TPG Energy Releases Its 2020 Mineral Rights Owners Royalty Payment Guide

DENVER, Dec. 12, 2019 /PRNewswire-PRWeb/ -- An oil company has leased a mineral rights owner and has drilled a well that is going to be producing oil soon. What should the owner of the mineral rights expect in terms of revenue? Obviously, the answer to this depends on several variables unique to each situation: what the royalty rate is, how many acres are owned, how many wells are being drilled and how good the geology is where the acreage lies to name a few. What is not variable, however, is the path that the size of these checks will follow over time.

Oil and gas wells are subject to what is known as a decline curve. A decline curve plots the amount of oil (and/or gas) a well will produce during its lifetime. When wells first starting producing, there is a significant amount of pressure in the well that brings large amounts of hydrocarbons (i.e. oil, natural gas liquids, gas, etc) to the surface at a rapid rate. Over time, this pressure decreases and the amount of oil produced falls commiseratively. This decline is usually drastic, and by year 3 the monthly production will generally be less than 10% of month 1.

It is important mineral rights owners understand that the income generated by minerals will follow the same path as above. Any mineral rights owner who has received production checks can attest to this. The very first check will include several months worth of production as the oil company will usually pay 3-6 months in arrears for this initial payment. This means there will be a very significant decrease between the first and second checks, with a continued decline month over month, before eventually more or less leveling off in years five and beyond. Additionally, oil and gas prices will impact monthly checks. Oil is the most volatile commodity in the world, so it can be difficult to project how much future cash flow mineral rights will generate. Because of this, many people choose to sell their mineral rights and invest the proceeds in asset class with more stable cash flows not subject to such a significant decline, often without having to pay any taxes via 1031s exchanges.

Another important fact to remember is that royalty income is taxed as ordinary income. This means it is taxed at the highest tax bracket the owner qualifies for. When an owner completes an outright sale of mineral rights, it is taxed as capital gains. If the owner has owned the minerals (inherited or purchased) for more than 1 year, he qualifies for long-term capital gains treatment, which is generally about 50% less than the ordinary income tax rate. As mentioned above, people also often take their sale proceeds and invest tax-free via a 1031 exchange. Being able to take advantage of the long-term capital gains tax treatment or deferring taxes indefinitely via a 1031 exchange are common reasons for owners opting to sell their minerals today instead of waiting to collect royalty payments.

SOURCE TPG Energy