Mineral rights are one of the darlings of the investment world. In this, the second of our series on mineral rights, we introduce you to three different kinds of investments that are all called mineral rights.
In our first article on mineral rights, we introduced the concept that surface rights and mineral rights may be conveyed separately; and further, that mineral rights are often shared among several owners.
Here we introduce the concept that not all mineral rights are the same.
Types of Mineral Rights
According to the Schlumberger Oilfield Glossary, five kinds of mineral rights may be granted by the owner:
“Ownership of the right to exploit, mine or produce all minerals lying beneath the surface of a property. In this case, minerals include all hydrocarbons.
Mineral interests include:
1. the right to use as much of the surface as is reasonably necessary to access the minerals,
2. the right to execute any conveyances of mineral rights,
3. the right to receive bonus consideration,
4. the right to receive delay rentals and
5. the right to receive royalty. Any or all of the above five rights of mineral ownership may be conveyed by the mineral owner.”
Comparing Investments in Mineral Rights
There are three general types of mineral rights investments available. Ranging from the most secure and potentially profitable to the least, they are (courtesy EIA Glossary):
Mineral Lease — An agreement wherein a mineral interest owner (lessor) conveys to another party (lessee) the rights to explore for, develop, and produce specified minerals. The lessee acquires a working interest and the lessor retains a non-operating interest in the property, referred to as the royalty interest, each in proportions agreed upon.
Royalty — A contractual arrangement providing a mineral interest that gives the owner a right to a fractional share of production or proceeds there from, that does not contain rights and obligations of operating a mineral property, and that is normally free and clear of exploration, developmental and operating costs, except production taxes.
Overriding Royalty — A royalty interest, in addition to the basic royalty, created out of the working interest; it is, therefore, limited in its duration to the life of the lease under which it is created.
It is important to understand the differences and similarities between these.
Lease vs. Royalty
Although for tax purposes both are considered assets because they can be held in perpetuity, the owner of the mineral lease has much more control of the investment than the royalty owner, often including the right to lease, assign, or sell it.
Offering less control yet, overriding royalties are only paid while the lease that creates them is in existence. That is, should you invest in overriding royalties in anticipation of future production, and the lease expires without production, your investment is worthless.
However, investing in overriding royalties can be a cost-effective way of investing broadly in a concentrated geographic area or particular formation.
Mineral rights can be as complicated as they can be profitable. But you don’t have to face them alone; call the professionals at KerNors LLC today. Put our nearly 90 years of experience to work for you.