Sitio Royalties : Minerals 101

Introduction to Oil and Gas Mineral and Royalty Interests

Table of contents

• Introduction to minerals ownership
• • Surface vs. mineral ownership
  • Mineral leasing process
• Mineral and royalty interest versus working interest
• • Margin comparison
  • Comparison of various types of mineral and royalty interests
  • Key distinctions between various types of royalties: Mineral Interests, Non-participating royalty interests, overriding royalty interests, and working interests
• Mineral and royalty life cycle
• • Revenue streams attributable to various royalties
  • Implications of E&P activity on perpetual and non-perpetual ownership
• Mineral and royalty acquisition process
• • Acquisition sourcing
  • Valuation
• Comparing mineral and royalty companies
• • Acreage calculation
  • Key terms and metrics

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Introduction

• Mineral interests:
• • Perpetual real property interests
  • Owns hydrocarbons and other minerals below the surface
  • Can lease the right to develop these hydrocarbons to an exploration and production ("E&P") company
  • Primary lease term is typically one to three years
  • E&P company pays mineral owners an upfront payment, most often in cash, known as a lease bonus
  • E&P company pays mineral owner a percentage of production revenue
  • Can be sold, leased or gifted
• Companies that acquire oil and gas mineral rights will typically purchase mineral interests from mineral owners for a negotiated amount commonly expressed in dollars per net royalty acre
• There are many benefits of mineral ownership:
• • No capital expenditures to explore, develop, or operate
  • No direct exposure to fluctuating oilfield service costs
  • No environmental liabilities
  • Higher margins than E&P operators without associated operational risks
• Other types of royalty interests include:
• • Non-participatingRoyalty Interests ("NPRIs"), which are carved out of the mineral estate
  • Overriding Royalty Interests ("ORRIs"), which are carved out of the working interest and are further described later in this presentation

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Surface vs. mineral ownership

Illustrative Ownership

Surface ownership:

Right to use and build on the property

Mineral ownership:

Right to develop and extract the minerals located under the property

Surface ownership

• Surface owners can sell, transfer, or develop land within the guidelines established by the governing jurisdiction
• Surface owners may or may not own the rights to the minerals
• • Surface and mineral rights may be severed and owned separately
  • Surface rights alone do not entitle an owner the right to lease the minerals to an exploration company nor the right to receive royalty payments
• Surface owners may receive consideration for surface locations and rights-of- way. They can receive payments related to fresh water production and saltwater disposal wells

Mineral ownership

• The mineral estate is dominant to the surface estate
• Subsurface rights extend to the center of the earth but may have different ownership by depth
• Minerals owners have the right to explore, extract, and develop naturally occurring deposits found beneath the land's surface
• The ownership of minerals extends into perpetuity
• Like surface rights, mineral rights can be acquired and sold

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Mineral leasing process

Illustrative 640-acre drilling unit

E&PCo Lease

Area

Linda's

Acreage

Illustrative scenario

• Linda is the owner of 100% of the minerals in the southeast quarter (SE/4) totaling 160 net mineral acres
• Leases to E&P operator "E&PCo" for a primary term of 3 years for $15,000 per acre, lease bonus of $2.4mm and 25% lease royalty applicable to future production
• E&PCo leases the other 480 acres from third parties to form a full 640-acre section and forms a Drilling Spacing Unit ("DSU") through filing a permit with the state regulatory agency
• E&PCo drills horizontal wells within the DSU during the primary term
• Linda's lease covers 25% of the DSU (160 / 640) so she will receive a royalty of 6.25% (160 / 640 x 25% lease royalty) of all production in the DSU

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