Reversionary Working Interest

Which oil and gas interest gives its owner a share of production revenues without any share of the program's costs, beginning with the first barrel sold?

1. A.A working interest held by a limited partner in the programWrong. Sharing the program's costs is precisely what defines this interest.
2. B.A reversionary working interest retained by the program sponsorWrong. It is cost-free, but nothing is paid on it until investors have recovered their costs.
3. C.An overriding royalty interest carved out of the underlying leaseCorrect. It is cost-free and measured against total production, so it pays from the outset.
4. D.A general partnership interest in the drilling program itselfWrong. A general partner shares costs and, beyond that, carries unlimited liability for the partnership.

Why: The outline defines an overriding royalty interest as one whose owner does not share program costs and who shares in revenues through a cost-free interest in production revenues, payable under an oil and gas lease out of the total production of the well or deposit. Because it is carved out of production rather than out of profit, it pays as soon as the well produces and continues whether or not anyone recovers an outlay. That is what separates it from a reversionary working interest, which is equally cost-free but deferred until investors reach payout. Convert the same interest into a working interest and the owner would begin funding drilling and operating costs from the start.

A limited partner in an oil and gas drilling program is told that his units represent a working interest. What obligation does that description carry?

1. A.An obligation to accept unlimited personal liability for the program's debtsWrong. Unlimited liability follows from general partner status, not from the type of interest held.
2. B.An obligation to buy further units if a well has to be deepened or reworkedWrong. Mandatory assessments are a term of a particular program rather than an attribute of the interest.
3. C.An obligation to bear a share of program costs, including the wells that failCorrect. Cost sharing is the defining burden that comes attached to the revenue share.
4. D.An obligation to market his share of production through the operator at posted pricesWrong. Marketing arrangements are contractual and are not what the term denotes.

Why: The outline defines a working interest as an interest in production revenues in which the partners share program costs. Revenue and cost travel together in this interest: the holder funds drilling, completion and operating expenses in proportion to the interest held and receives production revenue in the same proportion. A dry hole is a cost like any other, so a working interest holder pays for the wells that fail as well as the wells that produce. The two cost-free interests, the override and the reversionary working interest, are defined precisely by the absence of this obligation.

In Cascade Resources Program, the sponsor holds a reversionary working interest that does not begin sharing in revenue until investors have recovered their invested costs from production. Before that point is reached, what is the sponsor's obligation for program costs?

1. A.The sponsor funds its full pro rata share of costs from the outset.Wrong. That describes an ordinary working interest, not a reversionary one.
2. B.The sponsor funds costs only until payout, then stops.Wrong. It is the reverse: the sponsor does not fund costs before payout in this structure.
3. C.The sponsor has no obligation to fund program costs before payout.Correct. The investors alone bear costs until payout under a reversionary working interest.
4. D.The sponsor funds dry hole costs only, and investors fund all other costs.Wrong. This split describes a disproportionate sharing arrangement, not a reversionary working interest.

Why: A reversionary working interest owner does not share in program costs during the initial period; the investors alone fund drilling, development, and operating costs while also receiving all revenue during that period. Only after the investors recover their costs out of production -- the payout point -- does the sponsor's interest revert and begin sharing in revenue. The arrangement is named for what happens to the sponsor's revenue share, not for a change in the sponsor's cost obligation, since the sponsor still is not funding costs even after reversion in the typical structure.

A sponsor retains a reversionary working interest in a drilling program and takes no other economic interest in it. At what point does the sponsor begin receiving a share of program revenues?

1. A.Only once the investors in the program have recovered their costsCorrect. Payout is the event that switches the sponsor's share on.
2. B.From first production, since a cost-free interest is paid like any royaltyWrong. Being cost-free does not make an interest current; the reversion is what postpones it.
3. C.From first production, but only in proportion to the costs the sponsor fundedWrong. This sponsor funds no costs under the interest, so there is nothing to proportion it to.
4. D.Only after the wells are fully depleted and the program is winding upWrong. The trigger is investor payout, not exhaustion of the reserves.

Why: The outline defines a reversionary working interest as one whose owner does not share program costs and who shares in revenues after investors recover their costs. The word reversionary describes a switch rather than a rate: before payout the sponsor's share is zero, and at payout an ordinary working interest reverts to the sponsor. The consequence is that all of this sponsor's compensation is contingent on the program first returning investor capital. Had the sponsor taken an overriding royalty instead, it would be paid out of production from the first sale regardless of whether investors ever recovered anything.