PROS AND CONS OF SELLING A MINERAL RIGHT VS SELLING A ROYALTY INTEREST

A mineral right or royalty interest may be sold in its entirety or as a fraction of the whole.  One of the four owners of an undivided interest in our 40 acre example, owning 10 net mineral acres, would have the right to sell a half interest in their mineral right.  This would result in their retaining a one eighth ownership interest in each of the gross 40 acres and the buyer owning a one eighth interest in each acre.  If the seller's mineral right was burdened by an existing mineral lease the buyer's mineral interest would be subject to the terms of that lease.  If the 10 acres was un-leased or an existing lease expired then both seller and buyer would be free to lease, or not, their separate ownership interest going forward.  A royalty interest exists only under a lease.  The royalty interest may be sold in its entirely or as a fraction of the whole.  A royalty interest expires when the lease under which it was created expires.  A mineral rights owner has the right to lease their interest, receive royalty, bonus and other payments. A royalty interest owner has only the right to receive their proportional share of the royalty. A sale of a mineral right is in perpetuity in most states and governed by prescription in Louisiana. For the purpose of federal taxes a sale of a royalty interest is considered regular income.  The sale of a mineral right is classified as a capital gain and, if owned for longer than two years, as a long term capital gain.  

Owing to the considerable tax advantages for a seller and the greater value of ownership of the asset for a buyer, mineral rights are of greater value than a royalty interest.  Proceeds from the sale of a royalty interest are taxed as regular income and, for most mineral owners, would be taxed at a minimum rate of 25% and a maximum rate of 39.6% depending upon tax bracket.   Proceeds from the sale of a mineral interest are taxed as capital gains.  The majority of mineral owners having owned their mineral interest longer than two years would have sale proceeds taxed as long term capital gains.  For those in the 25% to 35% tax brackets the federal long term capital gains tax would be 15%.  Those sellers in the top tax bracket, 39.6%, would have a long term capital gains tax of 20%. Buyers understand the risks involved with ownership of a royalty interest and discount their offers accordingly.  Offers to acquire a royalty interest in producing minerals are commonly based upon a multiple of a monthly average payment.  As an example a buyer of royalty may take the average of the most recent three monthly payments and then multiply that amount by a number of months of production, commonly 60 to 120, to calculate their dollar offer.

Experienced mineral buyers understand and seek to manage risk in a number of ways.  Interested sellers in emerging plays should account for one of those ways.  It is very common for buyers to develop an acquisition strategy where there is little or no actual production that sets target acreage totals by location.  Simply put, they don't want too many eggs in one basket.  They scatter their purchases across a defined area and decline to acquire more than their target range in any one drilling unit.  For that reason a buyer may prefer a 20 acre tract to a 200 acre tract.  Those with a different acquisition strategy may prefer the 200 acre tract.  In either scenario once they have acquired their acreage target they quite often decline to buy any additional minerals or royalty.  Buyers often have a budget and a strategy to buy acreage in locations and in multiple drilling units scattered across their area of interest.  Experienced buyers know that not all rock will turn out to be equal and that unexpected geologic factors such as faults can negatively impact prospective minerals.  Acquiring mineral on the periphery of an emerging play carries additional risk as even the most extensive unconventional plays do not extend forever.  Productivity can decline rapidly or cease over a relatively short distance. 

Where lands have been proven with completed wells and mineral ownership has undergone the scrutiny of a high due diligence division order review the risk of acquiring mineral interests is much reduced.  It follows that the value of those minerals would be increased.  Not all risk is eliminated however as the market price for hydrocarbons has a history of wide fluctuations.  At this point the assessment of future value tends to be based on how many wells will be drilled in a unit and in what time frame.  The concept of the present value of a dollar is important to both buyer and seller.  Minerals in a unit where an operator is actively permitting or drilling additional wells can be of greater value than similar minerals where there is no evidence of additional near term development.  However minerals where multiple wells have been drilled and produced for any significant period of time are declining in value as the unit reserves are depleted.

Determining the value of minerals is a subjective exercise and boils down to what a seller is willing to accept from a buyer.  Mineral owners should seek professional help and get multiple offers including one or more that originates with a buyer or broker who knows the history and current activity where the mineral interest is located.  Before soliciting offers a mineral owner should give thought to just what they are willing to sell.  It is easier to make a decision to sell and not second guess that decision or the sales price if a mineral owner has exercised a modicum of due diligence in the process.

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