29 Mar What Does “Interest” Mean?
This is one of the most common questions we receive from people new to oil and gas investing. Below is a breakdown of the term.
Working Interest (W.I.): This refers to the amount of “shares” measured by a percentage point in a lease and/or drilling/re-entry program. Typically, a lease owner with no other participants, J.V. partners, etc., will own 100%. A JV partner may own 50%, while individual investors typically own less than 40% of the total working interest. Working interest holders pay for the operating expenses associated with the program.
Carried Interest (CI): This refers to what the operator “holds” for themselves when promoting the sale of a development program, lease, etc. For new development, this means the Operator has possession of the lease and geological data and may want to sell 75%WI and keep 25%WI (the carry). This is called in the industry “third for a quarter.” Another typical CI seen is 10%. The Operator often has no carry but may sell a smaller amount of working interest, especially if they are confident and internally funded. Those who hold CI are still responsible for their share of development expenses.
Royalty Interest (R.I.): This refers to interest available that is NOT responsible for paying any operating costs associated with any hydrocarbon production on a typical lease. R.I. is hard to obtain, harder to find in larger amounts and more expensive due to lack of risk and participation. In Texas, much of it is in the hands of the original landowner who sold the mineral rights or their trust funds. R.I. can vary per lease on availability and state. In TX, programs are burdened with up to 25% R.I., whereas Kentucky is around 15% R.I.
Example Scenario: An operator who owns a lease in Texas wants to do a 2 well drilling program for oil. The lease itself is burdened with a 25% royalty. The AFE (authority for expenditure) is $1MM. If the program goes as planned, it should produce 100 barrels of oil a day (bopd).
- Operator promotes a “third for a quarter” program in 5 blocks of 15%WI ($200,000 per block)
- Program stays within development AFE
- Program hits the anticipated 100 bopd steady for a year
What does the investor see who purchases a single block?
- 100 bopd gross – 25 bopd by RI holders = 75 bopd to 100% WI holders
- 75 bopd to 100% W.I. holders – 25% CI = 56.25 bopd to the individual investors
- To a single block holder: 11.25 bopd.
- Taking today’s taxes, 10% expenses, and $60 oil, rolls out into about a 12 month payout.
- Working Interest is typically sold by operators to program investors
- Carried Interest may held by operators in development programs
- Royalty Interest is typically held by inactive third parties and not possible for purchase for development programs
Hope this helps…if not, contact us.