Oil Royalty Traders

Companies in the oil royalty trading industry invest in oil and gas royalties and leases. Besides investing for third parties, they may also buy and sell interests for themselves. According Dun & Bradstreet, in 2010 there were approximately 504establishments that received revenues from oil and gas royalties, which totaled more than $6.8 billion. Global demand for oil and gas were increasing rapidly during the early twenty-first century, with estimates that demand could jump by over 35 percent by 2025, the United States oil and gas industry was seeking more viable sites for exploration, drilling, and production. In addition, the largest oil spill in U.S. history, which occurred in April 2010 after an explosion on a deepsea drilling rig in the Gulf of Mexico, caused the federal government to ban all new offshore exploration leases. Although many private landowners held royalty leases, the federal government was, by far, the largest owner of lands containing oil and gas reserves.

An oil and gas lease is a contract between a mineral owner and the company that wants to extract oil and gas deposits. The lease specifies the length of time that the company is allowed to mine the mineral owner's deposits, rental payments, advance compensation for exclusive drilling rights, and other terms of the agreement. A typical rental payment is usually a relatively small amount, ranging from $1 to $10 annually per acre. This rental payment, which is also called a deferred drilling payment, serves to legally maintain the lease contract when the company is not actively drilling. This rental payment is not what generates high income for the mineral owner. The big money comes if oil or gas is actually found on the land.

The mineral lease also specifies royalties. The royalty is the percentage of revenues that the company pays to the mineral owner in the event that gas and petroleum is actually extracted from the land. Royalties vary from 10 percent to as high as 25 percent of total oil and gas revenues before any associated drilling expenses are subtracted.

Because the true value of a royalty interest is unknown before the company drills for oil and gas, investing in royalties and leases can be a highly speculative endeavor. Royalty owners often sell part of their interests to reduce their exposure to risk or to generate cash. Royalty investment companies that buy and sell such royalties are trying to either gain a return on their investment or generate commissions by investing for their clients.

Investors have been trading oil and gas rights in the United States since the early 1800s. Between 1859 and 1870 more than 10,500 new oil and gas wells were drilled. Between 1871 and 1900, an additional 135,000 wells sprang up. It was during first two decades of the twentieth century, however, that investments in oil and gas ventures started to boom. More than 400,000 new wells were drilled during that period. The number of new wells drilled annually continued to rise through the 1950s to more than 50,000 by 1959.

The royalty investment industry, which is largely driven by drilling activity, sagged between 1960 and 1979 in comparison to the first half of the century. Skyrocketing foreign oil prices in the late 1970s and early 1980s, however, spurred renewed U.S. drilling. The number of new wells drilled jumped past 90,000 per year, and U.S. oil production surged to nearly 9 million barrels per day in the early and mid-1980s. Growth was short-lived, however, as falling crude and gas prices plummeted in the late 1980s. By 1990 the United States was producing about 7 million barrels of oil per day. That number declined throughout the 1990s. In December 1999, the U.S. produced 5.9 million barrels a day, down slightly from a year earlier when production stood at 6 million barrels per day. During this same time, liquid natural gas production stood at 1.8 million barrels per day, up from 1.6 million the previous December.

Oil and gas drilling in the United States, however, ended the 1990s on a strong note. According to Petroleum Finance Week, during the fourth quarter of 1999, completions of oil and gas wells and dry holes hit 5,442, a 5 percent increase from 5,188 completions during 1998's fourth quarter. The number of U.S. drilling permits increased in 31.2 percent in December 1999 to 2,445, as compared to 1,864 a year earlier. There was, however, a 32 percent decrease in the total footage drilled, from 139.5 million feet in 1998's fourth quarter, to 19.5 million feet in 1999.

In the mid-1990s, royalty investment firms suffered from the effects of low energy prices and reduced drilling activity. Revenues dropped more than 13 percent to around $70 million. Likewise, the number of royalty trading companies slipped from 600 to 550. The industry continued its decline in the early 1990s as the number of active U.S. oil wells continued to drop. Contributing to the continued lull in U.S. oil and gas royalty trading activity was an increase in drilling overseas, particularly in South America and Australia.

U.S. oil and natural gas drilling expenditures, on the other hand, increased throughout the late twentieth century. In 1998 they hit $17.6 billion, the highest level they had been since 1985, according to the Joint Association Survey on Drilling Costs (JAS). These figures seemed minute, however, compared to those experienced in the next decade. The 2007 JAS showed that total drilling expenditures hit an all-time high of $226.4 billion that year, nearly double the previous record of $109.9 billion set in 2006.

In the late 2000s the U.S. government was the largest leaser of lands for oil and gas exploration, drilling, and production through the activities of the Department of the Interior's Mineral Management Services (MMS) and the Bureau of Land Management. The MMS took in more than $5 billion annually in oil and gas royalties, making it one of the federal government's largest sources of nontax income. Approximately 80 percent of revenues were generated by offshore production. The oil and gas companies compensated the federal government by paying a lease and, once production began, a royalty of between approximately 12 percent and 17 percent of the production value. A growing trend was for the MMS to accept in-kind payment for royalty fees. Once a minor part of its compensation, by 2005 nearly 40 percent of MMS's royalty payments were in-kind.

Although many conservation advocates lamented the government's decision to lease lands for oil and gas production, oil and gas companies continually lobbied for increased land leases. According to American Petroleum Institute (API), about 80 percent of the nation's oil and 59 percent of the natural gas supply in the mid-2000s were located on federal lands--primarily in the Western states, Alaska, and the outer continental shelf. According to API, only about 1.5 percent of onshore and 0.5 percent of offshore federal lands were under lease and viable gas- or oil-producing sites. In February 2005 a U.S. District Court judge denied a lawsuit by environmental groups who filed court action to stop the government's plan to make available for lease to oil and gas companies 5.6 million acres of the National Petroleum Reserve in Alaska.

As both U.S. and global demands for oil and gas continued to increase rapidly during the mid-2000s, the industry sought new avenues for oil and gas production. For example, in July 2005, 80 companies submitted more than $342 million in high bids for 403 tracts leased by the MMC. The lease income was distributed among the affected states as well as the general fund of the U.S. Treasury. In addition, the Bureau of Land Management (BLM) managed over 245 million acres in 2010, primarily located in the Western states, some of which was open to oil and gas leasing.

Older leases from private landowners generated several concerns in the industry during the 2000s. For example, in rural Oklahoma, many older oil and gas leases contained free gas clauses whereby landowners were allowed to hook up to a gas line free-of-charge for household use. Because gas does not have an odor, leaks from lower quality pipes used by landowners could go undetected, causing safety concerns. In addition, royalty owner lawsuits were increasing as landowners filed action against oil and gas companies for underpaying royalties. Although many cases had been settled, litigation continued to take place primarily in Oklahoma, Louisiana, and Wyoming.

In 2010, after suffering from the effects of the economic recession of the late 2000s, the oil royalty trading industry was showing signs of recovery. Although total oil and gas production of the top 10 oil and gas U.S. royalty trusts decreased by more than 20 percent in 2009, according to Research and Markets, API reported that the demand for petroleum was rising in late 2010, indicating the economy may be on its way back up. According to David Swearingen of United Capital of Texas, oil and gas royalty investments were increasingly appealing to wary investors after the subprime mortgage crisis and resulting meltdown on Wall Street. Said Swearington in a August 2010 Investment Weekly News article, "Over the many years that we have invested in royalties, we have found superior returns on those [gas and oil] investments."