Momentary ramble

Texas Mineral Rights Reeves County, TX
1

My family has owned a decent amount of acreage out in Reeves and Culberson since the mid 30's to early 40's. We've drilled a bit out there, gotten others to drill and in 2008 began to experience the beginning of the Wolfcamp and Bonesprings leasing boom. By the way, I find it funny that the news is reporting this as a recent find. We all recently experienced the huge drop from $110/bbl to now $46/bbl. This drop occurred due to a number of factors but primarily because we over produced and created a surplus of oil.

The Oil and Gas industry always experienced Booms and Busts. There is no in between. Those of us that have been through a number of these things know to save for when the bust happens because it always does. The price of oil or gas is high so everyone and their cousin Billy are out drilling to make that high dollar. This creates the surplus and down we go again.

The weirdest thing this time is that even though we have not seen an increase of any substance as to the price of oil, we are seeing an increase in the prices for bonuses on unleased and expiring acreage. The most that we had received per acre in the central part of Reeves in 2014 was $3500/acre. This year as we've had a number of leases expire, Operators have started offering at $3500 and I have actually signed several leases at $5000/acre and recently for $7000/acre. Several landmen have called and are offering $8000 since I signed that lease. We have a number of leases expiring in Jan and Feb and I have no doubt that we'll be able to get some record numbers per acre for them.

So the last week or so, the national news has been talking about the new find (been around for years) and how the Alpine High is a huge deal as well (I think it's an Apache stock play). A large number of operators are buying leases at really high prices from individuals as well as the State. The State, not long ago, saw their highest Lease sale ever in PSL 56 and ranged from 5k to 15k/acre. People are coming in with huge dollars from NY funds and other countries wanting to buy minerals in the Permian. Kimmeridge Energy flipped a large amount of acreage to PDC for $27k/acre for a total of 1.5 billion. Don't know about you but until I read that article I had never heard of either of those companies.

Ok so all this looks and sounds great for us as mineral owners right? Here's where you need to think and reply. With all this activity, and high dollar spending, they will be drilling again because they can still make a profit at $30/bbl. Opec and other countries are discussing manipulating the price of oil so that it returns to a higher number. They will either agree or they won't. Probably won't because Iran is back in the game and they want their share of world prices but let's say that Opec does get some sort of fixed higher price. This will cause us to go out and drill more because we'll get more dollars/bbl. Next thing to consider is that with Trump removing a number of regulations on the industry we will drill more. I personally think with all these "great" things going on that we will see $20/bbl at some point or that we will have so much supply that we can't get rid of it all. Who knows, in 10 to 15 years, we might all be electric powered by natural gas and oil is only used in manufacturing. Essentially we are headed for another bust due to over production. This upcoming boom may only last 3 to 5 years but I think the upcoming bust may last a really long time.

The Wolfcamp alone has 7 zones that are productive. There are also other zones above and below. Technology will determine if going below 13,000 feet is economical. Another thing to consider - as a mineral owner, you and your minerals don't move. You can't pick them up and move to where a play or an Operator is drilling. If you go out and hunt Lessees like I do, you have to convince an Operator that your acreage is a good place to be. If I can't convince them, the acreage stays unleased. If an Operator drills the acreage and it is a dry hole, they will abandon the acreage. This also scares off any potential Operators down the road because "that had a dry hole on it". If an Operator does produce the acreage and after some time, quite a while if they drill and produce all zones, they will abandon the acreage and go elsewhere leaving your acreage all drilled up until someone discovers a technology that makes it cheaper to drill deeper. Will the economics be there at that point?

Now with all that said, do you change generational thinking and sell your minerals at a stupid price, one being so high that you've calculated what you would ever get out of them and demand that price? With all these Operators and their huge funds supplied by New York and other countries do you take advantage of their willingness to buy at a high price and sell at a higher price to northern or foreign investors? Do you even sell knowing that China or Japan might own Texas minerals?

I look forward to your comments as to the current boom and incoming bust as well as selling at stupid prices.

2

Thanks for the insight.

3

It is a very hard question to answer. My wife passed away a couple of months ago and was not able to enjoy the gift that our properties have now created. We never had money and had financial "challenges".....significant challenges for 30 years.

We sold three tracts at a very good price 6 months ago to clear up past problems and to put a comfortable amount in the bank. Now there is one very very good tract that is throwing off good income that is very valuable. The acreage is HBP and as such, I have no clue when Oxy will develop it.

I have had excellent offers and currently have a petroleum engineer doing a reserve study for me, to further ascertain true potential and current value.

I want to see it developed and enjoy waiting for results etc., but the 63 year old in me keeps saying that if I can set the family up with a good sale, take the variables out and quit worrying about the %^$*# oil price, that I should do it.

Not easy.

4

Wade, you make some very good points and I agree completely. Another bust is inevitable and folks should prepare for that. We're tied up with a lease whose primary term doesn't expire until next July and we are unsure whether the defunct lessee is trying to sell their assets or what will happen. It's very tempting to consider the purchase offers. I think selling is based on so many factors. Age, financial goals, current financial situation, etc. The constant ups and downs in the o&g industry can be stressful and there is some peace of mind to be found in just getting the best lump sum you can get, paying your capital gains tax rather than the ordinary income tax you would pay on your royalty and bonus, and putting that money in a more secure investment. I inherited my interest and was told never, ever to sell, so I have that looming over my head! It costs a little money, but there are some good folks out there that can value your minerals to help in the decision making (not that you've asked for any advice--seems like you have a greater understanding of the issue than most of us).

That's my 2 cents. Waiting to see how this "new" play pans out.

5

I too, have inherited minerals in Reeves county. Also, my Father told me to never sell my minerals. I don't think however, he ever anticipated the outside money that is now coming into minerals. Here is something to think about. What would you do with the money if you sold? Number one, you would have to pay capital gains on most of it. 25%. Then, where would you invest it? The stock market is at an all time high. Thanks to the Keynesian idiots at the Federal Reserve money markets are at an all time low. The minerals are in the ground and not going anywhere. We all switch to electric cars where is the energy coming from??? Certainly not wind and solar or nuclear. Natural gas. It has to. So, I will follow my Father's advice. When I pass on, they will go to my son. I can't think of a better inheritance.

6

John, like you and so many others, I inherited my minerals also and my father told me the same thing, never to sell. And, like Stephen, my spouse recently passed away, so all the things we were going to do, we’re not. I really like this discussion because it makes one think very seriously about how to use what those before us have blessed us with. My question to John (and the rest of you) is, what if you didn’t have that son?

7

If you look for the numbers you will find that the storage in the US was filled up with imported oil. After the crash the multinational oil companies imported more oil. The US became the dumping ground for an extra 1,000,000 barrels of oil per day because cheap Nigerian oil could be sold at a profit even at $30 per barrel. We went from importing 7 million barrels a day to 8 million barrels a day.

8

Well Linton, that is a good question. You could give them to some charity I suppose but you need to be careful. Years ago, my wife was on the board of a local hospice. Someone donated some minerals to them but they didn't realize what they were and were afraid of them. She wound up buying them for $200.00 and they were glad to get rid of them. 40 acres in sw North Dakota and 360 acres in eastern Montana. In your case it might be best to sell them and then you could some good with the money. Sorry to hear about your wife. It must be pretty tough.

9

John, thanks for the reply. That’s what I keep fighting with. The capital gains doesn’t sound too appetizing. That’s generally when I decide not to sell. I’m thinking I might order them sold on my death and the proceeds given to the ASPCA. I’m a female, BTW, but I was named after my grandfather, go figure!! Think they wanted a boy!!

10

I'm not a CPA, but I believe current capital gains tax is 15%, or max 20% if your ordinary income is over $414,050 that year. A big lease bonus, coupled with my regular income put me over the 30% tax on income, which would also include ordinary income. So, there could be some significant tax savings selling and paying capital gains, rather than paying tax on the income over the years. A good CPA can definitely provide much more information.

11

Thanks, Lori, more food for thought. I’m retired so I don’t have a great deal of income outside the O&G income. Think I’ll wait and see what Trump is going to do and what it’s like a year or so down the road, and save up my pennies to pay my CPA for his expertise!! Thanks. Linton

12

Linton, if the minerals were in your husband's name, you will receive a step up in basis with the transfer into your name.....and that might be very significant.

13

In my case, should I sell a certain producing property, I might pay no taxes as a result.

14

Thanks for the reply, Stephen. And sorry for your loss. I know how devastating it is to lose your spouse. The minerals are all in my name only, as I inherited them from my parents.

15

If there is a likelihood that you have a chance to project living for another 20 years...and you don't need the money? Hold on!!!

They are just now trying to figure out how to extract oil from the many shale layers.

16

Your momentary ramble has sparked an important conversation. I have a stupid question. If I have leased my property, can I sell the leases. Doesn’t seem right, but had to ask.

17

Back in June I was supposed to get my division paperwork but it never happened. Then the Friday before Thanksgiving it was supposed to happen and still I wait. Is the OPEC mtg holding everything up? They have already tested the well for 24 hrs, so I am confused.

18

Wade

I'm sure the idea has been discussed in detail on this board but how about selling some and keeping some?

Any good financial planner can tell you the benefits of diversification. Your situation may be comparable to someone who worked for the same company for years and received lots of stock benefits as the company grew. Now they've retired and have nearly everything they own in that one stock. Even if they love that company and feel like it has has lots of upside potential, keeping all their eggs in that same basket may not be the best way to go.

My father used to say "There is a right time to sell anything". I'd never suggest anyone sell all their minerals but if you have enough that it dominates your net worth then making the best deal you can (and taking some of that "stupid money" you mentioned) for some part of your minerals might be logical.

On the problem with capital gains taxes you might investigate the benefits of using a 1031 tax free exchange for all, or part, of the proceeds from what you sell. Talk to a CPA. I think they will tell you mineral and royalty interests are considered 'real property" for income tax purposes and thereby qualify for use in a 1031 exchange. Using a tax free exchange would allow you to turn part of your mineral interest into some other kind of real estate without any taxes having to be paid. Keeping diversification in mind though I'd try to exchange for real estate you think will run counter in value to the oil market...not apartments, motels or shopping centers in Pecos or Midland.

19

you, as lessor, cannot sell the leases. Only the Lessee or person you leased to can.

20

call them every day and harass them. have them send it to you by email. Opec has nothing to do with it.