It is based on the spot price the oil actually sells for, WTI is the standard, but their are several different market prices depending on where the oil is coming from. The oil company may have a hedge price of $75, for example, but the royalties are based on the spot price at the time of sale, which may be lower or higher. This may seem unfair, but the royalty owner can also, theoretically, hedge their future production based on what they think their wells will produce. This is a lot of guess work and often there is not enough to justify the size of the hedging contract. This actually benefits the landowner when the oil company thinks the price is going to go down, so they hedge at, say $50, but it actually goes up. The royalty owner is paid based off the higher price and the oil company is stuck swallowing the difference.
I’ve been tinkering with some market strategies over the past few years to protect the income from my mineral and ORRI holdings. Rolling put options on USO is the simplest form. If a big move looks impending, I’ve developed a strangle technique that can capture the move either way. Sounds fancy, but when juxtaposed to ones expected cash flow it can be a simple way to protect yourself from this volatile market. If that is of interest to anybody, PM me and I will explain further.
I’m interested in the simplest version
Hedging is difficult and requires a sense of timing. I know a lot of mineral owners are frustrated that they do not participate in any given operators hedging strategy but these are financial risks that a company pays for. They get it wrong too- more often than not.
That said, If oil gets to a certain price range and looks toppy or if you are just satisfied with that price range:
Estimate your monthly cash flow from your production for the prompt month. Let’s assume you expect $10,000 for October’s payment. I do not try to hedge more than 50% of my expected production. I’m ok with leaving some in the spot market but it’s really an individual choice.
USO (United States Oil Fund) is my preferred vehicle. It is a highly liquid ETF that tracks WTI oil price. You can trade it on etrade, fidelity etc. These types of ETF’s are flawed long term investments because the fund managers must roll the contracts every month thus causing a decay in equity value. I’ll try not to get to deep in the woods on options trading strategies because it can get tough. Simply put, the stock goes down easier than it does up.
As an example, WTI was roughly $75 october first. I like that price, plus the chart was suggesting a reversal. USO was $16 per share. 3 one month put options contracts might cost me $60 each or $180 total and allow me the option to control 300 shares @ 16(300) = $4800 implied leverage or about half my expected cash flow. If the price of oil drops, I capture the move in the financial market from my gains on the put options. If the price stays high or goes up, I just let the options expire worthless and lose $180 for my effort.
This kind of thing isn’t for everybody and it certainly doesn’t always work. But there are some measures that people can take to protect their cash flow. I realize the differentials in the Permian make this even more difficult so make of it what you will. You can practice by taking small position (like 1 contract at a time.) The financial loss is minimal if you get it wrong. USO is pretty liquid as well. You can outright short it if you don’t like options.
I own minerals in section 26 block 55 - 7. If the other owners of minerals in that section will contact me I can give you some information about our lease
Hello, I just received a lease contract for Reeves County, I have never entered into one before and I am trying to figure out if the offer is competitive or not. I cannot figure it out. Can you direct me to a resource that will make this clearer to me? Thank you!!
Thank you very much, I appreciate your help.