You received an offer to buy your minerals and you are wondering, “Is this a fair offer?” And “What is the value of my mineral rights?” These are some of the most frequent questions that we get (right up there with “I received an offer to lease my minerals, please help!”).
There are several methods that can be used when valuing mineral rights.
How Mineral Rights Value is Determined
Many mineral rights owners are looking for the Mineral Rights MLS or Zillow/Trulia for minerals but unfortunately they don’t exist. The reason for this is it is very difficult for a computer algorithm to accurately value minerals and also there is a lack of readily available data on actual prices paid in arms-length mineral transactions.
Don’t worry, because there is still hope! Mineral rights can be valued several different ways. If there is a lot of activity in the area, you can use a combination of looking at comparable sales (the “Market Approach”) and having a qualified person perform a cash flow analysis (the “Income Approach”). Read further and we’ll also cover two easy rule-of-thumb approaches that you can use yourself! Be sure to also download our FREE Mineral Rights Valuation Resource Guide for 5 resources that will help you understand the value of your Mineral Rights Royalty Interests.
Click here for our FREE Mineral Rights Valuation Resource Guide.
“Market Approach” (AKA Looking at Comps)
To understand comparable sales prices, in some states like Oklahoma, you can back calculate the amount paid in a mineral transaction by looking at the Documentary Stamp fees. Check the county clerk & recorder’s website for info on how much the fee is per $10k and you can use this to come up with how much was paid based on the Documentary Stamp fee shown on the deed. Most county recorder’s websites allow you to search by the legal description (Section, Township, Range) and document type so that you can narrow down the relevant transactions in your area. The other important piece of the puzzle is understanding how many net acres were purchased to determine the Price per Net Mineral Acre (simply, the sales price divided by the number of Net Mineral Acres). The net acreage amount is not always obvious (unless it is mentioned on the deed). If it is not mentioned on the recorded deed, you may have to do a little title research to determine the net acreage.
Another source of comparable sales prices from arms-length transactions is from mineral brokers and auction websites like EnergyNet.com. Some websites require you to be an accredited investor to register. EnergyNet.com will let you view the auction results for a specified amount of time after the auction finishes.
Actual data from arms-length comparable sales represent the best and most defensible approach to determining value. This is because it relies on data from actual transactions.
If there isn’t enough data for this market approach, then the “Income Approach” can be used. You can hire an experienced geologist or engineer to do this.
The Income Approach (AKA “Cash Flow Analysis”)
The “Income Approach” refers to the calculation of future cash-flows which are discounted at a certain interest rate and then added together in order to determine the Net Present Value in today’s dollars. This is also called a “Discounted Cash Flow Analysis“. Future cash flows (royalty checks) are worth less in the future than they are today because of the time value of money. Any money you receive today can be invested and receive interest or dividends and thus would have grown over time vs. the same amount of money received in the future. Money received further out in the future will have less value than the same amount of money received today because of this. What this means is if you were to invest the lump sum of cash (the Net Present Value) at that interest rate, it would be equivalent in value of your future royalty checks over the entire life of the well(s) from today’s standpoint. The undiscounted sum of all your royalty checks over the life of that well will be higher than this lump sum value today due to this time effect on the value of money. The higher the interest rate used, the bigger the difference between these two amounts.
A qualified person can analyze nearby production from analog wells to determine likely reserves on your tract and estimate when wells would be drilled based on current activity level and available information from active operators in the area. This information along with your Net Revenue Interest based on likely spacing unit size and expected oil and gas prices over time feeds into this discounted cash flow analysis to come up with how much your minerals would be worth today if that scenario were realized. It should take an experienced person 2-4 hours to perform a high-level analysis of a property so ballpark cost to perform a cash flow analysis would be $400-$800 per tract. If you have a bunch of tracts together in the same Township, the price per tract may be lower if the same reserves estimate could be applied between the different tracts in that Township.
For non-producing minerals, you can still use the Income Approach if your minerals are in an area with a lot of activity and well understood geology. This approach is often a good fit for relatively mature unconventional / shale plays with a lot of recently drilled wells. This is because the well productivity is somewhat predictable, so you can closely approximate the future production rates from any future wells that are drilled. The discount rate range used varies and may be adjusted (up or down) based on the risk associated with the property (e.g. how much nearby production history is available, the type of property, if there are nearby environmental concerns, or infrastructure constraints in the area). For example, the Texas Comptroller of Public Accounts, Property Tax Assistance Division (PTAD) publishes the annual Property Value Study – Discount Rate Range for Oil and Gas Properties. For 2017, the PTAD published a discount rate range of 13.85 to 20.62 percent as generally suitable unless property-specific risk requires use of a discount rate outside this range.
The Income Approach is often the best method for valuing royalty interests and working interests (producing properties). That is because you can forecast future production rates from the existing wells along with known oil and gas properties (such as BTU factor), expenses, and deductions to accurately forecast future cash flows. Given the lower risk associated with these types of producing properties, a lower discount rate than that used for non-producing minerals is often used to determine the NPV.
If you have non-producing minerals in an area with little or no oil & gas activity, then using the income approach may not be as accurate as the Market Approach. In this scenario, you can sometimes approximate the value using a few rules of thumb.
The final two methods that we’ll cover are the Lease Bonus Multiple and the Cash Flow Multiple. These are two rule-of-thumb methods that are sometimes used to understand a ballpark range of value. Keep in mind that these two methods can grossly under or over value minerals so beware!
The Lease Bonus Multiple method takes the lease bonus amount being paid in your area and multiplies it by a factor of 2 or 3 to approximate the value of minerals if they were sold. This method can grossly under or over value mineral rights. The value you come up with depends entirely on the lease bonus you use so it can be off by an order of magnitude if you are not careful. The results using this method do not correlate at all with reserves potential or timing of when wells might be drilled. In area with a lot of interest but relatively unexplored, it could significantly over-value minerals if nearby wells don’t come in as good as expected or if wells are not drilled for many years.
The Cash Flow Multiple method takes the amount of recent royalty checks and multiplies it by a multiple of between 50 and 70 to determine total value. This methodology may have been used originally to approximate value of royalties in mature fields where there was no expectation of future development and where well declines were well understood. This method doesn’t consider any un-developed acreage you may have and as such gives little or no value to non-producing properties. This method can be a bit more accurate than the lease bonus multiple method in determining the low end of the fair market value for a fully developed tract in a stable commodity price environment but it depends entirely on the multiple you use and if it is consistent with actual sales in your area. Again, this method should only be used as a rough approximation at best.
Valuing Mineral Rights
At the end of the day, it pays to do your homework to determine the value of mineral rights that you own. This is especially important if you are considering selling some or all your minerals or royalty interests. In most current unconventional plays a combination of the Market Approach and Cash Flow Approach will allow you to determine the Value of Mineral Rights that you own and if any offers you receive are reasonable. Being armed with this information, you can make an informed decision whether to hold or sell your mineral interest.
Please let me know if this information was useful and if we can be of help in performing a Cash Flow analysis to help you better understand the likely fair market value of your mineral rights or royalty interests.
Free Resource Guide
Want to find out more information on how to value mineral rights and royalty interests?
Click here for our FREE Mineral Rights Valuation Resource Guide.