Royalty interest definition
/What is a Royalty Interest?
A royalty interest is an interest retained in the output of a property when the owner of mineral rights enters into a lease agreement. A royalty interest entitles the mineral rights owner to receive a portion of the minerals produced or a portion of the gross revenue from sold production. The holder of a royalty interest is responsible for any production or severance taxes associated with the holder’s share of production. The holder of a royalty interest is usually not responsible for the exploration, development, and production costs of the leased property, so the royalty interest is considered a non-operating interest.
A royalty interest continues for the term of the underlying lease agreement. Once the agreement terminates, the royalty interest is gone.
Example of a Royalty Interest
A landowner (grantor) leases her property to an oil and gas company (lessee) for exploration and production. The lease agreement specifies that the grantor retains a 12.5% royalty interest in the production, while the lessee agrees to bear all exploration, drilling, and production costs.
If the oil and gas well produces $1,000,000 in revenue, then the grantor receives 12.5% of this amount, which is $125,000. This payment is gross revenue, meaning that the grantor does not pay any of the production costs. Meanwhile, the lessee retains the remaining $875,000, but must pay for all operational costs. In this scenario, the grantor’s royalty interest provides passive income without operational responsibilities.