Understanding Royalty Structures

Christopher G. Baldwin

Before examining the different types of royalty in detail, it may be useful to consider the dynamic which influences all royalty agreement negotiations, and all subsequent disputes and litigation between the operator and recipient. Known as the “royalty value theorem”, it states: “When compensation under a contract is based upon a set percentage of the value of something, there will be a tendency by each party to either minimize or maximize the value.” There are two major types of royalties in use in the North American mining industry today. They are the net smelter returns royalty and the net profits interest royalty. A third type of royalty, the gross overriding royalty, is sometimes used in relation to diamonds and thus is becoming better known outside the oil and gas industry, where it had its origins.