What is a 'Royalty Interest'

A royalty interest in the oil and gas industry refers to ownership of a portion of the resource or revenue that is produced. A company or person that owns a royalty interest does not bear any of the costs of the operations needed to produce the resource, yet the person or company still owns a portion of resource or revenue produced.

BREAKING DOWN 'Royalty Interest'

In contrast to a royalty interest, a working interest refers to an investment in an oil and gas operation where the investor does bear some of the costs for exploration, drilling and production. An investor that has a royalty interest only bears the cost of the initial investment and isn't liable for ongoing operating costs.

Royalty interests are commonly associated with companies that farmout their production to other larger oil companies to reduce project and financial risk. Farmout agreements work because the farmor usually takes a royalty interest once the field is developed and producing oil or gas, with the option to convert the royalty back into a specified working interest in the block after paying for drilling and production expenses that were incurred by the farmee. This type of option is commonly known as a back-in after payout (BIAPO) arrangement.

Royalty interests are favorable for smaller companies that have ownership rights to the oil fields that hold developable resources but lack the financing or technology to bring these resources to the production phase. Entering into a royalty interest agreement works for all parties involved. The company that is tasked with bringing the resources to production is entitled under contact to retain a portion of the production to sell on the market. This operator will need to decide for themselves if any particular project is profitable or not. In return for access to the oil fields, the producing company pays the field owner a royalty payment. The owner would not be able to receive this royalty interest unless the resources are developed, produced and sold, so entering this agreement is economically profitable for them.

One company that makes frequent use of this type of royalty interest arrangement is Kosmos Energy (NYSE: KOS). Kosmos has rights to acreage off the coast of Ghana, but the cost and risk to develop these resources is high because they are under water. To help reduce these risks, Kosmos farmsout its acreage to third parties like Hess (HES), Tullow Oil and BP and, in return, receives royalty payments from these operators.

RELATED TERMS
  1. Royalty Income Trust

    A type of special-purpose financing created to hold investments ...
  2. Canadian Royalty Trust (CanRoy)

    Canadian Royalty Trust, or CanRoy is an oil, gas or mineral company ...
  3. Oil Field

    An oil field is a tract of land used for extracting petroleum, ...
  4. Commercial Well

    Oil or gas drilling sites that produce enough oil to be commercially ...
  5. Revenue-Based Financing

    Revenue-based financing is a method of raising capital for a ...
  6. Integrated Oil & Gas Company

    An integrated oil and gas company is a business entity that engages ...
Related Articles
  1. Investing

    From Gold to Water, Here Are Top Plays on Resources From 8 Experts

    Eight experts see opportunity in a diverse group of commodity plays ranging from gold, copper, cobalt and iron ore to salt mining and water resources.
  2. Investing

    SandRidge's 3 Most Profitable Lines of Business (SDOC)

    Learn about the three most profitable lines of business for SandRidge Energy Inc., an oil and natural gas exploration company headquartered in Oklahoma.
  3. Investing

    Mine For Profits With Natural Resource Sector Funds

    These funds allow everyday investors to get in on the action in this promising sector.
  4. Investing

    Getting in On the (Next) Texas Oil, Gas Land Boom

    Landowners enjoyed rich royalties from their oil- and gas-producing plots. But how can the rest of us hitch a ride on the next boom?
  5. Tech

    Tech Startups Eye the Oil Industry

    Although the oil and gas industries have plummeted, high tech companies and investors see promise.
  6. Investing

    Key Ratios For Analyzing Oil And Gas Stocks

    Oil and gas investors need to focus on a different subset of ratios to analyze the growth and profitability of these companies.
  7. Investing

    5 biggest risks faced by oil and gas companies

    Learn about factors to consider, such as political and geological risks, before investing in gas and oil stocks.
  8. Investing

    Projected Gas Prices for 2016

    Learn what major authorities on gas prices are predicting for 2016, and about the different factors that can impact the price of gas.
  9. Investing

    Key Financial Ratios to Analyze Oil Companies

    Learn about key financial ratios investors will want to use when analyzing oil companies, and what these ratios say about the future prospects for companies.
RELATED FAQS
  1. What percentage of the global economy is comprised of the oil & gas drilling sector?

    Read about a rising industry that already composes as much as one-twentieth of total global economic output: the oil & gas ... Read Answer >>
Hot Definitions
  1. Discount Rate

    Discount rate is the interest rate charged to commercial banks and other depository institutions for loans received from ...
  2. Economies of Scale

    Economies of scale refer to reduced costs per unit that arise from increased total output of a product. For example, a larger ...
  3. Quick Ratio

    The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets.
  4. Leverage

    Leverage results from using borrowed capital as a source of funding when investing to expand the firm's asset base and generate ...
  5. Financial Risk

    Financial risk is the possibility that shareholders will lose money when investing in a company if its cash flow fails to ...
  6. Enterprise Value (EV)

    Enterprise Value (EV) is a measure of a company's total value, often used as a more comprehensive alternative to equity market ...
Trading Center