Over the last few posts in our Adding Up Underpayments series, we’ve taken a deep dive into improper deductions, incorrect decimal calculations, and funds in suspense, so be sure to check out those informative articles.
Next up on our list is the perfect example of just how complex the land and legal side of mineral investing can be and the cash that can fall through the cracks if you don’t pay close attention to all of your agreements.
Payout is the break-even point when well expenses equal production revenue. Before payout,
an owner has either a reduced or zero ownership. After payout, ownership can dramatically increase and/or convert to a different ownership type. This all depends on type of interest and provisions set out in farmout and joint operating agreements. For example, in the case of a “back-in after payout” scenario, overriding royalty interest converts to a working interest.
Your interest conversions may not be applied post-payout as a result of change in purchaser, inaccurate or incomplete records. Operators should issue payout statements quarterly, but legal complexity and bandwidth to stay on top of payouts can cause delays. Asset acquisitions and bankruptcies frequently create a massive document management challenge where vital records are simply lost or misplaced, in which case an operator might not even be aware a well is subject to payout.
Risk to Investors
Preventing this type of underpayment is especially tough because payout on a new well can take years with multiple factors determining the timing, including daily commodity price changes. And for investors with thousands of mineral interests, it can be a land data management nightmare to sift land records for the provisions that govern interest conversion.
Missing a payout conversion can have huge implications especially if there is an unleased interest in a drill tract that is not subject to forced pooling. In such a case, payout converts the interest to an NRI without being reduced by the tract participation factor since no agreement was signed. Be sure to spot these types of payouts since the difference in decimals can be an order of magnitude bigger.
Like funds in suspense due to a missing well, tackling the payout and interest conversion problem is a matter of being proactive. To determine whether or not a claim is required, ensure you are using a land records management system that allows for easy data mining of agreements involving payout provisions. Then match those agreements with relevant wells and reconcile payout status and revenue to address any issues.