Last Updated on Interpreting mediums that convey interest in oil and gas leases can be a difficult situation at times. It is the same in the art industry, where some terms are used interchangeably with different items. In the reservation or transfer of minerals rights, the language used in describing the interest is often a source of confusion.
A mineral interest represents the interest created after separating the mineral rights from the surface estate rights. Severing the mineral rights from the surface rights by using legal conveyance or an agreement creates a fee-based interest. A mineral estate owner has a non-executive mineral interest, including reasonable rights to the surface, executive rights to enter a lease and develop or drill for the minerals beneath the surface.
Alternatively, holders of overriding royalty interests (RIs) are entitled to a share of the production revenue during the lease. There are many ways to create RIs, such as conveyances or deeds. These may transfer executive, bonus, and delayed rental rights, and lease agreements. An RI holder does not possess a non-executive mineral interest like a mineral interest holder.
There are many types of mineral interests and royalties, and each type defines how much leverage a holder possesses over land and how much they can receive from the sale or extraction of oil or gas. We’re going to focus on NPRI.
Key Takeaways
- A mineral estate owner has a non-executive mineral interest, including reasonable rights to the surface, executive rights to enter a lease and develop or drill for minerals beneath the surface.
- Non-participating royalty holders do not have executive rights in lease negotiations, leasing incentives, or delayed rental payments.
- Revenue from an NPRI is taxed as income tax.
What are Non-Participating Royalty Interests?
NPRIs are non-cost bearing interests in mineral production from a property. Landowners can sell their property and still retain a stake in the profits made from the oil or gas beneath the surface if they own an NPRI. Essentially, NPRI is the royalty severed from minerals just as minerals are severed from the surface interest.
Unlike mineral owners, non-participating royalties do not have executive rights in lease negotiations, leasing incentives, or rental payments. They just receive the actual production proceeds. To create a perfect example of NPRI, let’s assume that oil companies are planning to drill for oil and the property owner is sure they will find either oil or gas. The mineral owner, however, needs some extra funds to fulfill a promise they made.
Since they have to fulfill that promise immediately and given that the well is not yet producing, it means there are no royalty checks yet. So the landowner decides to carve a small percentage of their royalty out in return for a lump-sum payment of cash to fulfill their promise. When the well starts producing, the NPRI holder will receive a percentage of the RI.
This situation is a win for everyone as they all go home happy. Even though the circumstances are different, you can see how an NPRI is created.
How To Calculate Non-Participating Royalty Interest
Without production, NPRI has no value since there is no revenue. However, these RIs are created out of the mineral estate and become a significant burden against future production streams from the RI.
The formula to calculate NPRI without proportionate share reduction is LRR – RI = NPRI. As an example, reducing your revenue interest from 25% LRR results in 1/16 NPRI, leaving 75% NRI for working interest owners. The formula using proportionate reduction is LRR * RI = NPRI. For example, if revenue interest is multiplied by 25% LRR, the answer is 1/64th NPRI, reduced proportionately. This leaves the remaining 75% NRI to the working interest owner:
- Where LRR = Lease Reservation Revenue
- RI= Royalty Interest
- NPRI = Non-Participating Royalty Interest
- NPR = Non-Participating Royalties
What are the Reasons for Assigning a Non-Participating Royalty Interest?
There are various situations in which people create and assign NPRIs. Let’s consider a few reasons. As ownership of land changes, NPRIs are commonly created and assigned to whoever the owners want.
The amount of revenue the mineral and surface rights generate can make present and past owners want to share in the future resources of their royalty payments. People, in general, don’t like to give up control, so NPRIs become a negotiating tool. To ensure that they benefit from the future benefits of the royalty payment, the seller of the land might reserve the minerals and assign an NPRI.
Another reason why people create and assign an NPRI is in the case of contemplated inheritance. To solve this issue, a landowner can create an NPRI for their grandkids to save them from negotiating leases or using executive rights to make any decision concerning the mineral royalty payments. As an alternative to what would otherwise pass through normal inheritance, an NPRI can be set up in the name of a trust, an individual, or any other legal entity.
What are the Benefits of Non-Participating Royalty Interests?
Since most NPRIs are created to save future beneficiaries the stress of battling with executive rights and lease obligation claims, this is not the only benefit of these rights. Other benefits include:
With the NPRIs, owners can ratify the pooling clause on the lease covering where the NPRI owner has a stake.
Aside from ratifying clause, the NPRI owner receives revenue from the mineral drilling, and rights are retained after a lease expires.
What Right is Missing from Non-Participating Royalties or Non-Participating Mineral Interests?
Holders of non-participating royalties and non-participating mineral interest titles benefit from the royalty payments gotten through their various rights allocated to them. But, they do not have the right to execute or negotiate a percentage of the oil and gas lease. It is not within their power or right to execute an oil and gas production lease or retain any proportion of the non-executive mineral interest.
How is NPRI Taxed?
Tax advantages can be obtained from royalty leases and trusts due to favorable tax rules. Royalty income from an NPR lease may be taxed differently, depending on if the county imposes its tax.
The first tax, federal income tax, is charged based on the revenue received on royalty payments.
NPRI is considered as investment revenue and taxed as income tax.
The owners may also pay the county ad valorem oil and gas tax, a form of tax charged on production. Since NPRI owners do not bear any operational costs, they are not deductible from tax.
Conclusion
Now you know and understand the essential information about NPRI. You can choose the best option to take if the number of properties or wells you own may cause issues regarding sharing and lease dispensation in the future. You can get a reliable broker to help you determine the value of your NPRI and the best option to take when you want to share your rights. One such broker is Pheasant Energy, a reliable broker for buyers and sellers.
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