Last Updated on Mineral rights are entitlements that grant an owner access to any underground mineral resources. This allows them to explore and exploit these resources. These rights are often sold separately from the land in which they are contained. These resources could be solid or liquid, including oil, gold, and more.
In many cases, mineral owners are required to sign a division order, which represents the legal instruments that can ensure the entitlement to royalty payments recovery. This guide will explain all you must know about division order. Let’s dive in!
What is a division order for oil and gas mineral rights?
A division order represents a record that states your interest in a particular well while comprising your interest type, decimal interest, well name, and well number. Receiving a division order implies that the production of oil or gas has already been set up from the property of interest.
The purpose of a division order is to eliminate the possibility of double liability for the oil and gas company that is paying the royalty. To understand how the division order works, it is important to explain with a real example.
Take, for instance, an oil and gas company that wishes to drill a well in a specific area. The first step they take is to employ landmen to make appropriate findings on the mineral title to tracts in the area while also determining the mineral owners of these tracts. The mineral owners are then contacted by the company to dicker the oil and gas lease related to their interests.
To secure the minerals in the area, the company may decide to acquire leases around this drill site. This is done to ensure that other wells can be drilled once the exploratory well is successful.
After acquiring the oil and gas lease, the company then chooses a drill site and then employs an attorney to evaluate the drill site tract title. The role of the attorney is to go through all documents that relate to the drill site tract mineral title. Then, an opinion is given – often referred to as drilling title opinion – by the attorney to the company.
This opinion ensures that the company possesses the entirety of the mineral estate present in the drill site tract. If a defect is discovered by the attorney about the mineral title, this raises questions and doubts about the mineral ownership. Then, the company resorts to engaging landmen to ensure that the defects are cured before any drillings can be done.
Once the aforementioned drilling opinion shows that the company owns the entire leased drill site, then the company proceeds to drill the well.
As soon as production starts, then an attorney is required to provide a division order title opinion. This second opinion is aimed at enlightening the company on how the royalty owners must be paid.
It also provides an insight into the interest of owners in the production, as well as their decimal interest in the production. All these must sum up to 100%. If an issue – related to ownership – arises, this opinion will tackle these problems, providing means to “cure” the issues, which are listed as requirements. Anytime these requirements exist, all affected owners are not paid until these are cured.
The company then provides a division order. Besides being based on the division order title opinion, this division order is prepared and sent to each entitled owner. A company’s division order analyst is responsible for tackling any issue related to division order. A key indication that shows that a well has been successfully completed is the royalty owner’s receipt. The decimal interest is estimated based on the unit on which the well is drilled.
What happens if you do not sign the division order?
Without signing the division order, there is no way to protect the payor of the profits – made from production – from the risks of double liability. If this order is not signed, no agreements can be made to ensure that the company can pay, depending on a particular decimal interest until the royalty owner notifies the owner that there has been a change in the ownership.
Who benefits most from division orders?
The company that provides the division order benefits most from this legal instrument. Through the division order, the company knows for certain who must be paid, as well as their decimal interest.
What is included in a division order document?
A division represents a record of an owner’s interest that should include:
- Interest type
- Well number
- Well name
- Decimal interest
These orders are sent to everyone with an interest in a particular well after achieving the first sale.
Another document that is worth mentioning is an IRS Form W-9, which often comes with Division Order. The purpose of this IRS form is simple: it is a one-page tax document that allows the company to send your Tax Identification Number to individuals, clients, and financial institutions. With this, the company can report royalty payments to the IRS. All needed information is present in the form.
What does decimal interest mean?
The decimal interest is a number that represents the interest of each landowner in the production of gas from wells, which are drilled on the unit. To confirm if the division order is correct before signing it, the importance of calculating the decimal interest cannot be ignored. The decimal interest must also match what is on the revenue statements. An example will be used to illustrate how the decimal interest is calculated, as well as its implication.
Take, for example, a landowner who has 300 acres in a 500-acre production unit while signing an oil and gas lease of 15% royalty. Their decimal interest is calculated as follows:
(300/500) × 0.15 equals 0.09, which represents their decimal interest.
The implication of this is that if there are 10 wells, with each producing $1,700,000, the landowner’s share becomes:
$17,000,000 × 0.09 gives $1,530,000
If, after going through several examples of how the decimal interest works, you still don’t understand it, you can consult your attorney to explain more to you how it works. As stressed earlier, a company needs to understand the decimal interest, as well as how to calculate, to be able to determine the amount of interest or a portion of the profits that goes to the landowner.
Again, based on the calculations made earlier, it is easy to determine if your division order or interest is right. Take, for example, you just received a division order from AKY company, which states that you will be paid 0.0625 royalty interest in a unit #1 well.
The decimal interest, as calculated earlier, can be estimated based on the royalty interest in the unit on which the well is drilled. A mineral interest is subject to oil and gas leases, which will assume a royalty based on production. If you possess 1/4 of the mineral interest, and the interest is subject to 25% royalty. The decimal interest in the production from the well is 1/4 of 1/4, which gives 0.0625.
From this, you can determine the percentage of your division order. This simply implies that 6.25% of any profit made from this unit is yours.
Besides this, it is worth mentioning that your interest could also be a non-participating royalty interest, which makes you entitled to a portion of the royalty, but prevents you from signing oil and gas leases. You should be acquainted with the two kinds of fee royalty interest: those that are expressed as a fraction of the royalty and those expressed as fractional royalty.
Hence, your non-participating interest can be represented as 1/4 of 1/4 of production – which represents a fractional royalty. You might also own a non-participating royalty of 1/4 of the royalty in any lease of the lands in the unit.
For this, if you want to know if your decimal interest is correct, you should familiarize yourself with the royalty that goes with the leases from which your royalty is paid. You must know the kind of interest you possess in the property if you wish to verify your interest on the division order.
Can division orders cause any potential issues to the mineral estate owner?
Yes, division orders can cause potential issues to the company and the mineral estate owner. If the division order is not handled the right way, there could be several issues, which include double liability. With the division order, there is a verification of the amounts of royalty present in the lease. A mineral rights owner must understand the division order and ensure that the royalty percentage matches the lease agreement before signing.
There are instances when “division orders are weaponized”.
While some oil and gas companies are honest in their dealings, many of them might be tempted by the returns a productive well offers them. Even though the decimal interest was agreed on when the lease was signed, it is sometimes another story when the well starts producing.
Some companies might attempt to take more of the returns that were agreed on in the original lease. They would include lower percentages in the required division orders they send to the mineral rights owners. Remember, the division order is only sent after production commences. This is not fair for the mineral rights owners. For this reason, it is only right for the mineral rights owners to consult an attorney when issues like this arise.
Division Order Special Cases
Special cases may consist of a statement “certifying ownership” of a decimal interest in production returns as explained in the Division Order. Besides this, signing or acknowledging subsequent payments implies your agreement with the payor’s estimation of your decimal interest while asserting that you are the legal owner.
In some special cases, you might not be asked to certify the legal title you own in the property, but only to your decimal interest in the returns. For instance, record ownership may be in another person’s name and they may acknowledge an unrecorded affidavit of heirship, which discusses the transfer of a little interest in a property even though the county records may still show this in the name of the previous owner.
Conclusion
The division order ensures that no dispute can arise between the operator and the interest owner, allowing the latter to know what their interest is. However, if there is any error, it is easy to notify the operator to rectify it. There is a variation in the laws that govern the use of division from one state to another. For this reason, it is important to familiarize yourself with the state law and how it might apply to you.
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