What is a Royalty Interest?

A royalty interest is a fractional share in the products of an oil or gas well held by a party other than the company doing the drilling or the person who owns the land. People who hold a royalty interest do not share in the costs of production, only the expenses associated with the initial startup. When a lease expires or a well stops producing, the royalty interest expires as well.

People obtain a royalty interest by providing some of the money used to start the well. In exchange for their investment at the beginning, these third parties are entitled either to a share of the oil and gas produced, or to a share of the profits from the sale of the well's products. The details of the agreement are spelled out in a contract that also specifies the percentage of the proceeds to which the person with the royalty interest is entitled.

Oil and gas exploration can be costly. People must be sent to survey sites, equipment to dig test wells is required, and costs are also incurred when a well is dug and equipped with a rig. People who have funds available to contribute to these costs can acquire a royalty interest and a steady supply of funds as the well is worked without any further financial obligations. Someone with a working interest in the well, by contrast, contributes to working expenses and is entitled to a share of the proceeds in result.

The productivity of a well is highly variable. If a well is placed correctly and it is in an area with rich deposits of oil and gas, it may be highly productive and can generate high returns for the investors. Care is certainly taken to select the optimal placement for wells, using a variety of equipment to survey and identify the best possible location for a well site. Even with careful exploration and research, it can be difficult to determine how much oil and gas will be pumped out of a well. Investors are taking a risk by contributing to startup costs.

People with royalty interests do not own the mineral rights associated with the well. These rights are reserved for the property owner, unless they are specifically assigned to another party. Individuals with a royalty interest only have a right to the oil and gas once it has been pumped, and do not control the management of the well or the land.