In today’s fast-paced financial world, there are numerous ways to put one’s money to work and receive revenue via smart investments. Investment in overriding royalty interests is just one of them. However, it’s potentially lucrative and well worth a second look.
But what is an overriding royalty interest? What are the differences between a royalty interest vs. overriding royalty interest, and what should potential royalty interest owners know before diving in?
Here’s everything you need to know, including a thorough definition of overriding royalty interest and an example scenario.
What Are Overriding Royalty Interests?
Also sometimes referred to as an ORRI, an overriding royalty interest is a fractional amount of a larger working interest or mineral lease. Being the rights holder of an ORRI entitles a person to a share of the revenue produced by the associated minerals, oil, or gas on a specific tract of land.
It is important to understand that an overriding royalty interest is not an interest in the actual gas, oil, or additional minerals. It strictly represents a portion of the gross revenue that proceeds from the sale of these resources.
Although exceptions exist, overriding royalty interests are most commonly distributed as part of a larger assignment.
Royalty Interest vs Overriding Royalty Interest: What’s the Difference?
Although there are similarities between royalty and overriding interests, it’s important to understand that they’re different.
With a standard royalty interest, the mineral owner retains said royalty when executing a dedicated oil and gas lease to a third-party lessee. It is typically presented as a fractional portion (such as 1/10 or 1/8) and correlates to a sales percentage of any resulting revenues.
For example, say a lessee is drilling for oil on a particular tract of land as part of a development project, and they’re successful. The oil and gas company (or other entity) that owns the mineral will receive monthly revenue payments according to the royalty interest until production stops.
An overriding royalty interest (ORRI) does work very similarly. Like a royalty interest, it represents part of the income from selling minerals like oil and gas. However, its assignment and creation are associated with a separate document, as opposed to being dictated by the original oil and gas lease itself.
See Related: How to Invest in Mineral Rights [Step-by-Step Guide]
Royalty Interest vs Mineral Interest: Are They the Same?
There are certain similarities between royalty interests and mineral interests. For example, both are types of property interests. However, they’re not the same, and it’s important to know the difference.
Mineral interests are actually real property interests associated with the on-site extraction of minerals from within the earth on an associated tract of land. A person holding a mineral interest also holds rights to options like oil and gas lease bonuses, shut-in payments, and delayed rental payments.
Meanwhile, a person with a standard royalty interest has rights only to the agreed-upon revenues resulting from the sale of the minerals.
What Is a Non-Participating Royalty Interest?
Non-participating royalty interests (NPRIs) differ from similar interests because they’re tied to oil and gas production via a mineral estate. (Non-participating royalty interests are a type of non-participating mineral interest.)
Someone holding an NPRI may have partial rights to the gross production associated with the mineral estate, or they may hold all of them. However, they don’t have rights to bonuses and delay rentals. An NPRI holder also may not develop a new lease, renegotiate an existing one, or explore additional oil and gas lease options.
How to Calculate Overriding Royalty Interest
Before correctly calculating overriding royalty interest, you must determine net revenue interest (NRI). The net revenue interest is left of a given working interest once you deduct the standard royalty interests.
NRI = Working Interest (WI) – Royalty Interests (RI)
Calculating overriding royalty interest (ORRI) from there starts with referring to the associated percentage related to the NRI. For example, if a particular ORRI agreement dictates a percentage of 5 percent, its value in this instance would be equal to 5 percent of the NRI.
What Is an Example of an Overriding Royalty Interest?
A hypothetical scenario can be a good example of an overriding royalty interest in action.
Richard is a Texas resident who owns a tract of land with an associated mineral estate. He also owns 30 percent of the royalty interests attached to that mineral estate. (To be clear, Richard does not own an NPRI or an ORRI.)
When a new tech advancement considerably increases production, Richard decides he’d like to include his two brothers so that they benefit, as well. He decides to bequeath his royalty interests to his only son, as might be expected. However, he also elects to carve out a couple of overriding royalty interests for his two brothers, amounting to 7 percent each.
In Richard’s family, his son will retain all the benefits of the executorship of royalty rights. However, Richard’s two brothers will also reap the benefits of the lucrative mineral estate via production-related revenues.
What ORRI Cost Deductions Are There to Consider?
Holders of overriding royalties are not personally responsible for any of the production costs associated with oil, gas, or other minerals. However, potential post-production expenses may apply. Examples include marketing costs, storage fees, processing fees, and transportation expenses.
Whether or not this should be the case for those with ORRI ownership is a much-discussed legal topic. How such issues are addressed can vary greatly from one state to another, with disputes eventually becoming county courthouse matters.
Therefore, those interested in becoming overriding royalty interest owners may want to seek an attorney review of the logistics before diving in. Many simply research a particular opportunity’s potential without considering whether additional clauses or expenses are involved, only to be surprised later.
See Related: How Much Do Solar Panels Cost Per Square Foot?
Overriding Royalty Interest Taxation: What to Know and Consider
Although taxes always concern royalty payments, ORRIs, and anything similar, tax treatments associated with options like trusts and royalty leases are fairly approachable.
Taxation specifics can vary greatly according to the gas or oil well’s location. There are three possibilities to consider:
Standard federal income tax
As with any other type of income, overriding royalty interest holders must pay income tax on their earnings. However, the federal government considers ORRI income a type of investment income, meaning it’s usually taxed toward the lower end of the gains spectrum.
County-specific ad valorem taxes
This is a specific type of sales tax associated with oil and gas production.
See Related: Does Carbon Tax Reduce Emissions?
State-specific severance tax
A severance tax applies when natural resources like oil and gas are transferred from one state to be sold in another. Both royalty interest owners and oil and gas producers must pay severance tax where applicable.
Additional Overriding Royalty Interest FAQs
How do you value overriding royalty interest?
ORRI value is determined by the production amount associated with the larger working interest. Calculating it can be simply accomplished by determining the correct percentage of the larger working interest lease.
Is overriding royalty interest a mineral interest?
Overriding royalty interests are attached to lease agreements, as opposed to the land containing the minerals. They expire when the lease expires, so they are not a type of mineral interest.
Related Resources
