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Calculating The Lessor’s Royalty Interest For An Oil Or Gas Lease

Tuesday, November 17th, 2015

Royalties are one way a landowner receives compensation for an oil or gas lease. Royalty interest is the landowner’s share of the gross production, and a royalty owner does not bear the costs of production. For many landowners, calculating royalties can be the most important part of a lease. However, this calculation can also be one of the most difficult to understand. There are a couple of things that determine how the royalty is calculated: the place where the royalty is established and the method used for calculating it.

The place where royalty is established

There are costs associated with exploration, production, and marketing. Those costs are usually borne by the production company that holds the lease. However, sometimes those costs are shared by the landowner. It all depends on where the royalty is established.

If the royalty is established at the well, then the landowner bears none of the expenses. The royalty calculation is based only on the total amount of oil or gas that is coming out of the well.

If the royalty is established at the pipeline or the place of sale, then the landowner may bear some of the costs after extraction.

The method of calculation

There are three methods commonly used in calculating the value of the oil or gas.

The first method is based on market price and the value of the oil or gas on the day of extraction. By taking the price at the well, the landowner can take advantage of rises in crude oil or gas prices. Another variation of this method is using the highest price posted by a major oil company within 100 miles of the well on the day of production.

The second method works with the actual revenue generated by the sale of the oil or gas. This actual revenue can be higher or lower than the market price and is most often used with gas leases. If a producer of gas enters into a long-term contract, the royalties to the owner may not rise that much even if gas prices rise significantly.

The third method of calculation is “in-kind”. Instead of receiving a monetary amount, the landowner receives a percentage of the actual gas or oil that is extracted at the well. The landowner can then sell the product as desired.

No matter how the royalty interest is calculated, taxes are paid by the landowner on its share. The production company will deduct federal and state taxes.

Getting help with oil and gas leases

Oil and gas leases can be confusing to the typical landowner. If you have any questions about an existing lease or a lease you are considering, you need the help of an experienced attorney.

The oil and gas team here at Brown & Fortunato, in Amarillo, can help. Call us today at (806) 345-6300 if you have any questions regarding royalty interest You can also connect with us via email by clicking on Contact Us. Check out our website to see our other practice areas and to read more About Us. We welcome you to visit our offices located at 905 S. Fillmore, Suite 400, in Amarillo, Texas.

This information is subject to change. Please check for updates that are more recent than the published date of this article.