The earliest dated oil and gas leases all provided for a one-eighth (1/8) royalty. It is unknown how that fraction was determined, or negotiated between the lessor and the lessee. One-eighth (1/8) equals twelve and one-half percent (12.5%). This means that the lessor is entitled to 12.5% of the income generated from the sale of oil and gas production, or, if permitted by the lease, may take in kind 1/8 (12.5%) of the production, and market it for sale.
In today’s environment you seldom see a lease providing for a 1/8 royalty. The amount of royalty reserved in leases has increased to 1/5, 1/6, 3/16, and in many areas, the lessor reserves a royalty of 1/4 (25%).
Lessees, in negotiating the terms of the lease, desire to minimize the amount of royalty reserved in the lease. A smaller royalty permits the lessee to retain a larger share of production or the production proceeds. If a lessor insists on a lease providing for 1/4 royalty, this means the lessee will pay 100% of the cost of drilling, completing, equipping, and producing a well, but only 75% of the revenue, with the lessor receiving 25% of the revenue, free of costs. While this may be acceptable in areas where costs and production can be estimated with some accuracy, in “wildcat” areas, a 1/4 lease royalty may not be acceptable to a lessee.
While it is not common to see leases executed, at current date, for a 1/8 royalty, a 1/4 royalty may not be attainable. Fractional royalty interests which are between 1/8 and 1/4 are 1/5 (.20000000), 1/6 (.16666667), and 3/16 (.18750000). These amounts are negotiable.