Hello, I own some mineral rights that provide monthly royalty income that I have owned for maybe around two years, I still have 20+ years until retirement. Is there any particular way one values their mineral rights for long term retirement planning?
Do I just go by how one would value the mineral rights if one were to sell them today? The formula I have seen is the average of the past three months of payments multiplied by 36 to 60.
I know there are several factors will effect royalty income, production declines over time, oil and gas prices fluctuate, etc.
This valuation is just for my own personal accounting and planning. I am not planning on selling my mineral rights. There is a big difference between using the lower multiplier (36) and the higher multiplier (60). Part of me thinks I should use the lower multiplier to be on the safe side, but I am mostly looking for what the “most accurate” valuation method is.
Whether you calculate the value based on 36 months or 60 months times revenue, I wouldn’t count on any revenue twenty years in the future. It does happen, but production declines. It is unlikely that this well will produce much in 20 years.
FWIW: I know of a person who assumed royalty income would continue when he negotiated child support and alimony during a divorce. A year or two later, the production dropped precipitously AND the price of oil fell precipitously too. He was in a really difficult position and it ruined his relations w ex-wife, and she poisoned the children against him. My personal motto is to live as if every royalty check is the last check I will receive. (My corollary is obviously “Always live below your means”.) I apologize that this isn’t a helpful response to your question, which is a valid question, but I do want to share my advice to be conservative in your estimation of future income. (In my experience, royalty income does taper off significantly as time goes by. . . and then there is all the geo-political risk nowadays.) Best wishes.
I appreciate the response. I understand what you are saying, caution is the name of the game.
I still would like to figure out some kind of valuation though. I am not counting on the income to still be there 20 years down the road, the valuation is more just for my own personal estimation.
Another way to put it is how to value the mineral rights if I was trying to calculate net worth. In that calculation I have one without my home value and one with. So the same way, I can have a NW calculation without the mineral rights value and one with, just to get a general snapshot of NW that can be tracked over time. There’s a potential for stocks or real estate to drop by more than 50% but these are still things people calculate into their net worth and retirement planning. I understand wanting to be cautious, but I think valuing producing mineral rights at zero is maybe too cautious for me.
Maybe I will just use the 36 months number for the calculation, that might be good enough for my purposes.
It depends where your rights are located. If you have a bunch of hypothetical future wells that are currently generating nothing on your monthly statement than the value is a lot higher than anything you are seeing today.
If there is never going to be anything else, and your wells are declining at, say, 25% for 4 years and then 10% for 16 years you are going to be getting like 6% of the current volume in 20 years. In that 20 years the wells will have made about 5x the annual volumes you are seeing today. Stash that in an investment account, get 6% interest and you probably have a decent retirement egg. But the revenue in 20 years in the absence of new wells is likely to be pretty low relative to what you currently have. As Tim said.
IMO, you should have a mental forecast of production for future years, and some guess on pricing, and that gives you a revenue forecast that you then start to plan around. Whether it’s converting to an NPV with some discount rate or its setting up an investment/savings schedule to have some future lump sum etc. Or whatever.
If you are really interested and willing to pay for it, you can have an engineering evaluation done which calculates the production from each of your wells and the potential for any future wells. A price deck is applied and a discount factor for the time value of money. You can use that as a ballpark idea. We have certainly seen wild variations in pricing over the last three years! You can invest your “black gold” into other investments and have a nice nest egg. The Directories tab above lists several good engineers in the Mineral Services area.
Thanks for the suggestion. I am curious about an accurate valuation, but probably not curious enough to pay for one, maybe I would if I needed a valuation for something official.
Do you think using a monthly royalty amount multiplied by 36 is a reasonable ballpark figure to use for valuation? I was thinking of taking the average of the lowest three months out of the past twelve and using that as the amount to multiply by 36, just to be extra cautious. I know production declines in a non-linear fashion and oil prices have been on the higher end lately, so I know it’s not a perfect way to calculate things.
in the “old” days for vertical wells, the general factor was four years annual oil royalties and seven years of gas royalties since gas wells tend to last longer. If you have horizontal wells, then the factors are completely different.
All great comments. I’ve been a cpa in public practice for 35 years. If you’re not going to sell then valuations are useless. What you care about is cash flow. And the answer you got showing decline curves on HZ wells is spot on.
Do a spreadsheet.
List each well and put production from highest month in column b.
Create a column for Terminal Production.
From here you can go crazy if you want to and drop in each month’s production and calculate declining production percentage.
But what I’d do is pick a termination factor starting in say year 3 that is 15% of highest and lower to 10% in year 4 and forward.
Price I have no idea but let’s say $60 or $65. No way to know for sure but it I think the world “needs” oil at least at this price and we’re many decades from alternative energy hurting carbon energy.
On that terminal production you can likely get pretty close by looking at production on more mature wells in the area and/or talking with the company landman/engineering department and get their internal estimates.
Keep in mind at all times number could go to $0 overnight and it happens a lot. Hard for anyone to predict what’s going to happen 6000 to 9000 feet below the surface of the earth.
TGC, I suspect that Todd’s way of calculating is more accurate than what i’m going to suggest, but I also suspect you aren’t looking to run a p/z curve to figure out value.
I would suggest 60 months x average revenue for the last three months.