SIC 6792
OIL ROYALTY TRADERS



This industry classification includes establishments primarily engaged in investing in oil and gas royalties or leases, or fractional interest therein.

NAICS Code(s)

523999 (Miscellaneous)

533110 (Owners and Lessors of Other Non-Financial Assets)

Companies in the oil royalty trading industry invest in oil and gas royalties and leases. Besides investing for third parties, they may also buy and sell interests for themselves. In the mid 1990s, there were 746 establishments engaged in this activity, but the number has increased, hitting 973 by 1997, according to Dun's Census of American Business. These are mostly small operations—78 percent (or 767) of these operations had less than five employees. Thirty of these establishments, however, posted revenues over $5 million each in 1997.

An oil and gas lease is a contract between a mineral owner and the company that wants to extract oil and gas deposits. The lease specifies the length of time that the company is allowed to mine the mineral owner's deposits, rental payments, advance compensation for exclusive drilling rights, and other terms of the agreement. A typical rental payment is usually a relatively small amount, ranging from $1 to $10 annually per acre. This rental payment, which is also called a deferred drilling payment, serves to legally maintain the lease contract when the company is not actively drilling. This rental payment is not what generates high income for the mineral owner. The big money comes if oil or gas is actually found on the land.

The mineral lease also specifies royalties. The royalty is the percentage of revenues that the company pays to the mineral owner in the event that gas and petroleum is actually extracted from the land. Royalties vary from 10 percent to as high as 25 percent of total oil and gas revenues before any associated drilling expenses are subtracted.

Because the true value of a royalty interest is un-known before the company drills for oil and gas, investing in royalties and leases can be a highly speculative endeavor. Royalty owners often sell part of their interests to reduce their exposure to risk or to generate cash. Royalty investment companies that buy and sell such royalties are trying to either gain a return on their investment or generate commissions by investing for their clients.

Investors have been trading oil and gas rights in the United States since the early 1800s. Between 1859 and 1870 more than 10,500 new oil and gas wells were drilled. Between 1871 and 1900, an additional 135,000 wells sprang up. It was during first two decades of the twentieth century, however, that investments in oil and gas ventures started to boom. More than 400,000 new wells were drilled during that period. The number of new wells drilled annually continued to rise through the 1950s to more than 50,000 by 1959.

The royalty investment industry, which is largely driven by drilling activity, sagged between 1960 and 1979 in comparison to the first half of the century. Skyrocketing foreign oil prices in the late 1970s and early 1980s, however, spurred renewed U.S. drilling. The number of new wells drilled jumped past 90,000 per year, and U.S. oil production surged to nearly 9 million barrels per day in the early and mid 1980s. Growth was short-lived, however, as falling crude and gas prices plummeted in the late 1980s. By 1990 the United States was producing about 7 million barrels of oil per day. That number has declined in the 1990s. In December 1999, the U.S. produced 5.9 million barrels a day, down slightly from a year earlier when production stood at 6 million barrels per day. During this same time, liquid natural gas production stood at 1.8 million barrels per day, up from 1.6 million the previous December.

Oil and gas drilling in the United States, however, ended the 1990s on a strong note. According to Petroleum Finance Week, during the fourth quarter of 1999, completions of oil and gas wells and dry holes hit 5,442, a 5 percent increase from 5,188 completions during 1998's fourth quarter. The number of U.S. drilling permits increased in 31.2 percent in December 1999 to 2,445, as compared to 1,864 a year earlier. There was, however, a 32 percent decrease in the total footage drilled, from 139.5 million feet in 1998's fourth quarter, to 19.5 million feet in 1999.

Going into the mid 1990s, royalty investment firms were still suffering from the effects of low energy prices and reduced drilling activity. Revenues dropped more than 13 percent to around $70 million. Likewise, the number of royalty trading companies slipped from 600 to 550. The industry continued its decline in the early 1990s as the number of active U.S. oil wells continued to drop. Contributing to the continued lull in U.S. oil and gas royalty trading activity was an increase in drilling overseas, particularly in South America and Australia.

U.S. oil and natural gas drilling expenditures, however, have increased in the late 1990s and in 1998 hit the highest level they had been since 1985. In 1998, total drilling expenditures rose 9.6 percent from 1997 and were estimated at $17.6 billion, up from $16.0 billion the previous year, according to the "1998 Joint Association Survey on Drilling Costs".

Despite a slowdown in the 1980s and 1990s, the long-term prospects for the oil and gas royalty investment industry are bright. Crude and gas prices, which are rising as a result of multiple factors, should boost investment activity and profits. Industry employment was expected to jump significantly between 1990 and 2005, according to the U.S. Bureau of Labor Statistics. Jobs for executives, which make up 10 percent of the industry work force, should climb by more than 50 percent. Management support positions should rise similarly, and sales and legal positions will likely leap more than 70 percent.

Further Reading

American Petroleum Institute. "1998 Drilling Expenditures." 9 November 1999. Available from http://www.api.org/release.cgi .

——. "Energy Facts & FAQs." January 2000. Available from http://www.api.org/faqs/ .

Darnay, Arsen J., ed. Finance, Insurance, and Real Estate, USA. Farmington Hills, MI: Gale Group, 1996.

Dun's Census of American Business, 1997. Bethlehem, PA: Dun and Bradstreet, 1997.

"U.S. Oil and Gas Drilling Showed Strength Toward the End of Last Year." Petroleum Finance Week, 7 February 2000.

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