Whenever oil or gas production begins, the landowner is entitled to part of the total production. A royalty is agreed upon as a percentage of the lease, minus what was reasonably used in the Lessee's production costs. The royalty is paid by the Lessee to the owner of the mineral rights, the Lessor in the Lease. It is based on a percentage of the gross production from the property and is free and clear of all costs, except for taxes.
Traditionally, royalty can be 1/8 of production or 12.8 percent of production; however, it can be any fraction of production, depending on the royalty clause in a lease. The landowner should negotiate for as high a royalty as can be arranged.
Previously, landowners bargained for an overriding royalty. The override was 1/16 taken from the Lessee's interest. Today, mineral owners negotiate for a firm royalty percentage without any override.
Oil royalties may be paid in oil. The Lessor may receive oil from the Lessee and then market the oil. Unless the Lessor is wise and understands the market, electing to receive the royalty in this manner, could be a disadvantage and the landowner, electing for this arrangement, may not benefit from it. Most landowners choose to receive the royalty in cash at the posted price of the oil. A Lessor deciding to receive the oil as the royalty payment can market the oil royalty back to the Lessee for marketing and receive cash through that arrangement.
Gas royalties usually are paid in the monetary units of the country, as in dollars. Gas price is also difficult to value given the fluctuating and volatile markets. Gas royalty clauses usually state a royalty as proceeds, market value or in kind
A landowner can specify separate royalties for oil and gas production. Landowners in negotiating the lease can place a due date for receipt of royalty payments and if timely payments are not made there can be an interest charge for late payment placed in the lease.
A royalty clause in the oil and gas lease specifies the amount of royalty to be paid to the Lessor and it can include other terms and conditions of payment.