Valuing Your Mineral Rights
I'm a commercial appraiser and have valued hundreds of office buildings, apartments, retail centers, warehouses, hotels, and a few others kinds of properties based on their income streams. When I signed my leased two years ago for gas drilling on my land in southeast DeSoto Parish, I whipped out Excel and began setting up a cash flow analysis spreadsheet.
Over the months, as I learned more and more about the drilling process from some wonderfully helpful and patient people here like Les B. and Skip Peel, I would refine and refine my spreadsheet, reviewing variables, estimates, and projections on everything from gas prices to decline rates.
A couple of months ago, I gave up.
Unlike almost all other commercial real estate, I finally realized there's absolutely nothing predictable about mineral land income. Some commercial properties have long-term leases locked in place, making income forecasts about as challenging as turning on a light switch. And even with empty building, a competent appraiser can make reasonable projections of future lease rates and occupancy levels.
But no one, not even the operators, know the pace at which gas will be extracted from the ground. The choke on the first well and drilling of all subsequent wells are set according to the operator's internal financial needs and the state of the national energy macro-economy. A full-throttle well may be forecast to decline, say, by 85% in it's second year, but there seems to be little likelihood that most wells will be full throttle.
So, if one can't make a valuation based on income, how else can mineral rights be valued? Just like homes or raw land, neither of which produce income. You do your best to find out what comparable properties (or comparable mineral rights) have recently sold for, and make an average.....
Over the months, as I learned more and more about the drilling process from some wonderfully helpful and patient people here like Les B. and Skip Peel, I would refine and refine my spreadsheet, reviewing variables, estimates, and projections on everything from gas prices to decline rates.
A couple of months ago, I gave up.
Unlike almost all other commercial real estate, I finally realized there's absolutely nothing predictable about mineral land income. Some commercial properties have long-term leases locked in place, making income forecasts about as challenging as turning on a light switch. And even with empty building, a competent appraiser can make reasonable projections of future lease rates and occupancy levels.
But no one, not even the operators, know the pace at which gas will be extracted from the ground. The choke on the first well and drilling of all subsequent wells are set according to the operator's internal financial needs and the state of the national energy macro-economy. A full-throttle well may be forecast to decline, say, by 85% in it's second year, but there seems to be little likelihood that most wells will be full throttle.
So, if one can't make a valuation based on income, how else can mineral rights be valued? Just like homes or raw land, neither of which produce income. You do your best to find out what comparable properties (or comparable mineral rights) have recently sold for, and make an average.....
Tags: Income, Leases, Mineral, Rights, Valuation
Views: 187
Replies to This Discussion
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Permalink Reply by Gingerbread Latte (N7)(T9N-R10W) on
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I think when you have so many players with their own agenda it might be impossible. The only thing I've gathered from friends and reading here is to not expect any long-term "I'm-gonna-retire-on-this" type income like you can will oil.
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Permalink Reply by ALongview on
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Does anyone know how shale royalty is being valued when sold? I have heard 3-5 yrs. of 6 month average royalty in the past. Is that accurate in the shale? Would this formula change to a buyer if multiple formations like the Haynesville and the Mid-Bossier are present?
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Permalink Reply by BirdDawg, plain ole' idiot on
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David
This is a very interesting post.
The answer to your question, oh it is so elusive.
There are many ways to value minerals, and none are conclusive or accurate.
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Permalink Reply by Crunchy on
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I always was told that something is only worth what someone is willing to pay for it. Not sure about the shale though.
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Permalink Reply by David Smith on
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that's true, but you'd have to talk to a lot of buyers to find out what they're really willing to pay
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Permalink Reply by Les Bamburg on -
David, I think all someone can do is to run a bunch of different scenarios to obtain a range of net present values for a particular section/unit. I think the most significant variable is the timing for wells 2 thru 7 (2 thru 15 for "double" shale properties). Only EOG has really shown their hand for their development plan for a single unit but then when will they develop a specific unit (one year, five years, ten years from today???). That would have a huge impact on NPV.
Natural gas price is the second biggest factor but the range of uncertainty is less in my opinion as it should be somewhat bounded over the next 10 years. After that the upside in price could be significant dependent upon actions by Congress on climate change.
And yes - well decline rates are a challenge. Although, I think the new restricted choke approach for some operators (Petrohawk, Questar, etc) may not impact NPV to a significant degree.
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Permalink Reply by David Smith on
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Les, Would you mind explaining what you mean by "the new restricted choke approach," and why only some operators are using it? I had thought an operator could alter the choke any time and as many times as he wanted.
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Permalink Reply by Les Bamburg on
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David, the restricted choke approach involves producing the well on a much smaller choke size initially (~ 14/64") in order to have a very low decline rate for the 1st year of production.
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Permalink Reply by David Smith on
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Les, Are chokes easy to manipulate, or once set are they difficult to change? I had always imagined a choke being something like a home a/c thermostat whose setting the operator can move about at will.
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Permalink Reply by Spring Branch,mineral owner on
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David, they are very easy to manipulate. Your assumption is correct.
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Permalink Reply by David Smith on
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Henry,
Income property sells for less today than a few years ago because rents and rent projections have fallen and vacancies have risen. For most income properties, the income approach, based on the future income stream, is far and away the most reliable method of valuation.
Why do you say some operators will drill more wells than others in the short term?
Royalty income pays 41% marginal taxes. Royalty sales only 21% (at least in 2010).
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