Landowner survey determines impacts of oil and gas leasing negotiation efforts Part 2: Lease royalty
Results of a survey sent by Michigan State University Extension in 2013 to 130 landowners in 19 Michigan counties determines their activities in oil and gas leasing negotiation regarding the lease royalty.
Part 1 of this series by Michigan State University Extension discussed these survey topics: 1. Sources of information landowners used to understand and negotiate oil and gas lease contract terms. 2. What the initial and final bonus payment offer was and if negotiation increased this payment. This segment will discuss the survey results regarding negotiating the lease royalty.
In the oil and gas industry, the royalty refers to ownership of a portion of the revenue that is produced. A mineral owner receives a royalty interest, but does not bear any of the costs of the operations needed to produce the resource. It is a cash payment that is paid based on the mineral owner’s share of production and the sales price of the hydrocarbons produced from the lease. As with many types of contracts, the lease royalty can be negotiated.
What was the initial royalty offer? An offer of 1/8 (.125) was received by 97 percent. An offer exceeding 1/8 was received by 3 percent.
What as the final royalty negotiated? The survey compared the average initial royalty offer of 12.5 percent with the final offer to determine if there was an increase due to lease negotiations. Only the answers from those landowners who eventually signed a lease were included. Sixteen percent of the respondents chose not to answer this question, with some indicating they had signed a confidentiality agreement and could not provide that information. Sixteen percent stated there was no increase in the royalty, while 67 percent stated they negotiated for better terms. Fifty-four percent negotiated the royalty to a range of 12.6 to 16.7 percent. Thirteen percent negotiated the royalty to a range of 16.8 percent to 18.8 percent. No respondents indicated a royalty greater than 18.8 percent.
The average royalty was increased to .153 or 15.3 percent. This is an increase of 22.4 percent from the initial offer of 12.5 percent.
To translate these results into dollar terms, we will use a sample well. For the sample well, we will assume the landowner was the sole owner of 40 acres and a successful well was drilled that produced 25 barrels per day. It operated for 200 days during the year and the oil sold for $90 per barrel. This well will produce $450,000 in gross income (25 barrels per day x 200 days x $90 per barrel = $450,000) in the first year. If the royalty was 1/8 or .125 the mineral owner would receive $56,250 the first year ($450,000 x .125 = $56,250.) prior to any post-production cost deductions.
The survey results indicated an average increase to .153 or 15.3 percent. Mineral owner’s income produced would be $450,000 x .153 = $68,850 the first year prior to any post production cost deductions.
By negotiating an increase to the royalty, the income, on average was increased $12,600 the first year of production ($68,850 -$56,250 = $12,600). This proportionate increase would occur each year of production.
These survey results demonstrate that when landowners gain an understanding of the oil and gas lease contract terms and the options to negotiate them, a substantial improvement in the financial aspects of the contract can occur.
Future articles will address the results of the remaining subject areas of the survey, such as post production costs deductions and other resource protections.