In a conference call on line about a confidential subject that had brought us together, I noted that among the participants were some folks who operate sites like this. And one of the subjects regard the "appraisal" of minerals (oil and gas explicitly). Not to go into the details (since it was confidential) but I dawned upon me that there is a less than clear understanding between the distinction between the well production v. the value of the mineral right among most people who are not working with same.
From the engineer's or geologist's standpoint the value of production normally relates to a single well and uses a single approach. Namely, the volume of product is estimated by decline curves, or if you have internal information and expertise, perhaps developed volumes from well logs, coring and estimating carbon content, volumetric estimates, etc. - all internal "stuff" that few of us have access to. So decline curve analysis - of the well or a proxy of the well - is the basic tool.
Then the engineer will apply a price (usually current NYMEX pricing) - adjusted for local market - and apply a discount - (time value of money) and that discount usually is either 10% (the SEC benchmark) or perhaps they will refer to the SPEE (SPEE.org) - petroleum evaluation engineers annual survey of parameters. And thus, use maybe 15-18% discount rate.
But this projection is an engineering evaluation. It more accurately would reflect PW - Present Worth, rather than PV - Present Value. A true appraisal (a Market Value or Fair Market Value as the IRS likes to say) takes two more steps. First, the appraiser will be valuing the entire holding of a person. If you own 20 acres of a 640 acre drilling unit, and there is only one well, then there is potential for more future wells, at least typically. And those wells may not be drilled for months or years down the road. To estimate the production then, the appraiser will discount for the risk of those wells being similar or not, being drilled timely or not, and include in the value, an estimate of the actual market value of the whole - producing or not.
That is awkwardly stated, but the value of your mineral RIGHTS is not the value of the single borehole, rather is the sum of the values of all boreholes, past, present, and future, that will reasonably be expected to be developed. And those are discounted for the unknown.
So to give some idea of that risk-adjustment needed, the appraiser may look at more than one method of valuation. The old tried and true 3 x income (or past 36 months summed) etc. works. Dr. Wm. Wright's 1865 method in the old oil fields of Pennsylvania ($ per barrel per day - such as $1,000 x 200 bpd = $200,000) is not unknown 150 years later. But again this is the value of a single well.
And very important are actual sales of mineral rights - often undeveloped mineral rights that are slated for development. Buyers flock to sections where a well is proposed seeking small interests to buy in front of the actual development.
The transaction price is difficult to determine in most states (some states do require deed stamps so the price is calculable) yet very important. If mineral rights are selling for $3,000 an acre in your area, then the "market value" isn't $6,000 or $10,000 an acre no matter what the decline curve/engineered method says. Nothing is more "Market" than a market sale between two parties.
And that is the real problem. The appraisal of mineral RIGHTS are transactional and involve a REAL property interest (be it an undeveloped or unleased tract or be it a developing parcel with production) based on the tangible aspects of a leased fee or fee in mineral. Mineral rights are real property.
Well production is personal property, once it reaches the surface, thus not real property. The engineered methods are valuing an ownership position that is often intangible (like an over-riding royalty interest or working interest).
For folks with legal issues to deal with such as creating a cost basis, or for division of an estate, payment of estate taxes, etc. you need an appraisal...not an evaluation relating only to a single well. (Not that the IRS won't accept these sometimes and not that it might even be an advantage to submit a report that is more favorable to the client's cause (increase cost basis or decrease the tax...) But the appraiser or engineer is supposed to evaluate a property without bias. Please don't ask them to "favor" your cause. That is solicitation of fraud. Perhaps paying for both an appraisal and an engineering report is a sound decision if you have a reasonably substantial mineral interest and that is especially true if you are a trustee of an estate. A misstep there can land you in court with siblings who may accuse you of "mismanagement".
Finally, I see some folks selling mineral rights where an existing well is "playing out" and the checks are very small. Someone comes along and offers 3 or even 4 x the current income and the party sells ignorant that future wells will be drilling in the unit and they just sold their entire holdings for a small fraction of their value. Often these are disguised as "borehole assignments" or "Royalty and Mineral Deed"... Don't be fooled.