Not to rehash an old post…but as Martha and I have discussed on many occasions, I would like to present some of the arguments on the other side of the “sell/don’t sell” debate. I also included some insight into the analysis I perform when evaluating minerals for acquisition. I think many on this site will agree that there are many unscrupulous minerals buyers out there. There’re also some pretty shady sellers as well, but that’s a discussion for another day.
I also think that everyone will agree that the key to making the right decision for any mineral owner is to be educated about their acreage, its potential, and the risks/rewards of holding minerals no matter what.
First and foremost, your acreage is sitting in a great location, you’re very fortunate in that regard. This area is some of the best in the STACK play.
I also understand being cautious about selling and the offers you have received. As a mineral owner and investor, I am on the receiving end of offers and negotiating leases often, and I can assure you that for the most part everyone you deal with is generally looking out for themselves. It is not personal to them, it is an investment. For you however, it is your asset and it may be very personal. I always tell mineral owners that in most cases, if you can it’s best to hold onto your minerals and not sale. HOWEVER, sometimes offers are so good, as investors are willing to take on so much risk, that it is hard to say ‘NO’. Either way it is an individual and personal decision that should be made with as much insight as possible, and there are options such as selling only a portion instead of all of your minerals – that way you can take some chips off the table, while maintaining some ownership in case something comes along down the road.
With that said, I think in general there are a couple of types of mineral buyer – (1) those that throw out low ball offers in the hope of catching deals from the less informed, (2) those that dig into the technical side of the business and analyze the geology, potential, etc.
As for as the 1st group – I don’t have a high opinion of them and don’t really know how they stay in business. As for the 2nd group – those that are digging in and evaluating, they analyze a lot of items to get to a purchase price.
Some of the main items to keep in mind including relating to risk/return – the more ‘unknowns’, the greater the risks. Some of the big unknowns that mineral buyers wrestle with include: (1) commodity prices, (2) timing of development, (3) number of wells (4) production profiles, (5) Lease Terms, (6) exit value/strategy, (7) taxes, and ……well there are a lot of risks and assumptions.
These unknowns influence the level of risk, and hence required return. When you invest in any investment, you are looking to achieve a rate of return commensurate with the risk you are taking. Higher risk investments require higher rates of returns, that’s why the perceived safety of US government debt have very low rates of return, while junk bonds, or penny stocks have high rates of return. Mineral interests are most akin to real estate investments than stocks or bonds, but with a bunch of different risks.
The items above are just some of the risk mineral owners face. If you are a mineral buyer, you have risks as well as a need to cover an “return hurdle” – most mineral buyers are using pooled investment vehicles and need to hit returns hurdles in the high single-digits to low-teens to cover cost of funds and overhead (some have much lower return hurdles as they are essentially division of insurance companies that are trying to beat inflation and therefore are looking for low single digit returns). It’s not cheap to analyze oil and gas investments, and reach out to thousands of mineral owners, and cover losses on the ones you get wrong.
On the flip side, the question for the potential mineral seller is “what risks I am willing to take”, and “what type of return I require or that I am willing to give up”. Additionally, for a mineral owner, what portion of my net worth am I willing to have tied up in a single asset – depending on the size of the mineral value to your overall net worth, it may not matter much, or it may be a situation where the value of your minerals dwarf everything else.
(1) Commodity prices – this is a risk that everyone takes – there are many opinions. I think the general consensus is that prices are range bound, there are as many downward pressures as upward pressures. Prices will be volatile, have periods where they seemingly go up each day, and periods where they seem to drop every day. I caution anyone thinking that $80/Bbl is likely and/or sustainable… Similarly, $40/Bbl is just as unsustainable as $80. So, when evaluating what prices and hence your potential revenues, will be, take a look at various scenarios. Then think about how those scenarios would impact you.
(2) Timing of development is a huge question for everyone…including the operators. If you are a mineral owner, it has huge impacts on value, the sooner may not be the ‘better’ but usually you want to see your acreage developed and put into production. This is also a big challenge for mineral buyers. Unless fully permitted with rigs on location, a mineral owner (and buyer) is speculating on when the wells will be drilled and completed. The reason this is so important, is that the longer the time until development, the longer the time a mineral buyer is incurring the cost of its investment (remember they have to deliver a return to their investors). In your case, your wells are fully permitted and you’re in a hot area - so timing is not in the too distant future - after drilling and completion, then you would probably anticipate another 6 months until 1st check on new wells.
(3) Number of wells developed – this is somewhat related to Number 2 but is still somewhat different. It is also related to the size of the unit – a good way to compare units in the same thermal maturity area is to look at the number of lateral feet of well bore(s) in the unit divided by total number of areas in the unit. For your unit, this is a known with the permits in place. The number of wells and how tightly spaced they are will influence production profiles - too close and the wells will interfere with each other - however, the positive thing is that overall recovery of the hydrocarbons in the section should be higher.
(4) Production profiles (what the wells will produce over their lives) – depend on a huge number of factors – location (geology, etc.), operator (how they complete wells, etc.). Operators complete wells differently as their objectives may be different. The production profile for the first well in a unit can be different than in-fill wells if they are drilled at different times. Overall, you really need to look at all the factors that influence production and base your assumptions on those factors to make your best guess.
(5) Lease terms – lease terms vary wildly – it’s not just about the royalty rate, but also what deductions (if any) an operator can take. I took a look at your leases, your royalty rate of 3/16th is good, but if your leases permit deductions then the impact on revenue can be noticeable. Operators can deduct the cost to transport and process gas, sometimes these charges are a large percentage of your revenues. I have seen discounts anywhere from 10% to 50% - since you are already receiving checks you can probably anticipate what those discounts will be.
(6) Exit value/strategy - Most mineral investors are not looking to hold the minerals they acquire forever, at some point in time most need to sell what they’ve acquired, and there are just as many unknowns when it comes to predicting how investors in the future will look at minerals.
(7) Taxes are another consideration, royalties are passive ordinary income, if you sell you may get hit with capital gains – depending on what your ordinary income is for the year. Usually taxes are not a major consideration in when deciding to hold or sell and investment.
All in, there are A LOT of assumptions that go into coming up with a purchase price and/or perceived value for minerals.
I model acreage for living you could say, and sometimes people would say that I actually do a pretty decent job at it. In my valuation model, I try to account for as many variables I can, including those mentioned above.
Using the current Fleenor well, nearby wells including the child wells in the Ludwig multi-well development as proxies for anticipated production profiles, I get to around 1.35 MBoe for each of the in-fill wells, including roughly 480 thousand barrels of oil. Of course, changes in completion techniques can have a huge influence on production. Furthermore, changes in geology can as well, hence why I utilize nearby wells when evaluating acreage.
When apply the production profiles and utilizing current forward commodity prices adjusted for basin differentials (regional discounts on gas and oil prices), as well as operating costs published by the operators (helps estimate the life of the wells and length you would receive checks), etc., I think that the offers at $25,000/acre would yield a pre-tax low teens IRR (rate of return) and an investor would make 1.5 times their investment over the life of the wells. This assumes first cashflows come mid-year next year. It will take around 5 years for the investor to recover their investment before they make any profit. Of course, this depends on everything going right, prices not dropping, etc. There is always the chance that prices go up, wells come in better than the surrounding analogous wells, etc.