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Understanding Minerals

• Introduction to Interests in Oil and Gas Properties
• Perpetual Ownership
• Regeneration Potential

Introduction to Interests in Oil and Gas Properties

One of EROC's unique features is its understanding of and participation in the acquisition of fee mineral, royalty and overriding royalty interests. These interests are related to working interests (the type most oil and gas companies own), but they feature a few very important differences:

• They do not bear drilling or production costs.
• Their ownership may be perpetual.
• They have the potential for "regeneration."

Because of these characteristics, we have prepared the following overview of fee mineral, royalty and overriding royalty interests.

Oil and Gas Ownership Interests

The chart below shows the major types of ownership interests in oil and gas properties.

The most fundamental level of mineral ownership is a "fee mineral interest." This is an absolute and perpetual ownership of the minerals beneath the surface of a tract of land. In most instances, the owner of the surface estate is also the owner of the mineral estate, but these two estates may be separated ("severed") from each other. If so, they may be bought and sold separately. EROC owns a portion of the minerals beneath millions of acres of land, but owns the surface only in very rare cases.

The owner of a fee mineral interest (hereafter referred to as a "mineral owner") often is not financially or technically capable of drilling wells to search for oil and gas. Oil and gas companies who do have this capability contact mineral owners to lease their minerals from them. The company makes a payment (called a "bonus") to the mineral owner in exchange for the exclusive right to explore for hydrocarbons within the mineral estate. The company also agrees to give a portion of the revenues from the sale of any oil and gas that they may produce in the future to the mineral owner. This portion is called a "royalty," and the mineral owner is then said to own a "royalty interest." The company that entered into the lease owns a "working interest" and is responsible for paying all of the costs associated with drilling and operating the wells.

The lease continues in effect for a set period of time, or so long as the wells drilled under the lease continue to produce in paying quantities. At some point in time, the lease will expire, and the company will no longer have an interest in future quantities of oil and gas produced from the lease. All of the ownership in the minerals then reverts back to the mineral owner.

After the original lease has expired, the mineral owner may lease the minerals again, perhaps to a different company. In this case, the mineral owner would receive additional bonus income, and if successful wells are drilled, additional royalty income. There have been many instances in which wells were drilled and then produced to depletion, yet years later another company leased the same property and found additional oil and gas accumulations.

The working interest owner may desire to carve out a portion of its interest into a separate interest that does not bear drilling or production costs. This type of interest is called an "overriding royalty interest" and, in many respects, is similar to a royalty interest. One critical difference, however, is that the override is not a perpetual ownership interest; it is valid only so long as the underlying lease is valid. When the lease expires, all future ownership interest in the minerals reverts to the mineral interest owner.

The company that owns the working interest may have other partners who also own a portion of the working interest, yet have limited influence on the day-to-day operations of the wells. These owners have an interest called "non-operating working interest." The non-operating working interest owner is responsible for its share of the drilling and production costs, and has other liabilities as well.

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Perpetual Ownership

Ownership of the fee mineral estate of a property is a perpetual ownership. In that sense, it is just like the ownership one has in his home or another piece of real estate. This is a very attractive feature of fee minerals because it gives the mineral interest owner the possibility of additional income in the future. For example, this income may come from wells drilled to deeper pools or from the application of future technologies to existing oil and gas accumulations.

Depending on how a royalty interest was conveyed to EROC, it may be perpetual. Some royalties are sold as "well-bore only," which means that when the existing wells cease production, the interest reverts back to the mineral interest owner. In most instances, though, when EROC purchases royalties, they are purchased via a mineral deed, which gives us perpetual ownership in the mineral estate.

As mentioned previously, overrides are not perpetual and are valid only so long as the underlying lease is valid. Even so, ownership of an override may last for a very long time — making it an attractive investment — because most leases are valid so long as economic quantities of oil and gas are produced from the wells. Many wells will produce for decades.

Regeneration Potential

The combination of non-cost-bearing ownership with perpetual ownership is the source of the "regeneration potential" of the mineral interest. What this means is that the operator may continue to drill wells on a tract, and the mineral, royalty or overriding royalty interest owner will share in the production from these wells without any effort or expenditure on its part. Of course, the working interest owners will also share in production, but they must bear the costs associated with exploration, drilling and production.

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