Mineral Interests: An Overview

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.