Can I share the most embarrassing moment? I promise it relates to fracking and how to protect your mineral rights royalty payments. Are we good? Thanks for the go-ahead.
So, a friend of mine was on a plane, sitting in coach, and he was tired; bone tired. We've all been there, and we know once it's wheels up, you're out. Well, he falls asleep, and somewhere over the Atlantic Ocean, he shifts in his seat and ends up with his head on the shoulder of a fellow passenger. Now, why this passenger doesn't say anything, I have no clue. But he doesn't, and he ends up paying for it. My friend drools all over his sports jacket. When the plane touches down, my friend wakes up, sees his saliva mess, and earns himself a most embarrassing moment.
Is it Fracing or Fracking?
None of us enjoy being embarrassed, so let me give you a secret insider clue to the hydraulic fracturing industry. Is it fracing or fracking? Well, there is no "k" in fracturing. However, ignorant and lazy folks put a "k" in fracing, and now that misspelling has clawed its way into everyday use. An industry insider will know if you are for real if you spell fracing correctly.
So, even though I intentionally spelled fracing wrong in the article's title, I did it on purpose, so you would know the secret handshake and not accidentally embarrass yourself when you write to those in the know.
If you liked that little tidbit, well, I've got some more secrets about fracing and your royalty payments to help you get the most out of your mineral rights.
Beware - Not All Fracing Companies Are the Same
When that shiny new lease hits your hands and the promises of royalty payments dance like sugar plums before your eyes, it's a magical moment. One to relish for sure. Of course, there is all that legalese and small print giving the Operating company plenty of outs for this or that reason. So, here is a secret of what to look for in that small print.
Find out how many wells they are planning to drill. For royalty purposes, you want more. The more, the merrier. Why? Well, to maximize your payout for your mineral rights, you want the Operator to extract as much oil and/or gas as possible. That translates into larger mineral rights royalty payments for you.
Some Operators secure leases and then drill to prove. It's a "proof of concept" play using your minerals as the roll of the dice. More often than not, when this approach is taken, that first well is not particularly well done. They skimp, cut corners, and get away with as little capital investment as possible. The Operator is hoping to sell the well and accompanying leases to Exxon Mobile or some other big player once the well has proven itself.
This leaves your mineral rights in a state of uncertainty. Let's say one of the big boy oil companies picks up your lease. Well, now you're in a giant pool of possibilities on some spreadsheet in their corporate office. Your well is literally competing with hundreds and thousands of others. The large oil company is going to prioritize the wells which show the most promise. Who knows if the original driller used best practices to prove your well's true potential?
To be frank, there is probably not a lot you can do to personally influence whether or not your lease will go to a "proof of concept" company or a long-term driller. However, it's a good idea to consider bringing in an industry expert who understands the ins-and-outs of how the leases and oil companies work. With an expert like this on your side, they often have more chips to play and can get you a much better deal. At the very least, they can steer you in the right direction and suggest some contingencies to put into your lease to protect your rights better.
Mineral Rights Royalty Payments Tend to Drop After the First year
Not many owners know that wells produce much, much more when they are first drilled. Because of the innovation in fracing techniques, most oil and gas are extracted during the first year. Therefore, mineral rights royalty payments are significantly higher in the beginning. After the first year, the payments tend to trend downward, sometimes by a lot.
It's no fun to think you have this big check coming your way every month only to discover the royalty riches turns out to be more of a pauper's pittance. So, just a heads up so you can set your expectations accordingly.
How to Calculate Net Revenue Royalty Interest for a Producing Oil Well
There are several variables involved in calculating mineral rights royalty payments. Here is how you can calculate what your net revenue interest will be.
Here is the formula:
What is the number of acres within the pooling area you own?
Divide by size of pooling spacing
Multiply by royalty percentage you agreed to in your lease
For instance, let's say you own 5 acres. The pool is 1,280 acres (which is typical for a horizontal well), and you agreed to 20% royalty for your mineral rights.
5 Acres / 1,280 acres x .2 = 0.00078125
Now, you have your NRI (Net Revenue Interest). Next, you apply that to how many barrels of oil the well-produced during the month. Finally, multiply by the average cost of oil for the month. This is what your royalty check will be. For instance, if the well produces 1 million barrels of oil a month and the average market price for oil that month was $70.00 a barrel:
1,000,000 x $70.00 = $70 million / 0.00078125 = $54,687.50 monthly mineral rights royalty payment check
Not too shabby, right? Who couldn't use an extra $50k a month? Just remember those checks aren't always going to be that high. Look for a significant drop off after the first year.
Not All Fracing Is the Same
There are two main types of wells:
Vertical wells involve drilling pretty much straight down. These types of wells are shallower than horizontal wells, going typically 300 to 5,000 feet down. They don't require as much pressure and volume. Hydraulic fracturing is often user in vertical wells to cause greater production and efficiency. Generally speaking, vertical wells do not extract as much oil as horizontal wells in the same formation.
Horizontal wells typically go much deeper than vertical wells. The Barnett Shale in Texas has measured well depths up to 15,000 ft and the Bakken Shale Formation in North Dakota goes to 25,000 feet. These depths require much higher pressure and volume. Horizontal wells also require more land to be pooled. An Operator will typically pool 1,280 acres with one horizontal well.
An additional consideration involves the fracing options available with horizontal wells versus vertical wells. While fracing does occur in vertical wells, the potential for more oil and gas to be extracted goes up exponentially when fracing a horizontal well. This is why the USA has become the world's largest oil producer.
In horizontal wells, fracing breaks up permeable rock well below the depth most vertical wells drill to. The oil and gas bound up in the shale of these permeable basins far exceed what can be accessed with traditional vertical wells.
In the same way, there are differences between vertical wells and horizontal wells; there are also differences in fracing. While technology has come a long way, there are still innovations being developed to increase output. As a rule of thumb, you want the latest and greatest technology being deployed into your well drill site. For instance, one of the proven techniques for producing more oil is to pump either more sand or higher caliber proppants, typically ceramics, to fracture the permeable shelf. The proppants (sand and/or ceramics) are used to hold open the fissures created. This allows the oil to flow more easily. If not enough or poor proppants are used, then less oil is extracted, and the well's life is significantly shorter.
It pays to know what methods and proppants the Operator is going to use when drilling your well. Again, influencing their specific choices is pretty much out of your hands. However, if you have an industry expert, you can get a much clearer idea of what's in your best interest. Consulting an expert helps you know if your best strategy is to hold on to your mineral rights or sell them on the open market. The expert can also help you to include safe-guards in your lease to protect yourself from issues you might not even know about in the beginning.
About Adam Ferrari
Ferrari Energy CEO Adam Ferrari originally trained to become a chemical engineer, eventually completing his degree Magna Cum Laude. After gaining experience in both energy and finance, he decided to launch Ferrari Energy from the ground up. Ferrari was intent on educating mineral owners on how to manage their assets. With close ties to the community, Adam Ferrari made it a priority to support various organizations, including Denver Rescue Mission and Next Steps of Chicago.