Mineral Rights Basics
Mineral rights can seem complex, but we hope to help you make an informed decision about whether too sell or hold.
Is Selling Right for Me?
People sell for different reasons, and selling isn’t right for everyone. Check out a few factors that may help you decide.
Valuing mineral rights is one of the hardest parts of the business. We can share some insights and our experience.
Mineral rights, in a nutshell, are the rights to oil and gas beneath the surface. They can be subdivided, delegated, or even sold entirely. And whoever owns them has the right to produce the oil and gas beneath the surface.
Pooling and Unitization
Pooling and unitization are two legal structures that allow for the combination of mineral interests or leases. They are very similar and are often used interchangeably, though they are technically distinct. Pooling is joining together separate mineral interests or leases to comply with spacing rules, while unitization is the join operation of part or all of a field without regard for lease lines or property lines (basically, a larger form of pooling). In other case, the resulting “pooled” or “unitized” properties are treated as a single property and properties are paid on an allocated basis. Learn more here.
Surface Rights vs Mineral Rights
In general, property in the United States starts off as a “fee simple” consisting of all the property from the center of the earth to the sky above. But that fee simple is often divided into a “surface state” and a “mineral estate.” In a nutshell, the surface estate is the right to use the surface of the land (usually down to a given depth), and the mineral estate is the right to access the sub-surface oil and gas, using as much of the surface as necessary to do so. Learn more here.
Most mineral owners do not “develop” the mineral rights themselves. Instead, they “lease” the mineral right to oil and gas operators in exchange for a share of the production (called a royalty) and sometimes a lease bonus. Lease bonuses vary significantly by region, but modern royalties are usually between 3/16ths and 1/4th of production (with some as high as 5/16ths). Learn more here.
Mineral Rights vs. Royalties
Mineral rights are the rights to develop the mineral estate, including (1) the right to produce minerals, (2) the right to delegate the production rights, (3) the right to receive payments and rentals, (4) the rights to a share in production, and (5) the rights to transfer some or all of the rights to others. A royalty interest, by contrast, is just the right to receive a share of production (#4). Learn more here.
We can’t advise you on your financial decisions, but we do know one thing: In general, if someone wants to buy your minerals, it’s because they think they can make a profit. So if you get an offer for $100,000, you can be sure that the company making that offer thinks those minerals are worth more than $100,000. That’s how this business works. So knowing that, what are some reasons owners choose to sell?
Minimizing Your Risk
A bird in hand is worth two in the bush. Many landowners would prefer the sure thing of $100,000 today than an 75% chance of $200,000 in the next five years. We can afford to take those risks because we have a whole portfolio of investments, but not everyone can or should.
Diversifying Your Portfolio
Don’t put all your eggs in one basket. Many landowners don’t like having most of their wealth tied up in one asset. If you wouldn’t invest $100,000 in a single stock, you shouldn’t hold onto a $100,000 property. Instead, landowners like to sell their property and diversify their investments to spread the risk.
Get Cash Quickly
Future profits don’t meet present obligations. Some landowners simply want money today, rather than waiting five years. Maybe they have an expense, but many simply want some extra money to enjoy a vacation.
Mineral management is a headache. Mineral rights can be lucrative, but they can also be an administrative hassle, especially when it comes to estate distribution or paying taxes. We have a team devoted to managing minerals, but most landowners don’t. So many want to simplify an estate or the administration of smaller properties by selling and reinvesting in simpler assets.
A Better Value for You
They can sell their mineral rights for more than they are worth. As strange as this sounds, you might be able to sell your minerals for more than they’re worth to you. That’s not because we’re foolish, but because we have expertise, connections, and leverage that allow us to maximize the value of minerals. So while it might only be worth $80,000 to you, they might be worth $120,000 to us. In that scenario, selling at $100,000 is a win-win.
In general, royalty payments on minerals are taxed at ordinary income rates, whereas asset sales are taxed at capital gains rates. For many people, particularly those with lots of ordinary income, the ordinary income rate can be substantially higher than the capital gains rate, and thus selling can be more tax efficient. Obviously, you should consult your tax advisor about your specific scenario.
Most people value mineral rights by estimating (1) how much will they produce and (2) when will they produce, and (3) the chance that you’re wrong. From there, it’s a fairly straightforward math equation: Calculate the production value, discount based on the time-value of money (money three years from now is worth less than money today), and multiply by the risk that you’re wrong. If you’d like help with that, you can always reach out for a no-obligation same-day quote. We are happy to help landowners value their minerals and explain our valuation.
How Much Will They Produce?
Mineral rights are only worth as much as the oil and gas that will someday be produced, so the first step in valuing minerals is to ask “How much will they produce?” This is largely a function of how many wells will be drilled and how productive those wells will be. You can answer both of these questions by looking at nearby units operated by the same operator. For instance, if your mineral rights are owned by an operator that tends to drill 6 wells per mile-wide section, and those wells produce 400,000 barrels of oil (and negligible gas), then your mineral rights will likely be worth about 6 wells x 400,000 bbls of oil x the price of oil x your division of interest on an undiscounted basis.
When Will They Produce?
It’s one thing to estimate that your minerals are worth $100,000 in total estimated production at some point in the future. But if that point is 10 years in the future, then those minerals are worth a lot less than $100,000 today (assuming you could get an average 5% in the stock market, $100,000 ten years from now is worth only $61,391.33 today!). So it’s important to know not just how much they will produce but when they will produce. This question is harder for the average landowner, but if there are any permits, you can at least look at the average time between permit and production for nearby wells by the same operator, and then running it through a present-value calculator. But again, we’re happy to help you calculate this using our data.
How Certain Is Your Estimate?
The thing about estimates is that they’re estimated. None of us can see the future (though we wish we could!). So we have to approach our estimates with humility, and that means discounting them for uncertainty. Maybe our time estimates are off. Maybe there’s a geological fault and the minerals will never get developed. Maybe the operator will go bankrupt and another operator will acquire the property and drill the property differently. A good way to estimate this uncertainty risk is to apply a larger discount if (1) oil prices are high, (2) the operator is smaller, (3) the operator drills inconsistent wells, or (4) your estimates are farther off in the future. If you’d like help thinking through the risk, don’t hesitate to give us a call.