Royalty Valuation and Management: Royalty-In-Kind Update

This paper reviews the long-standing debate about the merits of Royalty-in-Kind (RIK); describes various RIK programs; and discusses ways to measure success.

Background

Oil and gas leases typically require a lessee to pay royalties based on the value of oil and gas production that is severed and sold from the lease. Most leases contain a provision whereby the lessor can elect to take their royalties in-kind. This provision establishes the right, but not the obligation, for lessors to take their royalty entitlement and market it themselves. RIK supporters assert that additional benefits accrue to a lessor from RIK because administrative and legal costs for audits and disputes are significantly reduced. However, RIK opponents are quick to suggest that disputes would not occur if lessees paid correctly, at which time Lessor and Lessee find cause to point the finger at the inadequacy of the lease terms and the state statutes and the federal regulations that govern royalty payments, but not before payors suggest that “if royalty owners think there is a better price, they should take their production in-kind and market it themselves.”

It's all about managing expectations. When royalty owners open the newspaper and see New York Mercantile Exchange (NYMEX) settlement prices for crude oil and natural gas, they develop certain expectations about the size of the