Royalty and Lease Payments: Local Economic Implications from Energy Contracts

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1 Royalty and Lease Payments: Local Economic Implications from Energy Contracts Energizing the U.S. Economy: Rural America at the Epicenter of America s Future October 29, 2015 Jason Brown Senior Economist The views expressed are those of the presenter and do not necessarily reflect the positions of the Federal Reserve Bank of Kansas City or the Federal Reserve System.

2 Converting Natural Resources to Cash Energy production has offered new opportunities to create rural wealth Exploiting oil and gas endowments or harnessing wind converts natural resources into cash payments to labor, governments, and land and mineral right owners Six major plays produced over $211 billion in oil and gas in 2014, 1.2% of U.S. GDP Estimated O&G royalty payments of $39 billion to private mineral right owners 2

3 Background Energy development is subject to boom and bust cycles Changes in commodity prices (oil, natural gas) or energy policy (renewables) Capture of economic value of energy development is key for local economies Distribution of costs vs. benefits of development varies within and across regions Participating vs. non-participating land and mineral right owners 3

4 The Issue On-going debate about the local economic implications from energy development A boom may yield large returns to land and mineral right owners, but for how long? Income and wealth effects depend on intensity and duration of development local ownership potential externalities (e.g., pollution, congestion, infrastructure) 4

5 Let s Make a Deal Most development is on located on private lands 75% of onshore oil and gas development (Fitzgerald, 2014) Over 98% of wind development (AWEA) Energy developers must enter into legal agreements with land and mineral right owners Contracts establish what owners will receive Lease payments fixed annual payment Bonus payments upfront onetime payment Royalty payments regular payments based upon value of production Payments increase wealth by increasing Savings vs. consumption And (potentially) household asset values, notably land 5

6 Typical Wind Leases Wind option agreement (Aakre and Haugen) $2 to $10 per acre for 3 to 5 years Like a bonus payment Development phase and beyond (Windustry) lease is typically 20 to 25 years Fixed annual lease payment is most common Per turbine payments range from $2,000 to $10,000 (and/or) Royalty 3 to 5% of value of electricity produced In 2014, leases paid around $180 million to landowners (AWEA) 6

7 Typical O&G Leases Leasing contracts signed before development begins Gives company the right but not obligation Avg. bonus payment of $200 per acre Term is usually 3 to 5 years Lease remains in effect as long as production continues Royalty rates vary across and within regions Avg. around 18% 13.5% (PA) 21.5% (LA) Source: Drilling Info; Brown, Fitzgerald and Weber (2015) 7

8 Farm Households Receiving Energy Payments Totaled $2.3 billion dollars in 2011 (oil, gas and wind) Roughly half of the largest Federal farm support program in 2011 In 2011, 3.4 percent of all farms received payments ( ~74,000 total farms) Payments were most common in the Plains states About half of farms with payments specialize in raising beef cattle Some farm households received large energy payments Average $30,613 vs. median $7,000 payment Source: 2011 Agricultural Resource Management Survey, Version 1. Weber, Brown and Pender (2014) 8

9 Energy Payments to Farm Households by Region, 2011 Region Median Energy Payment Percentage of farms receiving payments Percentage of total energy payments Percentage of total government farm payments Atlantic $4, South $5, Midwest $1, Plains $7, West $13, Continental U.S. $7, Source: 2011 Agricultural Resource Management Survey, Version 1. Weber, Brown and Pender (2014) 9

10 Wealth Effects for Farm Households Most of the wealth effect is from higher land values Total farm household wealth increased by estimated $7.7 billion in 2011 $1.7 billion from saving payments $6 billion from higher land values For land values, a dollar of energy payments increases land values by $2.60 Smaller than estimates of the capitalization of farm program payments, $4.94 to $5.35 on a per acre basis Lower capitalization could be from lower quality land being leased more frequently Source: Weber, Brown and Pender (2014) 10

11 Selected Shale Plays Source: Energy Information Administration 11

12 Value of Production ($ Billions) Average Royalty Rate Value of Production & Royalty Rates by Play, % 20% 15% 10% 5% 0% Source: Brown, Fitzgerald and Weber (2015) 12

13 Local Ownership Share Local Value of Production ($ Billions) Local Ownership & Local Value of Production, % % % 30% 20% 10% 0% Source: Brown, Fitzgerald and Weber (2015) 13

14 O&G Royalty Income Estimates, 2014 Shale Play Bakken Eagle Ford Haynesville Marcellus Niobrara Permian Royalty income ( $ per capita) 27,770 12,008 1, ,946 Local royalty income ($ per 4,202 2, ,183 capita) Govt. transfers ($ per capita) 1 6,455 6,712 8,345 9,146 5,652 6,997 Federal farm payments ($ per capita) BEA REIS; Census of Agriculture A one percentage point reduction in royalty rate negotiated would reduce local royalty income per capita $16 to $250 across the plays Source: Brown, Fitzgerald and Weber (2015) 14

15 Conclusion Recent energy development may generate significant wealth for some in rural areas How much wealth depends upon intensity and duration of development and local ownership Royalties and lease payments vary substantially across regions within regions over time Suggests that land and mineral right owners likely view payments as temporary vs. permanent implications for how they are spent or saved 15

16 References Aakre, D. and Haugen, R Wind Turbine Lease Considerations for Landowners. NDSU Extension Service. EC AWEA, Public lands and wind energy. Available at: AWEA, Wind was largest source of new electricity in Available at: Brown, J.P., Fitzgerald, T. and Weber, J.G Capturing Rents from Natural Resource Abundance: Private Royalties from U.S. Onshore Oil and Gas Production. RWP 15-04, Federal Reserve Bank of Kansas City. Fitzgerald, T Importance of Mineral Rights and Royalty Interests for Rural Residents and Landowners. Choices 4 th Quarter. Weber, J.G, Brown, J.P. and Pender, J.L Rural Wealth Creation and Emerging Energy Industries. In: Rural Wealth Creation, Pander, J.L., Weber, B.A., Johnson, T.G. and Fannin, J.M. (eds.) Routledge, pg Windustry Wind Energy Easements and Leases: Compensation Packages. Available at: 06.pdf?

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