18 Jul Surface Owner Royalties: Lessees Should Know the Lesser-Known Interest… by Ian A. Tennery

Every oil and gas title attorney and landman should already be familiar with the following types of interests in real property:

• Surface Interest (SI)
• Mineral Interest (MI)
• Non-Participating Royalty Interest (NPRI)
• Working Interest (WI)
• Overriding Royalty Interest (ORI or ORRI)
• Non-Operating Working Interest (Non-Op WI)
• Net Profits Interest (NPI)

However, one interest that may be less familiar to even seasoned professionals is the Surface Owner Royalty Interest (SOR).

Why is the SOR Less Known?

In the typical course of oil and gas exploration and production—activities that inevitably impact the surface estate—surface interest owners are compensated by way of cash payments for surface damages. These payments are usually negotiated on a case-by-case basis between the SI owner and the WI owner(s), who are conducting drilling operations.

In some instances, however, no such agreement is reached. As a compromise (either in addition to or in lieu of cash payments), a WI owner may convey to the SI owner a defined portion of the proceeds from oil and gas production—carved out of the WI—either with or without deduction for production costs. Absent any other language, this might resemble an overriding royalty interest (ORI).

So, how does the WI owner ensure future surface owners don’t revisit or challenge this compromise?

Enter the Surface Owner Royalty Interest

To lock in this arrangement and prevent future disputes, the WI owner can tie the production-based payment directly to surface ownership. This creates a Surface Owner Royalty Interest—an interest in oil and gas proceeds that is inextricably linked to, and transfers with, ownership of the surface estate.

An SOR can be defined as:

An interest, running with the surface ownership of land, in the proceeds derived from the production and sale of oil and gas from said land.

Example Language from a Surface Owner Agreement

Consider this excerpt from a Surface Owner’s Agreement (“Agreement”) between a surface interest owner (“Landowner”) and a working interest owner (“Operator”), which illustrates the creation of an SOR:

• This Agreement is intended to avoid and resolve any and all disputes of whatever nature in connection with the ownership of oil, gas, and associated liquid hydrocarbons in the Premises.
• In consideration of mutual benefits and other good and valuable consideration, Landowner hereby confirms, extends, and grants to Operator… the easement and rights to enter upon the Premises… for the exploration, production, and sale of oil and gas…
• Operator agrees, so long as it is receiving oil and gas production from, or oil and/or gas royalties upon production from, the Premises… to pay to Landowner in cash the value on the Premises of 2.5% of all oil and gas produced, saved, and marketed therefrom or allocated thereto, free and clear of production costs…
• Operator also agrees to pay for all damage to Landowner’s lands. Other than the payments to be made as aforesaid, the Landowner shall not be entitled to any other or additional payments…
• The covenants to pay the sums shall be covenants running with the surface ownership of the Premises and shall not be held or transferred separately therefrom…
• The Surface Owner Royalty is effective for a period of one year and for so long thereafter as the oil and gas rights in the Premises are committed to a lease, license, or unitization agreement, or so long as a well capable of production remains on the Premises…

Key Takeaways from this SOR Structure

• Supplemental to Surface Damages: The SOR is in addition to the Operator’s obligation to compensate for surface damages. The Agreement limits further claims by the Landowner beyond what is expressly provided.
• Appurtenant to the Surface Estate: The SOR runs with the land, not the individual. It transfers automatically with changes in surface ownership.
• Non-Alienable: The SOR cannot be severed from the Surface Interest. It cannot be sold, reserved, or conveyed separately like a Mineral Interest.
• Limited Burden: The SOR burdens only the Operator’s interest (as of the Agreement date). It does not affect other parties who might own interests in the Premises.
• Term-Dependent: The SOR remains in effect for one year. The SOR continues as long as the Operator’s rights are committed to production under a lease or unit, or while a productive well remains on the land.

Final Thoughts

While the Surface Owner Royalty Interest may not be as widely known or encountered as other common oil and gas interests, it is just as important for the accurate payment of proceeds from operations. For land professionals, understanding the nuances of SORs—especially their inextricable link to the surface estate and their non-transferable nature—is essential to effective title analysis and negotiation.

By Ian A. Tennery, Senior Attorney at KMD Law