Mineral Rights 101
Do you own, or have you inherited, land and are wondering if you have any valuable assets above and below the surface? Are you wondering how
to start, but are unsure what it all means to buy, sell, or lease minerals? Here, we will cover the basics about mineral rights.
What are mineral rights?
Mineral rights (otherwise known as a “mineral estate” are the legal rights that a person has to exploit, mine, or produce any materials
underneath the surface of the earth. These materials may be any organic or inorganic substance such as ores of metal, coal, oil, natural
gas, gemstones, stone, salt, or any other substance besides sand, gravel, or water. The owner of the mineral rights can sell, lease, gift,
or bequeath these minerals to any individual or entity they choose. For example, a person may own 20 acres of land, and beneath the surface
of that land lies minerals that can be sold or leased or gifted for an amount of money. That person may own the surface of the land, while
someone else may own what is beneath the surface; in other words, the mineral rights.
In most other countries, the minerals beneath the surface usually automatically belong to the government, but in the United States of America, that is not the case. Whoever owns the rights to minerals can do whatever he or she sees fit with those minerals. This greatly benefits the oil and gas industry which relies on having fair opportunities to offer to pay money to drill, mine, and explore properties that they don’t own. This greatly expands their production and profit rates, and it gives you, the mineral rights holder, and opportunity to potentially make some profit.
When an agreement is desired between two parties such as the mineral holder and an oil and gas company, the agreement will usually depend on five elements of a mineral right which are:
In most other countries, the minerals beneath the surface usually automatically belong to the government, but in the United States of America, that is not the case. Whoever owns the rights to minerals can do whatever he or she sees fit with those minerals. This greatly benefits the oil and gas industry which relies on having fair opportunities to offer to pay money to drill, mine, and explore properties that they don’t own. This greatly expands their production and profit rates, and it gives you, the mineral rights holder, and opportunity to potentially make some profit.
When an agreement is desired between two parties such as the mineral holder and an oil and gas company, the agreement will usually depend on five elements of a mineral right which are:
- The right to use as much of the surface as is reasonably necessary to access the minerals.
- The rights to further convey rights, which mean they are allowed to make new rights.
- The right to receive bonus consideration, which means that you are entitled to be considered for extra royalties (typically when initially signing an agreement).
- The right to receive delay rentals, which means fees are paid to the lessor (the owner of the minerals), to delay production or commencement of drilling, without terminating the lease.
- The right to receive royalties (financial compensation).
Severability: Surface Rights vs Mineral Rights
When it comes to minerals and rights, they are usually divided into two categories: Surface and Mineral. “Surface” means just what it sounds like;
it refers to what is on the surface (or the top) of the property, while “mineral” refers to what lies beneath the surface (see above). More specifically:
Surface Rights refer to any inorganic substance that lies on top of the surface, such as water, gravel, etc. If an owner wants to keep possession and control of the surface, these are known as surface rights, and these are different from mineral rights which lie beneath the surface. For example, a farmer can choose to sell the mineral rights to the coal beneath his property, but keep the surface rights, which would allow the farmer to keep control of the buildings, the water, and anything else on “top” of the ground (surface).
Therefore, severability is the term applied to this separation of surface and mineral rights.
Surface Rights refer to any inorganic substance that lies on top of the surface, such as water, gravel, etc. If an owner wants to keep possession and control of the surface, these are known as surface rights, and these are different from mineral rights which lie beneath the surface. For example, a farmer can choose to sell the mineral rights to the coal beneath his property, but keep the surface rights, which would allow the farmer to keep control of the buildings, the water, and anything else on “top” of the ground (surface).
Therefore, severability is the term applied to this separation of surface and mineral rights.
Mineral Rights Leasing
When a mineral rights owner wants to try to earn money from those minerals, the owner has the choice to either sell the minerals or “lease” them. Leasing
the minerals means that an oil and gas company will offer a contract based on the five rights (see above), and the mineral owner and the company will come
to an agreement on how much money (royalties) is to be paid to the mineral owner. It is much the same as renting property: the owner of the house will offer
that house to someone willing to pay the rental price; in other words, they “lease” the house from the owner. Likewise, a company can “lease” minerals
from a mineral rights holder.
There are a few terms that you, as a mineral rights holder, should be aware of that are typically used in lease agreements:
Once a contract is agreed upon, the lessor (mineral rights holder) will receive a royalty check, or payment for that lease which will usually be paid once a month (terms to be agreed upon before signing of the contract). The amount of these payments may fluctuate per month due to the amount of substances that are extracted and sold, and due to the changes of oil and gas prices. Royalties are typically calculated from this equation:
Revenue interest decimal = (A÷U) × R × P × Y
There are a few terms that you, as a mineral rights holder, should be aware of that are typically used in lease agreements:
Lease: the one buying or leasing the minerals from the mineral owner. This would often be the company that is
interested in buying or leasing.
Lessor: the lessor is the owner of the minerals or “client” from whom the company buys or leases those minerals.
Division Order (Division of Interest, DOI): is the term applied to how minerals are divided between the mineral rights
lessee, which is usually the oil and gas company, and the lessor, who is usually the owner of the minerals. The lessee is the one leasing or buying the
minerals, and the lessor is the owner or “client” from whom the company buys or leases those minerals. The Division of Interest is the contract between
those two groups. For example, if a company wants to lease your minerals, you and that company must come to an agreement on how much royalties will be
paid and how much minerals you will let that company lease/buy. These agreements usually include conversations about: how long the lease will be (this
is known as the “term” of the lease), whether or not the lessor will receive a bonus upon signing of the contract, the royalty rate, and on whether or
not payments will be made even if a well is not producing (this is known as a shut-in royalty agreement). These are just a few basic items that a lessor
and a lessee may negotiate, but there are many more items that can be included, depending on the situation.
Once a contract is agreed upon, the lessor (mineral rights holder) will receive a royalty check, or payment for that lease which will usually be paid once a month (terms to be agreed upon before signing of the contract). The amount of these payments may fluctuate per month due to the amount of substances that are extracted and sold, and due to the changes of oil and gas prices. Royalties are typically calculated from this equation:
- A = Net Mineral Acres owned
- U = Number of Mineral Acres in the oil and gas drilling unit or pool
- R = The Royalty assigned to the mineral right owner by the oil and gas lease covering his or her minerals
- P = Participation Factor assigned to the tracts owned by the mineral owner as described in a unit agreement
- Y = Additional Ownership Factor assigned to the owner's mineral rights by any other arrangement or agreement
Revenue interest decimal = (A÷U) × R × P × Y
Selling vs Leasing Mineral Rights
Many people have concerns about whether or not they should sell their mineral rights or lease them. There are both benefits and liabilities to both choices.
Benefits and Risks of Selling Mineral Rights:
When it comes to selling mineral rights, the appeal lies in receiving a large lump sum payment, and not having to worry about falling prices in the future. However, one disadvantage of selling is that the seller will never receive any future royalty payments from those minerals. So, the concern is that the seller may be losing out on money because a lease could last for years and years and if prices go up, the seller would make more money than he/she earned at the time of selling. Again though, the advantage of selling is that there is no hassle of worrying about whether or not mineral prices will rise or fall, and instead the seller can receive a price that he/she is happy with, and never have to worry about it again.
Benefits and Risks of Leasing Mineral Rights:
Leasing the mineral rights is very much the same as selling, except instead of a large, one-time payment, the lease will pay a royalty every month over an agreed upon length of time. So, in this case, “time” is both an asset and a liability. On one hand, time can help a lessor earn more money if the prices of minerals go up in value; on the other hand, time also can include phases of falling mineral prices, and the lessor could potentially lose money over time.
Benefits and Risks of Selling Mineral Rights:
When it comes to selling mineral rights, the appeal lies in receiving a large lump sum payment, and not having to worry about falling prices in the future. However, one disadvantage of selling is that the seller will never receive any future royalty payments from those minerals. So, the concern is that the seller may be losing out on money because a lease could last for years and years and if prices go up, the seller would make more money than he/she earned at the time of selling. Again though, the advantage of selling is that there is no hassle of worrying about whether or not mineral prices will rise or fall, and instead the seller can receive a price that he/she is happy with, and never have to worry about it again.
Benefits and Risks of Leasing Mineral Rights:
Leasing the mineral rights is very much the same as selling, except instead of a large, one-time payment, the lease will pay a royalty every month over an agreed upon length of time. So, in this case, “time” is both an asset and a liability. On one hand, time can help a lessor earn more money if the prices of minerals go up in value; on the other hand, time also can include phases of falling mineral prices, and the lessor could potentially lose money over time.