the final net revenue interest.

Royalty Rate Accuracy

Verify that the royalty rate in the lease is the same number being used in the calculations. When there’s an error with the rate, it’ll affect your payment.

Professional Guidance

No one is an island, and when it comes to oil and gas royalties, you can never be too careful. Speak to legal practitioners who are experts in oil and gas production, as they can provide you with valuable information and interpret your lease terms if needed.

Audit and Verification

Occasionally, remember to audit and verify the accuracy of the royalty calculations, to be sure you are receiving the exact revenue as discussed. You can employ the services of third parties to help you check and be certain there are no discrepancies in the figures.

Timeliness and Frequency

Breaking the royalty agreement timeframe is a “red flag”, and once that starts, it’s a recipe for more problems.

Ensure that your oil and gas royalties are paid on the due dates (as written on the lease), and document every penny received.

Market Conditions

Oil and gas prices are influenced by global economic trends and supply and demand dynamics. Stay updated on the average price of oil and gas, and consider their impact on the price per unit used in royalty calculations.

Market Price at the Well

Sometimes, in the lease agreement, the royalty percentage is based on the prevailing price of oil or gas at the wellhead. Meaning that the price used for royalty calculation isn’t the benchmark price but rather the price at which production is sold at the well.

Tools to Help You Calculate Oil and Gas Royalties

Calculating oil and gas royalties is a tedious task, but several tools can help make your work a lot easier.

• Royalty Calculation Software: Some software are specially designed to calculate oil and gas royalties. They have features such as royalty rate tracking and customizable reporting. A royalty software will easily handle complex calculations and generate accurate royalty statements. Examples of these software include; P2 BOLO, WolfePak, Quorom, Olidex, and OGSys.
• Online Royalty Calculator: Various websites on the internet offer online calculators specific to oil and gas production. With these calculators, you’ll need to input all relevant data including deductions like production costs, and other expenses. While it may not give you the exact owner’s share interest, it’ll provide an estimate of royalty payments. An example of an online royalty calculator is the “Texas Royalty Calculator”.
• Spreadsheet Applications: This is by far one of the easiest ways to calculate oil and gas royalties, and know the exact amount a landowner receives. Microsoft Excel and Google Sheets have built-in functions that help with data analysis. So, all you need to do is customize the Spreadsheet to your specification, input all the necessary data, and proceed to calculate your royalty interest. As operators involved in producing oil or selling oil, knowing the right way to calculate royalties is necessary, so your revenues are not well accounted for.
• Royalty Calculation Templates: This is very similar to the royalty software, the only difference is that there are already existing templates with formulas that can serve as a starting point. Using a guide to calculate oil and gas royalties is easy, plus in addition, you are certain that you are being provided with the correct data.
• Accounting and ERP Systems: If as a property owner, you get stuck when trying to analyze your royalty interest, probably because of the complex and huge figures, then the ERP software can be really helpful. The ERP systems usually have modules tailored for oil and gas royalties, and they can also handle multiple lease agreements and track adjustments/deductions.
• Consulting Professionals: There are lots of terms that could be in a lease that needs to be properly interpreted before even starting any calculation. Not all property owners are familiar with the terminologies used in the oil and gas industry. With the help of oil specialists, you can understand all the royalty clauses, especially when you need to consider pooling agreements as well.

So, if you are in a fix, consult a specialist firm to help out with all the intricate details to avoid mistakes.

Why Calculating Oil and Gas Royalty Payments is Essential?

Here are a few reasons why you need to calculate oil and gas royalty interest;

• Royalty Obligation: Oil and gas royalties are the financial obligations of the lessee to the property owner. According to the lease, the mineral rights owner is entitled to receive fair compensation from the oil and gas production and sale. It’s an avenue for them to benefit from their resources, and it creates an incentive to allow companies to produce and develop the resources.
• Lease Agreement Compliance: Lease agreements usually outline what percentage of a royalty interest is due to a property owner. So, accurately calculating oil and gas royalties ensures the lessee complies with the terms and doesn’t breach the royalty clauses.
• Financial Planning and Management: For mineral rights owners, proper calculation of the royalty interest helps them know how much to expect in terms of payment, and this is essential as the payout can be used for various purposes like settling debts or funding other projects. While for the lessee it helps with financial budgeting and forecasting.
• Legal and Regulatory Compliance: Several laws govern the extraction and production of oil and gas. Every oil and drilling company needs to comply with the legal requirements, and it includes mandatory accurate royalty calculations to ensure transparency and equity.

In essence, calculating oil and gas royalties is important to make sure that all parties are fairly compensated.

What Are Common Mistakes That Can Occur When Calculating Oil and Gas Royalty Payments?

When calculating net revenue interest, you need to be careful, because a single mistake might either increase or decrease the royalty interest, thereby causing problems between all parties involved.

Some of the common mistakes both lessee and mineral rights owners make are;

• Wrong Production Measurement: Using incorrect production volume, faulty equipment, and inaccurate gauges can cause significant errors in oil and gas royalty interest.
• Not Accounting Deductions: To arrive at the actual revenue for each landowner, you need to make deductions and adjustments. Failure to account for them will result in having a higher net revenue interest.
• Wrong Price Determination: The price per unit used in the royalty calculation must be the current market price or this will affect the landowner’s royalty payment. Utilize correct pricing information, and stick to the terms outlined in the lease.
• Ignoring Fractional Interests: In the case of a pooled unit, it’s necessary to account for each owner’s share interest, based on their contribution.
• Calculation Errors: It’s important to establish a process for the verification of data before finalizing. Simple addition and subtraction errors can affect the royalty interest rate. Double-check all figures and uses royalty calculators to ensure accuracy.

What Documentation and Records Need to be Maintained to Support the Royalty Calculations?

In oil and gas royalties, here are some key documents that should never be discarded;

• A copy of the lease that states the percentage of oil and gas royalties and the mineral rights the landowner is entitled to. It should also show all the deductions, adjustments, and minimal royalty provisions if any. It’s the share of oil and gas produced from the oil well in your property that you’ll be paid.
• Detailed record of the well’s revenue, and production volumes of oil and gas.
• Documents relating to the sale of oil and gas, including sales contracts, invoices, and pricing agreements.
• Maintain all records of adjustments and reconciliations made during the oil royalties calculation. Including transportation costs, and other deductions specified in the lease.
• Keep records of all communication relating to the oil and gas royalties, that’s emails, messages, and other forms of communication with the resource owners.

Conclusion

Knowing how to calculate oil and gas royalties is knowledge worth having, especially when you happen to give out your land to oil companies for exploration and production.

It may seem like a difficult process, but understanding all the factors in your royalty clause will help you estimate the royalty interest accurately.

Fortunately, various tools help support the calculation of oil and gas royalties and ensure efficiency and accuracy.

In the end, accurate royalty calculations benefit the landowners, oil and gas companies, the drilling company, and the industry as a whole.

Frequently Asked Questions about Oil and Gas Royalty Payments

1. Are There Any Specific Reporting Requirements Or Deadlines For Royalty Calculations And Payments?

There’s no general date for royalty payouts, as it varies with jurisdictions. However, sometimes it could be paid every month or evenquarterly; it’s always specified in the royalty clause.

2. How Frequently Should Royalty Calculations Be Performed And Royalty Payments Made?

Oil royalties are usually paid on a monthly basis, but they can also be quarterly, depending on the agreement between the lessor and lessee.

3. Are There Any Penalties Or Interest Charges For Late Or Incorrect Royalty Payments?

Yes, there are, as specified in the lease. Late payment of oil and gas royalties might attract interest charges, and in more severe cases, it may attract legal remedies.

4. Are There Any Special Circumstances Or Events That May Affect The Royalty Payment Calculation (E.G., Force Majeure, Shut-Ins, Non-Operational Periods)?

Yes, certain events like shut-ins, force majeure, and non-operational periods can affect oil and gas royalties because they disrupt normal operations. When the operators are unable to sell oil, payouts will be affected. But the lease should have a royalty clause that addresses such issues.

5. How Do Oil And Gas Prices Affect Royalty Payments?

When the price of oil is high, the owner’s share interest increases as well, but a drop in the price of oil and gas will result in decreased oil and gas royalties.

6. What Does 3 16 Royalty Mean?

This simply means that the operator will pay oil royalties of 3/16 (18.75%) of revenue generated from the production on the land to the property owner.

7. What Is The 25% Rule For Royalties?

The 25% rule states that the operator has to pay the resource owner oil and gas royalties that are equivalent to 25% of the profit from the sale and production of the oil and gas. While the operator retains 75% because they took on the majority of risks.

8. Are There Any Minimum Royalty Payment Requirements?

Yes, there can be minimum oil royalties specified in the lease between the landowners and the exploration company. This serves to protect the resource owner and ensure a level of compensation, regardless of the market conditions.

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