“You Never Give Me Your Money”—Royalties are Critical but Complicated

There has been a great deal of publicity around royalties involved with the shale gas—stories of instant millionaires (or “shaleionaires,” as 60 Minutes called them in 2010), stories of producers reducing or even eliminating some royalty payments as the vast oversupply of natural gas took hold in the last couple of years, stories of long, excruciating negotiations to reach a royalty/lease agreement, only to find out that the seller’s side of the table didn’t actually contain the owner of the rights, and stories of neighbors turning on each other when they got radically different deals based on timing or whom they were dealing with, and so on.   Unless you have been directly involved in leasing and royalty work, a lot of it can be confusing.  So today we begin a blog series to illuminate the world of mineral rights, oil & gas leases and royalties.

In this world it seems like there are lots of arguments in both directions from both sides of every issue.  What we’d like to do here is simply get to the factual fundamentals and explain the basics:  How do mineral leases work, what are royalties, why are they important, who pays whom for what, and what are some of the issues that are coming up these days? To that end, what follows is a description of the players and commercial processes involved in natural gas development and production, especially in the era of shale gas.   Many of the same players and processes are involved in the development and production of shale oil, but most of our emphasis is on gas to keep things reasonably simple.

Everyone knows that to get gas or oil out of the ground, a producer drills a well—and as has been publicized a lot recently, if the target is shale, that well goes down and then sideways, often passing under the property of multiple owners (see Tales of the Tight Sand Laterals).  The “producer” usually has joint investors in the well, and the property owners can also have a piece of the action.  So let’s look at who they are and how the commercial transaction works.