Replies to This Discussion

Permalink Reply by Skip Peel - Mineral Consultant on December 1, 2009 at 8:42

Mac. I don't disagree with your reasoning but I would point out that calculating the future value of a revenue stream based on production from an oil or gas well(s) is an extremely difficult undertaking. There are numerous examples of wells with significant production and seemingly with many productive years remaining that suddenly and without warning turn to salt water. Impressive production one month on SONRIS, the next zero, zip, nada. The occurrence is not rare. With the Shale the long term unknown is decline rate. The answer to that question is years in the future.

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Permalink Reply by Mac Davis on December 1, 2009 at 9:58

Absolutely correct, skip. You are trading a known quantity of cash now for a difficult to estimate amount of cash in the future. There's a lot more uncertainty in future payouts of minerals than there are in most investments.

However, don't forget that future cash flow can increase as well as decrease.

Your mineral production may go to zero, or may be much higher than expected. Maybe there really is some mega reservoir under the HA. (Yeah, right!) Maybe there will be new technology to get more gas and oil out. Prices can collapse or spike again. Taxes or regulation changes can ruin you.

In concept, you calculate a range of possible payouts and assign probabilities to them and calculate an "average" payout. In reality, the calculations are too difficult to really nail it down, but you should make some sort of estimate, even if it's only "gut feel".

You can bet your bottom dollar that the person offering to buy your mineral rights is making this calculation and offering you something less than the number he comes up with.

Anyone buying your mineral rights is going to expect to make more than they pay over time because they're assuming all the risks. Risk vs. reward is the way the economy works. By selling now, you no longer have risks, but you give up some of the potential reward.

You need to balance these risks vs. rewards when making these decisions.

Permalink Reply by Skip Peel - Mineral Consultant on December 1, 2009 at 10:13

Mac. The risk equation is usually quite different for the seller of a mineral interest than it is for the buyer of that interest. In most instances the seller has only the one mineral asset. The buyer (investor) has a number of mineral assets diversified by location, operator, producing formation, etc. If an unforeseen negative event affects a well or wells owned by an investor(s) as a portion of a mineral portfolio, the impact is moderated by the diversity of the portfolio as a whole. If the same unforeseen negative event impacts the well or wells of the mineral owner, it can have a much more detrimental effect.

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Permalink Reply by Mac Davis on December 1, 2009 at 11:57

Good point, Skip.

However, for a lot of small mineral owners, mineral revenues are "free money." You didn't buy the property for the mineral rights, you're not counting on them for living expenses or retirement income. You may look at is as worst case you lose nothing, best case, you win big.

There's no one answer for TVM calculations. Everyone has to evaluate their needs over time, risk tolerance, and the structure of the rest of their portfolio.

Everyone preaches diversification, but we need to remember that diversification doesn't give you higher average gains, it simply reduces volatility. Roughly speaking a diversified portfolio will be better than a non-diversified portfolio half the time, and worse half the time.

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Permalink Reply by Skip Peel - Mineral Consultant on December 1, 2009 at 12:34

Mac.

I think of minerals as a hard asset. Whether considered "found" or "free". And find that none of my clients regardless of their financial circumstance are interested in a worse case scenario. The unvarnished truth is that many mineral owners over time had become lax in performing due diligence, seeking professional counsel and making informed decisions. That fact is irrefutably brought home by the experience of the Haynesville Shale Play. There are a large number of NW. LA. mineral owners who wish they could turn back the clock and make different decisions. The greater tragedy is that many remain uninformed and subject to making the same poor decisions almost two years later. Fortunately this boom is different in that the average mineral owner can utilize the Internet to become informed. And GoHaynesvilleShale is the best resource I have found. Thank you Keith.

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Permalink Reply by Mac Davis on December 1, 2009 at 13:18

I agree, far too many mineral owners can only see the best case scenario now, and may end up sadly disappointed. I'm particularly concerned by those who are spending or counting on the money before they get it.

Just like the many mineral owners who didn't think about the best case scenario back in the early days of the play and sold out for a song.

I'll also throw in my hurrah for this site being here to help out. Thanks to Keith and all those who participate.

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Permalink Reply by ledlights on March 23, 2010 at 19:38

Mac,

(Getting a little off topic for a minute) Diversification (true non-correlated) does more than reduce volatility. Your comparison seems to assume a long time-horizon before the "investments" have to be liquidated. If and when you are forced to liquidate something in order to meet some expense, if you only have "down" investments you can lose ground that will never be made up in comparison to the diversifier who can liquidate something that is doing relatively okay and has more time for their other down investments to recover. A mineral owner with good mineral prospects who has to sell their mineral rights to meet an expense is in a somewhat similar situation where they might likely wind up way short of where they would wind up if they kept their minerals and had them developed. Good paying mineral production is not guaranteed, but in a resource play like the shale, odds can be fairly decent (though my estimatation and tolerance of risk seems to fluctuate with my level of pessimism)

As far as offers to buy minerals go, the only interest I have taken in them in the past has been as a really rough indication of what someone thinks my minerals are worth. Just off of the top of my head I have always assumed that I was being offered somewhere between 1 and 10 cents per estimated dollar's worth. So I take what I am offered, calculate the average investment gain I think I would make from it over 20 yrs (40+ for HS?) then multiply that by 10 for my projection of the minimum the buyer thinks the purchase is worth (For all I know the buyer may very well be able to make more on that money than me on other types of investment too, so maybe I am estimating low here). On offers for my mineral rights that already have production, 95%+ of the offers seem to make their valuations based solely on the current production without any mention of the potential for other depth plays that may look very promising in my mineral right's location. Am I way off with my crude estimations?

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Permalink Reply by Mac Davis on March 24, 2010 at 23:45

Re: Diversification

I think the analysis you're making about selling the winners and holding the losers makes sense on the surface, but not if you look into it in depth. I think your analysis assumes that the losing assets in a diversified portfolio will perform better in the future than the winning assets. If this assumption is correct, you could simply buy stocks that have dropped in value and sell any stocks you have if their value rises. The Efficient Market Hypothesis (EMH) says that this theory doesn't work out in the long run. I won't claim the EMH is gospel, but it's a strong force in any economic analysis.

Note that I'm not saying diversification is wrong. I'm simply saying that it doesn't necessarily pay off better. It reduces risks and it reduces gains.

Re: Estimated values

Yes, I suspect offers to buy minerals are usually based only on Haynesville Shale minerals. However, I think the probability is low that there will be another mineral formation with significant value compared to the HA formation. Even if there may be something else there, people are unlikely to plop down cash for a big unknown like that.

I wouldn't be surprised if those offering to buy minerals are only offering 10 cents on the dollar for what they estimate it will eventually pay off, even including interest/TVM/market fluctuation considerations. That's not necessarily "evil," but that doesn't mean mineral interest owners should sell for what's being offered.

I know a lot of mineral owners have unrealistically high estimates of what their minerals will be worth, too.

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Permalink Reply by John Avatar on December 1, 2009 at 20:54

Your minerals are worth what a willing buyer and you agree they're worth or what they will bring at auction on a given day. Kind of like baseball cards and beanie babies.

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Permalink Reply by s watson on December 9, 2009 at 6:27

John Avatar if you have nothing of importance to add why commint and look stupid.

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Permalink Reply by The_Baron on December 9, 2009 at 8:40

His statement is accurate. The value of minerals is a very individual thing and hard to put a number on.

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Permalink Reply by Anthony DiGennaro on March 23, 2010 at 17:08

There is quite a bit of conjecture in your post...a few people have honestly given you the only answer there really is to give..."it's only worth what someone is willing to pay for it"... however if you are interested in selling it and have a couple minutes every day to scout and do research I would suggest going to energynet.com and checking out what other properties similar to yours are selling for. That may be one of the most effective ways of valuing your own property.

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