Instruments that convey oil and gas interests can be difficult to interpret. Frequently, industry terms of art are used interchangeably, and the intent of the drafters is difficult to determine, particularly with very old instruments. One common source of confusion is the language used to convey or reserve mineral and royalty interests.
A “mineral interest” is the real property interest created in oil and gas after a severance of those minerals from the surface estate. Typically, a mineral interest is severed from the fee estate by virtue of a conveyance or a reservation, and the interest created is in fee. A mineral interest owner possesses executive rights, including reasonable surface use, the right to enter into a lease, and the right to drill or develop the minerals underlying the surface. A mineral interest owner also possesses the right to receive lease bonuses, delay rental payments, shut-in payments and royalties.
A “royalty interest,” on the other hand, is the property interest created that entitles the owner to receive a share of the production. A royalty interest can be created in many ways, including by virtue of a conveyance or reservation in a deed or a lease. Unlike a mineral interest owner, a royalty interest owner does not possess executive rights. In addition, a royalty interest owner does not possess the right to receive lease bonuses, delay rental payments, or shut-in payments.
The diagram below demonstrates the rights possessed by a mineral interest owner in comparison to a royalty interest owner:
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Although the distinction between the rights possessed by each interest owner may be relatively clear, the language used to create these interests quite often presents challenges to interpretation.
Assume that X conveys to Y “a ½ interest in all of the royalty oil in and under Blackacre.”
It may appear from the use of the word “royalty” that X intends to convey to Y a royalty interest—an interest in the share of production. However, the phrase “in and under” is typically utilized in conjunction with the conveyance or reservation of a mineral interest. Thus, the conveyance in the above example may be open to interpretation.
When analyzing a grant to determine the type of interest conveyed, it is often necessary to read the grant in conjunction with the other provisions of the instrument in order to reach a conclusion about what the parties intended by the language.
Assume that X conveys to Y “a ½ interest in all of the royalty oil in and under Blackacre.” The instrument of conveyance is entitled “Mineral Deed,” and also contains a provision, which states: “Y shall also have the right to drill and produce oil and gas from said premises.”
The use of the words “in and under,” the title of “Mineral Deed,” and the explicit conveyance of the “right to drill and produce,” all weigh in favor interpreting this instrument as a conveyance of the mineral interest to Y.
Now, assume the following:
X conveys to Y “a 1/8 interest in the royalty oil which may be produced and saved from Blackacre and the rents and royalties that may be derived from gas wells drilled thereon.” The instrument contains no other provisions granting rights to Y.
In this example, the use of the words “produced” and “saved” would indicate that X has conveyed an interest in 1/8 of all of the oil and gas removed from the ground. In addition, the conveyance of the “rents and royalties” derived from gas wells is an indication that X intends to convey only the right to receive royalties and not the executive rights associated with mineral ownership. Finally, the absence of other provisions in this instrument that could be interpreted as conveying executive rights or an obligation to share in the costs of production weighs in favor of interpreting this instrument as a conveyance of a royalty interest, and not a conveyance of a mineral interest.
As a best practice, conveyances and reservations should be analyzed based upon the contents of the entire instrument, and not just the language of the grant, and the factors that weigh in favor of one interpretation over another should be evaluated using a holistic approach. As a practical matter, the best way to make a determination of the interest being conveyed is to analyze whether that instrument also purports to convey the rights possessed by a mineral interest owner. If the instrument does not purport to convey those rights, the analysis may weigh more in favor of the creation of a royalty interest.
To hear more about issues involving reservations and conveyances of mineral interests, register for the National Business Institute’s Ultimate Guide to Oil and Gas Title Law, at which the author will be presenting on December 3 and 4.