A working interest in an oil or gas drilling operation gives the owner of the interest the right to work on the land where drilling will occur. The owner of the interest also must pay a percentage of the expenses incurred while working on the land that's equal to the percentage of the interest he owns. Investors seek out a working interest because it also entitles them to a share of the profits from exploration after royalties are paid. If an investor finds the right piece of land, he can make significant profits from such an investment.
Becoming involved in oil or gas exploration usually requires a significant amount of wealth from an individual investor. Such investors are lured by the potential for practically limitless profits from this lucrative business. They must pay for the opportunity to get into this industry, though. One way for an investor to buy in is through a working interest, which gives her a share of the profits commensurate with the cost of working the land.
For example, imagine that an investor pays for a 50-percent working interest in a piece of land to be used for gas or oil exploration. This means that the investor then pays for 50 percent of the expenses attached with the drilling. The rest of the expenses would be divided among the other individuals holding working interests in the land. If profits start rolling in, the investor with the 50 percent interest would reap 50 percent of the profits, minus any royalty payments that are due.
These royalty interests can significantly cut into the profits earned by those holding other interests. Using the above example, imagine that the initial owner of the land demanded a 10-percent royalty from investors for the right to work the land. Suddenly, the owner of the 50-percent working interest would see be entitled to half of the profits after the 10 percent for the royalty interest is subtracted, which means that his profits would be reduced to 45 percent. This is true even though he must still pay for 50 percent of the expenses.
Since this is the case, an investor should be especially confident that a piece of land will produce copious amounts of gas or oil before buying a working interest. While the potential for reward is great, the risk incurred is equally large. For that reason, investors wishing to play it safe in this industry might prefer to purchase a royalty interest instead.
