“If it’s worth that much to you, then it’s worth at least that much to me.”
We hear this objection all the time from prospective sellers. In one sense, there’s an undeniable nugget of truth here. Most businesses aim to make money, and mineral buyers are no different. So mineral buyers offer to pay $100,000 for minerals because they think they’re worth more than $100,000. So in many cases, unless there is an urgent use for the money, we might encourage mineral owners to just sit on their minerals rather than sell them.
Assumptions to Examine
But what’s true in many cases is not true in every case. In particular, this claim rests on three core assumptions that might not be true.
First, it assumes that the seller and the buyer are equally good at maximizing the value of the minerals. But that might not be the case. For instance, a buyer might have the financial resources to go non-consent, i.e., refuse to sign a lease. Going non-consent requires mineral owners to share in the costs of the well, but it also entitles them to share in the full production of the well, effectively earning a 100% royalty on all production after the well pays out. In that case, the minerals might actually be worth ~3-4x as much to a deep-pocketed investor/buyer compared to most mineral owners. Likewise, mineral buyers usually have sophisticated management operations and industry connections that allows them to maximize their lease bonuses or royalties.
In short, it might actually be worth more to the prospective buyer than it is to the prospective seller.
Second, it assumes the seller and the buyer are equally good at minimizing the costs of mineral ownership. But the management operations that allow more sophisticated buyers to maximize their lease bonus and royalty also allows them to minimize their ownership costs. The idea is simple: managing 500 properties is not 500 times harder than managing just one property, so the per-property management costs are lower.
A simple example of this is taxes. A county tax office might send a bill to the wrong owner, and then when the right owner doesn’t pay, they get hit with a fee/penalty. Having a process to monitor county tax offices and make sure all the taxes all get paid on time can save hundreds or thousands of dollars in penalties on any given property. (The federal analog involves making sure that the appropriate taxes are paid at the appropriate times throughout the year to avoid penalties).
In short, larger owners can leverage economies of scale to reduce ownership costs.
Third, it assumes that the seller and the buyer have similar risk tolerance. But minerals are never entirely risk free. Seemingly great acreage can be intersected by a fault. Wells can get drilled or they can be put on hold. They can be productive monsters or total duds. And commodity prices can soar, but commodity prices can also crash to near zero. Operators are typically hedged against the ups-and-downs of commodity prices and have drilling obligations to meet, so they will often keep drilling regardless. A lot of owners discovered that the hard way in 2020, when oil prices crashed from $70 down to $9, but operators kept producing.
Most mineral buyers spread this risk out across hundreds or thousands of investments. If a given investment is a dud, the mineral buyer can typically absorb the loss and still come out ahead in the aggregate. That’s less true of mineral owners, who typically own far less. If a particular investment doesn’t pan out, then they’re out a substantial portion of their net worth.
In short, selling minerals is a risk management strategy: taking your chips off the table while you’re ahead. Sellers take a good result instead of the best possible result to insure themselves against a bad result, because a bad result costs them too much.
Questions to Ask
If any of those three assumptions aren’t true, then this claim starts to break down. So if someone offers to buy your minerals for $100,000, here are three questions to ask before deciding to sell or to hold:
1. What do I think the minerals are actually worth to me? And do I have reason to believe that they’re worth more to the prospective buyer?
2. What is my cost of ownership? And does it make sense for me to continue paying those costs or should I liquidate the minerals now?
3. Given my risk tolerance, am I okay if this property drops in value by 50%? Or even 75%? Another way to think about it would be, “If I had $100,000 today, would I use it all to buy this property?”