When you have oil or gas interests, you also have the opportunity for significant profits. The term “black gold” was coined for a reason. However, you may have legal questions about the financial side of oil and gas deals, such as non-operating working interest. When questions or disputes come up, our Nix Patterson oil and gas attorneys are here to help.
Oil and gas investors typically have one of three types of working interests in their land, one of which is non-operating working interest:
An interest in an oil or gas property through an operating agreement, lease, fee title, or another arrangement. The owner must pay part of the expense of the property’s operating costs, including drilling, leasing, and operating oil and gas wells. In addition, the working interest owner is entitled to a percentage of the oil and gas revenues.
For example, if an oil and gas property has a 20% royalty interest, someone with a 100% working interest would be required to pay 100% of drilling costs and would be entitled to 80% of the production profits. The other 20% would be due to the person who holds the royalty interest. If there is more than one working interest owner, they will share 80% of the production profits based on the size of their investments.
A non-operating working interest refers to an interest in an oil and gas property that does not participate in the day-to-day operations of drilling, testing, completion, and maintenance of the production or the sale of the minerals produced. Non-operating working interests include overriding royalty interests, production payments, and net profit interests. Unlike royalty interests, non-operating working interest must include a portion of the costs associated with the day-to-day operation of the well.
This partnership is between parties with a working interest in an oil or gas well. These parties can share working interests via a partnership where a group offers financing to keep the well operating. Or they can share their working interests through a joint venture. Investors do not have to participate in the daily operational activities of the well, and their investment is paid upfront. Then, when production begins, they receive profits from the produced revenue, less expenses of the operation.
Royalty interest is the ownership of part of an oil or gas-producing property and the revenue it creates. Someone who owns a royalty interest does not pay operational costs that are required to produce oil and gas, but they keep part of the property or the revenue it generates.
Royalty interest differs from working or non-operating working interest. Only working interests pay for the costs for drilling, production, and exploration. However, royalty owners are usually not required to pay operating costs. Royalty interests are created when a private landowner grants an oil and gas company a working interest to produce oil and gas on their property. In exchange, the landowner receives a share of the proceeds derived from the sale of any oil and gas produced. This share in proceeds is called a royalty interest.
Royalty interests can also be created when companies farmout oil and gas production to larger companies to reduce the financial and project risks. A farmout agreement can be desirable because the farmer typically retains an overriding royalty interest when the oil or gas field is developed and generates revenue. However, they retain the option to convert the override back to a working interest after they cover the drilling and production costs.
Being a working interest owner of an oil or gas well has many benefits, but it comes with much responsibility and regulation. These benefits include:
- If the oil and gas property is successful, profits can be substantial and may continue for years.
- Tax benefits are viewed as a loss; losses are active income, so you can offset them with other income.
- A working interest in an oil or gas well can be active where you are part of production decisions. However, in the case of non-operating working interests, you are not involved in these decisions.
- Owners of a working interest may receive tax incentives that could be up to 80% of the cost of the investment in a working interest.
All investments have risks and oil and gas investments are no different. Some of the risks include:
- The upfront investment is high because you must pay for production costs
- The high cost of the investment means you may operate at a loss
- In addition, onsite problems, such as environmental damage or worker injury, could risk your investment
- Duties owed to the other interest holders in the property must be taken very seriously. In particular, the working interest owner must make sure it is paying royalty owners correctly and on time. If it fails to do this, the working interest owner can be sued for royalty underpayment.
Any time you have questions about working interests or royalty interests, it’s important to have the matter reviewed by one of our attorneys.
Profits can be abundant in oil and gas investments, but legal issues and questions sometimes arise with royalty interest, overriding royalty interest, and non-operating working interests. If that happens, you should retain an experienced oil and gas attorney to assist you in addressing your questions. Contact Nix Patterson’s attorneys today for more information.