Nonparticipating Royalty Clause in an Oil and Gas Lease
Also called “NPRI” by analysts, a non-participating royalty gets its name from its non-participation in signing bonus, delay rentals, lease negotiation, and lease execution. An NPRI owner does not own the right to negotiate and sign a lease covering the land in which they own their royalty interest. The mineral estate owner(s) who have signatory (also called “executive”) rights are the landowners with legal authority to negotiate and sign a lease. The NPRI owner is entitled to their record-title share of whatever royalty rate is reserved in the lease.
Every analyst should be aware that in Texas an NPRI owner is not bound by the pooling clause in the oil and gas lease. Most commonly the Lessee will obtain a Ratification of Oil and Gas Lease from each NPRI owner under any leases they take. Each NPRI owner has the option of signing the Ratification—ratifying the lease pooling clause to allow their NPRI to be pooled into any unit involving their acreage—or ratifying each Designation of Unit in which their lease is included, in whole or in part. The choice the NPRI owner makes impacts analysis of the lease, Lease Data Record, and the Revenue Division of Interest for each well involving this lease.
Most other oil and gas producing states have involuntary pooling statutes making ratification of the lease or unit by an NPRI owner unnecessary. Additionally, the statutes in a few producing states do not allow an NPRI interest to be created, such as Kansas, making the information presented here for the lease analyst and division order analyst moot.
Example of a Nonparticipating Royalty Clause
“It is agreed and understood that the Lessor herein, its successors and/or assigns, shall not bear any additional burden on its royalty due to a nonparticipating royalty interest that has not been pooled or unitized, than Lessor would bear from the same interest being pooled or unitized. Any additional royalty due to a nonparticipating royalty interest that has not been pooled or unitized due to failure by Lessee, its successors and assigns to obtain the right to pool or unitize the nonparticipating royalty interest, for any reason, shall be borne solely by the Lessee, its successor or assigns. The Lessor herein, its successors and/or assigns, shall bear Lessor’s share of any nonparticipating royalty interest that has been pooled or unitized, but no greater burden will be applied if said nonparticipating royalty interest owner has not agreed or consented to be pooled or unitized. The nonparticipating royalty interest addressed in this paragraph covers only the nonparticipating royalty interest to which the mineral interest leased herein is subject, and no other nonparticipating royalty interest.”
Simplified. “Lessor [s]hall not bear any additional burden on its royalty due to a nonparticipating royalty interest that has not been pooled or unitized, than Lessor would bear from the same interest being pooled or unitized. Any additional royalty due to a nonparticipating royalty interest not pooled or unitized due to failure by Lessee to obtain the right to pool or unitize the nonparticipating royalty interest, for any reason, shall be borne solely by the Lessee. Lessor shall bear Lessor’s share of nonparticipating royalty interest pooled or unitized, no greater burden if said nonparticipating royalty interest owner has not consented to be pooled or unitized. [T]his paragraph covers only the nonparticipating royalty interest to which the mineral interest leased herein is subject.”
The first sentence requires that NPRI royalties are to be deducted from the Lessor’s lease royalty based solely on a unitized calculation, should the leased land be pooled, even if the NPRI owner never ratifies the lease or Unit Designation. By stating this, the Lessor is making certain the Lessee agrees to the limitation, which is accepted when the Lessee records the lease. The second sentence states that any higher difference between the ratified decimal and the unratified decimal must be paid out of the Lessee's net working interest. The third sentence states the same requirement as the first sentence, but in a more direct way. The final sentence makes it clear that this clause covers, or addresses, the NPRI to which the reserved lease royalty is subject.
In Texas, the NPRI owner is entitled to its full share of royalty from the tract if any part of the perforated lateral runs across it. If the NPRI has ratified the lease pooling clause and is pooled, the share of NPRI being deducted from the reserved lease royalty remains proportionate and the executive Lessor receives the proportionate excess. On the other hand, if an NPRI owner does not ratify the lease or the Unit Designation, and their NPRI is in a drill site tract, the NPRI cannot be proportionately reduced by the amount of acres in the tract divided by total unit acres. It is allocated to the NPRI owner using a different calculation method, often resulting in a royalty share higher than a unitized royalty share.
This example clause prohibits the Lessee from deducting from the Lessor’s lease royalty share the larger amount of NPRI royalty resulting from failure to ratify the lease or the Unit Designation. Only the decimal equal to a unitized NPRI share can be deducted from this Lessee’s royalty. Any additional decimal amount must be carved out of the Lessee’s net revenue interest.
In this clause, the Lessor makes it clear that if the owner of any NPRI to which his mineral royalty is subject fails to ratify, this Lessor must receive the same royalty decimal as if the NPRI owner did ratify.
Now let’s look at an example and the calculations involved, to illustrate the benefit of this clause for a Lessor.
Say an NPRI owner owns a fixed 1/8 NPRI out of the entire mineral interest in an 80-acre tract. The 100% mineral owner signs a lease reserving the maximum royalty the Lessee would give in return for a larger bonus, a 3/16 royalty. The 80-acre tract then is pooled into a 640-acre unit for a horizontal well. If the 80-acre tract has 500 feet of perforated wellbore running through it out of a total perforated lateral length of 3,000 feet, the 80-acre tract contributes 500’/3000’, or 16.666667%, of total unit production using the wellbore allocation method. The NPRI owner is entitled to 16.666667% of its 1/8 NPRI share from the tract, or (1/8 x 500’/3000’) but the unitized royalty of the mineral owner only gets (3/16 x 80/640 = 0.02343750) minus (1/8 x 500’/3000’= 0.02083333). That would leave the Lessor with 0.00260417 RI. By comparison, if the NPRI owner had ratified the lease or the Unit Designation, the NPRI owner would be entitled to (1/8 x 80/640 = 0.01562500) and the Lessor would be entitled to 0.02343750 minus 0.01562500 or 0.0078125 RI. Quite a difference! That’s 0.00520833 RI the Lessor would lose without this clause in his lease!
Management should be aware of this clause so as to decide how best to proceed with obtaining ratifications. This clause should be noted by the lease analyst in the lease data record when it is set up in the database system. The code on the lease analyst’s note will allow a report to be generated to alert the landman and the division order analyst, respectively, to take action to comply with it when appropriate.
While the landman should seek NPRI ratifications before spud, the division order analyst is affected directly by this clause because it requires that the division order analyst calculate production royalties for this lease differently than the usual method. The division order title opinion, if one is rendered, may or may not provide the full calculation breaking out the royalty between the Lessor and NPRI owner(s). The revenue division of interest or its supporting spreadsheet will need some type of notation that the royalties calculated under this lease were calculated differently to comply with the lease terms.
Several more examples of Non-Participating Royalty Clauses and their varying impact on the lease analyst and division order analyst can be found in the reference book, “Principles of Oil and Gas Lease Analyst: Uncommon Clauses,” sold in the Oil Patch Press bookstore.