In this post, we will delve into what mineral interests are, how they are monetized, and some legal framework.

What Are Mineral Interests?

Mineral interests, often referred to colloquially as “mineral rights”, are a significant and unique form of real estate interest in the United States. The United States is the only major country in the world where these interests are predominantly owned by private individuals and companies rather than by the government.

Mineral interests in a particular parcel of land grant the owner the entitlement to extract and profit from minerals found beneath the earth’s surface. These rights encompass a variety of natural resources such as coal, lithium, gold, and silver.  However, in the United States, the most prolific and valuable natural resources are oil, natural gas, and related hydrocarbons used for energy.

Mineral rights can be sold, leased, or otherwise transferred separately from the surface of the land, which means that the person or entity that owns the surface rights to a piece of land might not also own the rights to the minerals beneath it.  Therefore, there are two major ownership classifications for the mineral estate of a particular parcel of real estate:

• Fee Simple Estate: Both surface and mineral rights are owned by the same party.

• Severed Estate: Mineral rights have been legally separated from surface rights at some point, meaning the ownership is different for these two components of the parcel. The exact depth at which the severance occurred may vary, but a good rule-of-thumb is around 100 meters below the surface of the earth. In areas of the United States where ample oil & gas production is occurring, the vast majority of property parcels are severed.

Mineral Interest Monetization

Before any exploitation of natural resources occurs on mineral interests for a particular parcel, the mineral interests are said to be “non-producing”.  It is initially unknown whether any valuable mineral deposits exist within a particular mineral estate, and unless some such deposit is located in the future, the mineral interest will stay in “non-producing” status perpetually.  In this state, the mineral interest portion of the parcel is generally not subject to property taxes, as there is no proven or determinable value to any minerals which may or may not be present.

Typically, in the oil & gas industry, mineral interests begin the process of being monetized via the following sequence of events:

• Step 1: Deposits are located. This occurs when an exploration & production (“E&P”) company, also referred to as an “operator” of wells, speculates that valuable oil, natural gas, or other hydrocarbon deposits may be present.  These deposits are located  by professionals (often, geologists or petroleum engineers) using various methods and technologies, but the presence or abundance of minerals present in a particular location are almost never known for sure until a well is drilled.  E&P companies are referred to as “upstream” companies in the oil & gas industry because they are actively involved in the extraction of natural resources from the earth.




• Step 2: Mineral interests are leased. After a sizable mineral deposit is located, the E&P company contacts the owner(s) of a mineral estate in order to lease the mineral interest.  The owner(s) must sign a formal oil & gas lease (“OGL”) document which grants the E&P company the right to explore for and extract the hydrocarbons in return for an immediate lease bonus, a royalty percentage of the revenue from any extracted minerals (typically, between 12.5%-25%), and other compensation terms stipulated in the lease.  If no wells are drilled within the term of the lease, which is typically between 3-5 years, the the mineral interests again become unleased.




• Step 3: Well(s) are drilled. Once an operator has received the necessary permitting from regulatory authorities, they can commence the drilling of one or more wells for the extraction of oil, natural gas, or other hydrocarbons.  The operator is responsible for 100% of the costs of drilling and therefore none of these costs are the responsibility of the mineral owner.  Upon successful drilling of the well(s), the operator will sell the produced hydrocarbons to a “midstream” company which buys, transports, and refines them into various substances, such as gasoline and diesel fuel, which can be used for energy. These  refined products are later sold to a “downstream” company, such as a chain of car refueling stations, which sells the refined products into the market. Sometimes, if the operator of the drilled wells is a very large oil & gas company, they will themselves have a midstream and/or downstream arm to their company and will therefore fill the role of “purchaser” of the hydrocarbons themselves. Whether or not this is the case, the produced commodities are sold at current spot prices as of the moment they are produced and taken away by the midstream company (or midstream division), less certain pre-agreed deductions and production-related taxes. Once a mineral interest reaches this “producing” state, it will now be appraised on an annual basis by governmental tax authorities for the assessment of an annual property tax on all mineral owners in the parcel.

Legal Framework Governing Mineral Interests

Ownership of mineral rights in the U.S. is influenced by both federal and state laws. The federal government, through laws such as the Mineral Leasing Act and the Mining Law of 1872, sets basic guidelines, while state laws provide further regulations which in some cases vary significantly. States like Texas, Oklahoma, and North Dakota, for example, have their own elaborate sets of rules which cater to their rich mineral deposits.

As with any real property, mineral rights can be conveyed through leasing, selling, or inheritance. Transactions must comply with both state and federal regulations, which are numerous, and certain title and administrative challenges arise during the transfer process.

Additional information about the complexities of mineral rights transfers, as well as how tokenization resolves many of these issues, is available in our blog post Why Tokenize Mineral Interests?

Conclusion

Mineral interests are a complex but integral part of the U.S. real estate landscape. Understanding the different types of mineral interests (see our blog post Types of Mineral & Royalty Interests), along with the regulatory and economic contexts in which they operate, is crucial for anyone involved in this field.

Mineral & Royalty Interest Types

In the United States, mineral and royalty interests come in various types and represent ownership of, or profit-sharing rights in, the production of oil, gas, and other minerals from the subsurface portion of a particular parcel of land. Understanding these interests is crucial for investors and landowners alike. Here’s a breakdown of the most common types:

Mineral Interest (MI)

• Full Ownership Rights: Full ownership of the minerals beneath a tract of land.

• Full Executive Rights: The right to lease the minerals to an oil & gas company for exploration & production.

• All Revenue Streams: Owners can receive all types of production- & property-related income, including lease bonuses, delay rental payments, and production royalties.

Royalty Interest (RI)

• Created From Lease Agreements: Royalty interests are created when a mineral interest owner leases their minerals to an exploration & production company to extract the minerals.

• Revenue Without Costs: Royalty interest owners receive a percentage of the revenue from mineral production without bearing any of the production costs.

• Distinct From Mineral Interest: Although a mineral interest owner can and often does also come into possession of a royalty interest at the time of signing a lease (and therefore holds both interests at the same time), it is important to understand that the mineral interest ownership rights and the royalty interest which relates to a specific lease which was signed on those mineral interests are each distinct in that one could be sold while the other is retained. This is not especially common, but it does occur.

Working Interest (WI)

• Operational Role: This refers to the interest that is created for the exploration & production company when a mineral owner signs a lease with them. This gives the exploration & production company (often called the “operator”) the right to explore, develop, and produce minerals on the leased mineral interests, but they must also bear all drilling, maintenance, and other production costs.

• High Risk and Reward: This interest type carries the potential for high returns (since the operator receives a majority share of the income from wells drilled) but also comes with significant financial obligations & risks. If a well is drilled at great expense and only a small amount or no hydrocarbons are produced, this is called drilling a “dry hole” and means that the operator will sustain great financial losses related to the drilling of the well. The royalty interest owner, however, will sustain no losses.

• Also Known As “Leasehold Interest”: Before wells are producing on a leased parcel of land, operators typically refer to their interest in the land as a “leasehold interest”. This is essentially a synonym for the term “Working Interest” but simply refers to the time period before production begins.

Overriding Royalty Interest (ORRI)

• Carved from Working Interests: Overriding Royalty Interests are not tied to the ownership of minerals but to the proceeds from the sale of produced minerals under a given lease agreement. Operators create these interests artificially from the Working Interest produced upon their execution of a lease agreement with a mineral interest owner. ORRIs are not cost-bearing, similar to traditional royalty interests. After these interests are created, they can be sold and transferred until such a time as the associated lease expires. When the lease does expire, the ORRIs expire worthless along with the Working Interest. Note, however, that any producing well will ensure a lease is “held by production” and doesn’t expire until such a time as the well stops producing.

• Common Origin: ORRI interests are typically created by operators as a form of incentive compensation to geologists, engineers, and landmen who work for them.

Non-Participating Royalty Interest (NPRI)

• Mineral Interest With No Executive Rights: With this interest type, owners have financial interest in a particular mineral interest parcel, but they do not have the authority to lease the mineral interest to any party or receive lease bonuses or delay rental payments. They are paid purely on the basis of the production of minerals from the acreage (the royalty interest).

• Common Origin: NPRIs are often created at the time of distributing an inheritance. By dividing a mineral interest in such a way that all but one divided part are NPRI, only one portion will retain the executive rights (to “speak for the acreage”) whereas revenue from production can be split evenly across all heirs.

Non-Operated Working Interest

• A Passive Working Interest: With this interest type, owners do not participate in operational decisions but still share in production costs and revenues. These are created from the total Working Interest that is initially created when an operator signs a lease with a mineral interest owner.

• Common Origin: Non-Op Working Interests can be created in many different ways, including as a result of a joint venture agreement between multiple operators, a risk mitigation effort of the operator, or as incentive compensation, similar to ORRIs.

• Tax Benefits: Owners of Non-Op Working Interest bear more risk than other, non-cost bearing interest types, but they may receive tax advantages from incurring these costs without the responsibility of actually managing production operations.

Net Profits Interest (NPI)

• Royalty Interest, With Some Deducted Costs: With this interest type, owners receive a share of the net profits from mineral production after certain costs are deducted. If, for example, substantial costs are required to transport produced hydrocarbons from the wellhead to be sold, an operator may negotiate for an NPI so that these costs can be deducted from royalty payments.

• Non-Operational & Passive: Like RIs, NPRIs, & ORRIs, NPIs are passive and do not involve direct participation in production activities.

For the most part, Mineral Vault products include only the interest types MI, RI, NPRI, ORRI, and NRI. These interest types are passive from an operational standpoint and are not significantly cost-bearing.

In the oil & gas industry, mineral property management companies are often hired to manage large mineral property portfolios. Property management companies are often paid a fixed percentage of royalty revenue as a management fee, which compensates the property manager for their effort & expenses in managing the properties.

In this article, we’ll explain the management responsibilities of these mineral property management companies.  Let’s jump in!

Negotiation & Execution of New Oil & Gas Leases

A cornerstone of mineral property management is the securing of new oil & gas leases on unleased portfolio acreage.  A good mineral property management company will not only negotiate and execute these leases in a favorable manner for their client, but they will also actively market unleased acreage to exploration & production (E&P) companies which may be interested to lease the acreage.

So what exactly is an oil & gas “lease”?

Before an oil & gas E&P company can drill wells on any acreage, they must first secure permission from the mineral interest owner(s) to do so.  This “permission” comes in the form of an oil & gas lease.

The process typically begins with the E&P company selecting a tract of land where they believe there is potential for drilling a lucrative well.

After an area has been chosen, public records are checked to determine what portions of the acreage are leased or open as well as who the record owners are of the mineral interests in question.

Once the open acreage & ownership has been determined, the E&P company will present an offer to the mineral owners to lease their mineral interests for a set period of time (typically, 2 to 5 years) at a specified price per acre. This payment is called the “lease bonus” and is payable regardless of whether the E&P company actually drills any wells during the lease term. The lease will also specify a royalty percentage (typically between 12.5% and 25%), which is the percentage of net proceeds from the sale of produced oil, gas, or other hydrocarbons to which the mineral owner will be entitled, should one or more wells be drilled during the lease term. Once the offer to lease is accepted, the mineral owner is sent a lease form and an order for payment.

It is important to understand that the mineral owner(s) receive the payments mentioned above since they own the mineral interests being developed, but they are not responsible for any of the costs of drilling or operating the wells – this expense (and risk) falls firmly on the E&P company.

Review & Validation of Division & Transfer Orders Related to New & Existing Wells

Mineral property managers also manage the division and transfer order processes for all of their clients’ new and existing wells.

Division orders are contracts between the well operators (E&P companies) and mineral owners which are executed immediately after a well is drilled and set to begin producing. To receive royalty payments, mineral owners must execute the associated Division Order for the well(s) which have been drilled.  The Division Order states clearly the final percentage of revenue from the wells which will be due & payable to the mineral owner and is executed for avoidance of doubt and to diffuse objections down the road.

It is critical that a mineral property management company review these division orders very carefully to ensure the accuracy of essential information like the effective date of production, the payor’s name and address, the well name and legal description, tax identification numbers, and, most importantly, the decimal interest (percentage) which the mineral owner will be paid on.

Another document which is occasionally relevant to mineral property managers is transfer orders – these documents are sent by operators when a particular property’s ownership changes. If a property with an already-existing well or wells (for which the mineral owner(s) are actively receiving royalty payments) is transferred from one mineral owner to another due to purchase, inheritance, or any other reason, transfer orders are issued to one or both parties to acknowledge the transfer and ensure that all parties agree to the change.

Verification of Payments from Operators & Purchasers

A good mineral property manager will review all lease bonus, royalty, and other payments received to ensure that they are accurate and in compliance with the executed lease terms.

In a more basic sense, they will also ensure that all payments to which their clients are entitled are actually received, as checks can very easily get “lost in the mail” when dealing with large mineral property portfolios. It is not uncommon for a single portfolio to receive several hundred or thousands of revenue checks per month, being issued by various parties. In managing a portfolio of this scale, simply ensuring all payments are received is critical.

Lastly, on an ongoing basis, a good property manager will ensure that payment is being received on all wells that cross portfolio acreage using specialized software to map the locations of all existing wells against owned acreage to ensure that division orders and ongoing royalty payments are being received from all overlapping wells. If wells are discovered to exist which the client is found to *not* be in-pay on, a good property manager will reach out to the operator of the well in question and ensure ownership information is corrected in their systems and payments are issued as required.

Verification & Payment of Property Taxes

When managing large mineral property portfolios, one of the most critical management responsibilities is the assurance that all due property taxes are paid on all owned acreage.

In most states, at the time of acquiring a new mineral interest, the new owner must inform the tax authority that the ownership of the property has transferred and provide their contact information. After that, each year, the tax authority will appraise the property in question and property tax statements will be sent by the tax authority to the owner in question, which must be verified against owned acreage and paid promptly to avoid penalty & interest charges – or contested if the appraised value is unreasonable or inaccurate.

When managing a large mineral property portfolio, among the most critical steps in this process is simply verifying that tax statements have been received and paid on all owned interests.  Why does this matter so much?  Well, if property tax payments aren’t received by the tax authority in question, even if they have the owner’s address incorrect or they are sending the statements to the previous (incorrect) owner, the property will become tax delinquent and can be sold at the courthouse steps to the highest bidder in a Tax Sale!

To avoid this, a good mineral property manager will compare all portfolio properties owned against the tax statements received each year to ensure that property taxes have been paid on 100% of all portfolio properties.

Filing of All Necessary Tax & Regulatory Paperwork

A mineral property management company will generally handle all of the necessary tax and regulatory paperwork, such as the organizing and indexing of annually-received 1099s related to royalty income received, cost basis on owned properties (relevant in the event of a sale), and all basic entity bookkeeping needed so that state & federal tax returns can be filed accurately by a CPA or other tax professional.

Token Management Services

In the case of Mineral Vault tokenized products, the designated property management company, Mineral Vault LLC, handles all processes related to token holder management and support.  For example, Mineral Vault LLC is responsible for the declaration and payment of noncumulative dividends to token holders, compliant onboarding of new token holders, token issuance, as well as transfer and wallet support requests.  The property manager is responsible for nearly all general token holder support processes & inquiries, as well as inquiries from prospective token holders.

Conclusion

So, there you have it! Managing mineral properties is somewhat complex, but a good mineral property management company can completely handle these responsibilities and turn mineral property ownership into a passive endeavor.  With Mineral Vault tokenized products, Mineral Vault completely handles all of the responsibilities discussed in this blog post on behalf of token holders, leaving them with a completely passive, yield-bearing investment in America’s finest mineral properties.