How to Calculate Overriding Royalty Interest

An Overriding Royalty Interest (ORRI) is a share of revenue from oil and gas produced from a specific mineral lease. It is an economic interest carved from a working interest, entitling its holder to a portion of production proceeds. This interest is significant for various parties in the oil and gas industry. Calculating an ORRI requires specific data and an understanding of how these interests function within oil and gas production.

Understanding Overriding Royalty Interests

An Overriding Royalty Interest is a non-operating interest, meaning the holder does not bear the costs of drilling, completing, or operating a well. This distinguishes it from a working interest, which carries the burden of all operational expenses. The ORRI is created from, and therefore subordinate to, an existing working interest in a mineral lease. Its existence is tied directly to the life of the underlying oil and gas lease; when the lease terminates, the ORRI typically ceases to exist.

ORRIs are commonly created through various mechanisms. They can be assigned as compensation for services rendered, such as to landmen for acquiring leases, to geologists for their reports, or to attorneys for their legal work. They may also be reserved by a lessee when assigning an oil and gas lease to another party or granted to investors to help fund drilling operations. Unlike a landowner’s royalty interest, which stems from direct ownership of the mineral estate, an ORRI holder does not own the minerals in the ground. The landowner’s royalty is typically established in the original lease agreement and is paid first, with the ORRI being a share of the production remaining after the landowner’s royalty is satisfied.

Essential Data for Calculation

Calculating an Overriding Royalty Interest requires specific information. Each data point contributes to determining the revenue share an ORRI holder is entitled to receive.

Gross Production refers to the total volume of oil, gas, or other hydrocarbons produced from a well or unit during a specific period. The Price is the per-unit market value at which the produced hydrocarbons are sold, such as dollars per barrel for oil or per thousand cubic feet (MCF) for natural gas. This price converts the volume of production into a monetary value.

The Lease Royalty Rate, also known as the landowner’s royalty, is the percentage of gross production reserved by the mineral owner as compensation for leasing their mineral rights. This rate is typically stipulated in the original oil and gas lease agreement.

The Working Interest represents the percentage of ownership in the operating rights under the lease, and the working interest owner typically bears the costs of exploration, development, and production.

The Net Revenue Interest (NRI) is the share of production revenue an owner receives after the deduction of the landowner’s royalty and other non-operating burdens. It is commonly calculated by multiplying the Working Interest by (1 minus the Lease Royalty Rate). The Overriding Royalty Interest Percentage (ORRI %) is the specific percentage that the ORRI holder is entitled to receive, as defined in the agreement creating the ORRI.

Performing the Overriding Royalty Interest Calculation

The exact methodology for calculating an ORRI depends on the specific language within the ORRI agreement. A common approach involves first calculating the Net Revenue Interest (NRI) for the working interest owner from whom the ORRI was carved. If the working interest is 100% and the lease royalty rate is 20%, the NRI would be 100% multiplied by (1 – 0.20), resulting in an 80% NRI. This NRI represents the portion of production revenue available to the working interest owner after the landowner’s royalty has been accounted for.

Next, the total value of the gross production is determined by multiplying the Gross Production volume by the prevailing Price per unit. For example, if a well produces 1,000 barrels of oil in a month and the price is $80 per barrel, the gross production value is $80,000.

The ORRI percentage is then applied to the appropriate base, which is usually the Net Revenue Interest of the working interest from which it was granted. To illustrate, if the ORRI is 5% and the working interest owner’s NRI is 80% of the gross production, the ORRI holder’s share would be 5% of that 80% NRI. If the gross production value is $80,000, and the NRI is 80% ($64,000), then a 5% ORRI on this NRI would yield $3,200 ($64,000 0.05).

However, some agreements may specify that the ORRI is a direct percentage of the gross production value, rather than being carved from the NRI. In such a case, a 5% ORRI on $80,000 gross production would directly result in $4,000. It is important to consult the specific ORRI agreement to identify the correct base for calculation.

Common Deductions and Considerations

While an Overriding Royalty Interest is typically “free of the costs of production,” this generally refers to the expenses associated with drilling and operating the well itself. The phrase “cost-free” does not universally apply to all potential deductions that might impact the final payment received by an ORRI holder.

Post-production costs are a primary consideration. These are expenses incurred after the oil or gas has been brought to the surface and include activities such as gathering, processing, compression, and transportation to a market. Depending on the specific language in the ORRI agreement and the applicable state laws, ORRI payments may be subject to a proportionate share of these costs. Clear contractual language is necessary to determine whether these costs are deductible from the ORRI payment.

Severance taxes are another common deduction. These are taxes levied by states on the extraction of natural resources within their jurisdiction. Severance taxes are typically deducted from the gross proceeds of production before the calculation and payment of royalty interests, including ORRIs.

Ad valorem taxes, which are property taxes assessed on the value of the mineral estate, are generally borne by the working interest owner. While not directly deducted from the ORRI payment, they influence the overall profitability of the working interest from which the ORRI is derived. Additionally, some specific agreements may contain other unique contractual deductions that can affect the final amount disbursed to the ORRI holder.