A royalty interest offers the benefit of sharing in production, without exposure to the capital costs, operating costs and environmental costs associated with oil and gas production. Compared with working interests, royalty interests have higher netbacks.

Royalty Interests Versus Working Interests

There are two types of ownership in oil and gas reserves - working interests and royalty interests. Working interests are participating (lessee) interests in land, and are expressed as a fraction or a percentage. Working interest owners pay capital and operating costs and pay royalties to the mineral title owner. Royalty interests are interests in production (or production income) only.

A royalty is a payment made from the gross production at the wellhead and the royalty owner is not responsible for any of the capital or operating costs required to deliver the oil or gas at the wellhead.

Freehold owns both royalty and working interests, but the majority of its production comes from royalties.

Types of Royalty Interests

There are two types of royalty interests - lessor royalties and overriding royalties. Lessor royalties represent the mineral title owner's share of production, free of expense of the production. Overriding royalties arise primarily from contractual arrangements between companies and are usually derived from working interests that would expire when production ceases.

Freehold owns both mineral title rights and gross overriding royalties, but the majority of its royalties are mineral titles which are held in perpetuity.

How Royalties are Calculated - Example

A contract (lease agreement) is entered into between the party that owns the mineral rights (lessor) and the party that wants to drill for oil and/or gas (lessee) in exchange for payment of a royalty. Royalty rates vary from lease to lease.

The working interest owner (lessee) drills for oil and/or gas. If the drilling results in a successful oil or gas well, then the lessor receives a royalty based on that production. For example, if the royalty rate as stipulated in the lease is 20% and a well is drilled that produces 100 barrels per day; the royalty owner receives 20% of 100 barrels (i.e. 20 barrels) or the cash equivalent. This will continue until the well no longer produces.